TAILIEUCHUNG - Shareholder Protection, Stock Market Development, and Politics

The risk-return profile of callable (non-amortizing) and prepayable (amortizing) securities is therefore not symmetrical. Investors in these securities have limited upside price potential. Investors are not willing to pay large premium prices for assets that can be called. Investors use the term “price compression” to refer to the inability of such securities to trade at prices significantly above par. However, these securities can have significant downside price potential. To compensate investors for this asymmetric and unfavorable risk profile, callable and prepayable securities must offer higher yields. The following table summarizes callable and. | Shareholder Protection Stock Market Development and Politics Marco Pagano Università di Napoli Federico II Paolo Volpin London Business School December 2005 Abstract This paper presents a political economy model where there is mutual feedback between investor protection and stock market development. Better investor protection induces companies to issue more equity and thereby leads to a broader stock market. In turn equity issuance expands the shareholder base and increases support for shareholder protection. This feedback loop can generate multiple equilibria with investor protection and stock market size being positively correlated across equilibria. The model s predictions are tested on panel data for 47 countries over 1993-2002 controlling for country and year effects and endogeneity issues. We also document international convergence in shareholder protection to best-practice standards and show that it is correlated with cross-border M A activity consistent with the model. JEL classification G34 K22 K42. Keywords political economy shareholder protection corporate governance stock market development. Authors addresses Marco Pagano Facoltà di Economia Università di Napoli Federico II Via Cintia 80126 Napoli Italy phone 39-081-5752508 fax 39-081-5752243 e-mail mrpagano@. Paolo Volpin Institute of Finance and Accounting London Business School Regent s Park London NW1 4SA . phone 44-20-72625050 fax 44-20-77243317 email pvolpin@. Acknowledgements We thank Abhijit Banerjee Alberto Bennardo Mike Burkart Tullio Jappelli Riccardo Martina Ashoka Mody Marco Pagnozzi Luigi Spaventa Jean Tirole Elu von Thadden and other participants to seminars at the Stockholm School of Economics the Cass Business School the University of Bristol and at the 2005 EEA 2005 CSEF-IGIER Symposium on Economics and Institutions for insightful comments and suggestions. Marco Pagano acknowledges financial support by the Fondazione IRI. 1 1. Introduction A central idea of corporate

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