Aurora Borealis
1 August 2013 CFA Institute Journal Review

Is Corporate Governance Relevant during the Financial Crisis? (Digest Summary)

  1. William Ang

A non-financial firm’s corporate governance quality had no significant impact on its share performance during the global financial crisis. The authors’ explanation for this finding is that stock markets in developed countries became less efficient at incorporating firm-specific information into prices during the crisis.

What’s Inside?

Examining the relationship between internal corporate governance and the performance of publicly traded non-financial firms during the recent crisis, the authors find that well-governed firms did not outperform poorly governed firms. They suggest three potential explanations: (1) cross-country differences in institutional development, (2) contraction of the market for information dissemination during the crisis, and (3) a decrease in the market’s efficiency with respect to the pricing of firm-specific information during the crisis.

How Is This Research Useful to Practitioners?

The link between corporate governance and firm performance is a widely studied topic in finance. But research that has examined how corporate governance affected performance during the financial crisis has been largely focused on financial institutions. Furthermore, little work has been done regarding the influence of broadly defined governance on performance during the crisis in a global context.

The authors contribute to the literature by assessing the relevance of a broad-based measure of corporate governance quality on the equity market performance of a global sample of non-financial firms. Because the authors’ primary focus is to study the influence of corporate governance on performance, they control for the effects of such other firm-level characteristics as company size, risk, growth opportunities, market liquidity, and institutional shareholding. After controlling for these other factors, the authors do not find any significant relationship between corporate governance and firm performance during the crisis.

They explore three possible explanations for their findings. First, they examine whether cross-country differences in institutional development can influence the effect of corporate governance on performance. Second, they investigate whether a narrowing of the informationally efficient segment of the stock market during the crisis can explain the findings. Their empirical results show that neither of the aforementioned conjectures can be supported. Finally, the authors examine whether during the crisis developed markets became less efficient at incorporating firm-specific information into stock prices. They find empirical support for this view and suggest that the causes include impediments in short-selling activity of risk arbitrageurs during the crisis and an increase in transaction costs.

How Did the Authors Conduct This Research?

The sample consists of 4,046 publicly traded non-financial firms across 23 developed countries (including the United States). To measure internal corporate governance, the authors construct an index of corporate governance using 41 firm-level governance attributes obtained from RiskMetrics. Performance is measured by using buy-and-hold equity returns and subtracting the corresponding country-specific industry equity returns to isolate the return arising from company-specific information.

The authors regress these buy-and-hold stock returns on the corporate governance index during the crisis period, which they consider to be from October 2007 to March 2009. They also use control variables for firm size, risk, growth opportunities, stock market liquidity, and the effect of institutional holdings.

They conduct a number of robustness tests, and they use an alternative measure of performance (cumulative return on assets) and an alternate governance index. The authors also use an alternative window for the crisis period and use the standard deviation of stock returns (i.e., a measure of equity risk) during the crisis period as the dependent variable. The results are qualitatively similar to the original findings.

Abstractor’s Viewpoint

The authors’ findings present a challenge to regulators and financial economists who advocate for good corporate governance. The empirical evidence is inconsistent with the mainstream belief often quoted in the financial press that corporate governance failure is somehow related to the dramatic decline in world stock markets during the financial crisis.

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