tailieunhanh - Does Weak Governance Cause Weak Stock Returns? An Examination of Firm Operating Performance and Investors’ Expectations

Such theories do not simply have the cross-sectional implication that small ¯rms' risk will be more strongly a®ected by tighter credit markets in all eco- nomic states. Based on the idea that a decline in a borrower's net worth raises the agency cost on external ¯nance, the theories identify asymmetries in the e®ect of tighter credit market conditions on risk during recessions and expansions. In a recession, small ¯rms' net worth, and hence their collateral, will be lower than usual and tighter credit markets will be associated with stronger adverse e®ects than during an expansion when these ¯rms' collateral is higher. . | THE JOURNAL OF FINANCE VOL. LXI NO. 2 APRIL 2006 Does Weak Governance Cause Weak Stock Returns An Examination of Firm Operating Performance and Investors Expectations JOHN E. CORE WAYNE R. GUAY and TJOMME O. RUSTICUS ABSTRACT We investigate Gompers Ishii and Metrick s 2003 finding that firms with weak shareholder rights exhibit significant stock market underperformance. If the relation between poor governance and poor returns is causal we expect that the market is negatively surprised by the poor operating performance of weak governance firms. We find that firms with weak shareholder rights exhibit significant operating underperformance. However analysts forecast errors and earnings announcement returns show no evidence that this underperformance surprises the market. Our results are robust to controls for takeover activity. Overall our results do not support the hypothesis that weak governance causes poor stock returns. Whether corporate governance affects firm performance is a matter of much study and debate. In an important and widely cited recent paper Gompers Ishii and Metrick GIM 2003 find for the period 1990 to 1999 that firms with strong shareholder rights have risk-adjusted stock returns that are higher per year than those of firms with weak shareholder rights. A puzzling feature of the paper is that the authors find persistent stock market underperformance for firms with weak shareholder rights but they do not find significant underperformance in firm operating performance which they measure with accounting return on This lack of operating underperformance is surprising given All authors are from the Wharton School University of Pennsylvania. We appreciate helpful comments from Gus De Franco Ted Goodman David Larcker Dawn Matsumoto Andrew Metrick Randall Morck Shiva Rajgopal Scott Richardson Terry Shevlin D. Shores Ran Wei Min Wu an anonymous referee and seminar participants at Arizona State University the University of Delaware the .

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