Abstract
By exploiting the local randomness in close-call votes on governance-related shareholder proposals, this paper finds a negative effect of passing a governance proposal on firms’ ex-ante tail risk measured by the cost of option protection against downside tail risks, which suggests that corporate governance is priced in the option market. In a local regression discontinuity (RD) analysis, firms that narrowly pass the majority threshold show a lower ex-ante tail risk measured by implied volatility smirk and model-free implied skewness than those that narrowly fail. This effect is stronger for firms with weaker corporate governance and higher information transparency and is attenuated when firms perform better. Evidence from a global RD analysis confirms the external validity of results in the local RD analysis. Overall, this paper observes a causal impact of corporate governance on the option market and sheds new light on the cross-sectional determinants of option prices.
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