Pricing of Corporate Governance

Question 1

La Porta, Lopez-de-Silanes, Shleifer and Vishny (1998)

Answer 1

• examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries.
• results show that common law countries generally have the strongest, and french civil law countries the weakest, legal protections of investors, with German and scandinavin civil law countries located in the middle
• also find that concentration of ownership of shares in the largest public companies is negativelyrelated to investor protections
• consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.

Question 2

La Porta, Lopez-de-Silanes, Shleifer and Vishny 2002

Answer 2

• present a model of the effects of legal protection of minority shareholders and of cash-flow ownership by a controlling shareholder on the valuation of firms.
• test this model using a sample of 539 large firms from 27 wealthy economies.
• Consistent with the model, we find evidence of higher valuation of firms in countries with better protection of minority shareholders and in firms with higher cash-flow ownership by the controlling shareholder.

Question 3

Bertrand and Mullainathan 2003

Answer 3

• Gist: “Enjoying the Quiet Life”
• This paper uses variation in corporate governance generated by state adoption of antitakeover laws to empirically map out managerial preferences.
• We use plant-level data and exploit a unique feature of corporate law that allows us to deal with possible biases associated with the timing of the laws.
• We find that when managers are insulated from takeovers, worker wages (especially those of white-collar workers) rise.
• The destruction of old plants falls, but the creation of new plants also falls.
• Finally, overall productivity and profitability decline in response to these laws.

Question 4

Gompers, Ishii and Metric 2003

Answer 4

• An investment strategy that bought firms in the lowest decile of the G 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 sample period.
• We find that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions.

Question 5

Cremers and Nair 2005

Answer 5

• We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact.
• portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10% to 15% only when public pension fund (blockholder) ownership is high as well.
• A similar portfolio created to capture the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of “high” vulnerability to takeovers.

Question 6

Klock, Mansi and Maxwell 2005

Answer 6

• examine the relation between the cost of debt financing and a governance index
• find that strong antitakeover provisions are associated with a lower cost of debt financing while weak antitakeover provisions are associated with a higher cost of debt financing, with a difference of about 34 basis points between the two groups.
• results suggest that antitakeover governance provisions, although not beneficial to stockholders, are viewed favorably in the bond market

Question 7

Cremers, Nai and Peyer 2006

Answer 7

• We use a framework where firms choose their level of shareholder rights after comparing the costs of takeover vulnerability, i.e., the loss of customers, with the synergistic benefits of an acquisition.
• we empirically find that indeed firms have stronger shareholder rights in concentrated industries and especially relationship based industries where customers tend to have a long-term relationship with the firm.
• also document that weak shareholder rights are associated with worse performance only in non-competitive industries.

Question 8

Hou and Robinson 2006

Answer 8

• Firms in more concentrated industries earn lower returns, even after controlling for size, book-to-market, momentum, and other return determinants.
• Drawing on work in industrial organization, we posit that either (1) barriers to entry in highly concentrated industries insulate firms from undiversifiable distress risk, or (2) firms in highly concentrated industries are less risky because they engage in less innovation, and thereby command lower expected returns.
• Additional time-series tests support these risk-based interpretations.

Question 9

Kim and Purnanandam 2006

Answer 9

• The average investor reaction is neutral to primary offerings by firms with managerial incentives closely tied to the shareholder value.
• Investors react negatively (1) when there are insufficient managerial ownership stakes to deter misuse of SEO proceeds and (2) when there are negative signals transmitted through secondary offerings by insiders and block-holders.
• Consistent with an agency-based explanation, firms engaging in value-destroying corporate acquisitions suffer large negative returns at the announcement of SEOs.
• Agency problems seem to be of less concern to investors, however, when firms are subject to intense monitoring by institutional investors and the market for corporate control.

Question 10

Villalonga and Amit 2006

Answer 10

• Using proxy data on all Fortune-500 firms during 1994-2000
• we find that family ownership creates value only when the founder serves as CEO of the family firm or as Chairman with a hired CEO.
• Dual share classes, pyramids, and voting agreements reduce the founder’s premium.
• **When descendants serve as CEOs, firm value is destroyed. **

Question 11

Cremers, Nair and Wei 2007

Answer 11

• investigate the effects of shareholder governance mechanisms on bondholders
• impact of shareholder control (proxied by large institutional blockholders) on credit risk depends on takeover vulnerability.
• Shareholder control is associated with higher yields if the firm is exposed to takeovers.
• In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 66 basis points.
• event risk covenants reduce the credit risk associated with strong shareholder governance.
• Therefore, without bond covenants, shareholder governance, and bondholder interests diverge.

Question 12

Ferreira and Laux 2007

Answer 12

• study the relationship of corporate governance policy and idiosyncratic risk.
• Firms with fewer antitakeover provisions display higher levels of idiosyncratic risk, trading activity, private information flow, and information about future earnings in stock prices.
• Trading interest by institutions, especially those active in merger arbitrage, strengthens the relationship of governance to idiosyncratic risk.
• results indicate that openness to the market for corporate control leads to more informative stock prices by encouraging collection of and trading on private information.
• Consistent with an information-flow interpretation, the component of volatility unrelated to governance is associated with the efficiency of corporate investment.

Question 13

Larcker, Richardson and Tuna 2007

Answer 13

• Using a sample of 2,106 firms and 39 structural measures of corporate governance
• our exploratory principal component analysis suggests that there are 14 dimensions to corporate governance.
• find that these indices have a mixed association with abnormal accruals, little relation to accounting restatements, but some ability to explain future operating performance and future excess stock returns.

Question 14

Lehn, Patro and Zhao 2007

Answer 14

• We test whether causation runs from governance to valuation or vice versa.
• After controlling for **valuation multiples during 1980–1985, no significant relation exists between contemporaneous valuation **multiples and governance indices during the 1990s.
• results are consistent with the hypothesis that firms with low valuation multiples were more likely to adopt provisions comprising the governance indices, not that the adoption of these provisions depresses valuation multiples.

Question 15

Masulis, Wang and Xie 2007

Answer 15

• examine whether corporate governance mechanisms, especially the market for corporate control, affect the profitability of firm acquisitions.
• find that acquirers with more antitakeover provisions experience significantly lower announcementperiod abnormal stock returns.
• supports the hypothesis that managers at firms protected by more antitakeover provisions are less subject to the disciplinary power of the market for corporate control
• also find that acquirers operating in more competitive industries or separating the positions of CEO and chairman of the board experience higher abnormal announcement returns.

Question 16

Bhagat and Bolton 2008

Answer 16

• Gist: when control for endogeneity of corporate governance, relation btw G-Index and returns vanishes
• find that better governance (via G and E index), stock ownership of board members, and CEO-Chair separation is significantly positively correlated with better contemporaneous and subsequent operating performance.
• contrary to claims in GIM and BCF, none of the governance measures are correlated with future stock market performance.
• given poor firm performance, the probability of disciplinary management turnover is positively correlated with stock ownership of board members, and board independence.
• However, better governed firms as measured by the GIM and BCF indices are less likely to experience disciplinary management turnover in spite of their poor performance

Question 17

Bebchuk, Cohen and Ferrell 2009

Answer 17

• 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.
• 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.

Question 18

Cremers, Nair and John

Answer 18

• This paper considers the impact of the takeover likelihood on firm valuation. If firms are more likely to acquire when there is more free cash or lower required rates of return, the targets become more sensitive to shocks to cash flows or the price of risk.
• Ceteris paribus, firms exposed to takeovers have different rates of return than protected firms.
• Using takeover likelihood estimates, we create a “takeover factor,” buying (selling) firms with a high (low) takeover likelihood, which generates “abnormal” returns.
• Several tests confirm that the takeover factor helps explaining cross-sectional differences in equity returns and is related to takeover activity.

Question 19

Johnson, Moorman and Sorescu 2009

Answer 19

• Gist: Properly control for industry clustering, low g abnormal return dissapears.
• Firms with strong shareholder rights and firms with weak shareholder rights differ from the population of firms and from each other in how they cluster across industries.
• Using well-specified tests under this industry clustering, we find statistically zero long-term abnormal returns for portfolios sorted on governance.

Question 20

Giroud and Mueller 2010

Answer 20

• Gist: Business combo laws only impact firms in non-competitive industries.
• Consistent with the notion that competition mitigates managerial slack, we find that while firms in non-competitive industries experience a significant drop in operating performance after the laws’ passage, firms in competitive industries experience no significant effect.
• **find evidence in support of a “quiet-life” hypothesis: **Input costs, wages, and overhead costs all increase after the laws’ passage, and only so in non-competitive industries.
• when we conduct event studies around the dates of the first newspaper reports about the BC laws, we find that while firms in non-competitive industries experience a significant stock price decline, firms in competitive industries experience a small and insignificant stock price impact.

Question 21

Giroud and Mueller 2011

Answer 21

• We find that weak governance firms have lower equity returns, worse operating performance, and lower firm value, but only in noncompetitive industries.
• When exploring the causes of the inefficiency, we find that weak governance firms have lower labor productivity and higher input costs, and make more value-destroying acquisitions, but, again, only in noncompetitive industries.
• We also find that weak governance firms in noncompetitive industries are more likely to be targeted by activist hedge funds, suggesting that investors take actions to mitigate the inefficiency.