Internal Governance Characteristics, Time-Varying Agency Costs and Stock Prices

44 Pages Posted: 25 Oct 2014 Last revised: 3 Dec 2014

See all articles by Peter Brooke

Peter Brooke

Platypus Asset Management

Paul Docherty

Monash University

Jim Psaros

University of Newcastle - Faculty of Business and Law

Michael Seamer

University of Newcastle - Newcastle Business School

Date Written: November 2014

Abstract

We propose that the relationship between corporate governance and equity prices operates through two distinct channels. First, at the individual firm level, strong corporate governance lowers agency costs and increases equity prices. Second, agency costs are time-varying, as manager expropriation is negatively related to the expected return on investment. This being the case, firms with strong corporate governance should outperform those with weak governance in the long-run, and this difference should be more prominent when the price of risk is high. Consistent with our proposition, and after controlling for traditional risk factors, we use a long time-series of hand-collected data to show that firms with strong internal governance characteristics have superior operating performance and generate higher returns for shareholders. This outperformance is particularly pronounced during the global financial crisis, when expected return on investment is low. Our proposition that both micro- and macro-level factors affect the relationship between corporate governance and returns provides a new framework for considering the impact of agency costs on shareholder 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 Characteristics, Time-Varying Agency Costs and Stock Prices (November 2014). 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)

Monash University ( email )

23 Innovation Walk
Wellington Road
Clayton, Victoria 3800
Australia

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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