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Investor protection, ownership, and the cost of capital, Volume 1
Author:Himmelberg, Charles P.; Hubbard, R. Glenn; Love, Inessa; Date Stored:2002/05/30
Document Date:2002/04/30Document Type:Policy Research Working Paper
SubTopics:Environmental Economics & Policies; International Terrorism & Counterterrorism; Economic Theory & Research; Financial Crisis Management & Restructuring; Banks & Banking Reform; Capital Markets and Capital Flows; Fiscal & Monetary PolicyLanguage:English
Major Sector:FinanceReport Number:WPS2834
Sub Sectors:Other FinanceCollection Title:Policy, Research working paper series ; no. WPS 2834
Volume No:1  

Summary: The authors combine the agency theory of the firm with risk diversification incentives for insiders. Principal-agent problems between insiders and outsiders force insiders to retain a larger share in their firm than they would under a perfect risk diversification strategy. The authors predict that this higher share of insider ownership and the resulting exposure of insiders to higher idiosyncratic risk will result in underinvestment and higher cost of capital. Using firm-level data from 38 countries, the authors provide evidence in support of their theoretical model, showing that the premium for bearing idiosyncratic risk varies between zero and six percent and decreases in the level of outside investor protection. The results of the study imply that policies aimed at strengthening investor protection laws and their enforcement will improve capital allocation and result in higher growth.

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