Investor Protection and Equity-Holdings: An Explanation of Two Puzzles?

Abstract

We develop a model where wealthy investors have an incentive to become controlling shareholders because they can earn additional benefits by expropriating outside shareholders. As a consequence, in countries where minority investor rights are poorly protected, both domestic and foreign portfolio investors have a disincentive to hold stocks. The model implies that the differences in stock market participation rates across countries and the pervasiveness of home equity bias depend on the degree of investor protection. We provide international evidence on stock market participation rates, and holdings of domestic and foreign stocks consistent with the predictions of the model.

Keywords: Home equity bias, portfolio choice, limited participation, investor protection, private benefits of control

JEL Classification: F21, F36, G11, G32, G38