The cost of equity for large non-financial companies in the euro area: an estimation over the last decade

Clément Mazet-Sonilhac () and Jean-Stéphane Mésonnier

Quarterly selection of articles - Bulletin de la Banque de France, 2016, issue 44, 28-39

Abstract: The cost of equity (CoE) borne by a company is a significant component of its overall cost of financing, which influences a firm’s ability to invest, notably in innovative projects with more uncertain, longer-term returns. Theoretically, the CoE is equal to the return expected by an investor to buy a share in the company as compensation for the risk incurred. It cannot be observed directly but may be estimated by applying an equity valuation model to the company’s stockmarket data. This article proposes an estimation of the average CoE for large listed companies in the four largest euro area countries over the 2006-16 period. We find that average CoE rose sharply during the 2008-09 financial crisis and again during the euro area sovereign debt crisis in 2011-12. It declined in nominal terms thereafter, falling below 10% in late June 2016, i.e. on a par with pre-2008 levels. However, since 2008, the long-term nominal risk-free interest rate has decreased from around 4% to virtually 0% in the euro area, notably owing to the Eurosystem’s highly accommodative non-standard monetary policies. The fact that the CoE has seemingly stabilised therefore reflects a trend increase in the equity risk premium (ERP). Yet because of the impact of monetary policy on firms’ cost of debt, which has fallen to historically low levels, this stabilisation of the CoE has been accompanied by a decline in the weighted average cost of capital (WACC) for large companies over recent years.

Keywords: Business financing; cost of equity; equity risk premium; CAPM (search for similar items in EconPapers)
JEL-codes: D21 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:bfr:quarte:2016:44:03

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