The corporate governance - performance puzzle: New insights

This paper provides newer insights on governance - performance relationship using recent data (2007 to 2015) on anti-takeover provisions' incidence in sample firms. Looking beyond the equally weighted methodology employed in related literature for constructing G-Index, E-Index, and Gov-Score, we present an alternate unequally weighted "new Governance (nG) Index" as governance proxy. We show that our proposed nG-Index traces governance - performance relationship more persistently than the equal-weighted measure. Firms with better governance structures are found to show higher firm values and superior operating performances in our sample period. Our analysis further reveals that a zero-investment hedge going long on poor governance stock portfolio and shorting the good governance one would have generated an abnormal return of over 1.33% per month or about 16% per year. This hedge is completely opposite to the long good governance - short poor governance strategy suggested in prior literature. We posit that such hedge reversal is an indication that, in recent years, investors underreact to good governance signals and/or seek compensation for high riskiness associated with poorly governed firms. Subsequent analysis reveals that poor governance firms have higher likelihood of future stock price crash risk, but shows relatively weaker support for the notion that investors underreact to good governance signals in short-run.