The Impact of Heterogeneous Market Sentiments on Corporate Risk-Taking and Governance

Hangbo Liu, Xuemeng Guo and Dachen Sheng ()
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Hangbo Liu: School of Economics and Management, Beijing Jiaotong University, No. 3 Shangyuancun, Beijing 100044, China
Xuemeng Guo: School of Economics and Management, Beijing Jiaotong University, No. 3 Shangyuancun, Beijing 100044, China
Dachen Sheng: International College of Liberal Arts, Yamanashi Gakuin University, 2-4-5 Sakaori, Kofu 400-8575, Yamanashi, Japan

Mathematics, 2024, vol. 12, issue 22, 1-21

Abstract: This research focuses on how market sentiment affects corporate governance in the Chinese market. The sample covers the years from 2014 to 2023. Market sentiment is estimated using a cross-sectional absolute deviation (CSAD) model, and earnings quality is used as an indicator of the consequences of corporate governance. Both mutual fund shareholding and the number of firm visits by mutual fund analysts are verified as effective corporate governance instruments that work well in a regular market but become ineffective when the market sentiment is high. The reason for this is that managers’ expectations change, and they may believe that disclosing good news during high-sentiment market periods significantly increases the share prices and helps them meet their performance requirements. In a high-sentiment market, an incentive contract encourages managers to take on projects with inappropriate risk or even manipulate earnings. One potential solution is to adopt venture capital firms’ high-water mark and clawback clauses to prevent managers from focusing on short-term goals rather than seeking long-term business sustainability.

Keywords: market sentiment; earnings quality; corporate risk governance; mutual fund shareholding; analyst firm visit; business sustainability (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2024
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