Agency and Asset Pricing

In this paper we present new empirical evidence on the agency based asset pricing model of Brennan (1993). We find strong evidence that in the recent period stocks whose returns covary more with the idiosyncratic component of the S&P500 return have significantly lower returns, holding constant either the market beta or the loadings on the Fama-French factors. The effect is confined mainly to large capitalization stocks, which is consistent with previous evidence that these stocks are favored by institutional investment managers. The lack of evidence for an agency effect in earlier years is also consistent with the much smaller importance of institutional investors in the earlier period and to the late development of risk-adjusted approaches to measuring portfolio management performance.