Corporate governance and the variability of stock returns

Purpose – The purpose of this paper is to analyze the impact of firm-level corporate governance practices on the riskiness of a firm's stock returns. Design/methodology/approach – The authors constructed an index of governance quality incorporating best practices stipulated by regulators. The authors employed regression analysis. Findings – The empirical evidence, using an index of corporate governance, shows that well-governed New Zealand firms experience lower levels of risk, ceteris paribus. In particular, the results indicate that corporate governance aspects such as board composition, shareholder rights, and disclosure practices are associated with lower levels of risk. Research limitations/implications – A limitation of the study is that the corporate governance index constructed is somewhat arbitrary and due to limitation of data availability the authors may have excluded some factors such as share trading policy of directors and policies regarding provision of non-auditing services by auditors. The research supports the view that institutional context could have an impact on governance outcomes. The work has three implications for managers, investors, and policy makers. First, the results imply that well-governed firms have lower idiosyncratic risk and that this reduction is most likely due to the reduction in agency costs and information risk. Second, in the absence of features like an active corporate control market and stock option based managerial compensation, managers have little incentives to take on risky projects that increase firm value. Third, the results suggest that the managers of well-governed firms are not more risk averse with respect to investment decisions compared to poorly governed firms. Practical implications – The work has practical implications for managers, investors, and policy makers. Well-governed firms face lower variability in stock returns compared to poorly governed firms. Firms that have independent boards that protect its shareholders’ rights and disclose its governance-related policies experience lower firm-level risk, other things being equal. Originality/value – This study is the first one to examine the impact of a composite measure of corporate governance quality on stock return variability in a non-US setting. The results suggest that firms can use specific corporate governance provisions to mitigate firm-level risk. The findings of the paper are therefore relevant and useful to corporate managers, investors, and policy makers.