The implied cost of equity capital and corporate governance practices

This paper examines the relation between corporate governance practices and the implied cost of equity capital through a sample of firm-year observations from 2001 to 2004. Enhanced corporate governance improves financial reporting quality, thereby lowers the cost of equity capital. To examine this relation, this paper uses a unique data set on firm-level corporate governance practices provided by the Korea Corporate Governance Service (KCGS). This study finds that sound corporate governance practices are negatively related to the implied cost of equity capital estimates. Among several advantages of sound corporate governance practices, shareholder rights protection has the most significant effect on lowering the implied cost of equity capital. Board of directors and disclosure policy are also important in reducing the implied cost of equity capital. Overall, consistent with our expectations, the result shows that sound corporate governance practices reduce the implied cost of equity capital through a reduction in agency problems and information asymmetry.