Stronger shareholder rights lead to better corporate performance
January 30, 2008
Their study “Corporate Governance and Equity Prices” can be seen as a “long-run event study”, the authors state. They developed a variable, “G”, that measures the degree to which a firm’s corporate governance policies favor management or shareholders (based on governance data compiled by the Investor Responsibility Research Center). Using a four-factor attribution model, the authors find that an investment strategy that bought firms in the lowest decile of the index (strongest rights) and sold firms in the highest decile of the index (weakest rights) would have earned abnormal returns of 8.5 percent per year during the period from September 1990 to December 1999. By 1999, a one-point difference in the index was negatively associated with an 11.4 percentage-point difference in Tobin’s Q.
In their study, the authors also sketch why many companies have added takeover defenses and other restrictions of shareholder rights. Until the 1980s, “large corporations had little reason to restrict shareholder rights. Proxy fights and hostile takeovers were rare, and investor activism was in its infancy. By rule, most firms were shareholder democracies, but in practice management had much more of a free hand than they do today.” They describe the diverse governance provisions, such as cumulative voting and poison pill provisions, in detail.
Gompers, Ishii and Metrick cannot draw strong conclusions about causality from their data. “There is some evidence, both in our sample and from other authors [La Porta et al. (2002) and Daines (2001)], that weak shareholder rights caused poor performance in the 1990s. It is also possible that the results are driven by some unobservable firm characteristic. These multiple causal explanations have starkly different policy implications and stand as a challenge for future research.” However, they conclude, “The empirical evidence of this paper establishes the high stakes of this challenge. If an 11.4 percentage point difference in firm value were even partially “caused” by each additional governance provision, then the long-run benefits of eliminating multiple provisions would be enormous.”
- Porta, Rafael La, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny. “Investor Protection and Corporate Valuation.” The Journal of Finance 57, no. 3 (June 1, 2002): 1147–1170.
- Daines, Robert. “Does Delaware Law Improve Firm Value?” Journal of Financial Economics 62, no. 3 (December 2001): 525–558.
Administrative Editor FSinsight