Working Paper: CEPR ID: DP4955
Authors: Rui Albuquerque; Neng Wang
Abstract: Corporations in many countries are run by controlling shareholders whose cash flow rights in the firm are substantially smaller than their control rights. This separation of ownership and control allows the controlling shareholders to pursue private benefits at the cost of minority investors by diverting resources away from the firm and distorting corporate investment and payout policies. We develop a dynamic general equilibrium model to study the asset pricing and welfare implications of imperfect investor protection. The model predicts that countries with weaker investor protection have more incentives to overinvest, lower Tobin?s q, higher return volatility, larger risk premium, and higher interest rate, consistent with existing empirical evidence. We show that weak investor protection causes significant wealth redistribution from outside shareholders to controlling shareholders. Finally, we provide evidence consistent with our model?s two new predictions: countries with higher investment-capital ratios have both larger variance of GDP growth and larger variance of stock returns.
Keywords: agency conflicts; investor protection; investment; specific technological change; overinvestment; asset pricing
JEL Codes: G12; G31; G32; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| weaker investor protection (G18) | higher level of investment by controlling shareholders (G34) |
| higher level of investment by controlling shareholders (G34) | lower dividend payout ratio from minority shareholders (G35) |
| weaker investor protection (G18) | lower Tobin's Q (R42) |
| weaker investor protection (G18) | higher return volatility (G17) |
| weaker investor protection (G18) | larger risk premiums (G19) |
| weaker investor protection (G18) | wealth redistribution from minority investors to controlling shareholders (G34) |