Investment, Protection, Ownership, and the Cost of Capital

National Bank of Belgium Working Paper No. 25

58 Pages Posted: 18 Oct 2010

See all articles by Charles P. Himmelberg

Charles P. Himmelberg

Goldman, Sachs & Co.

R. Glenn Hubbard

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER)

Inessa Love

World Bank - Development Economics Data Group (DECDG)

Date Written: May 1, 2000

Abstract

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.

Keywords: Investor protection, ownership, investment, cost of capital, agency costs

JEL Classification: G31, G32, E22, D92, O16

Suggested Citation

Himmelberg, Charles P. and Hubbard, Robert Glenn and Love, Inessa, Investment, Protection, Ownership, and the Cost of Capital (May 1, 2000). National Bank of Belgium Working Paper No. 25, Available at SSRN: https://ssrn.com/abstract=1692686 or http://dx.doi.org/10.2139/ssrn.1692686

Charles P. Himmelberg (Contact Author)

Goldman, Sachs & Co. ( email )

200 West St
New York, NY 10233
917-343-3218 (Phone)

Robert Glenn Hubbard

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

HOME PAGE: http://www.gsb.columbia.edu/faculty/ghubbard

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Inessa Love

World Bank - Development Economics Data Group (DECDG) ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

HOME PAGE: http://econ.worldbank.org/staff/ilove

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