Does corporate governance matter for stock returns volatility in the Brazilian context?

Pages1236-1252
DOIhttps://doi.org/10.1108/CG-03-2019-0083
Date02 October 2019
Published date02 October 2019
AuthorGuilherme Cardoso,Dannie Delanoy Carr,Pablo Rogers
Subject MatterStrategy
Does corporate governance matter for
stock returns volatility in the Brazilian
context?
Guilherme Cardoso, Dannie Delanoy Carr and Pablo Rogers
Abstract
Purpose This paper aimsto examine the Brazilian stock market behaviorand volatility term structure of
two portfolios that, theoretically, the companies that comprise them have different degrees of
idiosyncratic risk: one portfolio consists of firms with good corporate governance and the other
comprisesfirms with poor corporate governance.
Design/methodology/approach The sample comprises corporate firms listed in the Brazilian stock
market during the periodfrom January 2008 to December 2017. Generalized autoregressiveconditional
heteroskedasticitymodels were applied.
Findings The results show that the portfolio of firms with good corporate governance practices presents
fluctuations that are more often temporary and reactive, with trends’ persistence of shorter durations, when
considering the punctual volatility of the parameters estimated. This opposed expectation that the portfolio
comprised of companies with good governance practices are better protected from short-term movements.
However, over time and with standard error measures in consideration, both portfolios’ volatilities behave in
similar ways. These findings may be related to Brazilian market characteristics, such as ownership
concentration, ineffective corporate boards and the ever-developing nature of the stock market in Brazil.
Any one of these characteristics present challenges to effective enforcement of the corporate governance
practices in the Brazilian context.
Originality/value The findings arepotentially to the interest of researchers and practitionersfor several
reasons. First, this paper contributes to the growing literature on the relationship between corporate
governance and market volatility. Second, it informs that volatility in the Brazilian context is likely only
partially, if at all, influencedby corporate governance practices.Third, longitudinally, both indices follow
the samepattern and converge to the same place.
Keywords Corporate Governance, Volatility, GARCH models, Idiosyncratic risk
Paper type Research paper
1. Introduction
The behavior of equity prices is a critical issue in studies of risk management. Scientific inquiry
seeks to understand in a systematic way how forces surrounding the firms exogenous and
endogenous affect the stock prices. The volatility of equity prices has been mostly related
with macroeconomic factors, which are, generally, out of control of managers, as economic
recessions, political affairs, spillovers effects, market interdependence, among others.
However, factors from firm-levels are also linked with oscillations of stock prices, and recent
researches have pointed out that the corporate governance practices can affect firms’ volatility
term structure (Rogers and Securato, 2009;Giroud and Mueller, 2011;An and Zhang, 2013;
Chang et al., 2014;Kim et al., 2014;Asker et al., 2015).
Corporate governance has its underlying framework in agency theory, which explain
conflicts between the principal and agent, wherein involved parties try to extract the best of
Guilherme Cardoso, Dannie
Delanoy Carr and Pablo
Rogers are all based at the
Federal University of
Uberla
ˆndia, Uberla
ˆndia,
Brazil.
Received 7 March 2019
Revised 3 June 2019
Accepted 16 June 2019
PAGE 1236 jCORPORATE GOVERNANCE jVOL. 19 NO. 6 2019, pp. 1236-1252, ©EmeraldPublishing Limited, ISSN 1472-0701 DOI 10.1108/CG-03-2019-0083
the situation for themselves, inevitably leading to conflicts that need to be managed to, as
evidenced by Jensen and Meckling (1976). Thus, managers (agent) may present risk by
acting on their own behalf, removing the investors (principal) from business decision, and
by this undertake projects that do not maximize the firm’s value but individual wealth or the
wealth of protected interestsparty to that decision.
Aiming to act on these issues and provide an environment for firms where the investors are
aware of the requirements and corporate governance practices, the Brazilian capital
markets regulatory authorities introduced three new levels of corporate governance
practices (Level 1, Level 2 and New Market), and firms could join them voluntarily and
commit to comply. Furthermore, it was enacted the Brazilian Corporation Law (2001) which
provided more transparency to the accounting affairs. These steps allowed investors to
have an overview of firms’ management and overseeing how is the commitment of
corporate governance practices.
As reported by Kim et al. (2014), governance mechanisms reduce hoarding behavior and
this effect is more significant when firms have weak governance practices and lower levels
of institutional ownership. Thus, the investors do not appreciate the agency costs
engendered by weak governance practices that these practices can exert on the financial
affairs of the firms and, consequently, effects on the behavior of the term volatility of them.
The weaknesses and failures in corporate governance practices are close related with
financial crisis and because of this the oversight of a qualified board and a good risk
management is highly important to reduce the risk of falling into a financial crisis
(Kirkpatrick, 2009). Thisinstitutional monitoring limits the manager for doing extractions from
the companies’ cash flows which lead to diminish the firm-specific risk by managers.
Further, it reduces the bad-news hoarding, and to mitigate them is important because the
stock price could crash when the accumulated bad-news are finally released (An and
Zhang, 2013).
Over these assumptions the managers should be concerned about the idiosyncratic risk
only which is related with factorsfrom the firm-level, because it is the only one the managers
can act on. As evidenced by Gompers et al. (2003) corporate governance can directly
influence equity prices, operational performance and capital structure. Thus, corporate
governance practices are related with the behavior of the equity prices and, if so, firms with
good governance practices diminish their idiosyncratic risks and, consequently, they
present less volatility of equityprices.
However, it has been raised concernsabout the influence of corporate governance in highly
concentrated ownership environment (Leal and de Oliveira, 2002;Caixe and Krauter, 2013)
and in markets with incipient corporate governance practices (Leal et al., 2015). The former
is related with the idea of lack of influence of these practices in highly concentrated
environment due to the firms comply to implement them, and, thus, they are not fully
enforced (Edmans, 2014;Funchal and Pinto, 2018). The latter is associated with the idea
that despite of the implemented practices they are not working due to the poorly functioning
judicial system (Claessens and Yurtoglu, 2013) and because they are not the drivers of
volatility, they act as complementary devices (Ferreira and Laux, 2007;McCahery et al.,
2016).
The purpose of this paper is to investigateBrazilian stock market behavior and volatility term
structure of two portfolios that, theoretically, the companies that comprise them have
different degrees of idiosyncratic risk: one portfolio consists of firms’ shares with good
corporate governance and the other is comprised of firms’ shares with poor corporate
governance.
The understanding of firm-levelfactors, as the corporate governance practices, in the stock
prices and its effects are relevant due to the aspects from this level can be managed and,
consequently, the practitioners can act on in terms of regulation and investment decision,
VOL. 19 NO. 6 2019 jCORPORATEGOVERNANCE jPAGE 1237

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