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

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 four different models using analyst forecasts to estimate firms' implied cost of capital. We find that countries with extensive securities and disclosure regulation and strong enforcement mechanisms exhibit lower levels of cost of capital than countries with weak legal institutions, even after controlling for various risk and country factors. The effects are strongest for institutions that provide information to investors enabling them to privately enforce their contracts. We also show that, consistent with theory, these effects become substantially smaller or insignificant as capital markets become more integrated.