Understanding the Information Content of Alternative Cost-of-Equity Proxies
49 Pages Posted: 7 May 2019 Last revised: 7 May 2021
Date Written: May 6, 2021
We examine why the implied cost of capital (ICC) and factor model-based proxies (FMPs) of the cost of equity show opposite association with corporate investment. We find that ICCs are negatively associated with corporate investment by capturing the discount rate news. Such a relationship is pronounced in firms with high private information and external finance dependence. By contrast, FMPs are positively associated with corporate investment by capturing cash flow news, and such a relationship is pronounced in firms with low private information and external finance dependence. Our findings suggest that ICCs and FMPs contain distinctive information content for capital budgeting decisions in different sets of firms.
Keywords: cost of equity; corporate investment; return decomposition
JEL Classification: G31, G32
Suggested Citation: Suggested Citation