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Does Corporate Investment Respond to the Time-Varying Cost of Capital? Empirical Evidence

Published online by Cambridge University Press:  21 December 2020

Yongjin Kim Open the ORCID record for Yongjin Kim [Opens in a new window]
Yongjin Kim*
Affiliation:
City University of Hong Kong
*
[email protected]
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Abstract

I examine whether the time-varying cost of capital is considered in firms’ capital budgeting decisions. For this test, I measure the conditional cost of equity using individual equity option prices. I find that corporate investment responds negatively to fluctuations in the option-implied cost of equity and the weighted average costs of capital. Furthermore, through decomposing marginal $ q $, I reveal that the cost-of-capital elasticity of empirical investment is almost identical to its productivity elasticity, as theory predicts. These findings suggest that firms’ discount rates are updated accurately in practice despite the failure of conventional frameworks, such as factor-based models, in this regard.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 2 , March 2022 , pp. 629 - 668
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

I am particularly grateful to my dissertation advisor Bryan Routledge, Jarrad Harford (the editor), and the anonymous referee for helpful comments. I also thank Peter Feldhutter, Brent Glover, Richard Green, Hope Hyeun Han, Stephen Karolyi, Lars-Alexander Kuehn, Kai Li, Tao Li, Justin Nguyen, Jianfeng Yu, and seminar participants at the 2014 Financial Research Association Meeting, the City University of Hong Kong, Peking University, Korea Advanced Institute of Science and Technology (KAIST), the 2017 Hong Kong-Shenzhen Summer Finance Conference, the 2019 Asian Financial Association meeting, and the 2019 Conference on Asia-Pacific Financial Markets.

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