Making the Most of Good Times: Shareholder Rights and Performance Revisited

Abstract

I provide a new explanation for the abnormal returns to governance and their disappearance after 2001 by demonstrating that firms with strong shareholder rights outperform only in good times. Specifically, they capture higher profits than poorly-governed firms in the same industry when that industry is in a period of high profitability, but both groups have similar profits during weaker industry conditions. Further, I show that this pattern is anticipated by investors. Consistent with such expectations, and with an updating of valuations as anticipated industry conditions change, positive abnormal stock returns to good governance are concentrated in periods of high industry returns, and are at least partially reversed during industry downturns. Additional evidence supports a causal interpretation of the results.