Analysts' estimates of the cost of equity capital

Balakrishnan, K, Shivakumar, L and Taori, P (2020) Analysts' estimates of the cost of equity capital. Journal of Accounting and Economics. ISSN 0165-4101 (In Press)

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.

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Item Type: Article
Subject Areas: Accounting
Additional Information:

© 2020 Elsevier. This manuscript version is made available under the Creative Commons CC-BY-NC-ND 4.0 licence

Date Deposited: 03 Nov 2020 15:15
Date of first compliant deposit: 24 Nov 2020
Subjects: E > Equity capital
E > Estimation
Last Modified: 04 Mar 2021 22:11
URI: https://lbsresearch.london.edu/id/eprint/1523
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