Author: Sophia Kassidova
Abstract: This paper studies the cost of equity and capital of three Bulgarian listed banks in the framework of the Modigliani-Miller (MM) theory of capital structure. It measures the impact of an increase in capital ratios on the equity risk (equity beta) of these banks.
It finds that, historically, while more equity results in lower banks’ systematic risk no causal relationship can be found between an increase in capital ratios and the predicted by the theory decrease in banks’ systematic risk. MM irrelevance argument holds that a decrease in equity risk will lead to a decrease in the shareholders’ required (and expected) return on equity and thus offsetting the higher equity (capital) level.
Thus, the results cannot find evidence in support of the so-called “Modigliani-Miller” offset.
Keywords: cost of bank capital of Bulgarian banks; equity beta; Modigliani-Miller theorem for banks; cost of equity.
JEL code: G31, G32
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