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Investment, protection, ownership, and the cost of capital

Listed author(s):
  • Charles P. Himmelberg

    ()

    (Columbia University)

  • R. Glenn Hubbard

    (Columbia University)

  • Inessa Love

    (The World Bank)

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 Working Paper Research with number 25.

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