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A revealed preference approach to understanding corporate governance problems: Evidence from Canada

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  • Chirinko, Robert S.
  • Schaller, Huntley

Abstract

By studying the gap between the discount rates used by executives and shareholders, we assess the extent to which governance problems distort firm behavior. The estimation strategy recovers discount rates used by executives from the pattern of their actual investment spending. Our empirical work is based on panel data for 193 Canadian firms. For the firms most likely to be affected by Free Cash Flow agency problems, investment behavior appears to be guided by discount rates that are less than the market rate by 350-400 basis points. This wedge is reduced for firms with a concentrated ownership structure. Firms in our sample facing Free Cash Flow problems have a stock of fixed capital approximately 7 per cent to 22 per cent higher than would prevail under value maximizing behavior.
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  • Chirinko, Robert S. & Schaller, Huntley, 2004. "A revealed preference approach to understanding corporate governance problems: Evidence from Canada," Journal of Financial Economics, Elsevier, vol. 74(1), pages 181-206, October.
    • Handle: RePEc:eee:jfinec:v:74:y:2004:i:1:p:181-206
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    3. Mar𨀠 Bel鮠Lozano, 2012. "Analysing the effect of excess cash accumulation on financial decisions," Applied Economics, Taylor & Francis Journals, vol. 44(21), pages 2687-2698, July.
    4. Kang, Qiang & Liu, Qiao & Qi, Rong, 2010. "The Sarbanes-Oxley act and corporate investment: A structural assessment," Journal of Financial Economics, Elsevier, vol. 96(2), pages 291-305, May.
    5. Martin Holmén & Peter Högfeldt, 2009. "Pyramidal Discounts: Tunneling or Overinvestment?," International Review of Finance, International Review of Finance Ltd., vol. 9(1‐2), pages 133-175, March.
    6. William Mingyan Cheung & Li Jiang, 2016. "Does free cash flow problem contribute to excess stock return synchronicity?," Review of Quantitative Finance and Accounting, Springer, vol. 46(1), pages 123-140, January.
    7. Cheung, William & Lam, Keith S.K. & Tam, Lewis H.K., 2012. "Blockholding and market reactions to equity offerings in China," Pacific-Basin Finance Journal, Elsevier, vol. 20(3), pages 459-482.
    8. Xie, Linlin & Liu, Guangqiang & Liu, Boyang, 2023. "Patent pledge policy and stock price crash risk: Evidence from China," Research in International Business and Finance, Elsevier, vol. 65(C).
    9. Mª Belén Lozano García, 2011. "Analyzing the Effect of Excess Cash Accumulation on Financial Decisions," Post-Print hal-00704672, HAL.
    10. Xingwei Hu, 2020. "Sorting Big Data by Revealed Preference with Application to College Ranking," Papers 2003.12198, arXiv.org.
    11. Chirinko, Robert S. & Schaller, Huntley, 2009. "The irreversibility premium," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 390-408, April.
    12. Johnson Kakeu, 2016. "Exhaustibility and Risk as Asset Class Dimensions: A Social Investor Approach to Capital-Resource Economies," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 65(4), pages 677-695, December.
    13. Nan Zhou & Wai Yan Shum & Sze Nam Chan & Fujun Lai, 2017. "Credit Expansion, Free Cash Flow and Enterprise Investment: An Empirical Study Based on Listed Companies in China," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(9), pages 70-82, September.
    14. Michael K. Fung, 2009. "Is Innovativeness a Link between Pay and Performance?," Financial Management, Financial Management Association International, vol. 38(2), pages 411-429, June.
    15. Hong Bo & Ciaran Driver, 2012. "Agency Theory, Corporate Governance and Finance," Chapters, in: Michael Dietrich & Jackie Krafft (ed.), Handbook on the Economics and Theory of the Firm, chapter 11, Edward Elgar Publishing.
    16. William Cheung & Li Jiang, 2016. "Does free cash flow problem contribute to excess stock return synchronicity?," Review of Quantitative Finance and Accounting, Springer, vol. 46(1), pages 123-140, January.

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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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