Cost of Capital: The Managerial Perspective

For a recent review of comparative rates of investment and productivity, see Norsworthy J.R. , “Why U.S. Manufacturers Are At A Competitive Disadvantage,” MAPI Policy Review, PR-114 (November 1990). (MAPI is the Manufacturers' Alliance for Productivity and Innovation, Washington, D.C.) Some authors now emphasize that the difference in rates of investment applies both to fixed or tangible investments as well as to invisible or intangible investments. For example, see Hatsopoulos G.N. Krugman P.R. Summers L.H. , “U.S. Competitiveness: Beyond the Trade Deficit,” Science, 241, July 15, 1988.

E.g., Hatsopoulos G.N. Brooks S.H. , “The Gap in the Cost of Capital: Causes, Effects, and Remedies,” in Landau R. Jorgenson D. W. , eds., Technology and Economic Policy (Cambridge, MA: Ballinger, 1986); McCauley R.N. Zimmer S.A. , “Explaining International Differences in the Cost of Capital,” Federal Reserve Bank of New York Quarterly Review (Summer 1989); Norsworthy J.R. , op. cit.

E.g., Kester W.C. Luehrman T.A. , “Real Interest Rates and the Cost of Capital,” Japan and the World Economy, 1 (1989) and “The Price of Risk in the United States and Japan,” Harvard Business School Working Paper, 90-050, 1990; Abuaf N. Carmody K. , “The Cost of Capital in Japan and the United States: A Tale of Two Markets,” Salomon Brothers Financial Strategy Group, July 1990.

Kester Luehrman suggest this way of posing the issue in Kester W. C. Luehrman T. A. , “Cross Country Differences in the Cost of Capital: A Survey and Evaluation of Recent Empirical Studies,” Draft, December 12, 1990.

E.g., Zielinski R. Holloway N. , Unequal Equities (Tokyo: Kodansha International, 1991); Kester W.C. , Japanese Takeovers (Boston, MA: Harvard Business School Press, 1991).

E.g., Norsworthy J.R. , op. cit. An analysis by Dr. V. Cattó, Chief Economist at Texas Instruments, well illustrates the point. It shows that although cost of debt and cost of equity are roughly comparable for U.S. and Japanese semiconductor manufacturers, the overall cost of capital for the U.S. manufacturers is roughly 75% higher because the capital structures of their Japanese counterparts are much more highly leveraged (and the cost of debt is lower than the cost of equity). The average debt/equity ratio for Japanese semiconductor manufacturers is more than an order of magnitude higher than for U.S. semiconductor manufacturers.

The study was designed in order to maximize the number of interesting contrasts that we could make, since most useful information concerning the cost of capital is relative in nature. Moreover, pairs of firms were selected for each category in order to provide an internal measure of repeatability or consistency. And financial data covering two business cycles were collected for each firm so that the influence of the business cycle could be investigated.

In addition to engaging in RDLPs, Centocor has gone one step further and spun off a publicly traded company called Tocor. With the money raised in the public offering, Tocor funds the early development of products for treatment of autoimmune diseases through R&D contracts with Centocor. Centocor has the option to purchase all Tocor shares at a 40% return on initial investment. Centocor proceeded in this fashion because the research that needed funding was of a more fundamental nature than is common for RDLPs. For a general discription of this approach to raising capital, see Henriques D.B. , “Disguising the Risks of Research,” New York Times, February 3, 1991, Business Section, p. 14.

See DiMasi J. A. Hansen R.W. Grabowski H.G. Lasagna L. , “The Cost of Innovation in the Pharmaceutical Industry,” The Journal of Health Economics (forthcoming, 1991).

The Wall Street Journal, November 8, 1989, A4.