To Have or Not to Have? The Impact of Financial Targets on the Cost of Capital

Sammanfattning: We study the effect of communicating long-term financial targets, but not the attainment of them, on the equity cost of capital. We examine the effect targets have on risk factors in an augmented Fama and French model, where illiquidity is added as a risk factor, and find that dividend, profitability and leverage targets decrease the cost of capital through the market risk premium and SMB risk factors. Sales, share-related and cash flow targets have no impact. Contrary to our initial belief, the impact of targets on the cost of capital does not feed through the illiquidity risk factor. We conclude that firms should communicate financial targets regarding dividend pay-out ratio, profitability and leverage if they are interested in lowering their cost of capital. A future research topic is the effect the attainment of financial targets has on the cost of capital.