Analysts’ estimates of the cost of equity capital
Journal
Journal of Accounting and Economics
Subject
Accounting
Publishing details
Authors / Editors
Balakrishnan K;Shivakumar L;Taori P
Biographies
Publication Year
2021
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.
Keywords
Analysts; Cost of equity; Expected stock returns; Implied cost of equity capital
Available on ECCH
No