Does Corporate Investment Respond to the Time-Varying Cost of Capital? Empirical Evidence

Journal of Financial and Quantitative Analysis

63 Pages Posted: 26 Sep 2017 Last revised: 28 Aug 2020

See all articles by Yongjin Kim

Yongjin Kim

City University of Hong Kong

Date Written: August 27, 2020

Abstract

I examine whether the time-varying cost of capital is considered in firms' capital budgeting decisions. For this test, I measure the conditional cost of equity, using individual equity option prices. I find that corporate investment responds negatively to fluctuations in the option-implied cost of equity and the weighted average costs of capital. Furthermore, through decomposing marginal $q$, I reveal that the cost-of-capital elasticity of empirical investment is almost identical to its productivity elasticity, as theory predicts. These findings suggest that firms' discount rates are updated accurately in practice despite the failure of conventional frameworks, such as factor-based models, in this regard.

Keywords: Capital investment, Time-varying cost of capital, Option-implied cost of equity, Investment elasticity

JEL Classification: G12, G31, E3

Suggested Citation

Kim, Yongjin, Does Corporate Investment Respond to the Time-Varying Cost of Capital? Empirical Evidence (August 27, 2020). Journal of Financial and Quantitative Analysis, Available at SSRN: https://ssrn.com/abstract=3042471 or http://dx.doi.org/10.2139/ssrn.3042471

Yongjin Kim (Contact Author)

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon Tong
Hong Kong

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