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The Promise and Peril of Corporate Governance Indices

91 Pages Posted: 14 Oct 2007 Last revised: 15 Feb 2009

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance

Brian J. Bolton

Portland State University - School of Business Administration

Roberta Romano

Yale Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: October 7, 2007

Abstract

Financial economists and commercial providers of governance services have in recent years created measures of the quality of firms' corporate governance which collapse into a single number (a governance index or rating) the multiple dimensions of a company's governance. The aim of this paper is twofold, to analyze the performance of corporate governance indices in predicting corporate performance, and to consider the implications for public policy that follow from that assessment. We highlight methodological shortcomings of the extant papers that claim a relation between particular governance measures and corporate performance. Our core conclusion is that there is no consistent relation between governance indices and measures of corporate performance. Namely, there is no one "best" measure of corporate governance: the most effective governance institution appears to depend on context, and on firms' specific circumstances. It would therefore be difficult for an index, or any one variable, to capture critical nuances for making informed decisions. As a consequence, we conclude that governance indices are highly imperfect instruments for determining how to vote corporate proxies, let alone for portfolio investment decisions, and that investors and policymakers should exercise caution in attempting to draw inferences regarding a firm's quality or future stock market performance from its ranking on any particular corporate governance measure. Most important, the implication of our analysis is that corporate governance is an area where a regulatory regime of ample flexible variation across firms that eschews governance mandates is particularly desirable, because there is considerable variation in the relation between the indices and measures of corporate performance.

Keywords: corporate governance, corporate performance, governance indices

JEL Classification: G30, G34, K22

Suggested Citation

Bhagat, Sanjai and Bolton, Brian J. and Romano, Roberta, The Promise and Peril of Corporate Governance Indices (October 7, 2007). ECGI - Law Working Paper No. 89/2007; Yale Law & Economics Research Paper No. 367. Available at SSRN: https://ssrn.com/abstract=1019921 or http://dx.doi.org/10.2139/ssrn.1019921

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States
303-492-7821 (Phone)

Brian J. Bolton

Portland State University - School of Business Administration ( email )

Portland, OR 97207-0751
United States

Roberta Romano (Contact Author)

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4965 (Phone)
203-432-4871 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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