Real Asset Illiquidity and the Cost of Capital

Abstract

We show that firms with more illiquid real assets have a higher cost of capital. This effect is stronger when real illiquidity arises from lower within-industry acquisition activity. Real asset illiquidity increases the cost of capital more for firms that face more competition, have less access to external capital or are closer to default, and for those facing negative demand shocks. The effect of real asset illiquidity is distinct from that of firms’ stock illiquidity or systematic liquidity risk. These results suggest that real asset illiquidity reduces firms’ operating flexibility and through this channel its cost of capital.

Keywords: real asset illiquidity, cost of capital, operating inflexibility, financial flexibility

JEL Classification: G31, G32, G12