Internal Governance Does Matter to Equity Returns but Much More So During ‘Flights to Quality’

43 Pages Posted: 25 Oct 2014 Last revised: 29 Jul 2019

See all articles by Peter Brooke

Peter Brooke

Platypus Asset Management

Paul Docherty

The Brattle Group

Jim Psaros

University of Newcastle - Faculty of Business and Law

Michael Seamer

University of Newcastle - Newcastle Business School

Date Written: May 3, 2015

Abstract

Although few doubt that good internal governance helps firms perform better, the statistical evidence is actually mixed because the positive effects of good corporate governance matters much more so at some times than others. The statistical link is strongest during “flights to quality,” when market sentiment turns bearish and pessimistic but weakens for long periods of time during bull markets and low market volatility. Using more than ten years' evidence from Australian firms, the authors show that internal governance is related to both firm value and performance and that firms with stronger governance are less risky, generate higher equity returns and perform significantly better during market downturns. When risk aversion is high, demand for well‐governed firms increases and investors discount the value of firms with potential agency conflicts. This time‐varying relationship between internal governance and returns may explain both the limited explanatory power of governance on firm value and the mixed empirical evidence reported in previous studies. Firms with strong internal governance do earn significantly higher stock returns compared with firms with weak governance; but that also means that the value of governance is not fully incorporated into prices, thereby explaining the limited explanatory power of governance on firm value.

Keywords: Corporate governance, agency theory, asset pricing

JEL Classification: G34, G11, G12

Suggested Citation

Brooke, Peter and Docherty, Paul and Psaros, Jim and Seamer, Michael, Internal Governance Does Matter to Equity Returns but Much More So During ‘Flights to Quality’ (May 3, 2015). Available at SSRN: https://ssrn.com/abstract=2514244 or http://dx.doi.org/10.2139/ssrn.2514244

Peter Brooke

Platypus Asset Management ( email )

16/1 Alfred St
Sydney, NSW 2000
Australia

Paul Docherty (Contact Author)

The Brattle Group ( email )

44 Brattle Street
3rd Floor
Cambridge, MA 02138-3736
United States

Jim Psaros

University of Newcastle - Faculty of Business and Law ( email )

University Drive
Callaghan 2308, New South Wales
Australia

Michael Seamer

University of Newcastle - Newcastle Business School ( email )

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