Board independence affects stocks less than shareholder rights do

Corporate governance, the authors note, has certainly been in the spotlight, particularly since the enactment of the Sarbanes-Oxley Act in the U.S. But the existing research suggests that differences in corporate governance do not have an impact on a company’s market value.

“I think we all recognize the area of corporate governance is a very timely issue in which to conduct research,” Klein said in a presentation today. “We all feel that good corporate governance is something for which we should all strive,” he added, suggesting that some hedge fund managers are incorporating measures of corporate governance into their buy/sell framework.

For their study, Klein, Shapiro and Young applied Tobin’s q to the aggregate corporate governance index, as well as the four sub-indexes, to determine whether a broad measure of corporate governance affects share price, and also whether some individual factors play more of a role than others. Tobin’s q is the ratio of a firm’s market value to its replacement value, normally, its book value.

The study also honed in on family-owned firms, and in a departure from U.S. findings, found little difference between family-owned firms and other firms.

Among their findings, the researchers found that the total governance index has no effect on firm performance, and in fact has a negative impact on family-owned firms. In general,variables that are connected to ownership type are not statistically significant.

To measure the effect of corporate governance, the authors created a broad corporate governance index, with a maximum value of 100. It is the sum of the four sub-indices: board composition, shareholding and compensation issues, shareholder rights and disclosure. The weights are 40%, 23%, 22% and 15% respectively.

Firm performance was then compared, using regression analysis, which also made use of some control variables, including firm size, debt to equity, average sales growth and profit variability.

When it comes to ownership, Klein, Shapiro and Young did find that family-owned firms had a lower Tobin’s q, but they attributed that to the fact that family-owned firms, on average, are larger than other firms. Larger firms tend to underperform.

Of the sub-indices, there is no indication that investors value an independent board; indeed, with family-owned firms, it is the opposite. However, strong shareholders rights policies, disclosure and shareholder-friendly compensation did have an impact. “It does appear corporate governance matters to investors in Canada, but not all aspects are equally important,” said Young.

Nor did the overall governance measure have an impact. The authors add that the variables that seem to matter the most are given the smallest weights in the Globe and Mail‘s index.

They conclude that different weightings might show a different relationship between overall corporate governance and share performance; in any case, regulators, they say, should exercise caution when drawing conclusions from the overall index, and analysts should be wary of using aggregate corporate governance indexes to forecast market performance.

“It forces people to wonder what really matters on governance,” said Barclay’s CEO Gerry Rocchi in presenting the $10,000 award. “What really matters is what boards do, not who they are.”

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com.

(06/15/04)