Research Articles

Investor Protection, Equity Returns, and Financial Globalization

Mariassunta Giannettia1 and Yrjö Koskinena2

a1 Stockholm School of Economics, CEPR, and ECGI, Sveavägen 65, Box 6501, SE-113 83, Stockholm, Sweden.

a2 Boston University School of Management and CEPR, 595 Commonwealth Ave., Boston, MA 02215.


We study the effects of investor protection on stock 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. 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. Thus, stocks have lower expected returns when investor protection is weak. This has implications for domestic and foreign investors’ stockholdings. In particular, we show that portfolio investors’ participation in the domestic stock market and home equity bias are positively related to investor protection and provide original evidence in their support.


We thank Franklin Allen, Hendrik Bessembinder (the editor), Arturo Bris, Mike Burkart, Karl Lins, Marco Pagano, Frank Warnock (the referee), and seminar participants at the EFA meetings, the Darden Conference on “Emerging Markets: Innovation in Portfolio Management,” the ECB Conference on “Capital Markets and Financial Integration,” the CEPR Conference on the “Evolution of Corporate Governance and Family Firms” at INSEAD, the Assurant/Georgia Tech Conference on International Finance, the CIBER Conference at UCLA Anderson School of Management, the 4th Asian Corporate Governance Conference in Seoul, the Shanghai Corporate Governance Conference, Boston College, the Stockholm School of Economics, Universidad Carlos III, Indiana-Bloomington, Norwegian School Management, Ivey School of Business, and HEC Lausanne for comments on an earlier version of this paper. We are also grateful to David Parsley for providing the distance data. The authors acknowledge financial support from the Bank of Sweden Tercentenary Foundation and the Tom Hedelius and Jan Wallander Foundation.