Synthetic Governance

40 Pages Posted: 9 Jul 2020 Last revised: 29 Jul 2020

See all articles by Byung Hyun Ahn

Byung Hyun Ahn

University of California, Berkeley - Haas School of Business

Jill E. Fisch

University of Pennsylvania Law School - Institute for Law and Economics, European Corporate Governance Institute

Panos N. Patatoukas

University of California, Berkeley - Haas School of Business

Steven Davidoff Solomon

University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy; European Corporate Governance Institute (ECGI)

Date Written: July 28, 2020

Abstract

Scholars, practitioners and policymakers continue to debate what constitutes “good” corporate governance. Academic efforts to evaluate the effect of governance provisions such as dual class voting structures, staggered boards of directors and separating the positions of CEO and Chairman of the Board, have produced inconsistent or inconclusive results. The consequence is that the debate over corporate governance is increasingly political and discordant.

We offer a way to address this debate. The rise of index-based investing provides a market-based alternative to governance regulation. Through the creation of bespoke governance index funds, asset managers can offer investors the opportunity to choose an index that corresponds to their governance preferences. We term this approach synthetic governance. At the same time, synthetic governance offers a new tool to collect evidence on the economic impact of corporate governance by providing a market-based tool for evaluating the relationship between corporate governance and stock returns.

We illustrate the potential of synthetic governance with the creation of a new governance-based index, the Dual Index, which selects portfolio companies on the basis of a dual class voting structure. We compare the performance of the Dual Index to various benchmarks and demonstrate the potential, through governance-based indexing, for investors to realize superior returns. We further modify the Dual Index by implementing synthetic sunsets to highlight the value creation of dual-class companies in their early years and provide evidence on the appropriate length of a time-based sunset provision. Finally, we expand our analysis of synthetic governance with a second index – the Split Index – which tests the effect of separating the positions of CEO and Chairman of the Board. We conclude that synthetic governance offers a meaningful way for investors and issuers to more economically adopt and invest in governance provisions. We thus provide a way out of the corporate current war over what exactly constitutes “good” governance.

Keywords: Law and economics, corporate governance, capital markets, securities regulation, mutual funds, dual-class stock, shareholder voting, investment choices, asset management, index funds, split board chair and CEO

JEL Classification: G11, G32, G38, K22

Suggested Citation

Ahn, Byung Hyun and Fisch, Jill E. and Patatoukas, Panos N. and Davidoff Solomon, Steven, Synthetic Governance (July 28, 2020). U of Penn, Inst for Law & Econ Research Paper No. 20-41, Available at SSRN: https://ssrn.com/abstract=3645312

Byung Hyun Ahn

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Jill E. Fisch (Contact Author)

University of Pennsylvania Law School - Institute for Law and Economics, European Corporate Governance Institute ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-746-3454 (Phone)
215-573-2025 (Fax)

Panos N. Patatoukas

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

HOME PAGE: http://sites.google.com/site/panossom/

Steven Davidoff Solomon

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

University of California, Berkeley - Berkeley Center for Law, Business and the Economy ( email )

Berkeley, CA 94720-7200

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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