Investment Efficiency and Beta Estimation

Abstract

Survey evidence suggests most firms use the CAPM to estimate their cost of equity. Previous research has documented these estimates can be extremely imprecise. We study the impact of the precision of beta estimates on firm investment decisions, and find that firms with precise beta estimates invest closer to their optimal levels. Using the decimalization of stock prices as an exogenous shock to the precision of beta estimates, we find evidence that supports a causal link between Beta Precision and firm investment efficiency. We employ quantile regressions to further examine the relationship between Beta Precision and investment levels and find that firms with more precise betas tend to avoid extremes in investment levels.

Keywords: Beta, Cost of Equity, firm investment