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Investor Protection, Equity Returns, and Financial Globalization

Published online by Cambridge University Press:  26 November 2009

Mariassunta Giannetti  and
Yrjö Koskinen
Mariassunta Giannetti
Affiliation:
Stockholm School of Economics, CEPR, and ECGI, Sveavägen 65, Box 6501, SE-113 83, Stockholm, Sweden. mariassunta.giannetti@hhs.se
Yrjö Koskinen
Affiliation:
Boston University School of Management and CEPR, 595 Commonwealth Ave., Boston, MA 02215. yrjo@bu.edu
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Abstract

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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 1 , February 2010 , pp. 135 - 168
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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