Shareholder Protection and the Cost of Capital

45 Pages Posted: 17 Sep 2015 Last revised: 6 Aug 2018

See all articles by Joel F. Houston

Joel F. Houston

University of Florida - Department of Finance, Insurance and Real Estate

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Wensi Xie

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Date Written: June 16, 2018

Abstract

Do shareholder protection laws affect the corporate cost of capital? To identify the causal impact of shareholder protection laws on firms’ implied cost of capital, we exploit the staggered adoption across 23 U.S. states of universal demand (UD) laws, which place significant obstacles to derivative lawsuits and thus undermine shareholder litigation rights. Using a sample of public U.S. firms between 1985 and 2013, we find that weakened shareholder litigation rights materially increase firms’ implied cost of capital. We further show that the curtailing of shareholder rights leads to a deterioration in information quality, increased risk-taking, and more severe insider expropriation, all of which contribute to the heightened financing costs. Overall, our findings indicate that weakened shareholders’ litigation rights lead shareholders to face greater agency conflicts and higher market risk, which ultimately translates into higher required returns.

Keywords: Shareholder protection, Universal demand (UD) laws, Implied cost of capital (ICOC)

JEL Classification: G32, G38, K22, M41

Suggested Citation

Houston, Joel F. and Lin, Chen and Xie, Wensi, Shareholder Protection and the Cost of Capital (June 16, 2018). Journal of Law and Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2661292 or http://dx.doi.org/10.2139/ssrn.2661292

Joel F. Houston (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Chen Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Wensi Xie

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, N.T.
Hong Kong

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