We investigate which provisions, among a set of twenty-four governance provisions followed by the Institutional Investors Research Center (IRRC), are correlated with firm value and stockholder returns. Based on this analysis, we put forward an entrenchment index based on six provisions – four “constitutional” provisions that prevent a majority of shareholders from having their way (staggered boards, limits to shareholder bylaw amendments, supermajority requirements for mergers, and supermajority requirements for charter amendments), and two“takeover readiness” provisions that boards put in place to be ready for a hostile takeover (poison pills and golden parachutes). We find that increases in the level of this index are monotonically associated with economically significant reductions in firm valuation, as measured by Tobin’s Q. We also find that firms with higher level of the entrenchment index were associated with large negative abnormal returns during the 1990-2003 period. Furthermore, we find that the provisions in our entrenchment index fully drive the correlation, identified by prior work, that the IRRC provisions in the aggregate have with reduced firm value and lower stock returns during the 1990s. We find no evidence that the other eighteen IRRC provisions are negatively correlated with either firm value or stock returns during the 1990-2003 period.
Date of Authorship for this Version
Bebchuk, Lucian; Cohen, Alma; and Ferrell, Allen, "What Matters in Corporate Governance?" (2004). Harvard Law School John M. Olin Center for Law, Economics and Business Discussion Paper Series. Paper 491.