Cost of equity capital, control divergence, and institutions: the international evidence

• DOI: 10.1007/s11156-013-0383-7
• Publication Date: 2013-06-13T03:23:33Z
• Authors: Teresa Chu; In-Mu Haw; Bryan Byung-Hee Lee; Woody Wu
• Keywords: Equity; Corporate Finance; Cost of equity; Divergence (linguistics); Agency cost

This study investigates the governance role of a country’s legal and extra-legal institutions in explaining the variations in firms’ cost of equity capital induced by concentrated ownership structures from 21 countries. Using four implied cost of equity proxies, the results show that the large ownership-control divergence of the ultimate owner has a positive and significant impact on the firm’s cost of equity capital. The finding lends support to the entrenchment effect in that the concentrated ownership structure increases the firm’s external financing cost. Further analyses demonstrate that the higher equity cost induced by the ultimate ownership structure is significantly reduced by a country’s stronger legal and extra-legal institutions, highlighting the governance role played by a country’s institutions in reducing the firm’s external financing cost.