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





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    • 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 University of Maryland, the University of Pennsylvania, the University of Technology Sydney, the University of Washington, the 2004 American Accounting Association meetings, the 2004 NBER Summer Institute, and the Sixth Maryland Finance Symposium. We are grateful to Paul Gompers, Joy Ishii, and Andrew Metrick for sharing the data on shareholder rights and I/B/E/S for the analyst data. We appreciate financial support from the Wharton School. Tjomme Rusticus is also grateful for financial support from the Deloitte & Touche Foundation. All remaining errors are our own.


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.