Research Seminar, ReFi – Merritt Fox, Columbia University – Contextualizing the Link between Corporate Governance and Performance: Governance Changes as a Signal of Managerial Quality
(CV & Bio here)
Professor of Law and the NASDAQ Professor for the Law and Economics of Capital Markets at Columbia Law School.
« Contextualizing the Link between Corporate
Governance and Performance: Governance
Changes as a Signal of Managerial Quality»
Prior scholarship reports a relationship between firms with good corporate governance index scores and those best at creating shareholder value, but little work explores why. We hypothesize that at least one explanation is that a score-changing alteration in governance structure can be a signal of the quality of a firm’s management.
The idea is that a poor governance with a poor score is more costly to bad managers than good ones because it imposes a higher risk of job loss on the bad managers. As well, adoption of governance changes that result in a poorer governance score do not run the risk of better managers sending false signals of poor quality. We test this hypothesis by comparing ordinary times with 2000-2002, a period of unprecedented corporate accounting scandals leading to greater uncertainty as to the quality of firm managers. Fixed effects tests reveal that a change in governance index score in the accounting scandal years is associated with a much larger change in Tobin’s Q than a comparably sized rating change occurring in the years before and after the accounting scandal period. OLS tests show no significant difference in the relationship between a firm’s score and its Q during the crisis period versus the surrounding years, which suggest that the market’s perception of the effectiveness of a highly-rated governance structure at better incentivizing managers or at filtering out bad ones did not change during the scandal years. Signaling — the third possible causal link between good scores and higher Tobin’s Q – must have been at work because a clarifying signal would be expected to have a bigger effect in a period of greater uncertainty as to which firms had good managers. These results are strong evidence that the impact of governance is in important respects contextual, depending on the particular circumstances of the time involved and the particular characteristics of the firms involved. This point, largely missed to date, helps illuminate the current debate concerning the corporate governance index studies. It suggests that that there is theory that can explain the index studies’ strong empirical results linking governance structure with firm value creation, but that, rather than a single link between the specified corporate governance provisions and performance, a range of linkages are possible whose direction and intensity depend centrally on the particular context in which a firm is operating
Friday, 12 October 2018