The effect of CEO ownership and shareholder rights on cost of equity capital

Purpose - The purpose of this paper is to investigate whether managerial ownership affects the association between shareholder rights and the cost of equity capital. Design/methodology/approach - Prior literature has shown that strong shareholder rights are associated with a lower level of cost of equity capital. This paper empirically tests the interaction between managerial ownership and shareholder rights on affecting the cost of equity capital, using Gompers et al.'s governance score and Ohlson and Juettner- Nauroth's estimate of cost of equity capital. To mitigate the endogeneity arising from other governance variables affecting both shareholder rights and the cost of equity capital, the paper adopts both OLS and two-stage regression. Findings - The results indicate that managerial ownership aligns managers' interests with those of shareholders, leading to a lesser degree of agency problems and lower cost of equity capital. Furthermore, the evidence suggests that managerial ownership could substitute for shareholder rights in affecting the cost of equity capital, making strong shareholder rights less important in a high managerial ownership setting. Research limitations/applications - Findings in this paper suggest that firms need to consider the interaction between managerial ownership and shareholder rights in designing their governance structure to minimize their cost of equity capital. Originality/value - This paper reveals the interaction between two major governance variables in affecting firm valuation.