In an award ceremony held in New York City on Tuesday, the Investor Responsibility Research Center Institute (IRRCi) announced the winners of its the 2013 prize competition. The academic award, coming with a $10,000 award prize, went to HLS professor Lucian Bebchuk, HLS Senior Fellow and Tel-Aviv University Professor Alma Cohen, and HBS professor Charles Wang. Bebchuk, Cohen, and Wang received the award for their study, Learning and the Disappearing Association between Governance and Returns, available on SSRN here.
The Bebchuk-Cohen-Wang study was published last month by the Journal of Financial Economics. In presenting the award, IRRCi chair announced that the winning paper “will be valuable … for investors, policymakers, academia, and other stakeholders.”
The study seeks to explain a pattern that has received a great deal of attention from financial economists and capital market participants: during the period 1991-1999, stock returns were correlated with the G-Index, which is based on twenty-four governance provisions (Gompers, Ishii, and Metrick (2003)) and the E-Index, which is based on the six provisions that matter most (Bebchuk, Cohen, and Ferrell (2009)). The study shows that this correlation did not persist during the subsequent period 2000-2008. Furthermore, the study provides evidence that both the identified correlation and its subsequent disappearance were due to market participants’ gradually learning to appreciate the difference between firms scoring well and poorly on the governance indices. Consistent with the learning hypothesis, the study finds that:
(i) The disappearance of the governance-return correlation was associated with an increase in the attention to governance by a wide range of market participants;
(ii) Until the beginning of the 2000s, but not subsequently, stock market reactions to earning announcements reflected the market’s being more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms;
(iii) Stock analysts were also more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms until the beginning of the 2000s but not afterwards;
(iv) While the G-Index and E-Index could no longer generate abnormal returns in the 2000s, their negative association with Tobin’s Q and operating performance persisted; and
(v) The existence and subsequent disappearance of the governance-return correlation cannot be fully explained by additional common risk factors suggested in the literature for augmenting the Fame-French-Carhart four-factor model.
The study is available here, and the IRRCi announcement of the award is available here, A blog post describing in detail the analysis of the paper is available here, and a DealBook column discussing the study is available here.