As the debate persists over how much regulation should exist in the area of corporate governance in the United States and around the world, a team of researchers from Georgetown University’s McDonough School of Business challenged the idea that the value of corporate governance regulations over the long-term is difficult to measure. Instead, they show positive results of corporate governance regulations in the United States.
In a study forthcoming in the Journal of Corporate Finance, the authors find regulatory reforms of corporate governance in the United States have had a positive impact on the value of poorly governed firms. However, despite such reforms, poorly governed firms maintain many of the non-shareholder friendly corporate governance practices that fall outside of the regulatory framework. And it is the persistence of these non-shareholder friendly practices that drive the ongoing gap between the value of poorly governed and well governed firms.
“Do corporate governance mandates impact long-term firm value and governance culture?” is authored by McDonough School of Business professors Reena Aggarwal, Jason Schloetzer, and Rohan Williamson. Unlike previous studies that examine the immediate stock market reaction to the passage of governance regulation, this study considers the regulatory perspective by examining the longer-term value implications and assessing how regulations affect non-regulated aspects of the corporate governance system.
“The power of this research stems from its illustration that regulatory efforts to improve corporate governance have a positive impact but do not come without persistent challenges,” says Aggarwal, who also is the director of the school’s Center for Financial Markets and Policy.
While the study presents evidence that regulatory interventions regarding corporate governance relate to higher firm values, the professors found that firms most affected by regulation continue to have bad corporate governance among non-mandated practices long after corporate governance regulations are put into place. For instance, the study finds that firms most affected by governance regulation continue to be more likely to have transactions between company executives and related parties — so called “related party transactions.” These firms also maintain corporate governance policies regarding CEO and director compensation that are widely viewed as indicators of poor corporate governance.
“Essentially what we found is that government regulation of corporate governance in the United States has raised the value of poorly governed firms,” says Williamson, who also is the interim dean of Georgetown McDonough. “A poorly governed firm still has lower value than its peers, but the regulations raise the bottom so that it is operating at a higher level than before.”
A key finding of the study revealed that the value gap between poorly governed firms and their comparable peers has been reduced by 48 percent after governance regulations were implemented. Thus, over time, corporate governance regulations from a decade ago have elevated poorly governed firm value, but not to the level of their well-governed peers.
Why does this value gap persist? “Firms that were considered poorly governed before regulatory action continue to be among the most poorly-governed firms nearly a decade later,” says Schloetzer. “The regulations motivate poorly governed firms to achieve regulatory compliance but do not seem to create a domino effect in which boards reduce the use of less shareholder friendly governance practices that were not part of the regulations.”
This difference between compliance and positive governance spillovers contributes to the observed “value gap” between poorly governed and well governed firms.
“We find that corporate governance regulation in the United States has had a positive impact for shareholders,” says Williamson. “In terms of the persistent gap between the values of poorly governed and well governed firms, regulations cannot change all aspects of a deeply engrained governance culture. However, they can force poorly governed firms to perform better than before.”
Aggarwal believes that both regulation and market forces are needed to change the governance culture of firms. As more regulators around the world continue to mull corporate governance reform, the results of this study suggest that regulations similar to those implemented in the U.S. markets a decade ago can have positive consequences, but likely cannot fully eliminate poor corporate governance practices.
“The message is clear. Corporate directors are rethinking how their board functions. Change is happening, and more change is needed,” says Schloetzer.