Stealing and Empire-Building Decisions in Investment and Asset Prices

Abstract

This paper studies two main problems of conflicts of interest, stealing and empire-building decisions, and their effects on equilibrium investment and asset prices under the governance mechanism of an economy. The stealing gives higher private benefit per unit of capital but incurs direct cost. The empire-building decision provides lower private benefit without direct cost but lessens the rate of return in corporate investment. The controlling shareholder reaps private benefit from corporate investment by balancing intertemporal utility and using both conflicting decisions. In equilibrium, the consequences of both conflicts jointly determine the weighted productivity of capital after private benefits, which dictates the equilibrium investment and asset prices. When governance mechanism changes, an increase in controlling shareholder's ownership induces higher investment due to the dominant role of empire-building decision over stealing. The risk-free rate, expected growth of risky asset price and risk premium are increased with investment. When benefit from empire-building investment decrease, the investment distortion is reduced and the equilibrium investment raises. This brings growth in asset prices and risk premium. A higher investor protection keeps investment efficiency constant, but lessens private benefit. The equilibrium investment, asset prices and risk premium hence decrease, while dividend payout rises.