Corporate Governance, the Cross Section of Returns, and Financing Choices: Theory and Empirical Evidence

Abstract

The first part of this thesis develops an investment-based asset pricing model with costly equity and debt financing and agency conflicts between shareholders and managers. In the model, managers seek private benefits proportional to the sizes of their firms and hence tend to overinvest. Corporate governance serves as a mechanism for shareholders to discipline managers. Consistent with recent empirical findings, the model predicts: (1) firms with stronger governance outperform firms with weaker governance in booms and underperform these firms in recessions; (2) firms with stronger governance have higher costs of debt financing and rely more on equity financing than firms with weaker governance.