Digital transformation and the cost of equity capital: Evidence from China

In the context of the rapid development of the digital economy, how corporate digital transformation affects firms’ cost of equity capital remains an open question in corporate finance. Using a panel dataset of Chinese A-share listed firms from 2013 to 2024, this study investigates whether and how digital transformation influences the cost of equity capital. We construct a firm-level digitalization index based on text analysis of annual reports and employ a two-way fixed effects model, supplemented with robustness tests and instrumental variable estimation, to address endogeneity concerns. The empirical results show that digital transformation significantly reduces firms’ cost of equity capital, and this finding is robust across alternative measures, model specifications, and estimation strategies. Further analysis reveals three mechanisms through which digital transformation operates: enhancing market profitability, strengthening strategic differentiation, and increasing analyst coverage. These mechanisms highlight that digitalization not only improves firms’ internal efficiency but also reshapes their external positioning and information environment, thereby jointly reducing risk premiums required by investors. Moreover, heterogeneity tests indicate that the effect is more pronounced in highly competitive industries, firms facing stronger financing constraints, and both state-owned and non-state-owned enterprises, though the underlying channels differ. This paper contributes to the literature by extending research on the economic consequences of digital transformation to the domain of capital market pricing and by uncovering the mechanisms and contextual conditions under which digitalization shapes financing costs. The findings also provide practical implications for firms to strategically advance digital transformation and for policymakers to design targeted digital economy policies that improve capital allocation efficiency. • Digital transformation significantly lowers the cost of equity capital. • Digital transformation reduces costs by boosting profitability, strategic differentiation, and analyst coverage. • Digital transformation reduces equity costs more in competitive industries and constrained firms.