Governance Risk and the Cross-Section of Stock Returns
61 Pages Posted: 26 Aug 2019 Last revised: 23 Aug 2021
Date Written: August 21, 2019
This paper modelizes and provides asset pricing implications of corporate governance policies. Agency costs, proxied by commonly used corporate governance indices, arise because insiders are self-interested and vary across firms. First, firms differ in their agency costs’ level during initial financing, and higher initial costs translate into lower average equity premium because insiders select a lower (sticky) leverage ratio. Second, they vary along with their difference in agency costs in bad versus good times. In bad times, firms with higher agency costs also have higher returns because it amplifies their stock price volatility at the business cycle frequency.
Keywords: Corporate governance, Asset pricing, Business cycles, Agency conflicts
JEL Classification: G30, G12, G32, G14
Suggested Citation: Suggested Citation