What Matters in Corporate Governance?
Lucian Bebchuk Harvard Law School and NBER Alma Cohen Tel-Aviv University Department of Economics, NBER, and Harvard Law School Olin Center for Law, Economics, and Business Allen Ferrell Harvard Law School and ECGI
We investigate the relative importance of the twenty-four provisions followed by the Investor Responsibility Research Center (IRRC) and included in the Gompers, Ishii, and Metrick governance index (Gompers, Ishii, and Metrick 2003). We put forward an entrenchment index based on six provisions: staggered boards, limits to shareholder bylaw amendments, poison pills, golden parachutes, and supermajority requirements for mergers and charter amendments. We ﬁnd that increases in the index level are monotonically associated with economically signiﬁcant reductions in ﬁrm valuation as well as large negative abnormal returns during the 1990–2003 period. The other eighteen IRRC provisions not in our entrenchment index were uncorrelated with either reduced ﬁrm valuation or negative abnormal returns. (JEL G30, G34, K22)
There is now widespread recognition, as well as growing empirical evidence, that corporate governance arrangements can substantially affect shareholders. But which provisions, among the many provisions ﬁrms have and outside observers follow, are the ones that play a key role in the link between corporate governance and ﬁrm value? This is the question we investigate in this article. An analysis that seeks to identify which provisions matter should not look at provisions in isolation without controlling for other corporate governance provisions that might also inﬂuence ﬁrm value. Thus, it is desirable to look at a universe of provisions together. We focus in this article on the universe of For those wishing to use the entrenchment index put forward in this paper in their research, data on ﬁrms’ entrenchment index levels is available at http://www.law.harvard.edu/faculty/bebchuk/data.shtml. A list of over seventyﬁve studies already using the index is available at http://www.law.harvard.edu/faculty/bebchuk/studies.shtml. For helpful suggestions and discussions, we are grateful to Bernie Black, Victor Chernozhukov, Martijn Cremers, Ray Fisman, Yaniv Grinstein, Robert Marquez, Andrew Metrick, Guhan Subramanian, Greg Taxin, Manuel Trajtenberg, Yishay Yafeh, Rose Zhao, Michael Weisbach (the editor), an anonymous referee, and conference participants at the NBER, Washington University, the Oxford Sa¨d Business School, Tel-Aviv University, the ı Bank of Israel, and the ALEA annual meeting. Our work beneﬁted from the ﬁnancial support of the Nathan Cummins Foundation; the Guggenheim Foundation; the Harvard Law School John M. Olin Center for Law, Economics, and Business; the Harvard Milton fund; and the Harvard Program on Corporate Governance. Send correspondence to Lucian Bebchuk, Harvard Law School, Cambridge, MA 02138; telephone: (617) 495-3138; fax: (617) 812-0554; E-mail: firstname.lastname@example.org. C The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: email@example.com. doi:10.1093/rfs/hhn099 Advance Access publication November 27, 2008
The Review of Financial Studies / v 22 n 2 2009
provisions that the Investor Responsibility Research Center (IRRC) monitors for institutional investors and researchers interested in corporate governance. The IRRC follows twenty-four governance provisions (the IRRC provisions) that appear beneﬁcial to management, and which may or may not be harmful to shareholders. Prior research has identiﬁed a relationship between the IRRC provisions in the aggregate and ﬁrm value. In an inﬂuential article, Gompers, Ishii, and Metrick (2003) found that a broad index based on these twenty-four provisions, giving each IRRC provision equal weight, was negatively correlated with ﬁrm value, as measured by Tobin’s Q, as well as...
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