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Agency Conflicts, Investment and Asset Pricing

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  • Albuquerque, Rui
  • Wang, Neng

Abstract

Corporations in many countries are run by controlling shareholders whose cash flow rights in the firm are substantially smaller than their control rights. This separation of ownership and control allows the controlling shareholders to pursue private benefits at the cost of minority investors by diverting resources away from the firm and distorting corporate investment and payout policies. We develop a dynamic general equilibrium model to study the asset pricing and welfare implications of imperfect investor protection. The model predicts that countries with weaker investor protection have more incentives to overinvest, lower Tobin’s q, higher return volatility, larger risk premium, and higher interest rate, consistent with existing empirical evidence. We show that weak investor protection causes significant wealth redistribution from outside shareholders to controlling shareholders. Finally, we provide evidence consistent with our model’s two new predictions: countries with higher investment-capital ratios have both larger variance of GDP growth and larger variance of stock returns.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4955.

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Date of creation: Mar 2005
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Handle: RePEc:cpr:ceprdp:4955

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Keywords: agency conflicts; asset pricing; investment specific technological change; investor protection; overinvestment;

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