Board Monitoring and the Wall Street Rule

Abstract

The “Wall Street Rule” (WSR) has long been viewed as a “cut-and-run” strategy adopted by disillusioned institutional investors to express their dissatisfaction with the management. In this study, I show that WSR, far from being a passive way of protesting, is in fact a potent weapon to improve corporate governance. I present empirical evidence that WSR, a form of institutional investor monitoring, is positively associated with board monitoring (measured by board independence) when the firm is endowed with a strong board (outsider-dominated) in the first place. The results are robust to the pre-SOX and post-SOX periods, the inclusion of firm fixed effects, and also hold after taking into account endogeneity issues, which are pervasive in corporate finance research. This suggests that the WSR improves stock price informativeness, providing the board with an additional source of information so that it may monitor more effectively.