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Financial Performance as a Determinant of The Cost of Capital: An Empirical Study on Listed Companies in India

Author

Listed:
  • Naseem Ahamed

    (Faculty of Finance and Accounting, ICFAI Business School, Hyderabad, ICFAI Foundation for Higher Education University, India.)

  • Nitya Nand Tripathi

    (Faculty of Finance and Accounting, ICFAI Business School, Hyderabad, ICFAI Foundation for Higher Education University, India.)

Abstract

Research Question: The purpose of this study is to examine the relationship between financial performance and the cost of capital of firms. Motivation: Access to inexpensive capital is a great enabler for firms especially during periods of uncertainty. The cost of capital reflects the investor’s attitude towards risk. The McKinsey Quarterly (in the December 2008) edition, found that the long-term price of risk has increased over time. This motivated us to examine the impact of firms performance on its cost of capital. Idea: The premise forming the bedrock of this study is that access to inexpensive capital would help a firm undertake multiple projects that would otherwise have not been financially feasible. Data: This study takes all non-financial companies listed on the National Stock Exchange (NSE hereafter) of India from 2004 to 2020 from the Prowess database containing more than 12,369 firm-year data points. Method/Tools: Multivariate panel regression model is used for analysis using firm and year fixed effects. We used financial data, board profile and dummies for sector and affiliation of firms. Findings: We found an inverse relationship between asset and cost of capital. This implies the corporate landscape of India is dominated by business groups and they are better placed to raise inexpensive capital than their standalone counterparts. Firms with a high dividend pay-out ratio also enjoy a lower cost of capital. Better corporate governance mechanisms such as board independence help lower the cost of capital. The results are particularly important for policymakers of emerging economies like India. Making policy decisions that would encourage wider retail investors’ participation in markets would go a long way in expanding the available capital pool for commercial enterprises. Contributions: One of the primary contributions of this study is the examination of the relationship between firm performance and cost of capital in the context of an emerging economy that is characterized by the predominance of business groups, concentrated ownership and institutional voids.

Suggested Citation

  • Naseem Ahamed & Nitya Nand Tripathi, 2023. "Financial Performance as a Determinant of The Cost of Capital: An Empirical Study on Listed Companies in India," Capital Markets Review, Malaysian Finance Association, vol. 31(2), pages 69-87.
    • Handle: RePEc:mfa:journl:v:31:y:2023:i:2:p:69-87
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Cost of capital; firm performance; emerging economy.;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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