Understanding the Effects of Alternative Cost-of-Equity Proxies on Corporate Investment and Financing
49 Pages Posted: 7 May 2019 Last revised: 30 Aug 2019
Date Written: August 24, 2019
Previous research shows that the implied cost of capital (factor model-based estimates for the cost of equity) have a negative (positive) effect on investment. Our paper documents that these alternative cost-of-equity proxies also have opposite effects on external financing activities. We show that the ICC has negative effects on investment and external financing by capturing the firm-specific discount rate news, whereas the factor model-based proxies has positive effects on these decisions by capturing the cash flow news. Furthermore, the negative effects of the ICC are more pronounced for firms with high private information and equity dependence, whereas the positive effects of the factor model-based estimates are more pronounced for firms with low private information and equity dependence. Thus, the opposite effects of the cost-of-equity proxies can be explained by their distinctive information contents.
Keywords: Implied Cost of Capital, Cash Flow News, Discount Rate News
JEL Classification: G31, G32
Suggested Citation: Suggested Citation