The effect of the alphabetic bias on firm valuation and cost of equity

Purpose - Investing is, with no doubt, a challenging process that is even tougher when considering the behavior of the stock market. Nowadays, the rapid spread of Internet has allowed the entry of new participants in the stock market increasing both the possibilities of trading and the amount of information to be managed. In this scenario, the investment decision-making process has become very tough. Investors processing information show emotions and behave in a way that is barely rational; among these behavioral aspects, scholars found evidence that investors tend to prefer companies whose tickers/names start with earlier letters of the alphabet. The purpose of this master thesis is to deep dive on the just mentioned matter by investigating on whether and how alphabetic bias may impact both on companies’ firm value and implied cost of equity capital. Structure – After a brief introduction, the first chapter of this work starts with a theoretical overview from standard finance theories, relying on rational approaches, going through the most recent theories of behavioral finance, until reaching behavioral biases and, of course, the core concept of alphabetic bias. The second chapter contextualizes the reasons of this work by formulating two-research hypothesis, explaining the reasoning laying behind them and exploring the relation between firm value and implied cost of equity capital. The third chapter illustrates the econometric model implemented and the different variables composing it. The fourth chapter is about data collection, therefore the creation and description of the panel. The fifth chapter shows the results of the application of the econometric model, therefore tests the validity of the hypothesis Lastly, chapter sixth gives some conclusion remarks, highlights research limitations, and tries to suggest some avenues future research. Design/methodology/approach – To carry out this work it has was decided to formulate two main research hypothesis, one related to the effect of alphabetic bias on firm value and one related to the effect of alphabetic bias on implied cost of equity capital. These ones are proved through the application of an ad hoc econometric model able to test their soundness. The empirical analysis is performed using data collected from Thomson Reuter’s database from year 2000 to year 2020 and related to 497 firms listed in S&P500. Findings - The results confirmed the evidence that companies having a name starting with a letter positioned at the beginning of the alphabet enjoy from the influence of the alphabetic bias; this latter is translated into an increase in firm value and, under certain conditions, a reduction in the implied cost of equity capital. Referring to this last point, it was found indeed that the alphabetical bias’s effect is negatively correlated with firm size, therefore, its effect may be insignificant for large firms. Another relevant finding identified through the empirical analysis concerns the trend of the alphabetic bias phenomenon over time; in particular, it was noted how, following the publishing of studies related to the topic, the effect of alphabetic bias appeared to be less consistent.