Estimating the Cost of Equity for
Canadian and U.S. Firms
Lorie Zorn, Financial Markets Department*
• There has been a concern among policy-
makers that the cost of equity financing may
be higher in Canada than in the United
States, but the empirical evidence supporting
this view is mixed.
• We improve on previous studies by imple-
menting a forward-looking, firm-specific
approach to estimating the nominal cost of
equity for Canada and the United States that
controls for firm characteristics, industry
effects, and business cycle effects.
• We find that greater firm size and greater
liquidity of a firm’s stock are associated with
a lower cost of equity, while greater firm
leverage and greater dispersion in analysts’
earnings forecasts are associated with a
higher cost of equity. Moreover, we find that
higher yields on longer-term sovereign bonds
increase a firm’s cost of equity.
• After taking firm-level and aggregate-level
factors into account, the cost of equity was
approximately 30 to 50 basis points higher
in Canada than in the United States over
the 1988–2006 period as a whole, but this
differential appears to be lower in the post-
1997 period.
* The research reported in this article is summarized from a working paper
written by Jonathan Witmer and the author (Witmer and Zorn 2007).
inancing costs are important for both firms
and the economy, affecting investment deci-
sions and, ultimately, economic growth. Since
equity is an important component of a firm’s
financing structure, Canadian firms may not under-
take as many projects that could potentially enhance
growth if the cost of equity financing in Canada is
relatively high. Considering the overall size of the
equity stock in Canada, even small differences in the
cost of equity financing can have a substantial impact.1
The cost of equity, which can be defined as the return
expected on a firm’s common stock, represents the
compensation demanded by shareholders for providing
capital and assuming the risk of waiting for this return.2
Thus, in addition to th