Agency Conflicts, Investment and Asset Pricing
62 Pages Posted: 27 Jul 2005
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Agency Conflicts, Investment, and Asset Pricing
Agency Conflicts, Investment, and Asset Pricing
Date Written: March 2005
Abstract
Corporations in most countries are run by controlling shareholders whose cash flow rights are substantially smaller than their control rights in the firm. This separation of ownership and control allows the controlling shareholders to pursue private benefits at the cost of outside minority investors by diverting resources away from the firm and distorting corporate investment and payout policies. We develop a dynamic stochastic general equilibrium asset-pricing model that acknowledges the implications of agency conflicts through imperfect investor protection on security prices. We show that countries with weaker investor protection have more overinvestment, lower market-to-book equity values, larger expected equity returns and return volatility, higher dividend yields, and higher interest rates. These predictions are consistent with empirical findings. We develop new predictions: countries with high investment-capital ratios have both higher variance of GDP growth and higher variance of stock returns. We provide evidence consistent with these hypotheses. Finally, we show that weak investor protection causes significant wealth redistribution from outside shareholders to controlling shareholders.
Keywords: Asset prices, heterogeneous agents, agency, corporate governance, investor protection, volatility, overinvestment
JEL Classification: G12, G31, G32, G34
Suggested Citation: Suggested Citation
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