Abstract:
The first part of this thesis develops an investment-based asset pricing model
with costly equity and debt financing and agency conflicts between shareholders
and managers. In the model, managers seek private benefits proportional to
the sizes of their firms and hence tend to overinvest. Corporate governance
serves as a mechanism for shareholders to discipline managers. Consistent with
recent empirical findings, the model predicts: (1) firms with stronger governance
outperform firms with weaker governance in booms and underperform these
firms in recessions; (2) firms with stronger governance have higher costs of debt
financing and rely more on equity financing than firms with weaker governance.
