Equity value,implied cost of equity and shareholders’ real options |
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Authors: | Byungcherl Charlie Sohn |
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Affiliation: | Department of Accountancy, City University of Hong Kong, Kowloon Tong, Kowloon, Hong Kong, China |
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Abstract: | This study investigates the effects of shareholders’ real options on (i) firm financial performance and (ii) estimations of the implied cost of equity. After measuring the equity value of steady‐state operations using the residual income model, and the abandonment and expansion options using the Black‐Scholes option pricing model, I find that firms with a large expansion (abandonment) option value experience better (worse) financial performance than those with a small such value. I also find that ignoring these options results in a downward bias in implied cost of equity estimates by an average of 1.23 percentage points. |
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Keywords: | Real options Abandonment option Expansion option Implied cost of equity M41 G12 |
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