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Stock Market Returns, Corporate Governance and Capital Market Equilibrium

54 Pages Posted: 1 Jul 2013 Last revised: 25 Nov 2014

Bruno Maria Parigi

University of Padua - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Ca Foscari University of Venice

Ernst-Ludwig von Thadden

Universitaet Mannheim; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2014

Abstract

This paper analyzes why corporate governance matters for stock returns if the stock market prices the underlying managerial agency problem correctly. Our theory assumes that strict corporate governance prevents managers from diverting cash flows, but reduces incentives for managerial effort. In capital market equilibrium, this trade-off has implications for the firm's earnings, stock returns, and managerial ownership, because governance impacts the firm's risk-return structure. In particular, the strictness of corporate governance is negatively related to earnings and positively to β. Various empirical tests with U.S. data using the governance index of Gompers, Ishii, and Metrick (2003) yield results consistent with these predictions.

Keywords: Corporate Governance, Agency, CAPM, Stock Returns, Equilibrium

JEL Classification: G32, G38, K22

Suggested Citation

Parigi, Bruno Maria and Pelizzon, Loriana and von Thadden, Ernst-Ludwig, Stock Market Returns, Corporate Governance and Capital Market Equilibrium (October 2014). ECGI - Finance Working Paper No. 362. Available at SSRN: https://ssrn.com/abstract=2270140 or http://dx.doi.org/10.2139/ssrn.2270140

Bruno Maria Parigi

University of Padua - Department of Economics ( email )

via Del Santo 33
Padova, 35123
Italy

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

Ernst-Ludwig Von Thadden (Contact Author)

Universitaet Mannheim ( email )

Department of Economics
Mannheim, 68131
Germany

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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