Cost of Capital and Equity Markets

Cost of Capital and Equity Markets
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Course: FIN501 MOD4 Discussion Cost of Capital
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The capital structure of a business integrates the debt, equity financing mix, and this then affects the business and financial risk (Pearson Learning, 2014). The financial risk has a direct impact on equity financing with variability in earnings given the use of securities with a fixed rate of return (Pearson Learning, 2014). At the same time, increasing the level of debt leaves a firm with less income to distribute to the stock brokers since there is a higher level of principal and interest payments (Pearson Learning, 2014). The financial risk is also associated with the likelihood of insolvency to shareholders when the financial risk is at a high level to the extent that leveraging becomes unsustainable.
Despite the US stock market having been bailed out following the 2008/2009 global financial crisis, the market is still more reliable compared to the other stock markets. The US stock market has increasingly become transparent following the implementation of Sarbanes-Oxley Act (SOX), while its efficiency and competitiveness make the stock market reliable. At the same time, the government is unlikely to influence the markets in the long-term and this has resulted in the market efficiency with the demand and supply of securities the driving force for changes in prices. The stock market intervention by the U.S government only happens during extraordinary circumstances including the bailouts.
The Enron, WorldCom and Madoff scandals represents the few instances when the need for a higher firm valuation has resulted in executives manipulating their financial statements. However, the penalties and punishment for dishonest acts means that there is belief in the strength of the US stock market, whereby investors for the local and cross-listed companies have a chance to seek legal redress. In any case, the share of speculative investors compared to China has made it easier for regulatory authorities to pinpoint the culprits in manipulating the share values. This includes the use of insider trading and company secrets to gain an advantage over the investors who have no privy information to factors that are likely to have a significant impact on the stock’s performance.
Despite the equity market being more reliable compared to their markets, there is still a risk for a b...