Do Firms With Better Corporate Governance Yield Higher Stock Returns? Evidence From Firms Listed in the Colombo Stock Exchange.

Abstract

Corporate governance received enormous attention from researchers and policymakers following a series of corporate scandals. Nonetheless, the effectiveness of prevailing governance best practices in achieving intended objectives remains a puzzle. Therefore, this study assesses the association between corporate governance and stock returns using data for the five years from 2016 to 2020 from a sample of 100 firms listed in the Colombo Stock Exchange. Four corporate governance subindices were formulated to measure the level of corporate governance compliance by classifying 18 board-related best practices into four sub-indices where each best practice was given the same weight. Capital gain, dividend, and total return were used as proxies for stock return. The nine random-effects panel regression models used in this study to analyze the data did not show adequate evidence to claim a positive association between stock returns and corporate governance compliance. Only the basic board-related best practices showed a weak positive impact on stock returns. The main reason behind this finding could be the concentrated and family ownership structure prevailing in a large number of smaller firms in Sri Lanka. More precisely, the Sri Lankan firms have maintained satisfactory levels of stock returns even when they do not comply with the corporate governance best practices. These indications highlight the necessity of formulating contextually relevant best practices instead of encouraging firms to comply with irrelevant practices. More precisely, what constitutes best practices of corporate governance need to be defined more contextually than globally. Moreover, future research can focus on the formulation of a contextually relevant corporate governance compliance index.