Corporate Governance and the Cost of Capital: Evidence from Australian Firms

Abstract

Using a sample of large Australian firms from 1994 to 2003, we show that variation in firm-level corporate governance mechanisms plays an important role in explaining a firm's cost of capital. Our empirical results show that greater insider ownership, the presence of institutional blockholders and independent boards all serve to reduce the perceived risk of a firm, thereby leading investors to demand lower rates of return on capital provided. This highlights the important role that corporate governance plays in creating value for shareholders by reducing the cost of external financing. Given the inconclusiveness of existing literature that uses Q to measure firm value, this research provides an alternative and potentially more suitable way to investigate the impact of corporate governance on firm value.

Keywords: Corporate governance, Firm value, Cost of capital, Australia

JEL Classification: G32