Investor Protection, Equity Returns and Financial Globalization

58 Pages Posted: 7 Nov 2006 Last revised: 27 Oct 2008

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

Multiple version iconThere are 2 versions of this paper

Date Written: March 2008

Abstract

We study the effects of investor protection on equilibrium stock prices, returns and portfolio allocation decisions. In our theoretical model, if investor protection is weak, wealthy investors have an incentive to become controlling shareholders. In equilibrium, the stock price reflects the demand from both controlling shareholders and portfolio investors. As a consequence, due to the high demand from controlling shareholders, the 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 should have lower expected returns when investor protection is weak. Second, domestic and foreign investors' participation in the stock market should be lower in countries with weak investor protection. Third, portfolio investors from countries with weak investor protection should hold relatively more foreign equity. Fourth, countries with weak investor protection should receive relatively more foreign direct investment. We show that these implications are consistent with existing empirical studies and we provide original evidence that domestic portfolio investors are less likely to participate in the domestic stock market and hold more foreign equity, when investor protection is weak.

Keywords: G11, G32, G38, F21, F36

JEL Classification: Investor Protection, Stock Returns

Suggested Citation

Giannetti, Mariassunta and Koskinen, Yrjo J, Investor Protection, Equity Returns and Financial Globalization (March 2008). Available at SSRN: https://ssrn.com/abstract=942513 or http://dx.doi.org/10.2139/ssrn.942513

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
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SE-113 83 Stockholm
Sweden
+46 8 736 9607 (Phone)
+46 8 312 327 (Fax)

HOME PAGE: http://sites.google.com/site/mariassuntagiannetti/Home

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Yrjo J Koskinen

Haskayne School of Business, University of Calgary ( email )

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

HOME PAGE: http://haskayne.ucalgary.ca/haskayne_info/profiles/yrjo-koskinen

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