Does shareholder-oriented corporate governance reduce firm risk? Evidence from listed European companies

Abstract

PurposeThe purpose of this paper is to explore the impact of the mechanisms of corporate governance on the volatility of companies’ financial profitability.Design/methodology/approachFor the period 2002-2014, the authors evaluate the relations linking various indices involved in corporate governance with the systematic risk supported by these companies for a sample of 355 firms domiciled in Europe. To empirically test these relationships, the authors calculated a synthetic index of corporate governance quality (QGI) based on the 53 items of assessment of the companies’ governance proposed by the database ASSET4. Following the method used by Boncori et al. (2016), the authors first reduced the number of dimensions of corporate governance by performing a principal component analysis of the sample, which resulted in the following five components: management’s shareholder commitment, shareholder rights, characteristics of the board of directors, transparency of the financial information and independence of the audit.FindingsThe results of the tests indicate that the synthetic index of governance that the authors have built is only significant at the 10 percent threshold. The impact of this variable on the systematic risk of the company is of the order of one-tenth of a point. The decomposition of this index into five variables shows that management’s commitment to shareholders and the effectiveness of the board of directors in carrying out its supervisory tasks are likely to reduce, but again to a limited extent, the risk borne by the company.Research limitations/implicationsThis observation guides the future work in introducing variables that reflect the social responsibilities of the companies in the sample in order to distinguish the effects of social responsibility from those of purely shareholder-oriented governance on systematic risk.Practical implicationsThis paper demonstrates the interest of good governance on the risk of firms and identifies certain characteristics upon which to act.Originality/valueAlthough the relations between corporate governance mechanisms and profitability expectations have been the subject of numerous studies, few authors have examined the influence of governorship on the volatility of this profitability, particularly in Europe. To the best of the authors’ knowledge, the rare work on this topic relates to only a limited number of countries.