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Corruption, Firm Governance, and the Cost of Capital

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  • Garmaise, Mark J
  • Liu, Jun
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    Abstract

    We develop a model of a firm owned by shareholders and administered by managers who may be either honest or dishonest. When managers have an informational advantage but shareholders retain control, dishonest managers can make false reports that distort investment and thereby reduce firm cash flows. When dishonest managers have privileged access to both information and control, firm value is further reduced and profits are diminished especially in the worst states of the world. Ine®ective corporate governance combined with corruption (dishonesty) thus increases firms’ exposure to systematic risk. In a cross-country empirical test of the model, we find that corruption substantially increases firm betas, particularly in countries with weak shareholder rights. Moving from the level of corruption in Canada to that in South Korea raises industry-adjusted betas by 0.35.

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    Bibliographic Info

    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt29403706.

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    Date of creation: 28 Feb 2005
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    Handle: RePEc:cdl:anderf:qt29403706

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    Keywords: Governance;

    References

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    Cited by:
    1. Collins, Denton & Huang, Henry, 2011. "Management entrenchment and the cost of equity capital," Journal of Business Research, Elsevier, vol. 64(4), pages 356-362, April.
    2. Söhnke M. Bartram & Gregory Brown & René M. Stulz, 2012. "Why Are U.S. Stocks More Volatile?," Journal of Finance, American Finance Association, vol. 67(4), pages 1329-1370, 08.

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