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Review of Quantitative Finance and Accounting

Erschienen in:

13.03.2021 | Original Research

The application of proxy methods for estimating the cost of equity for unlisted companies: evidence from listed firms

verfasst von: Julio Sarmiento, Mehdi Sadeghi, Juan S. Sandoval, Edgardo Cayon

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 3/2021

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Abstract

The Campbell and Vuolteenaho (Am Econ Rev 94(5):1249–1275, 2004) two–beta model decomposes the systematic risk in the sensitivity of cash flow and discount rate change. We employed this model, which we call the Two Beta Decomposition Model (TBDM) and found that this model is useful to compute the cost of capital for unlisted companies (UCs) via a proxy from listed companies. This model includes not only the accounting return reaction to long-term changes in consumption, but also links fundamental reactions to temporal changes in risk aversion. We test this model along with three traditional alternatives that are potentially useful in computing the cost of equity for UCs: accounting betas (AB), unlevered betas (UB), and operational betas (OB). Our results show that AB, UB and TBDM can partially explain the cross-sectional variations of stock returns. Additionally, using a series of non-parametric ranking test along with several statistics of goodness of fit, we found that the TBDM is the model that produces the best fit among competing models followed by the UB which is currently the most used among proxy methods.

Vorheriger Artikel Who’s behind the wheel? The role of social and media news in driving the stock–bond correlation

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Note that the model is set to allow an ex-post analysis since future shocks are not observable. This change implies the usual bias of ex-post models (Brown and Walter 2013).

Income Statement information in thousands.

The null hypothesis that the mean of our sample is equal to 15.5% was rejected for the t-test and the Wilcoxon signed rank test even with a statistical significance of 10%.

In Sect. 4, we provide a detailed explanation regarding how the variables in panel B are estimated.

The outputs of the Shapiro–Wilk normality test are presented in Table 7.

Most annual financial statements are released from February to March. Therefore, April market prices should reflect the accounting information of the preceding year.

For Campbell et al. (2010), K = 5 and for annual data\(\rho = 0.95\). For monthly data\(\rho = 0.95^{1/12}\), see Khan (2008).

P/E ratio has been made available by Professor Shiller at his web page.

Although the formal definition of \(\hat{\beta }_{i}^{u}\) uses the market value of debt rather than its book value, previous studies have shown that this is not likely to affect our results (Bowman 1980; Mulford 1985).

The discussion regarding the theoretical implications of including taxes in the unlevered betas is still an open question. However, Sarmiento-Sabogal and Sadeghi (2014) find that models including this factor outperform those that omit it.

Available by Professor French at his web page.

We require at least three observations for each risk class to compute\(\overline{b}_{y}^{u}\), which do not present cases.

See, for example, brki and Wahlen (2003), Cohen et al. (2003), Nekrasov and Shroff (2009), Cohen et al. (2009), and Campbell et al. (2010).

Note that AB definition in OB context is similar but not equal to the one we use in Eq. (9).

Note that the complete setting of OB assumes that accounting earnings are a good proxy of market return. For example, Eq. (5), in Mandelker and Rhee (1984) study, implicitly makes this assumption.

See, for example, Mandelker and Rhee (1984), Chung (1989), and Schlueter and Sievers (2014).

Since we work with excess returns and the price of any risk should be positive.

In the appendix section we present the results running OLS regressions with standard errors in Table 8 and reports the output of MacKinnon–White heteroskedasticity-consistent standard errors estimators in small samples in Table 9. In general, the results seem to be not sensitive to the selection of the standard errors estimators for all the models. Also, in Table 8 we present the Breusch–Pagan/Cook–Weisberg test for the homoscedasticity of the residuals.

The estimations are presented in Table 10 of the “Appendix” section.

See Table 11 in “Appendix” section.

In the “Appendix” section, we present the estimation for 20 value-weighted portfolios of BE/E in Table 12.

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Titel: The application of proxy methods for estimating the cost of equity for unlisted companies: evidence from listed firms
verfasst von: Julio Sarmiento
Mehdi Sadeghi
Juan S. Sandoval
Edgardo Cayon
Publikationsdatum: 13.03.2021
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 3/2021
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-021-00968-3

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