Equity Risk Premium (ERP)
Definition
The incremental return that investors require for holding equities over risk-free government bonds, reflecting the additional risk associated with equity ownership. The ERP is a critical input to cost of equity estimation under both CAPM and build-up methods. Historical ERP estimates typically range from 4% to 7%, though forward-looking (implied) estimates derived from current market valuations and earnings expectations are increasingly preferred by valuation practitioners.
Complementary Terms
Concepts that frequently appear alongside Equity Risk Premium (ERP) in practice.
An additional return demanded by investors for holding the equity of smaller companies, reflecting the empirically observed tendency for small-capitalisation stocks to earn higher returns than predicted by the Capital Asset Pricing Model alone. Size premiums are commonly sourced from the Duff & Phelps (now Kroll) Cost of Capital Navigator and are added to the cost of equity in the build-up method or as a modification to CAPM.
An additional return added to the cost of equity to reflect idiosyncratic risks unique to the subject company that are not captured by beta, the equity risk premium, or the size premium. Common factors justifying a specific company risk premium include customer concentration, key person dependence, regulatory exposure, limited product diversification, geographic concentration, and early-stage business risk.
The additional amount a buyer pays above the pro-rata market value of a company's shares to acquire a controlling interest. The control premium reflects the value of being able to direct the company's strategy, operations, capital allocation, and management.
Net income divided by shareholders' equity, measuring the return generated on owners' invested capital. High ROE can indicate efficient use of equity but should be interpreted alongside leverage levels and the quality of earnings.
The percentage ownership interest a shareholder holds in a company. Equity stakes determine voting rights, dividend entitlements, and the share of proceeds received in a sale or liquidation event.
A financing feature that allows a borrower to make interest payments by issuing additional debt or equity instruments rather than paying cash, thereby conserving cash flow during periods of investment or growth. PIK interest accrues and compounds, increasing the principal balance over time.
Investment capital provided to companies that are not listed on a public stock exchange, or used to take public companies private. PE firms typically acquire controlling stakes in mature businesses, apply operational improvements, and seek exits within 3-7 years.
A contractual feature that gives an investor the right to share in additional value creation beyond a base return, commonly found in preferred equity and mezzanine instruments. Upside participation structures are designed to reward investors for the risk associated with backing intangible-driven growth, aligning their interests with the company's long-term value creation.
Related FAQ
What ESG-related intangible assets are gaining recognition?
ESG-related intangible assets include sustainability certifications, carbon credits, green brand equity, social licence to operate, ESG data systems, and responsible supply chain relationships.
Read full answer →How do you value a brand and what factors drive brand worth?
Brand value is driven by pricing premium, customer loyalty, and market position. Valuation methods include comparable company analysis, price premium multipliers, and income approach based on branded revenue.
Read full answer →How can intangible assets drive revenue growth?
Intangible assets drive growth through brand premium pricing, customer retention, technology differentiation, proprietary data advantages, and scalable IP licensing — all generating returns without proportional capital expenditure.
Read full answer →Put this knowledge to work
Use Opagio's free tools to measure and grow the intangible assets that drive your business value.