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Three essays on corporate governance

University of British Columbia

The thesis is comprised of three essays on corporate governance. The first essay empirically tests the claim that well governed firms are safe investments and provide superior stock returns. The results show that well governed firms in fact are unusually risky, even after controlling for variables such as firm age, size and leverage. The positive and significant relationship between stock return volatility and good corporate governance also cannot be explained completely by managerial risk-taking behavior, as suggested in standard agency theory. I find that the reported abnormally high return (Gompers, Ishii and Metrick, 2003) for well governed firms is largely driven by two factors: penny stocks and outliers. By showing that there is actually no abnormal return, the essay suggests that the high firm-level risk associated with good governance is not priced and can be diversified away. In the second essay, I demonstrate that growth prospects play a crucial role in determining a firm's governance structure choices. When growth prospects are extremely promising, board structure choices are irrelevant. When growth prospects are modest, a firm may need to voluntarily adopt a friendly board to encourage its manager to undertake risky investments. When growth prospects are weak, an independent board is needed to avoid managerial misbehavior. The model explains why empirical evidence concerning the relationship between board independence and firm performance is mixed. Also, it predicts various announcement effects across firms with different board structures. The essay suggests that improvement in legal protection can be beneficial for shareholders, but regulatory agencies' requirements aimed at increasing board independence may in fact destroy firm values and growth opportunities. In the third essay, I modify the standard agency model to explain certain predictions provided by sociology-based executive compensation theories. When a director is also a CEO of another company, concerns about his own compensation and the non-pecuniary private benefits of being a director can affect his decisions when designing the incentive contract for the CEO. Under certain conditions, the model generates predictions consistent with those of social comparison theory, social exchange theory and social similarity theory. This simple model also provides testable implications about how and where the predictions of these social compensation theories will break.

Text

2009-12-23

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http://hdl.handle.net/2429/17150

Business Administration

University of British Columbia

UBCV

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