Corporate Life Cycle and Cost of Equity Capital

Abstract

This paper investigates the impact of the corporate life cycle on the cost of equity capital. Using a sample of Australian firms during the years 1990–2012, we find that the proxies for the cost of equity capital vary across the life cycle of the firm. In particular, we find that the cost of equity declines as the earned/contributed capital mix (a proxy for the firm life cycle) increases, after controlling for other relevant firm characteristics and unobserved heterogeneity. Moreover, when different stages of the firm life cycle are taken into account, we find that the cost of equity is higher in the introduction and decline stages and lower in the growth and mature stages, resembling a ‘U’ shaped pattern. These findings are robust when subjected to a series of sensitivity tests. Collectively, the results are consistent with the notion that firms in the introduction (or decline) stages are more risky in the sense that their resource base, competitive advantages and capabilities are limited (concentrated), while those in the growth and mature stages are relatively less risky due to the richness and diversity of their resource base, competitive advantages and capability. Hence, the market demands a higher risk premium for the former than for the latter.

Keywords: Cost of equity; Firm life cycle; Earned equity; Contributed capital

JEL Classification: D21, G12, G30, L22