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The Cost of Equity: Evidence from Investment Banking Valuations

Published online by Cambridge University Press:  07 April 2025

Gregory W. Eaton Open the ORCID record for Gregory W. Eaton [Opens in a new window] ,
Feng Guo ,
Tingting Liu  and
Danni Tu
Gregory W. Eaton
Affiliation:
University of Georgia geaton@uga.edu
Feng Guo
Affiliation:
Iowa State University fengguo@iastate.edu
Tingting Liu*
Affiliation:
University of Tennessee
Danni Tu
Affiliation:
Southern Illinois University Carbondale danni.tu@siu.edu
*
tliu22@utk.edu (corresponding author)
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Abstract

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Using manually compiled cost of equity (COE) estimates disclosed in takeover regulatory filings, we provide novel evidence on how investment bankers estimate discount rates. COE estimates are related to several risk proxies, such as beta and size. Other firm characteristics are unrelated to COE estimates or provide relations contradicting academic evidence. We also explore the role of incentives. For example, banks use significantly higher COEs in management buyouts, which potentially underestimates target value, making the bid more attractive for target shareholder approval.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 60 , Issue 7 , November 2025 , pp. 3228 - 3266
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2025. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We are grateful for the helpful comments and suggestions from Ran Duchin (the editor), an anonymous referee, Ginka Borisova, James Brown, David Denis, John Graham, Tyler Jensen, Paul Koch, Brian Roseman, Shu Yan, Dexin Zhou, and seminar participants at Iowa State University and Oklahoma State University. All errors are our own.

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