Corporate Governance and Equity Prices: A Temporary Component Perspective

Abstract:     
This paper examines whether a firm's openness to takeover markets fosters genuine informed trading or speculative noise trading for its stock. To this end, we conduct the variance ratio analysis, and find that firms with fewer antitakeover provisions have greater portion of their daily stock return volatility attributable to a temporary component in stock price than do firms with more takeover protections. We also find that this pattern is more evident among the stocks with greater information asymmetries or greater investor interests. We obtain these results using individual stock returns; at the portfolio level, no such relationship is found between takeover vulnerability and variance ratio. Taken together, our results suggest that a firm's openness to takeover markets motivates investors to acquire and trade on private information on its stock, but it causes speculative noise trading more than it fosters genuine informed trading.

Keywords: Corporate governance, Antitakeover provisions, Temporary component, Variance ratio

JEL Classifications: G10, G14, G30, G34

Working Paper Series