Synthetic Governance

38 Pages Posted: 19 Aug 2020 Last revised: 6 May 2021

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: April 22, 2021

Abstract

Although securities regulation is distinct from corporate governance, the two fields have considerable substantive overlap. By increasing the transparency and efficiency of the capital markets, securities regulation can also enhance the capacity of those markets to discipline governance decisions. The importance of market discipline is heightened by the increasingly vocal debate over what constitutes “good” corporate governance.

Securities product innovation offers new tools to address this debate. The rise of index-based investing provides a market-based mechanism for selecting among governance options and evaluating their effects. Through the creation of bespoke governance index funds, asset managers can create indexes that correspond to investors’ governance preferences. We argue that this “synthetic governance” offers a way to gather 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 by creating a new governance-based index, the Dual Index, which selects portfolio companies on the basis of a dual class voting structure and comparing its performance to various benchmarks. 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 demonstrates the ability of securities market innovation to discipline corporate 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 (April 22, 2021). U of Penn, Inst for Law & Econ Research Paper No. 20-41, European Corporate Governance Institute – Finance Working Paper No. 693/2020, Columbia Business Law Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3645312 or http://dx.doi.org/10.2139/ssrn.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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