Corporate Governance and Corporate Risk Taking: Theory and Evidence

60 Pages Posted: 15 Mar 2006

See all articles by Lubomir P. Litov

Lubomir P. Litov

University of Oklahoma - Michael F. Price College of Business; University of Pennsylvania - Wharton Financial Institutions Center

Kose John

New York University (NYU) - Department of Finance

Bernard Yin Yeung

National University of Singapore - Business School

Multiple version iconThere are 5 versions of this paper

Date Written: January 27, 2006

Abstract

This paper examines the relationship between investor protection and corporate insiders' incentive to take value-enhancing risks. In a poor investor protection environment corporations are often run by entrenched insiders who appropriate considerable corporate resources as personal benefits. When these private benefits are large, insiders may undertake sub-optimally conservative investment decisions to preserve them. Better investor protection reduces these private benefits and may therefore induce riskier but value enhancing investment policy. Such a relationship can also result from risk-averse behavior on the part of dominant shareholders with undiversified exposure in their own firms, which is again more prevalent in countries with poorer investor protection. If prominent non-equity stakeholders such as banks, labor unions or the government can influence corporate investment, and their influence is decreasing in investor protection, that can also give rise to a positive relationship between investor protection and investment risk. We test these predictions using a large cross-country panel. We find strong empirical confirmation that corporate risk-taking and firm growth rates are positively related to the quality of investor protection. On the other hand, the data do not lead to consistent evidence for the alternative channels.

Keywords: Corporate Governance, Investor Protection, Managerial Incentives

JEL Classification: G15, G31, G34

Suggested Citation

Litov, Lubomir P. and John, Kose and Yeung, Bernard Yin, Corporate Governance and Corporate Risk Taking: Theory and Evidence (January 27, 2006). AFA 2007 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=890915 or http://dx.doi.org/10.2139/ssrn.890915

Lubomir P. Litov (Contact Author)

University of Oklahoma - Michael F. Price College of Business ( email )

307 West Brooks
Norman, OK 73019-4004
United States

University of Pennsylvania - Wharton Financial Institutions Center

2306 Steinberg Hall-Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Bernard Yin Yeung

National University of Singapore - Business School ( email )

15 Kent Ridge Drive
BIZ 1 Level 6
Singapore, 119245
Singapore
65 6516 3075 (Phone)
65 6779 1365 (Fax)

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