Working Paper: NBER ID: w15912
Authors: Lucian A. Bebchuk; Alma Cohen; Charles CY Wang
Abstract: In an important and influential work, Gompers, Ishii, and Metrick (2003) show that a trading strategy based on an index of 24 governance provisions (G-Index) would have earned abnormal returns during the 1991-1999 period, and this intriguing finding has attracted much attention ever since it was reported. We show that the G-Index (as well as the E-Index based on a subset of the six provisions that matter the most) was no longer associated with abnormal returns during the period of 2000-2008, or any sub- periods within it, and we provide evidence consistent with the hypothesis that the disappearance of the governance-returns association was due to market participants' learning to appreciate the difference between firms scoring well and poorly on the governance indices. Consistent with the learning hypothesis, we document that (i) attention to corporate governance from the media, institutional investors, and researchers has exploded in the beginning of the 2000s and remained on a high level since then, and (ii) until the beginning of the 2000s, but not subsequently, market participants were more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms. Our results are robust to excluding new economy firms or to focusing solely on firms in non- competitive industries. While the G and E indices could no longer generate abnormal returns in the 2000s, their negative association with Tobin's Q persists and they thus remain valuable tools for researchers, policymakers, and investors.
Keywords: Corporate Governance; Abnormal Returns; Market Learning
JEL Codes: D03; G10; G12; G30; G34; K22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| G-index and E-index (C43) | abnormal returns (1990s) (G14) |
| market participants' learning (D84) | G-index and E-index no longer associated with abnormal returns (2000-2008) (G14) |
| media attention to corporate governance (G38) | market participants' expectations regarding earnings announcements (G14) |
| good-governance firms' earnings announcements positively surprising (G38) | higher abnormal returns (1990-2001) (G14) |
| G-index and E-index (C43) | negative association with Tobin's Q (G19) |