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Types of investor uncertainty and the cost of equity capital
Author(s) -
Larson Chad R.,
Resutek Robert J.
Publication year - 2017
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/jbfa.12283
Subject(s) - cash flow , equity (law) , accrual , econometrics , economics , equity capital , cost of capital , cost of equity , stock (firearms) , financial economics , actuarial science , microeconomics , accounting , capital market , finance , earnings , incentive , mechanical engineering , political science , law , engineering
We jointly test the effects of two types of investor uncertainty, one related to future firm performance and unrelated to accruals (cash flow uncertainty) and one directly related to accrual estimation errors (accounting quality uncertainty). Distinct from prior studies, our uncertainty estimates are based on a matched‐firm design that minimizes the mechanical relationship between the two uncertainty variables. We find a strong negative relationship between cash flow uncertainty and multiple estimates of the cost of equity capital. With respect to accounting quality uncertainty, we find a strong positive association with both expected stock returns and implied costs of equity, but only in settings that control for cash flow uncertainty. Collectively, our results suggest the need to consider different types of investor uncertainty when examining how investor uncertainty affects the cost of equity capital.