ABSTRACT

This paper examines the impact on cost of equity due to globalisation. Here, the argument is that globalisation leads to decrease
in the cost of equity capital for two important reasons. First, the expected returns that investors require to invest in equity to
compensate them for the risk they bear generally fall. Second, agency cost which makes it harder and costly for the firm to raise
funds become less effective. The empirical evidence goes hand in hand with the theoretical prediction that globalisation leads to
decrease in the cost of capital. However, the documented effects are lower than what theory leads us to expect. I have therefore
taken into account various reasons for why this is the impact of globalisation on the cost of capital.

INTRODUCTION

Towards the end of world war second, global financial markets were characterised by many barriers to free flow of capital. Most
of the currencies were not convertible, there was a phase of high transaction cost as well as high taxation, there were many more
other explicit restrictions such as restrictions on foreign ownership and capital mobility, political risk, not proper institutions to
deal with foreign equity shares, lack of accounting harmonization across countries.

Over the last fifty years, many of such barriers have tumbled down among countries. Many of finance academicians have
welcomed this move of globalisation of capital market and have taken into account the benefits of it and on the other way round
corporations, many policymakers have questioned its success. The financial crisis of Mexico (1994), the recent upheavals in Asia
and Russia have led to the reimposition of some barriers to international investment.

In this paper I have evaluated how the cost of capital got affected by the process of globalisation. Section I contains the
investigation that how globalisation affects the discount rate of a given stream of equity cash flows as discount rate is considered
as cost of capital for an all equity firm by neo-classical financial economists and a number of consulting firms.

Section II discusses how globalisation affects firm’s governance in several ways and thus the cost of capital. First, globalisation
means new shareholders across the world come and invest in the firm and such investors have skills and knowledge that enables
them to monitor management in much more better way than local investors. Second, globalisation creates competition among
suppliers of capital. This reduces the cost of capital in both ways that is by reducing the rents that accrue to the capital providers
and by reducing transaction costs.

In section III, there is review of the existing evidence on the impact of globalisation on the cost of capital and present some new
evidence. I present the condition that must satisfy in order to show there is decrease in the cost of capital due to globalisation.
There is review of alternative approaches to estimate the discount rate. All these observations show that the opening markets
decreases the discount rate but not as large as theory predict.