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The separation of ownership and control allows controlling shareholders to pursue private benefits. We develop an analytically tractable dynamic stochastic general equilibrium model to study asset pricing and welfare implications of imperfect investor protection.
Consistent with empirical evidence, the model predicts that countries with weaker investor protection have more incentives to overinvest, lower Tobin's q, higher return volatility, larger risk premium, and higher interest rate. Calibrating the model to the Korean economy reveals that making investor protection perfect increases the stock market's value by 22%, a gain for which outside shareholders are willing to pay 11% of their capital stock.
The firms listed on the stock market in aggregate contribute less to total non-farm employment and GDP now than in the 1970s. A major reason for this...