Teresa Chu, University of Macau
In-Mu Haw, Texas Christian University
Lee-Seok Hwang, Seoul National University
Woody Wu, Chinese University of Hong Kong

1.
Introduction
2.
Literature Review & Hypotheses
Development
3.
Research Design & Sample
4.
Empirical Results & Interpretations
5.
Conclusions
2

Introduction
Research Questions:
 Whether the separation of ownership and control of the ultimate owner is systematically related to the firm’s cost of equity capital?
 Whether the investor protections play a corporate governance role in constraining the risk of expropriation of minority shareholders thereby reduce the increase in the cost of equity capital as induced by the ultimate ownership structure?
3





Cost of capital is the expected return of investors who supplied financial capital to firms
Market information models:
Modigliani and Miller (1958), Sharpe (1964), Fama and
French (1993 & 1995), etc.
Accounting information models:
Ohlson (1995), Gebhardt et al. (2001), Claus and
Thomas (2001), Easton (2004), Ohlson and Juettner
(2005), etc.
Gode and Mohanram (2001 & 2003), Botosan and
Plumlee (2005), Easton and Monahan (2005) and Guay et al. (2005) examine different cost of equity models but
4 find confounding results

Literature Review -
Cost of equity & corporate governance




Corporate governance emerged from concern over the principal-agent problem in corporations
Insider trading enforcement has negative and significant association with equity cost (Bhattacharya and Daouk [2002])
Firms with high quality accounting earnings can enjoy significantly lower cost of equity (Francis et al. [2004])
Both theoretical and empirical studies generally support a negative relation between disclosure levels and cost of equity (Diamond and Verrecchia [1991], Easley
O’Hara [2004], Botosan [1997], Botosan and Plumlee
[2002], Hail [2002], Chen et al. [2004], Hail and Leuz
[2006a], etc.)
5

 Ultimate owner is the shareholder who has determining voting rights and not controlled by anyone else
 Except for large firms in richest common law countries, firms are typically controlled by families or government
AND ultimate owners generally possess control rights in excess of ownership rights through group structure and management participation (La Porta et al. [1999])
 Other studies find similar phenomenon in East Asia
(Claessens et al. [2000]), Western Europe (Faccio and
Lang [2002]), Canada (Attig et al. [2002]), Sweden
(Cronqvist and Nilsson [2003]) and emerging economies (Lins [2003])
6

Literature Review
- Ultimate ownership & expropriation of minority shareholders


Concentrated ownership may lead to opportunistic incentives of ultimate owners to hold up minority investors (Shleifer and Vishny [1997])
Recent evidence of expropriation:
 Less informative accounting earnings (Fan and Wong [2002])







Income management incentives (Haw et al. [2004])
Higher dividend rates (Faccio et al. [2001] and Leung [2004])
Firm value discounts (Claessens et al. [2002], Lins [2003],
Lemmon & Lins [2003])
Lower stock returns (Baek, et al. [2004])
Higher asymmetric information costs (Attig et al. [2002] &
[2006])
Higher agency costs (Cronqvist & Nilsson [2003])
Higher external auditing costs (Fan and Wong [2005]) 7

Hypothesis One
 Outside United States, concentrated ownership and ownership-control divergence is prevalent (La Porta et al. [1999], Claessens et al. [2000], Attig et al. [2002], Faccio and
Lang [2002], Lins [2003], Cronqvist and
Nilsson [2003], etc.)
 Ultimate owners have both incentives and abilities of expropriation (Shleifer and Vishny
[1997])
 Shift agency conflicts to between controlling owners and minority investors
8

Hypothesis One - continued
 No ideal ownership structure and entrepreneurs can set up a particular organizational structure to achieve different objectives
 To provide private enforcement of property rights and confront poor judicial system (La Porta et al.
[1999])
 To preserve proprietary information and optimize decision making (Christie et al. [2003])
 Conjecture those controlling owners who obtain effective control but maintain low equity investment have incentives to expropriate
9

Hypothesis One - continued





Firm ownership structure is observable and shareholders can price-protect themselves if they expect potential divergent actions by controlling owners
Evidence shows that shareholders capitalize potential agency costs into stock price (Claessens et al. [2002],
Lins [2003] and Lemmon and Lins [2003])
Ownership-control divergence increases bid-ask spread hence higher asymmetric information costs and agency costs (Attig et al. [2002])
Big 5 auditors charge fee premium to clients with controlling owners (Fan and Wong [2005])
Detrimental effect caused by ownership-control divergence increase potential costs and should ultimately translate to higher external capital cost
10

Hypothesis One - continued
H1: Positive relationship exists between the firm’s cost of equity capital and the level of ownership-control divergence of the ultimate owner, after controlling for traditional risk factors, industry factors and country factors.
11

Hypothesis One - continued
Alternative explanations:


Firms engage in group building precisely because they suffer from capital market imperfection
 Group-affiliated firms can benefit from risk sharing, internal capital transfer, income smoothing and liquidity smoothing
(Khana and Yahef [2005] and Claessens et al. [2006])
 Internal market hypothesis is efficient in Japanese keiretsu
(Hoshi et al. [1991])
Agency problem arises from reasons unrelated to firm’s cost of equity
 Concentrated ownership alleviates free-riding problem as in dispersed shareholding (Grossman and Hart [1980] and
Shleifer and Vishny [1986])
 Agency problem is simply a side effect of monitoring
12



Investor protection is potentially useful corporate governance mechanism as it reduces power and incentives of controlling owners and makes expropriation less cost effective (La Porta et al. [2000])
Some recent evidence:





Better shareholder protection is associated with higher valuation of corporate assets (La Porta et al. [2002])
Foreign firms that cross-list in U.S. have significantly higher firm valuations (Doidge et al. [2004])
Firms in countries with strong and well-enforced outsider rights engage in less earnings management (Leuz et al. [2003])
Extra-legal investor protection outperforms legal investor protection in constraining earnings management (Haw et al.
[2004])
Both legal and extra-legal mechanisms can curb private benefits of control (Dyck and Zingales [2004])
13

Hypothesis Two & Three
 Good investor protection is expected to be able to constrain the higher equity cost as induced by the ultimate ownership structure
 Evidence shows that legal protection is directly related to cost of equity


Insider trading enforcement (Bhattachrya & Daouk
[2002]), high quality accounting standards (Francis et al. [2004]), extensive securities regulation and strong enforcement mechanism (Hail and Leuz [2006a]) are negatively associated with cost of equity
Stronger commitment to stricter corporate governance also have a significant impact on cost of
14 equity (Hail and Leuz [2006b])

Hypothesis Two & Three
- continued



Legal protection is expected to reduce cost of equity indirectly through less severe agency problem
 Less auditing and enforcement costs (Lombardo & Pagano
[2000]), decrease information asymmetry and increase stock liquidity (Brockman & Chung [2003]), less earnings management (Leuz et al. [2003] and Haw et al. [2004]) and higher firm valuation (La Porta et al. [2002], Lins [2003] and
Doidge et al. [2004])
Extra-legal investor protection can further restrain private benefits of control (Dyck and Zingales [2004] and Haw et al. [2004])
Extra legal investor protection provides auxiliary investor protection or surrogate for legal protection
15

Hypothesis Two & Three
- continued
H2: The positive relation between the firm’s cost of equity capital and the level of ownership-control divergence of the ultimate owner is less pronounced in high legal investor protection countries
Two legal institutional factors:
(1) Disclosure requirement index ( DISRE )
(2) Securities regulation index ( SECRE )
16

Hypothesis Two & Three
- continued
H3: The positive relation between the firm’s cost of equity capital and the level of ownership-control divergence of the ultimate owner is less pronounced in high extra-legal investor protection countries
Two extra-legal institutional factors:
(1) Product market competition ( MKTCOM )
(2) Tax compliance ( TAXCOM )
17

Research Design and Sample
 21 countries (9 East Asian plus 12 Western
European countries)
 1991 to 2003
 Both financial and industrial firms
 Financial data (Worldscope)
 Analysts forecasts and price (IBES international)
 Ownership structure (Claessens et al. [2000] and
Faccio & Lang [2002])
 Legal institutional variables (La Porta et al. [2006])
 Extra-legal institutional variables (Dyck & Zingales
[2004])
18

Research Design and Sample
- continued
 4 implied cost of equity models
 Claus and Thomas (2001)
 Gebhardt et al. (2001)
 Ohlson and Juettner-Nauroth (2005)
 Easton (2004)
 Final Sample consists of 8,868 firm-years (or
1,791 individual firms)
19

Research Design and Sample
- continued
Initial sample in WORLDSCOPE with sufficient data to compute SIZE , DB and ROAVAR
Less :
Insufficient data for RETVAR
Insufficient data for FBIAS
Insufficient data for r avg
No ownership data
1% of all firm-level attributes (except SIZE ), firm-years with inflation rates greater than 25% and less than 5 observations in a country-year
Final sample
Firm-years
79,586
(34,362)
(17,189)
(9,680)
(8,407)
(1,080)
8,868
20

Panel A: Distributional Statistics
Variable r
CT r
GLS r
OJ r
PEG r
AVG
N
8,894
8,968
8,923
13,374
8,868
Mean Std. Dev.
10.09% 4.13%
9.37%
11.97%
11.94%
4.37%
4.27%
5.48%
10.89% 3.91%
Min.
3.49%
2.28%
5.01%
2.92%
4.37%
Q1
7.27%
Percentile
Q2 Q3 Max.
9.40% 11.96% 31.38%
5.84% 9.03% 12.17% 24.07%
9.08% 11.10% 14.02% 32.49%
8.29% 10.89% 14.49% 40.69%
8.13% 10.26% 12.83% 28.22%
21

Panel B: Pearson Correlation Coefficients r
GLS r
OJ
Variable r
CT
0.609 *
0.810 * r
GLS
0.528 * r
PEG
0.562 * 0.465 * r
AVG
0.865 * 0.758 *
* indicates statistical significance at 1% level (two-tailed) r
OJ
0.865 *
0.938 * r
PEG
0.856 *
22

Descriptive Statistics- Table 1
13
14
15
16
9
10
11
12
17
18
19
20
21
7
8
5
6
3
4
1
2
Panel C: Sample Information, Cost of Equity Proxies and Institution Variables by Country
Country Firm-years Country-years Mean Coverage Mean r
AVG
Austria
Belgium
Finland
France
Germany
Hong Kong
Indonesia
Italy
Japan
Korea (South)
Malaysia
Norway
Philippines
Portugal
Singapore
Spain
Sweden
Switzerland
Taiwan
Thailand
UK
Total/Average
7.84%
15.72%
10.39%
12.85%
14.28%
10.07%
10.31%
10.94%
11.00%
11.05%
13.23%
11.13%
10.62%
13.41%
16.42%
9.76%
12.00%
11.19%
10.43%
14.22%
11.64%
11.83%
22.26%
18.95%
36.34%
39.08%
27.74%
39.95%
39.38%
31.03%
36.20%
48.42%
30.41%
25.60%
49.14%
42.06%
25.94%
15.27%
34.34%
3.18%
15.57%
10.81%
45.37%
31.24%
10
5
13
13
13
4
13
12
13
13
8
11
10
12
12
13
13
12
10
8
13
231
1,638
70
411
156
110
35
339
294
828
473
88
166
123
205
293
710
298
237
135
69
2,190
8,868
4.81%
3.09%
2.69%
4.35%
3.31%
3.68%
4.24%
2.78%
Standard
Deviation
3.36%
3.52%
3.97%
3.56%
3.59%
4.25%
4.12%
3.12%
3.99%
2.75%
2.69%
4.42%
3.53%
3.61%
Disclosure
Requirement
0.83
0.42
1.00
0.50
0.75
0.75
0.92
0.58
0.42
0.92
0.50
0.67
0.25
0.42
0.50
0.75
0.58
0.67
0.75
0.92
0.83
0.66
Securities
Regulation
0.89
0.55
0.84
0.50
0.47
0.55
0.78
0.43
0.21
0.81
0.59
0.46
0.18
0.34
0.49
0.58
0.45
0.48
0.64
0.62
0.73
0.55
Market
Competition
4.61
4.81
5.21
5.07
5.64
4.90
4.84
4.96
5.91
5.85
4.42
5.14
5.29
--
5.26
5.83
5.08
5.22
5.56
4.77
5.74
5.21
Tax
Compliance
1.83
2.18
5.05
1.91
4.41
3.29
4.34
3.96
3.39
4.49
3.25
3.41
3.41
4.56
2.53
1.77
3.60
--
3.53
3.86
3.47

Research Design and Sample
- continued







Traditional risk controls
SIZE = Natural log of US$ market capitalization
RETVAR = Standard deviation of monthly returns over last 12 months
DB = Total long-term debt

Total common equity
ROAVAR = Standard deviation of accounting ROA over last 5 years
FBIAS = (Mean forecast EPS
1
- Actual EPS)/Price
INFL = Expected inflation proxied by 1-year ahead realized annual inflation rate
24

Panel A: Distributional Statistics
Variable
INFL
SIZE
RETVAR
DB
ROAVAR
FBIAS
CASH
VOTE
DIV
N
8,868
8,868
8,868
8,868
8,868
8,868
8,868
8,868
8,868
Mean Std. Dev.
1.78% 1.88%
Min.
-3.20%
6.635
0.098
0.536
0.030
1.627
0.047
0.780
0.033
0.009
0.041
20.93% 19.85%
1.359
0.029
0.000
0.002
-0.061
0.00%
25.00% 20.42%
0.196
0.297
0.00%
0.000
Q1
0.60%
5.468
0.065
0.076
0.010
Percentile
Q2
1.70%
6.506
0.088
0.309
0.019
Q3
2.91%
7.723
0.118
0.679
0.036
Max.
11.88%
12.432
0.354
7.495
0.241
-0.005
0.0004
0.010
0.439
5.00% 15.00% 31.33% 100.00%
10.00%
0.000
20.00%
0.000
36.00%
0.381
100.00%
1.000
25

Panel B: Pearson Correlation Coefficients
Variable
SIZE
INFL
-0.108 *
SIZE RETVAR
RETVAR -0.052 * -0.148 *
DB -0.075 * 0.134 * 0.020 #
ROAVAR
FBIAS
CASH
0.112 *
-0.019 #
0.144 *
-0.207 *
-0.123 *
-0.229 *
0.187 *
0.158 *
0.013
DB
-0.062 *
0.063 *
-0.035 *
ROAVAR
0.052 *
0.038 *
FBIAS
0.048 *
VOTE
DIV
0.139 *
-0.172 *
-0.239 *
0.075 *
0.013
0.007
-0.032 *
0.050 *
0.031 *
-0.097 *
0.053 *
0.010
CASH
0.930 *
-0.400 *
VOTE
-0.135 *
DIV r
AVG
0.251 * -0.418 * 0.200 * 0.051 * 0.226 * 0.271 *
* and # indicate statistical significance at 1% and 10% levels (two-tailed), respectively
0.128 * 0.134 * -0.087 *
26

Empirical Results &
Interpretations
r
AVG
 
0

(


1
)
DIV

(


2
)
CASH

(


3
)
INFL

(


4
)
SIZE
(


5
)

RETVAR
 j
YEAR


(


6
)

DB
 k

(


7
)
ROAVAR
INDUSTRY
 

(


8
)
FBIAS

 l
COUNTRY

 
27

Variable
N
Intercept ?
Model 1
8,868
15.711 *
Model 2
8,868
16.095 *
Model 3
8,868
16.016 *
VOTE
DIV
CASH
INFL
SIZE
RETVAR
DB
ROAVAR
+

+
+
+

+
+
+
--
--
--
0.208 *
-0.729 *
8.028 *
0.639 *
3.222 **
0.004
--
-0.013 **
0.208 *
-0.747 *
8.001 *
0.636 *
3.147 **
--
0.295 **
-0.008 *
0.208 *
-0.745 *
7.993 *
0.634 *
3.218 **
FBIAS
Year
19.466 *
Included
19.482 *
Included
19.480 *
Included
Industry & Country
Adj. R 2
Included
43.60%
Included
43.75%
Included
43.79%
F-Statistics 150.01 * 144.70 * 144.89 *
* and ** indicate statistical significance at 1% and 5% levels (two-tailed), respectively
Model 4
13
20.588 *
--
0.277 *
-0.007 *
-2.251
-0.658 *
9.857 *
0.616 *
4.799 *
17.540 *
--
Included
48.82%
--
28

Sensitivity Analyses of Main Results
– Table 4 r
MED r
PC r
PREM r
DP r
FF
N
Intercept
DIV
CASH
INFL
Variable
?
+

+

(1)
8,858
15.446 *
0.268 #
-0.007 **
0.200 *
(2)
8,868
2.235 *
0.129 **
-0.003 *
0.092 *
(3)
8,868
14.325 *
0.252 #
-0.009 *
--
(4)
7,083
4.891 *
0.136 #
-0.003 **
0.084 **
SIZE
RETVAR
DB
ROAVAR
FBIAS g
Forecasts
Year, Industry &
Country
Adj. R 2
+
+
+
+
+/

-0.759 *
8.359 *
0.659 *
3.233 **
19.250 *
--
Included
-0.329 *
3.533 *
0.282 *
1.384 **
8.474 *
--
Included
-0.757 *
7.604 *
0.627 *
3.028 **
19.439 *
--
Included
-0.185 *
-4.402 *
-0.011
-5.556 *
--
-0.291 *
Included
42.69% 43.10% 37.44% 26.09%
F-Statistics 138.42 * 140.94 * 113.88 * 55.34 *
*, ** and # indicate statistical significance at 1%, 5% and 10% levels (two-tailed), respectively
19.57%
36.82 *
(5)
6,037
3.174 *
0.278 **
0.002
0.036
-0.006
11.676 *
0.261 *
8.925 *
--
--
Included
29

N
Sensitivity Analyses of Main Results
– Table 4
Exclude 8
Euro-in
Exclude UK
Firms
Exclude
Japanese
Exclude Asian
Firms during
Firms 1995 to 1997 countries
Variable (6)
6,214
(7)
6,678
(8)
7,230
(9)
8,224
Intercept ?
16.148 * 17.363 * 16.149 * 16.566 *
DIV
CASH
INFL
SIZE
RETVAR
DB
ROAVAR
+

+
+

+
+
0.438 **
-0.009 **
0.209 *
-0.763 *
8.557 *
0.507 *
2.826 #
0.286 #
-0.003
0.237 *
-0.781 *
6.374 *
0.717 *
4.722 **
FBIAS
Year, Industry & Country
Adj. R 2
+ 21.478 *
Included
17.082 *
Included
20.444 *
Included
47.70% 47.13% 35.94%
F-Statistics 142.64 * 127.63 * 87.31 *
*, ** and # indicate statistical significance at 1%, 5% and 10% levels (two-tailed), respectively
0.345 #
-0.009 *
0.209 *
-0.748 *
7.833 *
0.660 *
2.913 #
0.295 #
-0.008 *
0.222 *
-0.750 *
8.394 *
0.649 *
3.127 **
18.848 *
Included
41.83%
124.17 *
30

Sensitivity Analyses of Main Results
– Table 4
Group
Affiliation
Diversification External
Capital Need
Financial
Constraint
2-stage
Regressions
N
Variable
Intercept ?
(10)
3,333
15.786 *
DIV
CASH
+

0.377 **
0.017 **
Additional variable +/

-0.0008
INFL
SIZE
RETVAR
DB
ROAVAR
FBIAS
+

+
+
+
+
0.355 *
-0.833 *
5.889 *
0.725 *
5.166 **
17.038 *
(11)
8,523
15.774 *
0.340 **
-0.006 **
0.065 *
0.217 *
-0.760 *
7.892 *
0.611 *
3.439 **
19.409 *
(12)
7,720
16.127 *
0.369 **
(13)
8,422
17.135 *
0.324 **
-0.006 ** -0.006 **
0.000
0.230 *
-0.741 *
8.061 *
0.642 *
3.162 **
20.218 *
-1.159 *
0.218 *
-0.717 *
7.290 *
0.608 *
1.441
19.684 *
(14)
4,651
16.204 *
2.851 #
-0.004
--
0.078
-0.732 *
6.171 *
0.768 *
3.658
15.684 *
Year, Industry &
Country
Adj. R 2
Included
56.62%
Included
44.10%
Included
43.10%
Included
44.75%
F-Statistics 118.54 * 138.21 * 120.33 * 140.18 *
*, ** and # indicate statistical significance at 1%, 5% and 10% levels (two-tailed), respectively
Included
49.34%
95.33 *
31

Sensitivity Analyses of Main Results
– Table 4
Foreign Listing Big-5 Auditor CIFAR
N
Intercept
Variable
?
(15)
8,518
16.277 *
(16)
8,488
16.042 *
DIV
CASH
Additional variable
INFL +

+
+

+/

0.378 **
-0.006 **
0.514 *
0.218 *
0.354 **
-0.007 **
-0.061
0.197 *
SIZE
RETVAR
DB
-0.797 *
7.819 *
0.621 *
-0.732 *
7.758 *
0.629 *
ROAVAR
FBIAS
+
+
+
2.975 **
19.403 *
3.490 **
19.420 *
Year, Industry & Country
Adj. R 2
Included
44.22%
Included
43.76%
F-Statistics 138.81 * 135.78 *
*, ** and # indicate statistical significance at 1%, 5% and 10% levels (two-tailed), respectively
(17)
1,283
8.290 *
0.474 #
0.026 *
0.031 **
0.256 *
-0.000 *
18.329 *
0.533 *
-0.583
11.836 **
Included
51.71%
30.85 *
32

Empirical Results &
Interpretations - continued
 Ownership-control divergence of the ultimate owner has a positive and significant relation with the cost of equity capital
 Cash-flow rights of the ultimate owner has a negative and significant relation
 Results are robust to alternative cost of equity proxies, sub-samples, specifications and with/without potentially correlated omitted variables
33

Empirical Results &
Interpretations - continued
 To test H2 and H3, full sample is split into subsamples using partitioning variables
 Sub-sample equals low for countries with less than or equal to the median index values of 49 countries
(La Porta et al. [2006]) and 39 countries (Dyck &
Zingales [2004])
 Run separate regression of the main model for each sub-sample
34

N
Disclosure Requirement Securities Regulation
Variable Low
2,320
High
6,548
Low
3,944
High
4,924
Intercept ?
17.526 * 15.701 * 16.216 * 14.971 *
DIV
CASH
INFL
SIZE
RETVAR
DB
ROAVAR
+

+

+
+
+
0.559 #
-0.005
-0.165
-0.792 *
7.907 *
0.873 *
5.065 #
0.234
-0.009 **
0.241 *
-0.744 *
8.114 *
0.542 *
2.475
FBIAS
Year, Industry & Country
Adj. R 2
+ 16.698 *
Included
38.33%
20.359 *
Included
45.59%
15.459 *
Included
47.36%
F-Statistics 41.03 * 141.66 * 99.53 *
*, ** and # indicate statistical significance at 1%, 5% and 10% levels (two-tailed), respectively
0.348 **
-0.006
0.004
-0.745 *
8.193 *
0.695 *
4.374
0.297
-0.008 **
0.249 *
-0.751 *
7.314 *
0.562 *
2.539
22.591 *
Included
36.94%
74.96 *
35

N
Market Competition Tax Compliance
Variable Low
1,531
High
7,132
Low
1,196
High
7,467
Intercept ?
19.029 * 14.142 * 16. 397 * 15.550 *
DIV
CASH
INFL
SIZE
RETVAR
DB
ROAVAR
+

+

+
+
+
1.071 **
-0.007
0.122
-0.859 *
3.792 #
0.543 *
3.126
0.196
-0.008 **
0.226 *
-0.733 *
8.419 *
0.648 *
3.160 #
FBIAS
Year, Industry & Country
Adj. R 2
+ 22.089 *
Included
42.74%
19.133 *
Included
43.10%
15.666 *
Included
46.08%
F-Statistics 32.73 * 143.12 * 30.17 *
*, ** and # indicate statistical significance at 1%, 5% and 10% levels (two-tailed), respectively
0.834 #
-0.005
0.048
-0.865 *
3.586
0.655 *
9.650 *
0.230
-0.008 *
0.214 *
-0.728 *
8.144 *
0.628 *
2.117
20.233 *
Included
43.39%
147.76 *
36

Empirical Results &
Interpretations - continued
 To further support H2 and H3, introduce the legal and extra-legal institutional variables into the regressions r
AVG
 
0

(


1
)
DIV

(


2
)
DIV

INSTITUTIO N

(


3
)



(


4
)
(


6
)

(
11

)
CASH
INFL

FBIAS

(


5
)
CASH

INSTITUTIO N
(


7
)

SIZE
 

(


8
) j
YEAR
RETVAR


(


9
)
DB
  k
INDUSTRY
 
(
10

)
 
INSTITUTIO N
ROAVAR
INSTITUTION = (1) DISRE (2) SECRE (3) MKTCOM (4) T AXCOM
37

Disclosure Requirement Securities Regulation
Variable (1)
8,868
(2)
8,868 N
11.779 *
1.266 **
Intercept
DIV
DIV

DISRE
DIV

SECRE
_
_
_
_
?
+
13.527 *
2.454 *
-3.931 *
DISRE
SECRE
0.495
CASH
CASH

DISRE
CASH

SECRE
_
_
_
-0.007
0.012
Year & Industry
Adj. R 2
Included
33.85%
F-Statistics 147.38 *
* and ** indicate statistical significance at 1% and 5% levels (two-tailed), respectively
-2.359 **
3.346 *
0.027 *
-0.042 *
Included
34.29%
150.28 *
38

Market Competition Tax Compliance
Variable (1)
8,663
(2)
8,663 N
14.436 *
2.778 **
Intercept
DIV
DIV

MKTCOM
DIV

TAXCOM
MKTCOM
?
+
_
_
_
9.225 *
13.048 *
-2.396 *
0.903 *
TAXCOM
CASH
CASH

MKTCOM
CASH

TAXCIN
_
_
_
0.034
-0.006
_
Year & Industry
Adj. R 2
F-Statistics
Included
33.93%
144.51 *
* and ** indicate statistical significance at 1% and 5% levels (two-tailed), respectively
-0.757 *
-0.120
-0.041 *
0.011*
Included
34.01%
145.03 *
39

Empirical Results &
Interpretations - continued
 DIV is always significant and positive in the low legal or extra-legal investor protection samples
 Magnitude of DIV in low sub-sample is always larger than the one in high sub-sample
 DIV and the interaction between the legal or extralegal investor protection are always significant with predicted signs
 Both analyses support Hypotheses Two and Three in that the positive relation between the ownershipcontrol divergence of the ultimate owner and the cost of equity is less pronounced in strong legal or extra-legal investor protection countries
40

Conclusions


Regression results suggest that the ownershipcontrol divergence of the ultimate owner is associated with a significant increase in firm’s cost of equity capital, even after controlling for traditional risk, industry and country factors
The increase in cost of equity capital as motivated by the ownership-control divergence of the ultimate owner is significantly limited in countries with extensive prospectus disclosure requirements, effective securities regulation enforcement, intense product market competition and strong disciplinary power of the taxing authority
41

Conclusions - continued
 Contributions





Direct evidence on relationship between risk of expropriation of minority shareholders and the firm’s cost of equity capital
Isolate cost of capital effects from cash flow effects and supplement prior findings on why firm value declines when control rights exceed ownership rights
Examine sole effect and interaction effect of internal and external forces on the cost of equity
Firm-level variables should contribute more robust results
Empirical evidence on effectiveness of the implied cost of capital models outside U.S.
42

Conclusions - continued
 Limitations and future research
 Measurement errors may exist in the cost of equity proxies
 Exclude firms with negative earnings forecasts
 Possible selection bias as sample only includes firms with IBES forecasts
 Introduce ultimate ownership variables only modestly increase the explanatory power for variations in the cost of equity capital
43

What is Rule of Law?
France: Everything is permitted
( except what is prohibited)
Germany: Everything is prohibited
Italy:
( except what is permitted)
Everything is permitted
( including what is prohibited)
Russia: Everything is prohibited
( including what is permitted)
China: ?
44