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Investor protection effects on corporate liquidity and the cost of capital

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  • Monish Chhabra
  • Stephen Ferris
  • Nilanjan Sen

Abstract

Studies by LaPorta et al. (2000, 2002) show that the strong protection of investor rights encourage the development of capital markets and are associated with higher levels of firm valuation as measured by Tobin's Q. Related research finds that well-developed capital markets produce higher rates of economic growth and allocate capital more efficiently. These studies fail, however, to explain how the investor protection environment produces higher firm values or facilitates the more efficient allocation of investment capital. Using a sample of 158 ADRs representing 26 different countries, this study provides such a linkage by examining the effect of investor protection levels on share liquidity and the firm's cost of capital. We find that lower levels of investor protection reduce share liquidity while simultaneously resulting in a higher cost of equity capital. The combination of less liquidity with a higher cost of capital suggests an explanation for the lower values observed for firms incorporated in countries with fewer investor protections.

Suggested Citation

  • Monish Chhabra & Stephen Ferris & Nilanjan Sen, 2009. "Investor protection effects on corporate liquidity and the cost of capital," Applied Economics Letters, Taylor & Francis Journals, vol. 16(8), pages 819-826.
    • Handle: RePEc:taf:apeclt:v:16:y:2009:i:8:p:819-826
    DOI: 10.1080/13504850701221915
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    References listed on IDEAS

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    1. Klapper, Leora F. & Love, Inessa, 2004. "Corporate governance, investor protection, and performance in emerging markets," Journal of Corporate Finance, Elsevier, vol. 10(5), pages 703-728, November.
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    Cited by:

    1. Hu, Jun & Long, Wenbin & Dai, Ming & (Troy) Yao, Daifei, 2022. "Does international experience of managers bring financing benefits? Evidence from the cost of equity capital," Journal of Contemporary Accounting and Economics, Elsevier, vol. 18(1).
    2. Ivan Miroshnychenko & Stefano Bozzi & Roberto Barontini, 2019. "Firm Growth and Legal Environment," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 48(1), February.
    3. Persakis, Anthony & Iatridis, George Emmanuel, 2017. "The joint effect of investor protection, IFRS and earnings quality on cost of capital: An international study," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 46(C), pages 1-29.

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