The Vote is Cast: The Effect of Corporate Governance on Shareholder Value

In our paper, The Vote is Cast: The Effect of Corporate Governance on Shareholder Value, which was recently made publicly available on SSRN, we present novel evidence of the effect of corporate governance on the market value and long-term performance of firms. We use a regression discontinuity model on the outcomes of votes on governance proposals in shareholder meetings. We exploit the fact that firms that pass a proposal by a close margin are ex-ante similar to those that reject it by a close margin, so that passing a provision is “locally” exogenous. Therefore, this approach provides a causal estimate and overcomes the endogeneity problems that have plagued the literature thus far. In addition, our empirical strategy also allows us to recover an estimate of the effect of governance even if the market had already incorporated the probability of passing the shareholder proposal into stock prices. This is because, proposals that fall around the majority threshold were ex-ante the most uncertain, such that investors could not perfectly predict whether they would pass or not. It is for these proposals that we are able to observe a price reaction.

We show that, on average, the market reacts to the passage of a governance-related shareholder proposal with positive excess returns around 1.3% on the day of the vote. This reflects between a 2.7% and a 2.8% increase in market value. We identify some heterogeneity of this reaction, with the effect being more pronounced among firms with concentrated ownership, high pre-existing anti-takeover provisions and high R&D expenditures. Firm behavior also changes with the new governance structure: dropping anti-takeover provisions leads to a more conservative investment policy, with fewer acquisitions. Finally, the long-term performance of the firm, measured as Tobin´s Q or book-to-market ratios, improves after two or three years when anti-takeover provisions are dropped; but we find modest results with respect to the return on equity.

When analyzed together, our results portray a picture in which good corporate governance is rewarded by the market, and generates performance improvements in the long-run. Our results also suggest that the channels behind these improvements include more conservative investment and acquisition policies. Some of these effects are common to all shareholder proposals, but they are more pronounced when we concentrate on the ones that lower anti-takeover provisions.

Overall, our results provide evidence in support of the fact that current corporate governance structures do not fully maximize shareholder value, and that the costs of the agency problem for modern corporations are non-negligible. A better understanding of the effect of governance provisions and the magnitude of the agency problem is crucial to guiding the public debate on the adequacy of implementing and regulating corporate governance. It is also important to understand the potential role of shareholder activism to improve the governance of firms and create value. Only causal estimates can be used to infer the impact of changing internal governance structures such as the level of protection from takeover, compensation arrangements or board independence. This paper is a step towards a better understanding of the consequences of current governance arrangements.

The full paper is available for download here.