Ativo Capital

Rigorous Thinking

Financial and economic commentary reflecting Ativo’s world view:

Does Good Corporate Governance Pay?

Monday, May 3, 2010


The Economist website recently published an article addressing the linkage (or lack thereof) between good governance and returns to shareholders. Critics of reform point to a study by Lucian Bebchuk showing that test portfolios of well-governed firms no longer earn excess returns. Although we approach the issue differently than Bebchuk, we concur (at least generally) with his conclusions.

Even though Bebchuk found no relationship between good governance and excess returns over the period studied, he did find a strong correlation between good governance and high Q ratios. This is eminently sensible. A high Q ratio is due to one of two things: either a company is earning a high Return on Investment, or investors are pricing the firm using a low implicit discount rate (or both). Abnormal returns are generated when the ROI rises, or when the discount rate falls. But once the ROI and/or discount rate have adjusted to reflect good governance, then future stock price appreciation will be much closer to market benchmarks.

But this doesn’t mean that good governance counts for nothing. The high Q ratio that is associated with good governance means that Return on Investment is probably high relative to the firm’s discount rate (cost of capital). Such firms have more profitable growth opportunities, happier shareholders, and the stock price premium means they are less likely to fall prey to hostile acquisition.

We’ve recently developed a methodology to quantify the effect of good governance, environmental practices, and social policies on stock price. Unlike other research, this approach explicitly separates the stock price impact into current financial performance vs. investor preferences and expectations. For more information on this project contact or