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Determinants of cost of equity: The case of Shariah-compliant Malaysian firms

Listed author(s):
  • Shafaai, Shafizal
  • Masih, Mansur

Firm-level analysis of the cost of equity is essential for many financial decision makings, capital structure choice, capital budgeting analysis, performance assessment and firm valuation. This study aims to shed some light on the determinants of cost of equity by analyzing Shariah compliant firms based in Malaysia. A list of potential determinants is identified and is divided into accounting-based and market-based variables. Pooled, fixed-effect, random-effect, and dynamic difference- and system-GMM panel models were employed to investigate determinants of cost of equity. The results show that for the full sample, the cost of equity is determined by debt-to-equity ratio (DE), earnings per share (EPS), total asset turnover ratio (TAT), firm size (SIZE) and stock liquidity (SL). Consistent with the literature, a significant positive relationship with cost of equity was found for DE and EPS, while a negative relationship with TAT and SIZE was exhibited. The study is also extended to seven subsectors, namely construction, consumer products, industrial products, plantation, properties, technology and services, to observe the sectoral effects on the cost of equity determinants. For the individual sectors, SIZE is significant for most of the sectors and is consistently negatively related to cost of equity. The results for other variables show that the determinants differ across different sectors, highlighting the importance of sectoral analysis. Firm based implication includes assisting firms to review their cost of equity estimates and optimizing capital allocation, while the government could fine-tune its policies based on the sectoral effects on the cost of equity determinants.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 62364.

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Date of creation: 16 Aug 2013
Handle: RePEc:pra:mprapa:62364
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  1. Rashid Ameer, 2007. "Time-varying Cost of Equity Capital in Southeast Asian Countries," Asian Economic Journal, East Asian Economic Association, vol. 21(2), pages 207-238, 06.
  2. James S. Ang & Rebel A. Cole & James Wuh Lin, 2000. "Agency Costs and Ownership Structure," Journal of Finance, American Finance Association, vol. 55(1), pages 81-106, 02.
  3. Jacoby, Gady & Fowler, David J. & Gottesman, Aron A., 2000. "The capital asset pricing model and the liquidity effect: A theoretical approach," Journal of Financial Markets, Elsevier, vol. 3(1), pages 69-81, February.
  4. Shanken, Jay & Weinstein, Mark I., 2006. "Economic forces and the stock market revisited," Journal of Empirical Finance, Elsevier, vol. 13(2), pages 129-144, March.
  5. Jianguo Chen & Dar-Hsin Chen, 2004. "The Downside Risk and Equity Evaluation: Emerging Market Evidence," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 3(1), pages 77-93, January.
  6. Roll, Richard, 1992. " Industrial Structure and the Comparative Behavior of International Stock Market Indices," Journal of Finance, American Finance Association, vol. 47(1), pages 3-41, March.
  7. Mishra, Dev R & O'Brien, Thomas J, 2001. "A Comparison of Cost of Equity Estimates of Local and Global CAPMs," The Financial Review, Eastern Finance Association, vol. 36(4), pages 27-47, November.
  8. Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
  9. Levin, Andrew & Lin, Chien-Fu & James Chu, Chia-Shang, 2002. "Unit root tests in panel data: asymptotic and finite-sample properties," Journal of Econometrics, Elsevier, vol. 108(1), pages 1-24, May.
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