The transaction cost theory of managerial ownership and firm value predicts that deviations from optimal managerial ownership reduce firm value. This paper empirically tests the transaction cost theory by studying the relation between deviations on either side of optimal CEO ownership and firm value. We find that both above-optimal and below-optimal deviations reduce firm value. We find that a change in CEO ownership is associated with a higher (lower) abnormal return if it moves the ownership towards (away from) the optimal level. These findings are consistent with the transaction cost theory of managerial ownership and firm value. © 2008 Elsevier B.V. All rights reserved.