Corporate governance over the business cycle

I provide empirical evidence that badly governed firms respond more to aggregate shocks than do well governed firms. I build a simple model where managers are prone to over-invest and where shareholders are more likely to tolerate such a behavior in good times. The model successfully explains the average profit differences as well as the cyclical behavior of sales, employment and investment for firms with different governance qualities. The quantitative results suggest that governance conflicts could explain up to a third of aggregate volatility.