What is the Relation (If Any) between a Firm's Corporate Governance Arrangements and its Financial Performance?

25 Pages Posted: 12 Feb 2014

See all articles by Roberto E. Wessels

Roberto E. Wessels

University of Groningen - Faculty of Economics and Business

Tom Wansbeek

University of Groningen - Faculty of Economics and Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 2015

Abstract

We present a model to test the null hypothesis that firms organize their corporate governance arrangements optimally given the constraints they face. Following the literature, the model rejects the null if the conditional correlation between governance and performance is significantly different from zero. Our model provides a clean test of this hypothesis by controlling for measurement errors in all observed variables and avoiding simultaneous equation biases by casting our model as a reduced-form bivariate equation. We model governance, performance and the constraints on the firm’s investment decisions as latent variables. Our estimate of the conditional correlation between our measures of governance and performance is statistically speaking equal to zero, which therefore provides empirical support for the in-equilibrium view proposed by Demsetz (1983), of corporate governance arrangements..

Keywords: corporate governance, firm behavior, hypothesis testing, errors in variables

JEL Classification: C380, G340, L200, M520

Suggested Citation

Wessels, Roberto E. and Wansbeek, Tom, What is the Relation (If Any) between a Firm's Corporate Governance Arrangements and its Financial Performance? (April 2015). CESifo Working Paper Series No. 4599. Available at SSRN: https://ssrn.com/abstract=2393995

Roberto E. Wessels

University of Groningen - Faculty of Economics and Business ( email )

+31-50-3633633685 (Phone)

HOME PAGE: http://www.rug.nl

Tom Wansbeek (Contact Author)

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands

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