Stakeholder Orientation, Agency Problems of Free Cash Flow, and the Cost of Equity : Evidence from a Natural Experiment

Using staggered adoptions of Constituency Statutes (CS laws) that authorize but not mandate managers to consider non-owner stakeholders' interests in business decisions, we find that the effect of expanding managers' discretion in considering stakeholder interests on the cost of equity depends on the severity of agency problems of free cash flow. After the adoption of CS laws, the cost of equity decreases for firms with less severe but increases for firms with more severe agency problems. Additional analyses show that for firms with less severe agency problems, CS laws increase the expected future cash flows and reduce the risks, as manifested in a lower exposure to risks related to environmental, social, and governance (ESG) issues and a higher ability to weather negative industry-wide shocks. In contrast, for firms with more severe agency problems, the CS laws reduce the expected value of future cash flows without reducing the risks. Our results are relevant to the current policy debate on whether or not managers' fiduciary duty should be expanded to all stakeholders