The purpose of this paper is to investigate the influence of idiosyncratic risk on firm decisions.
By introducing managerial ownership as a key variable, the paper presents a parsimonious model to describe the consequences of idiosyncratic risk on firm decisions. Then the paper uses data from the Chinese stock market, in which the managerial ownership is very low (around 0.02 percent) to examine the model predictions.
The authors find that: first, the negative relation between idiosyncratic risk and firm investment, which is found in prior studies, tends to be insignificant when managerial ownership is very low; second, diversification, as an alternative firm decision to lower risk positively, relates to idiosyncratic risk despite lower managerial ownership; and third, this kind of positive relation is weaker for firms with more managerial incentives when diversification is endogenously modeled.
This paper provides new evidence to complement existing studies from developed markets, in which executives hold substantial stakes.
JEL Classifications — G31, G32, G34
The authors thank Zohaib Uddin, Shasha Liu, and Yan Sheng for helpful comments and valuable suggestions. All remaining errors and omissions are the authors own. The authors gratefully acknowledges financial support from the National Natural Science Foundation of China (Grant No. 71003030; 71372130; 71173078), the National Social Science Foundation of China (Grant No. 12CJY047), the Ministry of Education of China (Grant No. 12YJC790032), the Guangdong Project of Philosophy and Social Science (Grant No. GD11YYJ02), the Guangdong Key Project of Philosophy and Social Science (Grant No. 11ZGXM63005), the Natural Science Foundation of Guangdong Province (Grant No. S2013010013890).
Deng, K., Chen, H. and Kong, D. (2014), "The effect of idiosyncratic risk on firm decisions: under-investment or diversification?", China Finance Review International, Vol. 4 No. 3, pp. 271-288. https://doi.org/10.1108/CFRI-05-2013-0048Download as .RIS
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