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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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Paper provided by National Bank of Belgium in its series Research series with number 200205-6.

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

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Related research
Keywords: Investor protection ownership investment cost of capital agency costs

Find related papers by JEL classification:
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  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. [Downloadable!]
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