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Investment, protection, ownership, and the cost of capital

Author

Listed:
  • 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.

Suggested Citation

  • Charles P. Himmelberg & R. Glenn Hubbard & Inessa Love, 2002. "Investment, protection, ownership, and the cost of capital," Working Paper Research 25, National Bank of Belgium.
  • Handle: RePEc:nbb:reswpp:200205-6
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    Cited by:

    1. Hornstein, Abigail S., 2013. "Corporate capital budgeting and CEO turnover," Journal of Corporate Finance, Elsevier, vol. 20(C), pages 41-58.
    2. Bottazzi, Laura & Da Rin, Marco & Hellmann, Thomas, 2009. "What is the role of legal systems in financial intermediation? Theory and evidence," Journal of Financial Intermediation, Elsevier, vol. 18(4), pages 559-598, October.
    3. repec:ces:ifodic:v:5:y:2007:i:1:p:14567264 is not listed on IDEAS
    4. Felix J. Lopez-Iturriaga & Emilio Lopez-Millan, 2015. "Institutional Framework, Corporate Ownership Structure, and R&D Investment: An International Analysis," HSE Working papers WP BRP 36/MAN/2015, National Research University Higher School of Economics.
    5. Hornstein, Abigail S., 2014. "The impact of local governance institutions on foreign market listings: The case of Chinese firms," China Economic Review, Elsevier, vol. 29(C), pages 46-67.
    6. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
    7. Ãscar López-de-Foronda & Félix J. López-Iturriaga & Marcos Santamaría-Mariscal, 2007. "Ownership Structure, Sharing of Control and Legal Framework: international evidence," Corporate Governance: An International Review, Wiley Blackwell, vol. 15(6), pages 1130-1143, November.
    8. Charles Chang & Paul Moon Sub Choi & Seth H. Huang, 2015. "Do Poorly Governed Acquirers Transfer Wealth to Targets in Cross-Border Acquisitions?," Financial Management, Financial Management Association International, vol. 44(3), pages 475-498, September.
    9. 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.
    10. repec:eee:pacfin:v:43:y:2017:i:c:p:256-266 is not listed on IDEAS

    More about this item

    Keywords

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

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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