Implicit cost

Abstract: The paper emphasizes the use of accounting data in regulatory or procurement contracts when the supplier (1) has superior information about the cost of the project and (2) invests in cost reduction. The main result states that, under risk neutrality, the supplier announces an expected cost and is given an incentive contract linear in cost overruns. This (optimal) contract moves toward a fixed-price contract as the announced cost decreases. An investment choice is then introduced and the use of a rate-of-return regulation is studied.

Abstract: Gordon Walker and David Weber This study focuses on make-or-buy decisions as a paradigmatic problem for analyzing transaction costs. Hypotheses developed from Williamson's efficient boundaries framework were tested in a multiple-indicator structural equation model. The influence of transaction costs on decisions to make or buy components was assessed indirectly through the effects of supplier market competition and two types of uncertainty, volume and technological. In addition to transaction costs, the decisions were hypothesized to be predicted by both buyer production experience and the comparative production costs between buyer and supplier. The hypotheses were tested on a sample of make-or-buy decisions made in a division of a U.S. automobile company. The results show that comparative production costs are the strongest predictor of makeor-buy decisions and that both volume uncertainty and supplier market competition have small but significant effects. The findings are explained in terms of the complexity of the components and the potential pattern of communication and influence among managers responsible for making the decisions.*

Abstract: In this study, we propose an alternative technique for estimating the cost of equity capital. Specifically, we use a discounted residual income model to generate a market implied cost-of-capital. We then examine firm characteristics that are systematically related to this estimate of cost-of-capital. We show that a firm's implied cost-of-capital is a function of its industry membership, B/M ratio, forecasted long-term growth rate, and the dispersion in analyst earnings forecasts. Together, these variables explain around 60% of the cross-sectional variation in future (two-year-ahead) implied costs-of-capital. The stability of these long-term relations suggests they can be exploited to estimate future costs-of-capital. We discuss the implications of these findings for capital budgeting, investment decisions, and valuation research.

Abstract: Ianalyze the impact of a firm's environmental profile on its cost of equity and debt capital. Using implied cost of capital derived from analysts' earnings estimates, I find that investors demand significantly higher expected returns on stocks excluded by environmental screens such as hazardous chemical, substantial emissions, and climate change concerns compared to firms without such environmental concerns. Lenders also charge a significantly higher interest rate on the bank loans issued to firms with these environmental concerns. I provide evidence that the environmental profile of a firm is not simply proxying for an omitted component of its default risk. Further, firms with these environmental concerns have lower institutional ownership and fewer banks participate in their loan syndicate than firms without such environmental concerns. These results suggest that exclusionary socially responsible investing and environmentally sensitive lending can have a material impact on the cost of equity and debt capital of affected firms. This paper was accepted by Brad Barber, finance.