Corporate Governance and Financial Crises

Abstract

This paper focuses on answering the three following questions: (1) Does corporate governance matter in financial crisis? And how does it matter? (2) Does the effect of corporate governance level on crisis in developing countries differ from that in developed countries? Why? (3). Does weak corporate governance make countries more vulnerable during global financial crisis? Theoretically, the contribution of corporate governance to financial crises is through two channels. The first channel is that weak corporate governance increases aggressive risk taking of financial institutions and the collapse of latter may cause a crisis (Tarraf (2011)). The second explanation is proposed by Johnson and all (2000) that weak corporate governance can cause an increase in net outflow of capital since the foreign investors lose their confidence. As a result, depreciation of exchange rate increases. Using the macroeconomic data and Worldwide Governance Indicators of 14 countries from 1996-2014, I find that besides economic fundamentals, better corporate governance reduces significantly the probability of financial crises, especially in developing countries and Asian ones. This effect remains unchanged in the global crisis period for the developing countries and the Asian ones while it seems to be smaller for the developed ones. However, the effect of corporate governance on the relative change of exchange rate is limited. Corporate governance indicators only influence the exchange rate in developing countries and this effect still remains during global financial crisis.