R-Squared Around the World: New Theory and New Tests

51 Pages Posted: 11 May 2004 Last revised: 26 Jul 2010

See all articles by Stewart C. Myers

Stewart C. Myers

Massachusetts Institute of Technology (MIT); National Bureau of Economic Research (NBER)

Li Jin

Harvard Business School - Finance Unit

Multiple version iconThere are 3 versions of this paper

Date Written: April 2004


Morck, Yeung and Yu (MYY, 2000) show that R2 and other measures of stock market synchronicity are higher in countries with less developed financial systems and poorer corporate governance. MYY and Campbell, Lettau, Malkiel and Xu (2001) also find a secular decline in R2 in the United States over the last century. We develop a model that explains these results and generates additional testable hypotheses. The model shows how control rights and information affect the division of risk-bearing between inside managers and outside investors. Insiders capture part of the firm's operating cash flows. The limits to capture are based on outside investors' perception of the value of the firm. The firm is not completely transparent, however. Lack of transparency shifts firm-specific risk to insiders and reduces the amount of firm-specific risk absorbed by outside investors. Our model also predicts that opaque' stocks are more likely to crash, that is, to deliver large negative returns. Crashes occur when insiders have to absorb too much firm-specific bad news and decide to give up.' We test these predictions using stock returns from all major stock markets from 1990 to 2001. We find strong positive relationships between R2 and several measures of opaqueness. These measures also explain the frequency of large negative returns.

Suggested Citation

Myers, Stewart C. and Jin, Li, R-Squared Around the World: New Theory and New Tests (April 2004). NBER Working Paper No. w10453. Available at SSRN: https://ssrn.com/abstract=538462

Stewart C. Myers (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

Sloan School of Management
Cambridge, MA 02142
United States
617-253-6696 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Li Jin

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-5590 (Phone)
617-496-5271 (Fax)

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