International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter?

TLDR

This paper examines international differences in firms' cost of equity capital across 40 countries and analyzes whether a country's legal institutions and securities regulation systematically relate to these differences. The authors estimate firms' implied or ex ante cost of capital using several models and conduct extensive sensitivity analyses to control for long‑run growth differences across countries. Results show that stronger disclosure requirements, securities regulation, and enforcement lower the cost of capital, but these effects diminish and often become insignificant as capital markets integrate globally.

Abstract

This paper examines international differences in firms' cost of equity capital across 40 countries. We analyze whether the effectiveness of a country's legal institutions and securities regulation is systematically related to cross-country differences in the cost of equity capital. We employ several models to estimate firms' implied or ex ante cost of capital. Our results support the conclusion that firms from countries with more extensive disclosure requirements, stronger securities regulation, and stricter enforcement mechanisms have a significantly lower cost of capital. We perform extensive sensitivity analyses to assess the potentially confounding influence of countries' long-run growth differences on our results. We also show that, consistent with theory, the cost of capital effects of strong legal institutions become substantially smaller and, in many cases, statistically insignificant as capital markets become globally more integrated.