Corporate Governance and Managerial Risk-Taking: Theory and Evidence

Abstract

We study how the investor protection environment affects corporate managers' incentives to take value-enhancing risks. In our model, the manager chooses higher perk consumption when investor protection is low. Since perks represent a priority claim held by the manager, lower investor protection leads the manager to implement a sub-optimally conservative investment policy, effectively aligning her risk-taking incentives with those of the debt holders. By the same token, higher investor protection is associated with riskier investment policy and faster firm growth. We test these predictions in a large Global Vantage panel. We find strong empirical confirmation that corporate risk-taking and firm growth rates are positively related to the quality of investor protection.

Keywords: Corporate Governance, Investor Protection, Managerial Incentives

JEL Classification: G15, G31, G34