Takeaway: Corporate governance is strongly correlated with stock returns. Companies with high shareholder rights outperformed those with high management rights, significantly. Researchers estimate that investing in a portfolio of companies with high shareholder rights would outperform a high management rights portfolio by 9.3% a year.
Suggested audience: Boards of directors, C-suite, investors
Researchers examined balance of control between shareholders and managers at about 1500 large firms during the 1990s. They analyzed data from publications of the Investor Responsibility Research Center (IRRC) from 1990-1999, which told them how many governance rules each company had adopted in order to restrict shareholder rights and increase management rights. Companies typically adopted these rules in order to avoid hostile takeovers. Using this data, the researchers divided the companies into different groups based on how high or low their shareholder rights were, and compared groups. The researchers controlled for other factors that might influence share price, and still found that shares of high shareholder rights companies significantly outperformed shares of high management rights companies. An investment strategy that bought shares in high shareholder rights companies and sold shares in low shareholder rights companies outperformed by 8.5%.
- Companies with high shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions. Investing in a portfolio with high shareholder rights yielded an annualized return of 23.3% throughout the 1990s. Investing in a portfolio with high management rights yielded a return of 14.0%: 9.3% lower.
- Firms with strong shareholder rights tend to be valued more highly than firms with strong management rights. This gap in firm value became more pronounced as the decade progressed.
- Firms with strong shareholder rights were more profitable and had higher sales growth than firms with strong management rights.
- There is a strong relationship between governance and S&P 500 inclusion. Overall, firms with weak shareholder rights tend to be large S&P firms with relatively high share prices, institutional ownership and trading volume, relatively poor sales growth, and poor stock-market performance.
Keywords: research, research briefs, stockholders, shareholders, capital investments
If citing please refer to the original article: “Corporate Governance and Equity Prices”, Paul A. Gompers, Harvard Business School Harvard University and NBER; Joy L. Ishii Department of Economics Harvard University; Andrew Metrick Department of Finance, The Wharton School University of Pennsylvania and NBER. Quarterly Journal of Economics, Feb 2003