Our manuscript titled “The impact of governance mandates on the evolution of firm value and governance culture” contributes to the growing literature that uses quasi-exogenous shocks to equilibrium governance practices to examine important firm outcomes. We specifically examine whether and how changes to the NYSE and NASDAQ corporate governance listing standards that were motivated by provisions of the Sarbanes-Oxley legislation relate to two important firm outcomes. One outcome is long-term firm value and the other is our new notion of a firm’s “governance culture” measured using the firm’s non-mandated governance practices. This new notion of a governance culture highlights how governance regulation has spillover effects inside boardrooms through the use of non-mandated governance practices.
We find that nearly 30 percent of industrial firms included in the Russell 3,000 were affected by the revised listing standards and thus were required to alter their governance practices. The mandates were intended to enhance the quality of board oversight among firms that did not already possess the preferred boardroom practices and procedures. Our manuscript discusses the ten provisions that are mandated by the exchanges and measureable with our firm-level governance data.
We use these ten provisions to identify firms that are differentially affected by the revised listing standards. This strategy helps mitigate endogeneity concerns by combining a largely exogenous shock (revision to NYSE and NASDAQ listing criteria) with the identification of firms differentially affected by the revisions. We augment this approach using a data-driven propensity score matching algorithm that relies on stepwise regression combined with higher-order terms and interactions among observables. We then construct a sample of firms whose existing governance practices do not meet the listing criteria, and similar matched control firms.
Our research design enables us to better examine how affected firms’ value and governance culture evolve over time relative to matched firms that are less affected by governance mandates. As the impact of mandates such as altering board composition and boardroom practices likely take time to influence monitoring and advising outcomes, assessing how value and governance culture evolve over time is necessary to provide a broader perspective on the overall impact of mandated changes in governance. Our conceptual framework assumes that observed governance practices are “optimal” for firms prior to forced changes in governance, and that mandates restrict firms’ ability to select their preferred practices.
We document that firms forced to alter their governance practices had lower firm value prior to the mandates. In the years following mandates, the “value gap” between affected and control firms is reduced by roughly 45 percent but the gap nevertheless persists at least five years after mandates were passed. Thus, even though there is a significant relative increase in firm value for affected firms, we find a persistent “value gap” between affected and control firms years after complying with forced changes in governance practices.
A natural question that arises from this analysis is: What drives the value gap? With this question as motivation, we show that a potential channel through which the value gap persists is that affected firms continue to have a “governance gap”. Generally, affected firms continue to have less shareholder friendly governance practices years after the mandates, suggesting the governance culture of these firms continues to be different from their matched peers. Specifically, affected firms’ governance practices are less shareholder friendly on board related practices and compensation and ownership related dimensions, and more shareholder friendly with regard to anti-takeover provisions. Importantly, we present evidence that links the “value gap” and “governance gap”, implying that governance culture is one potential channel through which a value gap can persist.
Finally, the manuscript completes the analysis by highlighting the interesting ways that affected and control firms’ governance cultures evolve across the post-mandate period. For instance, while affected firms tended to allow options repricing in the pre-mandate period, this practice tends to wane in the post-mandate period. By contrast, while affected firms tended not to have poison pills in the pre-mandate period, these firms tend to adopt poison pills in the post-mandate period.
Overall, we believe that the evidence supports the idea that affected firms have a different governance culture that persists following the implementation of governance mandates, and that this difference in culture is one channel through which the “value gap” can persist.
The preceding post comes to us from Reena Aggarwal, McDonough Professor of Finance at Georgetown University – Robert Emmett McDonough School of Business, Jason D. Schloetzer, Assistant Professor at Georgetown University – McDonough School of Business and Rohan Williamson, Professor and Stallkamp Research Fellow at Georgetown University – McDonough School of Business. The post is based on their recent article, which is entitled “The Impact of Governance Mandates on the Evolution of Firm Value and Governance Culture” and is available here.