| Abstract: | Common sense suggests that the adoption of better corporate governance practices, which enable greater transparency, more protection against capital expropriation, and greater rights for investors, should have the effect of reducing the risk perceived by shareholders and so lead to lower required returns. This article investigates the existence of an inverse relationship between the quality of corporate governance and the cost of equity capital for Brazilian companies. The authors begin by constructing a broad index of corporate governance quality that combines four key aspects of corporate governance: (1) transparency and disclosure; (2) structure of the board of directors; (3) ownership and control structure; and (4) shareholder rights. To estimate the cost of equity, the CAPM was applied by using ex ante market premiums calculated with a simple discounted‐dividend method. On the basis of a sample of 67 Brazilian companies traded at the São Paulo Stock Exchange (Bovespa) during the period 1998–2008, the study concludes that there is a significant inverse relationship between the cost of equity and a number of proxies for effective governance, particularly those representing transparency and disclosure. Closer inspection of the reductions in cost of capital associated with improvements in the specific governance quality index components suggests that companies would benefit the most from prompt submission of information to regulators and full disclosure of executive pay. |
