Investor Protection And The Cost Of Equity

The cost of equity is one of the earlist topics in finance research and is still a much-debated topic over the last five decades. Researchers have found that the cost of equity is affected not only by firm financial characteristics but also by macroeconomic variables. With the theory of information asymmetry and agency cost, institutional factors of firm level disclosure and corporate governance are also considered to have important impact on the cost of equity. Recently, in the framework of"Law and Finance", investor protection, one of the country level institutional factors, has been introduced into the cost of equity studies.Security markets all over the world abide by the principles of establishing regulations of investor protection in order to keep investor's confidence, to lower the cost of equity, and to improve the efficiency of capital resources allocation. As the emerging Chinese stock market in a transitional economy, investor protection, which is critical to the market's survival and development, is the core of the work of security regulators. Whether the cost of capital can be lowered by investor protection is therefore a practical issue in the global capital market.Despite the importance of the relationship between investor protection and the cost of equity, research on this issue is still rare. Although research in other areas do sporadically address the issue, integrated and appropriate analytical framewok, systemic and logical research process, and full and accurate empirical evidence are still in demand.This paper, therefore, attempts to address the issue of the relationship between investor protection and the cost of capital. The paper begins with a literature review, followed by theoretical analyses, and the empirical research. It is divided into eight chapters.Chapter 1 briefly introduces the issues, contents, and framework, as well as the contributions of the paper to research in this area.Chapter 2 gives an overview of the literature of the cost of equity, traces the oringins of the studies of the cost of equity and then postulates that investor protection is a potential institutional factor that influences the cost of equity.Chapter 3 reviews some theoretical viewpoints that are from different perspectives, then design a simple but general model of game theory to show how the cost of equity is affected by investor protection.Chapter 4 explores the institutional background for investor protection in China, including the evolvement of the law and the status of the enforcement, and then gives a comparison of the law and the enforcement of investor protection between Chinese mainland, Hongkong and the other countries in the world.Chapter 5 examines the effect of the law of investor protection on the cost of equity. Using the time series data in Chinese stock market, this paper tests whether the cost of equity will become lower as a result of the establishment of the law.Chapter 6 examines the effect of the enforcement of investor protection on the cost of equity. Using typical event and the cross-section data in Chinese stock market, this paper tests the influence on the cost of capital through the enforcement of investor protection.Chapter 7 examines the effect of the institution of investor protection as a whole on the cost of equity. Using the cross-listing data, this paper tests whether the difference of investor protection between Chinese mainland and Hongkong will result in different cost of equity.Chapter 8 concludes the research and points out the future areas of the research. The conclusions of this research are as follows.Firstly, the law of investor protection generally lowers the cost of equity. However, with the ineffective enforcement, such effect is limited and only significant in the second stage of the whole process.Secondly, with the relatively well-developed law, the enforcement of investor protection can significantly lower the cost of equity.Finanlly, in Chinese mainland stock market, the listed companies with H shares have lower cost equity than those only offer shares and go public domestically.The results justify that the cost of equity is affected by investor protection. While the improvement of the law itself has only limited effect, the enforcement can act as a creditable threat and the combination of sound law and effective enforcement can reduce the cost of equity significantly.The major contributions and innovations of this paper are in the following aspects:In the literature review, this paper integrates the literature in the areas of finance and accounting by focusing on the cost of equity, then traces the origin of the research and points out the direction of future studies.In the theoretical analyses, this paper induces the implied academic viewpoints from three different perspectives, then designs a simple model of game theory. The model provides a more general explanation how the cost of equity is affected by investor protection and thus contributes to the theory.In the empirical study, this paper tests the relationship between investor protection and the cost of capital systemically using the data within one country and provides meaningful evidence for the research of the cost of equity and"Law and Finance".The main limitation of this paper is that the model in this paper is still na?ve and the future study is to find a new measurement model for the cost of equity.