Does Corporate Governance Impact Equity Volatility? Theory and Worldwide Evidence

Abstract

This paper studies the impact of corporate governance on equity volatility. We develop a corporate finance model with endogenous financing policies and manager-shareholder agency conflicts. Stronger corporate governance boosts equity valuation and the optimal level of debt, but the valuation effect reduces equity volatility more than the additional debt increases it. Thus, equity volatility drops with corporate governance improvements, especially for financially constrained firms. We confirm our 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, corporate governance, financial risk, idiosyncratic risk, international markets

JEL Classification: G12, G32, G34