The Weighted Average Cost of Capital Over the Life-Cycle of the Firm: Is the Overinvestment Problem of Mature Firms Intensified by a Higher WACC?

26 Pages Posted: 25 Nov 2015 Last revised: 20 Jan 2016

See all articles by Carlos Garcia

Carlos Garcia

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF)

Jimmy Saravia

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF)

David Yepes

Universidad EAFIT

Date Written: January 18, 2016

Abstract

Firm lifecycle theory predicts that the Weighted Average Cost of Capital (WACC) will tend to fall over the lifecycle of the firm (Mueller, 2003, p. 80-81). However, given that previous research finds that corporate governance deteriorates as firms get older (Mueller and Yun, 1998; Saravia, 2014) there is good reason to suspect that the opposite could be the case, that is, that the WACC is higher for older firms. Since our literature review indicates that no direct tests to clarify this question have been carried out up till now, this paper aims to fill the gap by testing this prediction empirically. Our findings support the proposition that the WACC of younger firms is higher than that of mature firms. Thus, we find that the mature firm overinvestment problem is not intensified by a higher cost of capital, on the contrary, our results suggest that mature firms manage to invest in negative net present value projects even though they have access to cheaper capital. This finding sheds new light on the magnitude of the corporate governance problems found in mature firms.

Keywords: WACC, firm lifecycle, corporate governance, overinvestment

JEL Classification: D23, G12, G30, G31, G34

Suggested Citation

Garcia, Carlos and Saravia, Jimmy and Yepes, David, The Weighted Average Cost of Capital Over the Life-Cycle of the Firm: Is the Overinvestment Problem of Mature Firms Intensified by a Higher WACC? (January 18, 2016). Center for Research in Economics and Finance (CIEF), Working Papers, No. 15-21, Available at SSRN: https://ssrn.com/abstract=2695102 or http://dx.doi.org/10.2139/ssrn.2695102

Carlos Garcia (Contact Author)

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF) ( email )

Carrera 49 No. 7 South - 50
Bogotá
Colombia

Jimmy Saravia

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF) ( email )

Carrera 49 No. 7 South - 50
Bogotá
Colombia

David Yepes

Universidad EAFIT ( email )

Carrrera 49 #7sur-50
Medellin, Antioquia 0
Colombia
3113193659 (Phone)
050022 (Fax)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
478
Abstract Views
2,288
Rank
108,170
PlumX Metrics