Corporate Governance, Expected Operating Performance, and Pricing

Abstract

We examine whether ownership and governance characteristics are associated with the firm’s operating performance and stock price. We hypothesize that while ownership structure and governance mechanisms impact the firm's operating performance, they can also impact stakeholders’ abilities to expropriate rents from other stakeholders. We use a two-step estimation approach to assess whether the benefit of a better governance system manifest itself as higher operating performance or a premium on share price. To mitigate potential problems from using conventional accounting performance measures, we use Ohlson’s (1995) expected residual income (ERI) valuation metric which incorporates the expected operating performance of the firm. Results suggest that (1) higher share ownership of the CEO, corporate insiders, and outside directors has a strong positive association with both firm performance (measured by the ERI metric) and market value; (2) large ownership of outside shareholders has a negative association with the firm’s operating performance; (3) presence of a controlling shareholder is negatively related to market value; (4) after controlling for ownership, there is no improvement in operating performance or share value from having greater representation of outside directors, or having a larger board; and (5) variables representing the CEO’s stature – the CEO’s tenure and the board chairmanship – have a negative association with operating performance or market value.

Keywords: Corporate governance, residual income model, ownership

JEL Classification: M41, G12, G32, G34