Is Good Governance Priced?
77 Pages Posted: 16 Jan 2018 Last revised: 17 Aug 2019
Date Written: August 15, 2019
A new governance index is constructed, which forms the basis of a new governance valuation factor, defined as the product of the firm governance index and the country institutional quality. Using monthly returns of 4,714 blue chip firms from 35 OECD equity markets for 17 years, our tests of variants of the augmented-CAPM, show that a two factor CAPM augmented with a factor mimicking portfolio based on our new governance metric yields the highest explanatory power in multi-country samples. In general, our results indicate variations in abnormal returns on portfolios that reflect returns differences between democratic (strong) and dictatorship (weak) governance sorted deciles not explained by existing augmented CAPMs. This confirms the importance of differences in governance and that minority investors should seek a premium to compensate for potential welfare losses and a means of hedging these losses within a conventional asset pricing framework. We argue that this is representative of the revealed preferences of insider controlling groups within firms towards expropriating minority outsiders
Keywords: Governance, Governance indices, GIM, Asset pricing
JEL Classification: G3, G11, G12, G15
Suggested Citation: Suggested Citation