Equity Factors and Firms’ Perceived Cost of Capital
49 Pages Posted: 11 Dec 2020 Last revised: 27 Apr 2021
Date Written: October 15, 2020
Using data from a decade of surveys of corporate managers, I document that firms with higher expected stock returns have a higher perceived cost of equity and use higher discount rates in capital budgeting. This result holds both when measuring expected returns using analyst forecasts and exposure to equity risk factors. In particular, exposure to the market, size, and value factors from Fama and French (1993) explains as much as 40% of the variation in perceived cost of equity with implied risk premia close to those observed in financial markets. The three factors also explain 26% of the variation in the hurdle rates used in capital budgeting and 18% of the variation in hurdle premia. The results lend support to the hypothesis that pricing in financial markets influence corporate discount rates and thereby corporate investment.
JEL Classification: G1, G10, G12, G31, G32, G40
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