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Corporate Governance and the Cost of Equity Capital

54 Pages Posted: 3 Feb 2005  

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis

Daniel W. Collins

University of Iowa - Department of Accounting

Ryan LaFond

Algert Global, LLC

Date Written: December 2004

Abstract

Separation of ownership and control in firms creates information asymmetry problems between shareholders and managers that expose shareholders to a variety of agency risks. This paper investigates the extent to which governance attributes that are intended to mitigate agency risk affect firms' cost of equity capital. We examine governance attributes along four dimensions: (1) financial information quality, (2) ownership structure, (3) shareholder rights, and (4) board structure. We find that firms reporting larger abnormal accruals and less transparent earnings have a higher cost of equity, whereas firms with more independent audit committees have a lower cost of equity. We also find that firms with a greater proportion of their shares held by activist institutions receive a lower cost of equity, whereas firms with more blockholders have a higher cost of equity. Moreover, we find a negative relation between the cost of equity and the independence of the board and the percentage of the board that owns stock. Collectively, the governance attributes we examine explain roughly 8% of the cross-sectional variation in firms' cost of capital and 14 % of the variation in firms' beta. The results support the general hypothesis that firms with better governance present less agency risk to shareholders resulting in lower cost of equity capital.

JEL Classification: G34, G12, G32, M41, M49

Suggested Citation

Skaife, Hollis Ashbaugh and Collins, Daniel W. and LaFond, Ryan, Corporate Governance and the Cost of Equity Capital (December 2004). Available at SSRN: https://ssrn.com/abstract=639681 or http://dx.doi.org/10.2139/ssrn.639681

Hollis Skaife

Graduate School of Management, UC-Davis ( email )

Graduate School of Management
1 Shields Ave
Davis, CA 95616
United States

Daniel Collins (Contact Author)

University of Iowa - Department of Accounting ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States
319-335-0912 (Phone)
319-335-1956 (Fax)

Ryan LaFond

Algert Global, LLC ( email )

One Maritime Plaza
Suite 1525
San Francisco, CA 94111
United States

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