How do Agency Problems Affect the Implied Cost of Capital?

Authors

  • Ching-Chih Wu Department of Finance, National Chung Hsing University
  • Bing-Huei Lin Department of Finance, National Chung Hsing UniversityDepartment of Finance, National Chung Hsing University
  • Tung-Hsiao Yang Department of Finance, National Chung Hsing University

DOI:

https://doi.org/10.6000/1929-7092.2016.05.18

Keywords:

, Agency problems, Free cash flows, Overinvestment, Implied cost of capital

Abstract

We test the relationship between the implied cost of capital and two agency problems, free cash flows and overinvestment. We show that free cash flows have a significant negative impact on the implied cost of capital, but overinvestment has a significantly positive impact. In addition, the pay-for-performance sensitivity has a negative effect but the sensitivity of volatility has a significantly positive effect on the implied cost of capital. After taking the incentives into account, we find that the significance of the impact from both agency problems still exists. Finally, we conclude that well-designed executive compensation should focus on reducing overinvestment and the sensitivity of volatility.

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Published

2016-06-01

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Section

Articles