Analysts’ Estimates of the Cost of Equity Capital

67 Pages Posted: 9 Jan 2021

See all articles by Karthik Balakrishnan

Karthik Balakrishnan

Rice University - Jesse H. Jones Graduate School of Business

Lakshmanan Shivakumar

London Business School

Peeyush Taori

London Business School

Multiple version iconThere are 2 versions of this paper

Date Written: October 30, 2020

Abstract

We explore a large sample of analysts’ estimates of the cost of equity capital (CoE) to evaluate their usefulness as expected return proxies (ERP). We find that the CoE estimates are significantly related to a firm’s beta, size, book-to-market ratio, leverage, and idiosyncratic volatility but not other risk proxies. Even after controlling for the popular return predictors, the CoE estimates incrementally predict future stock returns. This predictive ability is better explained as the CoE estimates containing ERP information rather than reflecting stock mispricing. When evaluated against traditional ERPs, including the implied costs of capital, the CoE estimates are found to be the least noisy. Finally, we document CoE responses around earnings announcements, demonstrating their usefulness to study discount-rate reactions of market participants. We conclude that analysts’ CoE estimates are meaningful ERPs that can be fruitfully employed in a variety of asset pricing contexts.

Keywords: analysts, cost of equity, expected stock returns, implied cost of equity capital

JEL Classification: G14, G24, G29, G32

Suggested Citation

Balakrishnan, Karthik and Shivakumar, Lakshmanan and Taori, Peeyush, Analysts’ Estimates of the Cost of Equity Capital (October 30, 2020). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3724862 or http://dx.doi.org/10.2139/ssrn.3724862

Karthik Balakrishnan

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

Lakshmanan Shivakumar (Contact Author)

London Business School ( email )

Regent's Park
London, NW1 4SA
United Kingdom
+44 20 7000 8115 (Phone)
+44 20 7000 8101 (Fax)

HOME PAGE: http://faculty.london.edu/lshivakumar/

Peeyush Taori

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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