Investor Protection, Ownership, and the Cost of Capital

Investor Protection, Ownership, and the Cost of Capital

The authors combine the agency theory of the firm with risk diversification incentives for insiders. Principal-agent problems between insiders and outsiders force insiders to retain a larger share in their firm than they would under a perfect risk diversification strategy. The authors predict that this higher share of insider ownership and the resulting exposure of insiders to higher idiosyncratic risk will result in underinvestment and higher cost of capital. Using firm-level data from 38 countries, the authors provide evidence in support of their theoretical model, showing that the premium for bearing idiosyncratic risk varies between zero and six percent and decreases in the level of outside investor protection. The results of the study imply that policies aimed at strengthening investor protection laws and their enforcement will improve capital allocation and result in higher growth.

Saved in:
Bibliographic Details
Main Authors: Himmelberg, Charles P., Hubbard, R. Glenn, Love, Inessa
Language:English
en_US
Published: World Bank, Washington, D.C. 2002-04
Subjects:INVESTOR PROTECTION, OWNERSHIP, COST OF CAPITAL, AGENCY CONCEPT, RISK DIVERSIFICATION, INCENTIVES ACCOUNTING, AGENCY PROBLEMS, BALANCE SHEET, BENCHMARK, BOOK VALUE, CAPITAL EXPENDITURES, CAPITAL MARKETS, CAPITAL PROJECTS, CD, CONTRACT ENFORCEMENT, CONTROL TRANSACTIONS, CORPORATE FINANCE, COUNTRY COMPARISONS, DEBT, DEMAND CURVE, DIVESTITURES, DIVIDENDS, ECONOMIC GROWTH, ECONOMIC REFORMS, EMPIRICAL EVIDENCE, EQUILIBRIUM, EXCISE TAXES, EXPECTED UTILITY, EXPENDITURES, FEDERAL RESERVE BANK OF NEW YORK, FINANCIAL DATA, FINANCIAL MARKETS, FIXED CAPITAL, FOREIGN FIRMS, FOREIGN INVESTORS, INCOME, LAWS, LEGAL PROTECTION, LEGAL REGIMES, LIQUIDITY, MARGINAL COST, MARGINAL COSTS, MARGINAL PRODUCT, MARGINAL UTILITY, MARGINAL VALUE, MERGERS, MONETARY POLICY, MORAL HAZARD, OPPORTUNITY COST, OWNERSHIP STRUCTURE, PAYOUT, PENALTIES, PORTFOLIO, PREDICTIONS, PRICE ELASTICITY, PRICE ELASTICITY OF DEMAND, PRODUCTION FUNCTION, PRODUCTION TECHNOLOGY, PROFITABILITY, PROPRIETORSHIP, PURCHASE PRICE, RATIONAL EXPECTATIONS, REORGANIZATION, RESEARCH AGENDA, RISK AVERSION, RISK PREMIUM, SHAREHOLDERS, TAKEOVER, TOTAL FACTOR PRODUCTIVITY, VALUE ADDED, WEALTH,
Online Access:http://documents.worldbank.org/curated/en/2002/04/1783726/investor-protection-ownership-cost-capital
https://hdl.handle.net/10986/14288
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:The authors combine the agency theory of the firm with risk diversification incentives for insiders. Principal-agent problems between insiders and outsiders force insiders to retain a larger share in their firm than they would under a perfect risk diversification strategy. The authors predict that this higher share of insider ownership and the resulting exposure of insiders to higher idiosyncratic risk will result in underinvestment and higher cost of capital. Using firm-level data from 38 countries, the authors provide evidence in support of their theoretical model, showing that the premium for bearing idiosyncratic risk varies between zero and six percent and decreases in the level of outside investor protection. The results of the study imply that policies aimed at strengthening investor protection laws and their enforcement will improve capital allocation and result in higher growth.

Similar Items