Equity Prices and the Risk of Expropriation: An Analysis of the Italian Stock Market

Abstract

Abstract We relate stock returns and asset values of closely held Italian listed companies to a measure of the risk of expropriation faced by minority shareholders. The risk of expropriation is measured using proxies for the power and the incentive to divert resources from the company by the controlling shareholder. We fi nd that a high risk of expropriation does not affect stock returns, while it has a quite strong negative impact on fi rm value when the ultimate owner is either the State or a family. These evidences are consistent with the model of Jensen and Meckling (1976), suggesting that rational investors require a price discount when they buy stocks issued by closely held companies whose controlling shareholder has both the power and the incentive to divert resources from the fi rm, and that, in equilibrium, the price discount is large enough to compensate for the expected diversion. These results have important policy implications, as they indicate that disclosure rules on ownership and governance structures are the only measures that really matter for investor protection, while statutory provisions that restrict companies freedom in choosing the desired ownership structure (through pyramiding or issuing of non voting shares) are at best useless.