Corporate Governance and Stock Returns in Hong Kong: Carrots or Sticks?

This study uses time-series data to examine the relation between corporate governance and stock returns. Based on internationally accepted principles (OECD, 2004), we develop a corporate governance index (CGI) to measure the quality of corporate governance practices of listed companies in Hong Kong. We find a positive relation between CGI scores and one-year buy-and-hold returns. Furthermore, our findings suggest an asymmetric response to changes in the quality of corporate governance practices. Specifically, the magnitudes of the decline in stock returns when firms show deteriorating CGI scores are much larger than the magnitudes of return increases when firms show improving CGI scores. Results further suggest that stock returns are more reponsive to deteriorating rights of shareholders and improving disclosure and transparency more than to changes in other aspects of governance.