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Shareholder Protection and the Cost of Capital

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  • Joel F. Houston
  • Chen Lin
  • Wensi Xie

Abstract

Do shareholder protection laws affect the corporate cost of capital? To identify the causal impact of shareholder protection laws on firms' implied cost of capital, we exploit the staggered adoption across 23 US states of universal-demand laws, which place significant obstacles to derivative lawsuits and thus undermine shareholders' litigation rights. Using a sample of public US firms between 1985 and 2013, we find that weakened litigation rights for shareholders materially increase firms' implied cost of capital. We further show that the curtailing of shareholders' rights leads to a deterioration in information quality, increased risk-taking, and more severe insider expropriation, all of which contribute to heightened financing costs. Overall, our findings indicate that weakened litigation rights for shareholders lead them to face greater agency conflicts and higher market risk, which ultimately translates into higher required returns.

Suggested Citation

  • Joel F. Houston & Chen Lin & Wensi Xie, 2018. "Shareholder Protection and the Cost of Capital," Journal of Law and Economics, University of Chicago Press, vol. 61(4), pages 677-710.
    • Handle: RePEc:ucp:jlawec:doi:10.1086/700269
    DOI: 10.1086/700269
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