Industry Concentration and the Implied Cost of Equity Capital

This study investigates whether industry concentration affects expected returns of stock investors. I employ the implied cost of equity capital estimates as a proxy for expected returns because they are ex ante well specified without relying on realized returns, which tend to be noisy. The results of an analysis using the Herfindahl-Herschman index as a proxy for industry concentration indicate that, even after several determinants of returns and some properties of analysts’ forecasts are controlled for, the implied cost of equity capital estimates have a significant positive relationship with industry concentration and that this relationship was robust to various sample periods and measures of industry concentration. These results provide support for the view that firms in highly concentrated industries are riskier because such firms are exposed to agency problems and opaque information environments.