Effect of corporate governance on stock return in firms listed in Colombo Stock Exchange

Abstract

Despite the enormous attention that corporate governance received following a series of corporate scandals, 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 the data on a sample of 100 firms listed in the Colombo Stock Exchange for the five years from 2016 to 2020. Four corporate governance sub-indices 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 is given the same weight. Capital gain, dividend, and total stock return were used as proxies for stock return. A series of random-effects panel regression models used in this study to analyse the data did not show adequate evidence to claim a positive association between stock return and corporate governance compliance. Only the basic board-related best practices show a weak positive impact on stock return. 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 return even when they do not comply with the corporate governance best practices. These findings highlight the necessity of formulating contextually relevant best practices instead of encouraging firms to comply with practices deemed best in developed markets.