CORPORATE GOVERNANCE AND FINANCIAL MARKETS

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Abstract

We link corporate governance with liquidity, trading activity, and the clientele that holds the firm’s stock. On the one hand high liquidity can decrease the quality of a firm’s governance because it reduces costs of turning over a stock attracting too many short-term agents who have little vested in good governance. On the other hand, liquidity can attract more sophisticated agents and hence improve the quality of a firm’s governance. In our cross-sectional analysis, we find that high liquidity is accompanied by poorer governance and vice versa. Further, increased institutional holdings are surprisingly associated with weaker governance in the 1990s, whereas in later years, they are not significantly related to governance. The proportion of orders transacted by small (large) traders is associated with weaker (stronger) governance, supporting the notion that a clientele consisting of small, unsophisticated investors can weaken the discipline imposed by outside investors on management. Given the known relation between corporate governance and stock returns, our results establish an indirect link between security prices and liquidity as well as trading activity, which goes beyond the direct channel described in Amihud and Mendelson (1986).

Keywords: Corporate Governance, Financial Markets, Stock Market

How to cite this paper: Subrahmanyam, A. (2008). Corporate governance and financial markets. Corporate Ownership & Control, 5(3-2), 263-278. https://doi.org/10.22495/cocv5i3c2p2