How does managerial expropriation affect equity volatility? Theory and worldwide evidence

Abstract

This paper investigates how the degree of managerial expropriation affects equity volatility of individual firms. We develop a corporate finance model with endogenous financing policies and manager-shareholder agency conflicts, and identify two countervailing forces. First, in response to stronger corporate governance, a reduction in managerial expropriation increases equity valuation and decreases equity volatility. Second, lower managerial expropri- ation induces managers to take on more debt, which pushes up leverage and equity volatility. We show that the valuation effect dominates, and equity volatility thus drops with corporate governance improvements. In the cross-section, this effect is especially strong for financially constrained firms, as they face greater difficulty in adjusting their capital structure. We confirm these theoretical predictions with a difference-in-difference specification exploiting the staggered passage of governance reforms on a sample of 33,831 firms from 48 countries over the 1990-2016 period.

Keywords: Equity volatility, agency conflicts, corporate governance, reforms, capital structure

JEL Classification: G12, G32, G34