The purpose of this paper is to investigate the effects of individual provisions of firm‐level shareholder rights on the cost of equity capital in the USA setting.
Prior literature has shown that strong shareholder rights, as measured by aggregated shareholder rights indices, could mitigate the agency costs and reduce the cost of equity capital. Stepwise regression method with control variables for financial risks and corporate governance risks is used to empirically test whether individual shareholder rights provisions have varying degrees of impacts on a firm's cost of equity capital.
Of the 24 shareholder rights provisions in the shareholder rights index, four provisions are found to be the most significant determinants of cost of equity capital with the absence of three provisions (poison pill, golden parachute, and control share cash out) and the presence of fair value provision reducing the firm's cost of equity capital.
First, the results suggest that a few individual provisions are major determinants of firm value. Hence, investors and regulators should pay the most attention to these provisions. Second, the result that some provisions that limit shareholders' rights actually reduce cost of equity capital suggests that investors and regulators should not view all aspects of weak shareholder rights negatively.
This paper tests the impact of shareholder rights on cost of equity capital from an individual provision basis.
