Comment: Some Evidence on the Effect of Company Size on the Cost of Equity Capital

Extract

Professors Alberts and Archer provide a valuable addition to our understanding of capital markets and how resources are allocated to firms of different asset sizes. Their hypothesis is that the cost of equity capital to smaller firms is higher than it is to larger industrial firms. They test their hypothesis by analyzing the variability of returns of 658 industrial firms and attempt to determine whether variability of return is inversely related to asset size. The authors assume that for all firms K_e must equal the sum of the risk-free rate of interest and a risk premium, when risk is defined by four different measures. Two measures of risk use ex post rates of return on book value and two measures of risk employ ex post rates of return on market value. In the first two cases, risk is defined as variability of the firm alone and, in the second two cases, risk is defined as the firm's variability incorporated with the variability of a market portfolio of securities.