COST OF

CAPITAL
RESEARCH
PAPER
SYED MUHAMMAD HASSAM HAIDER TIRMIZI

LONG-TERM INVESTMENT, THE COST

OF CAPITAL AND THE DIVIDEND AND
BUYBACK PUZZLE

ADRIAN BLUNDELL WIGNALL

Special advisor to the OECD secretary general for financial
markets and the deputy director to the directorate of
financial and enterprise affairs.

CAROLINE ROULET
OECD economist and analyst.

PUBLICATION
OECD journal : financial market trends
Volume 2013
Issue 1

ABSTRACT
Interest rate are extremely low to support banks
Search for yield pushed liquidity driven speculative bubble
from real estate
Derivatives and structured products markets into the
corporate debt market
Helping banks to reduce hidden losses on illiquid securities
and reduce the cost of equity

Cont.

Cont.

ABSTRACT
Present a panel model
CAPEX decision in general depends on the cost of equity, the
accelerator and uncertainty,
Buyback are driven mainly by the gap between the cost of equity
and debt

Paper also makes some policy suggestions.

INTRODUCTION
Strong corporate borrowing, Weak equity issuance
Frequent return cash flow to shareholders in the form of
dividend and buyback.
Microeconomic data on
Cash flow
Capital expenditure
Dividends
Buyback decisions

HYPOTHESIS
Ho ; High level of uncertainty, the low cost of corporate debt and the
high cost of equity funding is favoring dividends and buybacks at the
expense of investment

DATA
4,143 publicly traded companies
31 countries
10 sectors
Q1 1997 Till Q4 2011
DataStream, Bloomberg

EMPIRICAL MODEL

VARIABLES
CAPEX_Sales

Cost of equity
Cost of debt
GDP
Volatility

DivBB
Relative cost of equity versus debt
Average earning yield by sector

RESULTS
The cost of equity variable is significant at the 1% level
Direct relation between GDP growth and long term investment
relative to sales
Strong support, that a high cost of equity and a low borrowing
rate encourages firms to carry out buybacks and to pay
higher dividends to shareholders instead of investing

CONCLUDING REMARKS
CAPEX decision in general depends on the cost of equity, the
accelerator and uncertainty
Buybacks are driven mainly by the gap between the cost of equity and
debt
Weak investment reduces future potential growth and this in turn
creates inflation and growth bottlenecks
The best way to improve long-term investment are policies that return
interest rate to normal levels, and reduce the distorted incentives for
buybacks and low investment