Does Corporate Governance Matter?

There is a time and a place when corporate governance has little influence over performance, say two researchers at New York University’s Leonard N. Stern School of Business, because competitive forces cut away at management fat.

Holger M. Mueller and Xavier Giroud, associate professor of finance and doctoral student, respectively, studied the performance of companies before and after 30 anti-takeover laws were passed in different states between 1985 and 1991, to determine how the provisions affected performance. In theory, laws that make hostile takeovers more difficult weaken corporate governance and undermine the ability of directors (and investors) to hold management to task. With more opportunity for managers to slack off, financial performance could suffer.

Sure enough, that’s what Mueller and Giroud found — but not for every industry. “A negative change in corporate governance [caused by the passage of an anti-takeover law], has a negative effect in noncompetitive industries,” explains Mueller. “But a change in corporate governance has no effect in competitive industries.”

In the 2007 working paper, Does Corporate Governance Matter in Competitive Industries? Mueller and Giroud explain how they tracked 10,960 companies from 1976 to 1995, and used the Herfindahl index — the sum of the squares of competitors’ market shares in a single industry — as a measure of competitiveness. With this index, if one company has a monopoly position, the value approaches one; the more evenly a larger group of competitors divides market share, the closer the value approaches zero. What they found is that the passage of an anti-takeover law reduced return on assets by an average of 0.6% in that state’s companies relative to the nation as a whole, but most of that effect was driven by companies with higher Herfindahl indices — the noncompetitive industries.

The analysis suggests more about how managers in noncompetitive industries are acting, by looking at companies’ cost structures. The authors find evidence that leaders in those industries are softer on spending. “CEOs want to have a quiet life. They don’t want to argue and quarrel with other parties,” says Mueller. “So they fight less hard with unions and with input suppliers. . . .Cutting costs is a tough thing.” When competition fails to enforce discipline on managers, weaker corporate governance indeed allows managers to taste the quiet life.

To be sure, the authors studied the corporate governance regime, not the governance of specific companies.