The Arrow-lind Theorem Revisited: Ownership Concentration and Valuation

Abstract: According to Arrow and Lind (1970), as the net returns of an investment are shared by a larger pool of shareholders, the aggregate of shareholders' risk premiums approaches zero. Employing a dataset 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 strong and robust results that: (i) contrary to the 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. We argue that both results are interconnected: when ownership concentration is low, investors' lower premiums and managers' risk-neutral behavior contribute to higher valuations.