Corporate governance quality and the cost of capital

Abstract

The objective of this study is to further investigate what channel causes firms with weak (strong) corporate governance to be valued less (more) by investors. Specifically, we examine the relationship between corporate governance scores and firms' cost of capital, including both equity capital and debt. This research is conducted in Canada over a four–year period from 2002 to 2005 and uses panel data of 155 S&P/TSX firms. The quality of firm–level governance is measured based on the ROB index published by The Globe and Mail. Using fixed–effect regressions in a 2SLS framework, we find strong evidence that the cost of equity/debt decreases as the quality of corporate governance practices increases. Canadian firms with higher ROB scores have a lower cost of capital.