Essays on agency problems and corporate governance

Date of Completion

January 2005


Economics, Finance




This dissertation consists of three essays covering corporate governance, agency costs and asset pricing. The recent spate of corporate governance scandals has led to the emergence of several commercial governance rating agencies which rate firms on their strength of governance mechanisms. In the first essay, we examine the quality of governance scores offered by one such vendor, The Corporate Library Board Analyst Ratings. We find that most of the factors used by Board Analyst Ratings are consistent with the extant corporate governance theory and evidence. However, Board Analyst Ratings fail to predict the future operating performance and stock returns of rated firms. Using a broader range of governance mechanisms, we construct an alternative score for governance which is linked to the future operating performance of firms. ^ The second essay examines how outside director compensation is linked to debt related agency problems. Recent evidence suggests that equity-based compensation for directors aligns the interests of directors with those of shareholders (Fich and Shivdasani, 2004). On the other hand, there is empirical evidence that suggests that equity-based compensation for managers increases the risk-shifting incentives and debt-related agency problems (Molina, 2004). In this essay, we provide evidence that equity-based incentives for directors decrease the agency costs of debt. We also show that the stock awards provide stronger monitoring incentives than stock options. ^ In the third essay, we examine the relation between agency costs and stock returns. Existing literature links several aspects of agency problems to firm valuation (Morck et al., 1988 and McConnell and Servaes, 1990). However, the relation between agency problems and the required rate of return on stocks has not yet been examined. In this paper, first we discuss several measures of agency costs. We then examine whether agency costs are correlated with stock returns using the Fama-French (1992) method. Our main findings are: (a) firms with higher industry-median adjusted dividend yields have lower stock returns, (b) debt ratios are positively linked to rates of returns, and (c) firms with higher institutional ownership have lower rates of return. ^