A revealed preference approach to understanding corporate governance problems: Evidence from Canada

Governance problems have a direct and immediate impact on the effective discount rate guiding investment decisions. Information from a transformed net present value rule and variation in firm-level panel data "reveal" the effective discount rate influencing investment. For the firms most likely to be affected by Jensen agency problems, investment behavior appears to be guided by discount rates less than the market rate by 350-400 basis points. This wedge is reduced for firms with a concentrated ownership structure. Firms facing free cash flow problems have a stock of fixed capital approximately 7-22% higher than would prevail under value maximizing behavior. (C) 2004 Elsevier B.V. All rights reserved.