IDEAS home Printed from https://ideas.repec.org/a/eee/bracre/v55y2023i6s0890838923000616.html
   My bibliography  Save this article

Validating implied cost of capital with realized returns by using alternative measures of cash-flow news

Author

Listed:
  • Ketterer, Simeon
  • Dionysiou, Dionysia
  • Eierle, Brigitte
  • Tsalavoutas, Ioannis

Abstract

We outline analytically that, when testing different implied cost of capital (ICC) estimates for validation by employing the Vuolteenaho (2002) framework, the cash-flow news in the validation framework should be defined in a way that considers the ICC model specific assumed sequence of future cash flows. This is based on market expectations, as proxied by analysts' forecasts. We then propose adjusting the cash-flow news proxies accordingly and implement these adjustments empirically. Consistent with the theoretical predications, the results from these tests show that ICC estimates are significantly positively related to realized returns. Informed by these findings, we employ the adjusted cash-flow news proxies in the validation framework and compare the correlation between adjusted and unadjusted for analysts' bias ICC estimates with realized returns. These tests show no difference in these correlations. This suggests that it is not the analysts' bias that weakens the validity of ICC estimates, as argued by prior literature. It is the proxies used in the validation framework that lead to the suggestion in removing analysts’ optimism from ICC estimates. Overall, our proposed alternative framework not only unlocks the gate for extensive use of the existing ICC estimates but also enables future researchers to develop more reliable and meaningful ICC estimates.

Suggested Citation

  • Ketterer, Simeon & Dionysiou, Dionysia & Eierle, Brigitte & Tsalavoutas, Ioannis, 2023. "Validating implied cost of capital with realized returns by using alternative measures of cash-flow news," The British Accounting Review, Elsevier, vol. 55(6).
    • Handle: RePEc:eee:bracre:v:55:y:2023:i:6:s0890838923000616
    DOI: 10.1016/j.bar.2023.101220
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0890838923000616
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.bar.2023.101220?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    More about this item

    Keywords

    Expected returns; Realized returns; Cash-flow news; Implied cost of capital; ICC;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:bracre:v:55:y:2023:i:6:s0890838923000616. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: https://www.journals.elsevier.com/the-british-accounting-review .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.