The paper presents a method for calculating the cost of equity capital for the non-marketable securities of private firms and its difference from the cost of equity capital of an all else equal public firm (the private firm premium). The method is based on a theoretical framework that assumes the investor is undiversified due to her holdings in non-marketable securities. We implement the method for both unlevered and levered firms, and also consider the effect of taxes. The findings indicate that the private firm premium increases with the firm's asset risk, its leverage ratio, and the non-diversification of the private firm's owner, while taxes are negatively related to the private firm premium.
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This research is the winner of the TEVA Pharmaceuticals Award in the name of Dan Suesskind for research in Corporate Finance and Financial Markets. We thank Saggi Katz, the seminar participants of the Institute for Banking and finance at Munich University, and the financial markets seminar at Mannheim University for their helpful comments. Abudy acknowledges the support by a grant from the GIF, the German–Israeli Foundation for Scientific Research and Development ( 2276/2010 ). Shust thanks the Research Unit of the School of Business Administration at the College of Management Academic Studies for financial support. Abudy and Shust dedicate this paper to the memory of Simon Benninga, who passed away in August 2015: a teacher, a mentor, a distinguished scholar and foremost a dear friend.
© 2016 Elsevier B.V.
- Cost of capital
- Private firm valuation