#07-06
Corporate Governance and Risk Taking
Kose John, Lubomir Litov, and Bernard Yeung, April 2007
Abstract: This paper examines the relationship between investor protection and corporate insiders’
incentive to take value-enhancing risks. In a poor investor protection environment corporations
are often run by entrenched insiders who appropriate considerable corporate resources as
personal benefits. When these private benefits are large, insiders may undertake sub-optimally
conservative investment decisions to preserve them. Better investor protection reduces these
private benefits and may therefore induce riskier but value enhancing investment policy. Such a
relationship can also result from risk-averse behavior on the part of dominant shareholders with
undiversified exposure in their own firms, which is again more prevalent in countries with poorer
investor protection. If prominent non-equity stakeholders such as banks, labor unions or the
government can influence corporate investment, and their influence is decreasing in investor
protection, that can also give rise to a positive relationship between investor protection and
investment risk. We test these predictions using a large cross-country panel. We find empirical
confirmation that corporate risk-taking and firm growth rates are positively related to the quality
of investor protection. On the other hand, the data do not lead to consistent evidence for the
alternative channels.
Keywords: Corporate Governance, Investor Protection, Managerial Incentives.
JEL classifications :G15, G31, G34..
