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http://ssrn.com/abstract=1589731
 
 

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Learning and the Disappearing Association Between Governance and Returns


Lucian A. Bebchuk


Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Alma Cohen


Tel Aviv University - Eitan Berglas School of Economics; Harvard Law School; National Bureau of Economic Research (NBER)

Charles C. Y. Wang


Harvard Business School

August 1, 2012

Journal of Financial Economics, Vol. 108, No. 2, pp. 323-348, May 2013
Harvard Law School John M. Olin Center Discussion Paper No. 667

Abstract:     
During the period 1991-1999, stock returns were correlated with the G-Index based on twenty-four governance provisions (Gompers, Ishii, and Metrick (2003)) and the E-Index based on the six provisions that matter most (Bebchuk, Cohen, and Ferrell (2009)). This correlation, however, did not persist during the subsequent period 2000-2008. We provide evidence that both the identified correlation and its subsequent disappearance were due to market participants’ gradually learning to appreciate the difference between firms scoring well and poorly on the governance indices. Consistent with the learning hypothesis, we find that:

(i) The disappearance of the governance-return correlation was associated with an increase in the attention to governance by a wide range of market participants;
(ii) Until the beginning of the 2000s, but not subsequently, stock market reactions to earning announcements reflected the market’s being more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms;
(iii) Stock analysts were also more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms until the beginning of the 2000s but not afterwards;
(iv) While the G-Index and E-Index could no longer generate abnormal returns in the 2000s, their negative association with Tobin’s Q and operating performance persisted; and
(v) The existence and subsequent disappearance of the governance-return correlation cannot be fully explained by additional common risk factors suggested in the literature for augmenting the Fame-French-Carhart four-factor model.
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Gompers, Ishii, and Metrick (2003) is available on SSRN at:
http://ssrn.com/abstract=278920

Bebchuk, Cohen, and Ferrell (2009) is available on SSRN at:
http://ssrn.com/abstract=593423

Number of Pages in PDF File: 56

Keywords: Corporate governance, governance indices, GIM, G-Index, E-Index, shareholder rights, entrenchment, market efficiency, learning, earning announcements, analyst forecasts, IRRC provisions, behavioral finance, asset pricing

JEL Classification: D03, G10, G12, G30, G34, K22

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Date posted: April 14, 2010 ; Last revised: June 12, 2014

Suggested Citation

Bebchuk, Lucian A. and Cohen, Alma and Wang, Charles C. Y., Learning and the Disappearing Association Between Governance and Returns (August 1, 2012). Journal of Financial Economics, Vol. 108, No. 2, pp. 323-348, May 2013; Harvard Law School John M. Olin Center Discussion Paper No. 667. Available at SSRN: http://ssrn.com/abstract=1589731

Contact Information

Lucian A. Bebchuk (Contact Author)
Harvard Law School ( email )
Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)
HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)
Alma Cohen
Tel Aviv University - Eitan Berglas School of Economics ( email )
Ramat Aviv, Tel Aviv, 69978
Israel
Harvard Law School ( email )
Cambridge, MA 02138
United States
(617) 496-4099 (Phone)
(617) 812-0554 (Fax)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Charles C. Y. Wang
Harvard Business School ( email )
Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States
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