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Rule of Law, Risk Sharing, and the Cost of Funds

34 Pages Posted: 24 Feb 2002  

Mariassunta Giannetti

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swedish House of Finance

Date Written: February 2002

Abstract

This paper shows that the quality of laws, by affecting the cost of investment for outside investors, has an effect on risk sharing and, through it, on the availability of external finance to firms. If, because of high investment costs, the provision of finance to projects is concentrated in few risk-averse individuals, the risk premium rises steeply with the amount of funds firms demand. As a consequence, in countries where the financial system does not favor risk sharing, the larger the demand for external funds of a firm, the costlier external finance becomes. Empirical evidence of this effect is also provided. The cost of debt is higher for firms demanding larger loans, even after controlling for leverage and other firm characteristics. Not surprisingly, the scale of the loans matters especially in countries where creditor rights are less protected.

Keywords: investor base, cost of debt, risk premium

JEL Classification: G3, O16, L1

Suggested Citation

Giannetti, Mariassunta, Rule of Law, Risk Sharing, and the Cost of Funds (February 2002). Available at SSRN: https://ssrn.com/abstract=300926 or http://dx.doi.org/10.2139/ssrn.300926

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
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SE-113 83 Stockholm
Sweden
+46 8 736 9607 (Phone)
+46 8 312 327 (Fax)

HOME PAGE: http://sites.google.com/site/mariassuntagiannetti/Home

Centre for Economic Policy Research (CEPR)

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London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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