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A Revealed Preference Approach. To Understanding Corporate Governance Problems: Evidence From Canada

Author

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  • Chirinko, Robert S.

    (Department of Economics, Emory University)

  • Schaller, Huntley

    (Department of Economics, Carleton University)

Abstract
Empire-building by managers implies that they use a lower effective discount rate in making investment decisions. We use actual investment decisions to measure the gap between the manager’s effective discount rate and the market rate. Our empirical work is based on panel data for 193 Canadian firms. Distinctive institutional features, such as interrelated groups of Canadian firms and concentrated share ownership, allow us to quantify the sensitivity of effective discount rates and governance problems to these institutional control mechanisms. For the firms most likely to be affected by the agency problems highlighted by Jensen (1986), estimated discount rates are 350-400 basis points less than the market rate, supporting the Free Cash Flow view that unresolved corporate governance problems distort firm behavior. Firms in our sample that face Free Cash Flow problems have a stock of fixed capital approximately 7% to 22% higher than would prevail under value maximizing behavior.

Suggested Citation

  • Chirinko, Robert S. & Schaller, Huntley, 2003. "A Revealed Preference Approach. To Understanding Corporate Governance Problems: Evidence From Canada," Economics Series 135, Institute for Advanced Studies.
    • Handle: RePEc:ihs:ihsesp:135
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    File URL: https://irihs.ihs.ac.at/id/eprint/1499
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    3. Mar𨀠 Bel鮠Lozano, 2012. "Analysing the effect of excess cash accumulation on financial decisions," Applied Economics, Taylor & Francis Journals, vol. 44(21), pages 2687-2698, July.
    4. Kang, Qiang & Liu, Qiao & Qi, Rong, 2010. "The Sarbanes-Oxley act and corporate investment: A structural assessment," Journal of Financial Economics, Elsevier, vol. 96(2), pages 291-305, May.
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    6. William Mingyan Cheung & Li Jiang, 2016. "Does free cash flow problem contribute to excess stock return synchronicity?," Review of Quantitative Finance and Accounting, Springer, vol. 46(1), pages 123-140, January.
    7. Cheung, William & Lam, Keith S.K. & Tam, Lewis H.K., 2012. "Blockholding and market reactions to equity offerings in China," Pacific-Basin Finance Journal, Elsevier, vol. 20(3), pages 459-482.
    8. Xie, Linlin & Liu, Guangqiang & Liu, Boyang, 2023. "Patent pledge policy and stock price crash risk: Evidence from China," Research in International Business and Finance, Elsevier, vol. 65(C).
    9. Mª Belén Lozano García, 2011. "Analyzing the Effect of Excess Cash Accumulation on Financial Decisions," Post-Print hal-00704672, HAL.
    10. Xingwei Hu, 2020. "Sorting Big Data by Revealed Preference with Application to College Ranking," Papers 2003.12198, arXiv.org.
    11. Chirinko, Robert S. & Schaller, Huntley, 2009. "The irreversibility premium," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 390-408, April.
    12. Johnson Kakeu, 2016. "Exhaustibility and Risk as Asset Class Dimensions: A Social Investor Approach to Capital-Resource Economies," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 65(4), pages 677-695, December.
    13. Nan Zhou & Wai Yan Shum & Sze Nam Chan & Fujun Lai, 2017. "Credit Expansion, Free Cash Flow and Enterprise Investment: An Empirical Study Based on Listed Companies in China," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(9), pages 70-82, September.
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    16. William Cheung & Li Jiang, 2016. "Does free cash flow problem contribute to excess stock return synchronicity?," Review of Quantitative Finance and Accounting, Springer, vol. 46(1), pages 123-140, January.

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    More about this item

    Keywords

    Corporate governance; Business investment; Discount rates;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment

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