Investor Protection, Equity Returns, and Financial Globalization
Posted: 16 Jun 2008 Last revised: 27 Mar 2012
Date Written: January 19, 2012
We study the effects of investor protection on stock returns and portfolio allocation decisions. In our theoretical model, if investor protection is weak, wealthy investors have an incentive to become controlling shareholders. In equilibrium, the stock price reflects the demand from both controlling shareholders and portfolio investors. Due to the high demand from controlling shareholders, the price of weak corporate governance stocks is not low enough to fully discount the extraction of private benefits. Thus, stocks have lower expected returns when investor protection is weak. This has implications for domestic and foreign investors' stockholdings. In particular, we show that portfolio investors' participation in the domestic stock market and home equity bias are positively related to investor protection and provide original evidence in their support.
Keywords: Investor Protection, Corporate Governance, Private Benefits of Control, Stock Returns, Portfolio Choice, Home Equity Bias
JEL Classification: G11, G32, G38, F21, F36
Suggested Citation: Suggested Citation