Corporate Governance and Cost of Equity Capital: A Cross-Sectional Study on Bangladesh

Abstract

This article investigates the influence of firm-level corporate governance on the cost of equity capital to firms in Bangladesh. Agency theory suggests that better corporate governance reduces agency costs and improves investors’ confidence, which in turn reduces the rate of return on stock expected by the investors, leading to lower cost of equity capital to the firm. This article uses a corporate governance index (CGI), comprising the five dimensions - ownership structure, shareholder rights, independence and responsibilities of the board and management, financial reporting and disclosures, and responsibility towards the stakeholders. The empirical results tend to be inconclusive. Whilst a firm’s governance quality is positively associated with CAPM-based KE and geometric average stock returns, it is inversely related with the dividend yields (for the dividend paying firms). Given the considerable agency costs in the majority of the firms of developing economies, this article recognizes a strong governance role for legal and regulatory institutions in removing the governance malfunctions at both firm level and operational level of the capital market.

Keywords: Corporate governance, agency theory, cost of equity, Bangladesh

JEL Classification: G10, G30, G38, O17