Macro Governance and Profitability around the World: A Methodological Improvement

Abstract

There is a multitude of country studies between 2000-2018 that focus upon the relationship between corporate governance and profitability, with mixed results because studies have generally focused upon historic book value ratio measures of profitability such as Return on Assets (ROA) and Return on Equity (ROE), rather than based on market values. Thus, the purpose of this paper is to examine the effect of macro governance environments upon aggregate dividend yield and earnings per share for developed and emerging stock markets as measures of profitability and to provide a useful methodology for correctly incorporating risk measures in a more controlled manner than many current papers undertake. Using an augmented version of the dividend growth model and allowing for the control of risk factors, we find that macro governance environments have a significant influence upon dividend yield and earnings per share. The results have policy implications for government policy setters as improvements to governance environments may induce portfolio equity inflow, which is increasingly seen as a driving force for economic growth. Future research papers should use our methodology to better model firm profitability and corporate governance within a market value context and recognise the limitations of ROE and ROA as they rely upon less relevant book market values. Further, studies need to better capture interaction effects between macro (country-specific) and micro (firm-specific) governance.