Cost of Capital and Investment Efficiency: A Critical Review of Empirical Literature

This paper reviewed relevant empirical research works on the association between cost of capital and corporate investment efficiency by adopting critical review approach. Data for the review are sourced from relevant journal articles published over fourteen (14) years (2010 -2023). The data generated was analyzed using percentages and chart counts. Based on the analysis and discussion of results from the reviewed works, the findings of the paper are that both cost of equity and overall cost of capital exert positive influence on underinvestment. The effect of cost of equity on underinvestment is significant in non-state-owned firms. Regarding influence of cost of capital on Overinvestment, the paper found that cost of equity exerts negative effect on overinvestment and that the effect is significant in state-owned firms. However, the paper found that positive relationship exists between overall cost of capital and overinvestment. Consistent with the summary of findings, the paper concluded that Issue-Invest Decision theory best suits and explain the relationship between cost of capital and investment efficiency, and so an increase in the overall cost of capital or in any of its components (that is, cost of equity and cost of debt) will result in more failure to undertake viable investment projects by both state-owned and non-state-owned firms. In line with the conclusions drawn, this paper recommended that corporate firms should be reviewing and analyzing key factors determining their cost of capital. They should be giving special attention to the compelling need for minimizing the level of asymmetric information between them and their capital providers. Thus, apart from modest contribution to extant literature on COC and IE, this paper provides critical analysis and examination of the literature. It also influences the way in which corporate firms view COC and its effect on investment efficiency thereby impacting on their decision regarding COC and its determinants.