ABSTRACT
Using firm-level panel data, this paper examines whether the cost of capital (COC) differs significantly between U.S.-based multinational corporations (MNCs) and U.S. domestic corporations (DCs). The results suggest that U.S.-based MNCs have higher COC than U.S. DCs and that industry importantly influences COC. The study also finds that there is a significant time effect on COC, and the time effect follows the trend of the U.S. economic growth rate. Using a Bayesian Markov chain Monte Carlo approach, we estimate jointly cost of equity, cost of debt, and capital structure, and find that the higher cost of capital for MNCs is due mainly to their higher cost of equity and greater use of equity financing; the cost of debt financing does not differ significantly for MNCs versus DCs.
Conclusion
When we control firm size, profitability, leverage, growth opportunities, and income tax rate and consider the industry effect and time effect, we find that U.S.-based MNCs have higher COC than U.S. DCs. The result suggests that international diversification is related to a higher COC, which causes an international diversification discount, all else equal. We also find a significant time effect: COC decreases over time during the study period, following the trend of the real GDP growth rate. The implication is that the GDP growth rate influences the COC. Relatedly, Chen et al. (1986) and Fama (1990), who focus on cost of equity only, find that stock return is positively related to monthly industrial growth. Further systematic inquiry shows that the higher COC for MNCs is not due to higher cost of debt. There is no significant difference for MNCs and DCs in cost of debt. The higher COC for U.S. MNCs stems from a higher cost of equity and less use of debt financing, which has lower direct costs. In accord with previous research, we find that capital structure plays an important role in determining COC. Therefore, scholars need to be cautious in relating the COC of a firm directly to the firm’s risk level. For MNCs, using more debt is one possible way to lower their COC and increase firm value. Cost of debt changes more actively over time than cost of equity, and firms can more effectively apply market timing to lower the cost of debt and hence the COC.
