Internal Governance Does Matter to Equity Returns but Much More So During “Flights to Quality” |
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| Authors: | Peter G Brooke Paul Docherty Jim Psaros Michael Seamer |
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| Institution: | 1. PETER BROOKE is Head of Quantitative Investments at Platypus Asset Management. From May 2006, Peter worked as a Quantitative Analyst with MIR Investment Management. Peter holds an MSci degree in Physics and Astronomy from the University of Durham, UK and has a PhD in Physics from Macquarie University, Sydney.;2. PAUL DOCHERTY is a senior lecturer in the Department of Banking and Finance at Monash University. He was previously employed at the University of Newcastle for ten years following the completion of his PhD at that institution. Paul's main research interests are in empirical asset pricing and funds management.;3. JIM PSAROS is Emeritus Professor at the University of Newcastle and has a PhD in Accounting from the University of New South Wales. Throughout his research career he has focused on issues of practical importance. He has conducted research in a range of areas including auditing and fraud, the inadequacies of Australian accounting standards, and more recently, corporate governance mechanisms. |
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| Abstract: | Although few doubt that good internal governance helps firms perform better, the statistical evidence is actually mixed because the positive effects of good corporate governance matters much more so at some times than others. The statistical link is strongest during “flights to quality,” when market sentiment turns bearish and pessimistic but weakens for long periods of time during bull markets and low market volatility. Using more than ten years' evidence from Australian firms, the authors show that internal governance is related to both firm value and performance and that firms with stronger governance are less risky, generate higher equity returns and perform significantly better during market downturns. When risk aversion is high, demand for well‐governed firms increases and investors discount the value of firms with potential agency conflicts. This time‐varying relationship between internal governance and returns may explain both the limited explanatory power of governance on firm value and the mixed empirical evidence reported in previous studies. Firms with strong internal governance do earn significantly higher stock returns compared with firms with weak governance; but that also means that the value of governance is not fully incorporated into prices, thereby explaining the limited explanatory power of governance on firm value. |
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