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Agency Costs of Free Cash Flow and the Effect of Shareholder Rights on the Implied Cost of Equity Capital

69 Pages Posted: 9 Apr 2009  

Kevin C. W. Chen

Hong Kong University of Science and Technology

Zhihong Chen

Hong Kong University of Science and Technology

K.C. John Wei

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: April 9, 2009

Abstract

In this paper, we examine the effect of shareholder rights on reducing the cost of equity and the impact of agency problems from free cash flow on this effect. We find that firms with strong shareholder rights have a significantly lower implied cost of equity after controlling for risk factors, price momentum, analysts' forecast biases, and industry effects than do firms with weak shareholder rights. Further analysis shows that the effect of shareholder rights on reducing the cost of equity is significantly stronger for firms with more severe agency problems from free cash flows.

Keywords: Agency costs of free cash flow, Anti-takeover provisions, Shareholder rights, Cost of equity capital, Investment opportunities

JEL Classification: G34

Suggested Citation

Chen, Kevin C. W. and Chen, Zhihong and Wei, K.C. John, Agency Costs of Free Cash Flow and the Effect of Shareholder Rights on the Implied Cost of Equity Capital (April 9, 2009). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1375436

Kevin C.W. Chen

Hong Kong University of Science and Technology ( email )

Clear Water Bay
Kowloon
Hong Kong
+852 2358-7585 (Phone)
+852 2358-1693 (Fax)

Zhihong Chen

Hong Kong University of Science and Technology ( email )

Clear Water Bay
Kowloon
Hong Kong
Hong Kong
(852)-2358-7574 (Phone)
(852)-2358-1693 (Fax)

Kuo-Chiang (John) Wei (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

School of Accounting and Finance
Hong Kong Polytechnic University
Hung Hom, Kowloon
Hong Kong
852 2766 4953 (Phone)
852 2330 9845 (Fax)

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