Corporate Governance and Expected Stock Returns: Empirical Evidence from Germany

1 Introduction and Motivation for the Study.- 2 Overview.- 3 Theoretical and Conceptual Framework.- 3.1 Theory of Principal-Agent Relationships.- 3.2 Corporate Governance.- 3.3 Preliminary Thoughts on Corporate Governance and Risk.- 4 Governance Mechanisms and Firm Performance.- 4.1 Overview and Methodology.- 4.2 Ex-ante Preventive Control Mechanisms.- 4.3 Ongoing Disciplinary Control Mechanisms.- 4.4 Ex-post Corrective Control Mechanisms.- 4.5 Summary.- 5 Modeling Governance as a Reward for Risk.- 5.1 Introduction.- 5.2 Alternative Approaches to Corporate Governance and Cost of Capital.- 5.3 Explanatory Power of Governance on Firm-Level.- 5.4 Testable Hypotheses.- 6 Empirical Evidence on the Relationship Between Corporate Governance and Expected Returns on Equity.- 6.1 Introduction and Research Objectives.- 6.2 Input Data to the Model.- 6.3 Characteristics of the Corporate Governance Rating.- 6.4 Univariate Analysis.- 6.5 Portfolio Buy-and-Hold Returns.- 6.6 Corporate Governance and Firm Value.- 6.7 The Corporate Governance Rating and Expected Rates of Return on Equity.- 7 Conclusions and Outlook.

Dr. Andreas Schillhofer promovierte bei Prof. Dr. Heinz Zimmermann am Lehrstuhl für Internationale Unternehmensfinanzierung der Wissenschaftlichen Hochschule für Unternehmensführung (WHU) in Vallendar. Er ist derzeit als Investmentbanker bei Greenhill & Co. in London tätig.

In the wake of several high profile corporate collapses the discussion about corporate governance has intensified and professional investors have become more conscious of their rights of control in the portfolio companies. Whereas Anglo-American authors have done excellent work on the relationship between corporate governance and firm valuation, there is little empirical evidence on this topic in Germany. But recent works suggest that a stricter legal environment leads to lower expected rates of return in an international cross-section of countries.

Andreas Schillhofer investigates whether differences in firm-specific corporate governance also help to explain expected returns in a cross-section of firms within a single jurisdiction. Based on his Corporate Governance Rating (CGR) for German firms, the author documents a positive relationship between the CGR and firm value. In addition, there is strong evidence that expected returns are negatively correlated with the CGR if dividend yields and price-earnings ratios are used as proxies for the cost of capital.