The Arrow--Lind theorem revisited: ownership concentration and valuation

According to Arrow and Lind (1970), the more shareholders participate in an investment and the more dispersed the ownership structure becomes, the lower the discount rate of an individual investor is due to risk sharing. This implies that the valuation of the investment should increase. Employing a data set of investor-level ownership records, asset pricing measures and managerial discretion proxies, we test Arrow and Lind's hypothesis of the relationship between ownership concentration and risk premium, and its implication for company valuation. We find that (i) contrary to previous studies on institutional ownership, greater ownership dispersion is associated with higher company valuation and (ii) managers are more likely to invest in fixed assets and hold less cash in companies with dispersed ownership. Our results remain robust after controlling for liquidity and governance by several measures. We argue that both results are interconnected: when ownership concentration is low, investors' lower premiums and managers' risk-neutral behaviour contribute to higher valuations.