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The Conditional Nature of the Value of Corporate Governance

Journal of Banking and Finance, Vol. 34, No. 2, pp. 350-361, February 2010

42 Pages Posted: 28 Nov 2008 Last revised: 27 Jul 2010

Jianxin Daniel Chi

University of Nevada, Las Vegas (UNLV) - Department of Finance

D. Scott Lee

University of Nevada, Las Vegas - Lee Business School

Date Written: July 27, 2009

Abstract

Agency theory suggests that governance matters more among firms with greater potential agency costs. Rational investors are unlikely to value safeguards against unlikely events. Yet, few studies of the relation between governance and firm value control for investor perceptions of the likelihood of agency conflicts. Shleifer and Vishny (1997) identify investment-related agency conflicts as the more severe type of agency conflicts in the U.S. We measure the perceived likelihood of this type of agency conflict using free cash flow (Jensen, 1986). We find that firm value is an increasing function of improved governance quality among firms with high free cash flow. In contrast, governance benefits are lower or insignificant among firms with low free cash flow. We show that not controlling for this conditional relation between governance and firm value could lead to erroneous conclusions that governance and firm value are unrelated.

Keywords: governance, agency, overinvestment, free cash flow, conditional

JEL Classification: C23, G34

Suggested Citation

Chi, Jianxin Daniel and Lee, D. Scott, The Conditional Nature of the Value of Corporate Governance (July 27, 2009). Journal of Banking and Finance, Vol. 34, No. 2, pp. 350-361, February 2010. Available at SSRN: https://ssrn.com/abstract=1307756

Jianxin Daniel Chi (Contact Author)

University of Nevada, Las Vegas (UNLV) - Department of Finance ( email )

4505 S. Maryland Parkway
Box 456008
Las Vegas, NV 89154-6008
United States

HOME PAGE: http://www.unlv.edu/people/jianxin-chi

D. Scott Lee

University of Nevada, Las Vegas - Lee Business School ( email )

4505 S. Maryland Parkway
Box 456008
Las Vegas, NV 89154-6008
United States
702-895-2526 (Phone)
702-895-4630 (Fax)

HOME PAGE: http://faculty.unlv.edu/slee

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