The implied cost of equity capital, corporate investment and chief executive officer turnover

Jinshuai Hu, Zhijun Lin and Henk Berkman

Accounting and Finance, 2015, vol. 55, issue 4, 1041-1070

Abstract: type="main" xml:id="acfi12072-abs-0001">

This study investigates how the cost of equity capital, along with corporate investment, affects chief executive officer (CEO) turnover decisions. We hypothesize that the cost of equity conveys information about firm performance uncertainty that is informative of CEO talent. Consistently, our empirical results show that the likelihood of CEO turnover is positively associated with the implied cost of equity, after controlling for earnings and stock performance measures and risk factors. Additional analysis of reverse causality supports the causal effect of the high cost of equity on CEO dismissals. We also find that the positive association is more pronounced for firms that are more likely to suffer from underinvestment problems. These results suggest that the cost of equity plays a more important role in assessing CEO performance when the firm needs more external equity capital to pursue investment opportunities.

Date: 2015
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