The Absence of a Size Effect Relevant to the Cost of Equity

Business Valuation Review, Vol. 37, Issue 3, 87-92.

Posted: 13 Jun 2017 Last revised: 1 Dec 2018

Date Written: February 12, 2018

Abstract

In this paper, I evaluate whether there is a size effect that is relevant to the cost of equity. I first analyze what model investors use to determine the required rate of return on their investment and find investors prefer the Capital Asset Pricing Model (CAPM) over other models, even those that include a size proxy. I also show that over the period 1981 to 2016, small stocks underperformed large stocks, which is inconsistent with the existence of a size effect. Finally, I conclude that size effect studies have not been able to surmount the criticisms that the size effect lacks a theoretical basis and that the results of size effect studies are susceptible to data mining criticisms. Given these results, practitioners should reconsider the standard practice of augmenting their cost of equity with a size premium.

Keywords: size effect, CAPM, cost of capital

Suggested Citation

Ang, Clifford S., The Absence of a Size Effect Relevant to the Cost of Equity (February 12, 2018). Business Valuation Review, Vol. 37, Issue 3, 87-92.. Available at SSRN: https://ssrn.com/abstract=2984599 or http://dx.doi.org/10.2139/ssrn.2984599

Clifford S. Ang (Contact Author)

Compass Lexecon ( email )

1111 Broadway
Suite 1500
Oakland, CA 94607
United States
510-285-1285 (Phone)

HOME PAGE: http://www.compasslexecon.com

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