Investor Protection and the Demand for Equity

50 Pages Posted: 13 Jun 2003

See all articles by Mariassunta Giannetti

Mariassunta Giannetti

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

Yrjo Koskinen

Haskayne School of Business, University of Calgary; European Corporate Governance Institute (ECGI)

Date Written: August 2005


Anecdotal evidence suggests that investor protection affects the demand for equity, but existing theories emphasize only the effect of investor protection on the supply of equity. We build a model showing that the demand for equity is important in explaining stock market development. If the level of investor protection is low, wealthy investors have an incentive to become controlling shareholders, because they can earn additional benefits by expropriating outside shareholders. In equilibrium, since the market price reflects the demand from both controlling and outside shareholders, the stock price of weak corporate governance stocks is not low enough to fully discount the extraction of private benefits. This generates the following empirical implications. First, stocks have lower expected return when investor protection is weak. Second, differences in stock market participation rates across countries, home equity bias and flow of foreign direct investment depend on investor protection. Finally, we uncover a good country bias in investment decisions as portfolio investors from countries with low level of investor protection hold relatively more foreign equity. We provide novel international evidence on stock market participation rates, and on holdings of domestic and foreign stocks consistent with the predictions of the model.

Keywords: Investor Protection, Private Benefits of Control, Portfolio Choice, Home Equity Bias, Limited Participation

JEL Classification: G11, G32, G38, F21, F36

Suggested Citation

Giannetti, Mariassunta and Koskinen, Yrjo J, Investor Protection and the Demand for Equity (August 2005). European Corporate Governance Institute (ECGI) Research Paper No. 64/2004, Available at SSRN: or

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

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Centre for Economic Policy Research (CEPR)

United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
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Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm

Yrjo J Koskinen

Haskayne School of Business, University of Calgary ( email )

SH 154, 2500 University Drive NW
Calgary, Alberta T2N 1N4
+1-403-220-5540 (Phone)

HOME PAGE: http://

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat

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