International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter?

Posted: 17 Jan 2006 Last revised: 20 Nov 2011

Luzi Hail

University of Pennsylvania - The Wharton School

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network

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Abstract

This paper examines international differences in firms' cost of equity capital across 40 countries. We analyze whether the effectiveness of a country's legal institutions and securities regulation is systematically related to cross-country differences in the cost of equity capital. We employ several models to estimate firms' implied or ex ante cost of capital. Our results support the conclusion that firms from countries with more extensive disclosure requirements, stronger securities regulation and stricter enforcement mechanisms have a significantly lower cost of capital. We perform extensive sensitivity analyses to assess the potentially confounding influence of countries' long-run growth differences on our results. We also show that, consistent with theory, the cost of capital effects of strong legal institutions become substantially smaller and, in many cases, statistically insignificant as capital markets become globally more integrated.

Keywords: Cost of equity, Disclosure regulation, Law and finance, International finance, Country risk, Legal system

JEL Classification: G14, G14, G15, G38, K22, M41, M45, M47

Suggested Citation

Hail, Luzi and Leuz, Christian, International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter?. Journal of Accounting Research, Vol. 44, No. 3, pp. 485-531, 2006. Available at SSRN: https://ssrn.com/abstract=875016

Luzi Hail

University of Pennsylvania - The Wharton School ( email )

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Christian Leuz (Contact Author)

University of Chicago - Booth School of Business ( email )

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HOME PAGE: http://faculty.chicagobooth.edu/christian.leuz/

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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HOME PAGE: http://www.nber.org

European Corporate Governance Institute (ECGI)

Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

University of Pennsylvania - Wharton Financial Institutions Center

3641 Locust Walk
Philadelphia, PA 19104-6218
United States

CESifo Research Network

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Munich, DE-81679
Germany

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