Internal Governance Does Matter to Equity Returns But Much More so During 'Flights to Quality'

16 Pages Posted: 10 May 2018

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: Winter 2018

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.

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' (Winter 2018). Journal of Applied Corporate Finance, Vol. 30, Issue 1, pp. 39-52, 2018. Available at SSRN: https://ssrn.com/abstract=3176248 or http://dx.doi.org/10.1111/jacf.12276

Peter Brooke (Contact Author)

Platypus Asset Management ( email )

16/1 Alfred St
Sydney, NSW 2000
Australia

Paul Docherty

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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