Shareholder Rights and the Cost of Equity Capital

46 Pages Posted: 26 Jun 2006  

Henry He Huang

Yeshiva University - Sy Syms School of Business

C.S. Agnes Cheng

Hong Kong Polytechnic University - School of Accounting and Finance

Denton Collins

Texas Tech University - School of Accounting

Date Written: February 2006

Abstract

This paper investigates the effects of firm-level shareholder rights on the cost of equity capital. Theory suggests that investors discount cash flows at a higher cost of equity capital for firms with higher agency costs, and that strong shareholder rights can potentially reduce agency costs. However, the empirical evidence is mixed on whether stronger firm-level shareholder rights actually lead to lower agency costs. Using the Gompers, Iishii and Metrick (2003) data from 1992 through 2002 in both levels and changes models of the cost of equity capital, we find that weak (strong) firm-specific shareholder rights levels are associated with higher (lower) costs of equity capital. Moreover, the market responds to changes in firm-level shareholder rights levels by adjusting the required rate of return accordingly. Further tests reveal that the effect is driven by the Protection and State shareholder rights sub-indices. Finally, we reconcile our results with those of Gompers et al. (2003) by showing that the strength of shareholder rights impacts both the ex-ante cost of equity capital and the subsequent abnormal returns.

Keywords: Shareholder rights, corporate governance, cost of equity capital

JEL Classification: G12, G34, J33

Suggested Citation

Huang, Henry He and Cheng, C.S. Agnes and Collins, Denton, Shareholder Rights and the Cost of Equity Capital (February 2006). Available at SSRN: https://ssrn.com/abstract=594505 or http://dx.doi.org/10.2139/ssrn.594505

Henry Huang (Contact Author)

Yeshiva University - Sy Syms School of Business ( email )

New York, NY 10033
United States
8322763834 (Phone)

C.S. Agnes Cheng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon, Kowloon
Hong Kong

Denton Collins

Texas Tech University - School of Accounting ( email )

Lubbock, TX 79409
United States

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