Is the cost of equity a mere function of leverage? The case of bond IPOs

Abstract

In this paper, we investigate how undertaking a bond IPO influences a firm's cost of equity. Using a sample of nearly 600 firms that have gone through a bond IPO over the 1980-2014 period, we show that the change in the cost of equity that results is not just a function of leverage influencing the risk of residual owners. The information and monitoring environment, and agency relationships of a firm change significantly with its first public debt, and these changes can have a significant impact on the firm's cost of equity. We find that firms that have relatively high information asymmetry before they undertake the bond IPO experience less of a rise in their cost of equity than firms with relatively low information asymmetry consistent with these firms benefitting from improvements in their information environment as a result of the IPO. We also show that firms with high pre-bond IPO free cash flow see less of an increase in their cost of equity than firms with low pre-bond IPO free cash flow consistent with the disciplining mechanism of additional debt and the benefit from additional monitoring. In addition, we find that firms with poor corporate governance experience less of an increase in their cost of equity after the bond IPO than firms with better corporate governance. The evidence suggests that the change in the riskiness of equity after a firm goes through a bond IPO is much more complex than what is predicted by the leverage increase.

Does financial fraud affect implied cost of equity?

“…We use the following model using pooled OLS regression to examine the relationship between financial misconduct and a firm's equity cost: where is the implied equity cost measure. Following Al‐Khasawneh et al (2020) and Yugang et al (2021)), the implied equity cost is computed by utilising the Ohlson and Juettner‐Nauroth (2005) model. We choose the ex‐ante equity cost based on a firm's share prices and earnings forecasts because of the criticism over the efficiency of asset pricing models to measure this variable (El Ghoul et al, 2018; Fama & French, 1997).…”

“…where K e is the implied equity cost measure. Following Al-Khasawneh et al (2020) and Yugang et al (2021)), the implied equity cost is computed by utilising the Ohlson and Juettner-Nauroth (2005) model. We choose the exante equity cost based on a firm's share prices and earnings forecasts because of the criticism over the efficiency of asset pricing models to measure this variable (El Ghoul et al, 2018;Fama & French, 1997).…”

Construction of fuzzy mathematical model for judging financial indexes of private enterprises under the perspective of deep learning

“…The data related to the 2021 China Top 500 Private Enterprises Summit show that Chinese private enterprises under the influence of the epidemic are still showing healthy development in general, the number of larger and more profitable private enterprises keeps growing, the operating efficiency of private enterprises continues to improve, and they are an important part of the national market economy. When private enterprises develop to a certain scale, they usually choose to carry out an IPO (Initial Public Offering) in order to achieve the purposes of raising capital, reducing financing costs, enhancing development space, and improving visibility [6][7][8]. In the context of IPO registration system reform, the proposed IPO of private enterprises in the preparatory period for its listing should effectively improve its comprehensive strength, competitiveness, and effective financial performance analysis to help the proposed IPO enterprises objectively analyze the business situation, not only for the company to formulate the development strategy to provide effective data to support, but also to help enterprises to timely identify deficiencies, and effectively prevent the risk of the proposed IPO enterprises are necessary to carry out effective financial performance analysis.…”