Working Paper: CEPR ID: DP6974
Authors: Xavier Giroud; Holger M. Mueller
Abstract: This paper examines the hypothesis that firms in competitive industries should benefit relatively less from good governance, while firms in non-competitive industries--where lack of competitive pressure fails to enforce discipline on managers--should benefit relatively more. Whether we look at the effects of governance on long-horizon stock returns, firm value, or operating performance, we consistently find the same pattern: The effect is monotonic in the degree of competition, it is small and insignificant in competitive industries, and it is large and significant in non-competitive industries. By implication, the effect of governance (in non-competitive industries) reported in this paper is stronger than what has been previously reported in Gompers, Ishii, and Metrick (2003, "GIM") and subsequent work, who document the average effect across all industries. For instance, GIM?s hedge portfolio - provided it only includes firms in non-competitive industries -earns a monthly alpha of 1.47%, which is twice as large as the alpha reported in GIM. The alpha remains large and significant even if the sample period is extended until 2006. We also revisit the argument that investors in the 1990s anticipated the effect of governance, implying that the alpha earned by GIM?s hedge portfolio is likely due to an omitted risk factor. We find that while investors were indeed not surprised on average, they underestimated the effect of governance in non-competitive industries, the very industries in which governance has a significant effect in the first place.
Keywords: corporate governance; G-index; product market competition
JEL Codes: D4; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Corporate governance (G38) | Stock returns (G12) |
| Corporate governance (G38) | Firm value (G32) |
| Corporate governance (G38) | Operating performance (L25) |
| Degree of competition (L13) | Effect of corporate governance on stock returns (G38) |
| Degree of competition (L13) | Effect of corporate governance on firm value (G38) |
| Degree of competition (L13) | Effect of corporate governance on operating performance (G38) |
| Governance-based trading strategies (G38) | Abnormal returns (G14) |
| Market pricing of governance-related factors (G38) | Earnings per share (EPS) (G35) |