In Practice Is there a payoff to better corporate governance

While academics and activist investors are understandably enthused by moves towards giving stockholders more power over managers, a practical question that is often not answered is what the payoff to better corporate governance is. Are companies where stockholders have more power over managers managed better and run more efficiently? If so, are they more valuable? While no individual study can answer these significant questions, there are a number of different strands of research that offer some insight:

• In the most comprehensive study of the effect of corporate governance on value, a governance index was created for each of 1500 firms based upon 24 distinct corporate governance provisions.11 Buying stocks that had the strongest investor protections while simultaneously selling shares with the weakest protections generated an annual excess return of 8.5%. Every one point increase in the index towards fewer investor protections decreased market value by 8.9% in 1999 and firms that scored high in investor protections also had higher profits, higher sales growth and made fewer acquisitions. These findings are echoed in studies on firms in Korea12 and Germany13.

• Actions that restrict hostile takeovers generally reduce stockholder power by taking away one of the most potent weapons available against indifferent management. In 1990, Pennsylvania considered passing a state law that would have protected incumbent managers against hostile takeovers by allowing them to override stockholder interests if other stakeholders were adversely impacted. In

11Gompers, P.A., J.L. Ishii and A. Metrick, 2003, Corporate Governance and Equity Prices, Quarterly Journal of Economics, v118, 107-155. The data for the governance index was obtained from the Investor Responsibility Research Center which tracks the corporate charter provisions for hundreds of firms.

12 Black, B.S., H. Jang and W. Kim, 2003, Does Corporate Governance affect Firm Value? Evidence from Korea, Stanford Law School Working Paper.

13 Drobetz, W., 2003, Corporate Governance: Legal Fiction or Economic Reality, Working Paper, University of Basel.

the months between the time the law was first proposed and the time it was passed, the stock prices of Pennsylvania companies declined by 6.90%.14 There seems to be little evidence of a link between the composition of the board of directors and firm value. In other words, there is little to indicate that companies with boards that have fewer insiders trade at higher prices than companies with insider dominated boards. 15

While this is anecdotal evidence, the wave of corporate scandals - Enron, Worldcom and Tyco - in the United States 2000 and 2001 indicated a significant cost to having a compliant board. A common theme that emerged at problem companies was an ineffective board that failed to ask tough questions of an imperial CEO,

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