The Effects of Country-Level Governance Quality on the Stability of Equity Markets: Evidence from Cross-Listed Securities

Abstract

We examine the impact of governance quality on the volatility of equity markets. Using 785 ADRs from 44 countries, we provide evidence that good (poor) quality governance in the home country is associated with reduced (enhanced) stock market volatility. The relationship is robust across various governance quality dimensions. To overcome the possibility of endogeneity in the governance-volatility relationship, we examine the stability of Brazilian, vis-à-vis non-Brazilian, ADRs in response to a notorious corruption event involving Brazil's President that significantly undermined governance quality in Brazil and possibly harmed the perceptions across different aspects of the World Bank governance quality measures. The inverse governance-volatility relationship is clearly demonstrated by this event. The information documented here supports the conjecture that governance quality is an important prerequisite for the stability of equity markets which, in turn, is a key requirement of economic growth.

Keywords: American depository receipts, volatility, governance, rule of law, control of corruption, political risk, voice and accountability