Diagnostics to Evaluate Cost of Capital Measures. Discussion of Christodoulou et al

Jeremy Bertomeu

Abacus, 2016, vol. 52, issue 1, 211-219

Abstract: type="main">

Christodoulou et al. ( ) develop measures of the cost of equity capital that require only accounting inputs, using as an identification strategy the linear information dynamics of Feltham and Ohlson ( ). I propose to test these measures by evaluating the predictability of innovations to abnormal earnings using various predetermined variables. The over-identifying restrictions of this model require these innovations not to be predictable. Using a generalized model, I observe that the estimated measures are probably too low. I conjecture that this anomaly, which occurs jointly with a positive drift in abnormal earnings, is caused by the omission of economic assets such as intangibles.

Date: 2016
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