Consequences of the Arbitrage Dichotomy of Capital Allocation for the Construction of Opportunity Cost of Equity in Private Companies

Abstract

The research presented in this paper aims to empirically examine the link between the rate of return on capital demanded by owners of private companies where ownership and management are not separated, and the opportunity costs of this capital redeemable on the capital market outside of the company’s projects. Based on the empirical survey carried out in the Czech Republic from 2016 to 2018 in the field of wholesale agricultural machinery companies, we first arrive at the existence of an arbitration dichotomy between (i) the cost of capital at the level of these companies and (ii) the opportunity cost of capital from the owner’s point of view by being the subject of valuation. We see reasons for the inefficiency of the capital market, when projects at the company level are not substitutable with allocations outside this company (alternative investments will be either riskier or less profitable). As a result of this, there is a way of forming the equilibrium price of these assets, where the key role from the point of view of the owners is not a rational reflection on the amount of the present value of cash flows replicated from alternative, equally risky investment allocations, but rather the subjective behaviorally driven consideration of the owners about the need to sell their company.