5. Conclusions
Idiosyncratic volatility has gained wide attention as an important risk factor in asset pricing. The challenge remains in explaining what determines idiosyncratic volatility. We postulate that high managerial (CEO) power is associated with low idiosyncratic volatility due to management's ability to manipulate board decision making and corporate strategies and risks via their board committee membership and an enabling context with high ‘management voice’ during board discussion. Based on Upper Echelon Theory and Agency Theory, we argue that powerful managers, under market structure constraints, are able to pursue self-interests at the costs of shareholders' welfare. This is possible because managerial effort cannot be fully observed by shareholders and outsiders. Our sample consists of Australian listed and delisted firms between 2004 and 2013. We use system GMM to address several shortfalls in OLS regression modelling, including autocorrelation in time variance firm characteristics and endogeneity between management variables and idiosyncratic volatility. We measure CEO tenure and construct a power index to measure the level of managerial power of the CEO. We control for the effect of other factors that affect idiosyncratic volatility, including trading turnover, the book-to- market ratio, analyst coverage, firm size, firm age, dividends, the GFC, takeover events, and market competition. We hypothesise that powerful managers (high power index) are associated with low idiosyncratic volatility and that the internal governance structure is superior in its influence on idiosyncratic volatility than firm-specific characteristics and external factors. After controlling for the important factors mentioned above, we find that the power index has a significant and negative effect on idiosyncratic volatility and its effect is robust to the presence of various control variables and other checks while CEO tenure has no significant effect. Our results support our hypothesis that higher managerial power leads to lower idiosyncratic volatility. We test our managerial power hypothesis through an investigation of a firm's governance structure that enables CEOs to accumulate control through their long tenure. Although we take a step closer to addressing the postulation of Gompers et al. (2003), that the governance structure is a symptom and not a cause of corporate strategies and culture, by examining the leadership structure that instils corporate strategies and culture, we stop short of examining how this structure results in various degrees of information asymmetry and in what form, as well as their effect on idiosyncratic volatility. This will be the next question in our quest to determine the causes of longterm idiosyncratic volatility.
