Governance by Constraint: The Corporate Governance Implications of an Anomaly

54 Pages Posted: 11 Sep 2020

See all articles by Xiaoran Huang

Xiaoran Huang

Xiamen University

Massimo Massa

INSEAD - Finance

Lei Zhang

City University of Hong Kong (CityU)

Date Written: July 2020


We study the corporate governance implications of the "beta anomaly," generated by the fact that major equity investors overweight their portfolios toward high-beta stocks because of leverage constraints. We hypothesize that the resulting higher portfolio concentration will increase the monitoring incentives of "leverage-constrained" investors and reduce the agency costs of the firms they own. We test this hypothesis by quantifying a measure of leverage constraint of mutual funds and relating it to their monitoring behavior and the portfolio firms' governance quality. We find that leverage-constrained funds monitor more actively – vote more often against management in contentious proposals and are more likely to induce CEO turnovers. Consequently, the portfolio firms have a higher value of cash holdings, lower need to alleviate agency problems through payouts, and higher investment efficiency. These effects are more pronounced as the beta anomaly becomes more acute, i.e., when the security market line gets flattened. We identify a causal effect using extreme fund outflows and the number of nearby banks as instruments for fund leverage constraints.

Keywords: betting-against-beta, leverage constraint, corporate governance, security market line

JEL Classification: G12, G3, G32

Suggested Citation

Huang, Xiaoran and Massa, Massimo and Zhang, Lei, Governance by Constraint: The Corporate Governance Implications of an Anomaly (July 2020). Available at SSRN: or

Xiaoran Huang

Xiamen University ( email )

Xiamen, Fujian 361005

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

Lei Zhang (Contact Author)

City University of Hong Kong (CityU) ( email )

College of Business
83 Tat Chee Avenue
Hong Kong

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