Corruption, Firm Governance, and the Cost of Capital

Mark J Garmaise and Jun Liu

University of California at Los Angeles, Anderson Graduate School of Management from Anderson Graduate School of Management, UCLA

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.

Keywords: Governance (search for similar items in EconPapers)
Date: 2005-02-28
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Citations: View citations in EconPapers (19)

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