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

32 Pages Posted: 11 Jul 2017

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

Lammertjan Dam

University of Groningen - Faculty of Economics and Business

Multiple version iconThere are 2 versions of this paper

Date Written: July 4, 2017

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. We estimate of the conditional correlation between our measures of corporate governance and firm financial performance to be statistically speaking equal to zero. This result therefore provides empirical support for the in-equilibrium view of corporate governance arrangements.

Keywords: corporate governance; optimal firm behavior; endogeneity; structural models; latent variables

JEL Classification: C38, G34, L20, M52

Suggested Citation

Wessels, Roberto E. and Wansbeek, Tom and Dam, Lammertjan, What is the Relation (If Any) between a Firm's Corporate Governance Arrangements and Its Financial Performance? (July 4, 2017). Multinational Finance Journal, Vol. 20, No. 4, p. 323-354, 2016. Available at SSRN: https://ssrn.com/abstract=2997920

Roberto E. Wessels (Contact Author)

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

+31-50-3633633685 (Phone)

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

Tom Wansbeek

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

Postbus 72
9700 AB Groningen
Netherlands

Lammertjan Dam

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

Postbus 72
9700 AB Groningen
Netherlands
+31-50-3636518 (Phone)

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