This study examines whether corporate governance helps explain cross-sectional stock return variation on the Tokyo Stock Exchange. We construct 32 portfolios sorted by firm size, book-to-market equity, profitability, investment, and a governance indicator distinguishing institutional and participatory structures. Using monthly data from 2010–2017, we estimate Fama–French five-, six-, and seven-factor models with ARIMAX specifications to address serial correlation. Unlike most existing Japan-focused studies that examine corporate governance primarily through firm-level regressions or simple portfolio sorts without incorporating it as a risk factor, this study adopts a more comprehensive approach by constructing governance-sorted portfolios and including a governance-mimicking factor (IMP) as an additional risk factor within multi-factor asset pricing models. We find governance has strong explanatory power, second only to market risk, and is associated with lower returns for firms with greater shareholder participation. Furthermore, governance alters size and value effects, while momentum is largely insignificant. In sum, the findings provide valuable information that portfolio managers, analysts, and investors may use for optimizing portfolio choices.
Karaca et al. (Mon,) studied this question.