Shareholder Protection and the Cost of Capital: Evidence from German and Italian Firms

We investigate implications for the cost of capital in a model with agency conflicts between inside and outside shareholders, where agency costs depend on investor protection. Using firm-level data for Italy and Germany we find significant differences in shareholder protection and its implications for the firm’s ownership structure and the cost of capital. Results indicate that concentrated inside ownership increases the cost of capital for Italian firms while having no significant impact on the cost of capital for German firms. Empirical evidence also suggests that bank influence in Germany may serve to reduce investor risk for outside shareholders. In contrast, the magnitude of capital stock distortions is found to be important in Italy. Policy implications of this study suggest that slow growth in continental Europe may be more closely linked to institutional differences in shareholder protection between countries rather than inside ownership of firms.