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Investment, protection, ownership, and the cost of capital

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Author Info

  • Charles P. Himmelberg

    ()
    (Columbia University)

  • R. Glenn Hubbard

    (Columbia University)

  • Inessa Love

    (The World Bank)

Abstract

We investigate the cost of capital in a model with an agency conflict between inside managers and outside shareholders. Inside ownership reflects the classic tradeoff between incentives and risk diversification, and the severity of agency costs depends on a parameter representing investor protection. In equilibrium, the marginal cost of capital is a weighted average of terms reflecting both idiosyncratic and systematic risk, and weaker investor protection increases the weight on idiosyncratic risk. Using firm-level data from 38 countries, we estimate the predicted relationships among investor protection, inside ownership, and the marginal cost of capital. We discuss implications for the determinants of firm size, the relationship between Tobin's Q and ownership, and the effect of financial liberalizations.

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File URL: http://www.nbb.be/doc/oc/repec/reswpp/WP25.pdf
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Bibliographic Info

Paper provided by National Bank of Belgium in its series Working Paper Research with number 25.

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Length: 58 pages
Date of creation: May 2002
Date of revision:
Handle: RePEc:nbb:reswpp:200205-6

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Related research

Keywords: Investor protection; ownership; investment; cost of capital; agency costs;

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Cited by:
  1. Müller, Elisabeth, 2004. "Underdiversification in Private Companies: Required Returns and Incentive Effects," ZEW Discussion Papers 04-29, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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