Agency Costs, Business Cycles, and Equity Prices
57 Pages Posted: 26 Aug 2019 Last revised: 11 Nov 2020
Date Written: August 21, 2019
This paper develops a framework for studying the impact of time-varying agency conflicts on the cost of equity. Investors infer agency costs coming from these conflicts by observing a firm’s governance policy. They dislike stocks of firms with higher agency costs in bad times, because this amplifies these stocks volatility. I empirically test the model with two commonly used measures of corporate governance and study the implications for U.S. firms from 1990 to 2006. A higher index level implies more power to insiders and is interpreted as leading to more costs by outsiders. I find that firms with a higher index in bad compared to good times have a higher cost of equity (more than a 6% difference), even after controlling for prominent market factors, firm-specific financial and operating variables, and also replacing the indices by their IVs.
Keywords: Corporate Governance, Asset Pricing, Asymmetric information
JEL Classification: G12, G32, G32, G14
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