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Analysts’ estimates of the cost of equity capital

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  • Balakrishnan, Karthik
  • Shivakumar, Lakshmanan
  • Taori, Peeyush

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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  • Balakrishnan, Karthik & Shivakumar, Lakshmanan & Taori, Peeyush, 2021. "Analysts’ estimates of the cost of equity capital," Journal of Accounting and Economics, Elsevier, vol. 71(2).
    • Handle: RePEc:eee:jaecon:v:71:y:2021:i:2:s0165410120300690
    DOI: 10.1016/j.jacceco.2020.101367
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    More about this item

    Keywords

    Analysts; Cost of equity; Expected stock returns; Implied cost of equity capital;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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