Measuring the impact of governance quality on stock market performance in developed countries

Abstract

The aim of this article is to examine the relationship between stock market performance and country level governance indicators. A good quality of governance in a country ensures effective implementation of laws which can protect the investor and improve stock market performance and vice versa. Our study utilises annual stock returns and country level governance indicators for 25 developed countries from 1996 to 2018. The fixed effect estimation suggests that stock market performance and governance indicators share a positive relationship. Our findings suggest that high quality of governance is associated with higher returns on stock. Institutional quality is a preconditioned for financial developed that set the direction of change to reduce transaction costs and agency costs and make profitable projects available to firms that subsequently leads to higher demand for equity financing. These findings have significant implications for stock market policymakers and standard asset pricing models that only include market risk factors to predict future expected stock returns.