An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Shamin Mashruwala
University of Washington Business School

Shiva Rajgopal
University of Washington

Terry Shevlin
University of Washington

Abstract: We view the Enron scandal as an exogenous shock to test whether the quality of corporate governance affects firms’ cost of capital. If governance is indeed reflected in the cost of capital, we expect to find increases in the cost of equity and debt capital post Enron for poorly governed firms. We find that the market betas from the one factor model and the cost of equity capital, computed from both the one factor and three factor Fama-French (1993) type models, increase in a statistically and economically significant manner post Enron for poorly governed firms relative to well-governed firms (governance proxied by g score, ownership by largest block holder and by public pension funds). We find modest downgrades in the debt ratings of poorly governed firms post Enron relative to well-governed firms. We conclude that high quality governance does have a favorable impact on firms’ cost of capital.

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