Do better governed firms enjoy a lower cost of equity capital?: Evidence from Spanish firms

Abstract

Purpose The purpose of this paper is to investigate the relationship between corporate governance and cost of equity capital for a set of Spanish firms. Design/methodology/approach The paper focuses on five board characteristics that have received widespread attention in corporate governance literature (board independence, board size, existence of both audit and nomination/remuneration committees, CEO duality, and independence of board committees) in order to construct a summary corporate governance measure for each firm. Then, by using regression analysis, it examines whether higher governance quality is associated with a lower cost of equity capital. Findings The results show that stronger governance firms have a lower cost of equity capital with respect to firms with weaker governance, even after controlling for differences in Fama and French's risk factors (i.e. beta, size and market‐to‐book). Research limitations/implications The dependent variable, i.e. the cost of equity capital, is an unobservable measure and, as such, it has to be estimated. Therefore, the results can be sensitive to the estimation method chosen. Practical implications There is a growing literature showing that corporate governance enhances firm valuation. However, these studies typically assume that corporate governance affects firm valuation by reducing expropriation by insiders and improving the expected cash flows that can be distributed to shareholders. Whether those mechanisms also affect the other determinant of firm value – i.e. the cost of equity capital – remains largely unknown. Moreover, there is no evidence of this issue for the case of Spain. Originality/value It is hoped that the results from the paper will provide additional information concerning corporate governance to interested parties.

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