Introduction

The study explores the relationship between shareholder rights and corporate performance. Shareholder power varies depending on governance provisions, which may either support democratic structures with strong shareholder rights or dictatorial structures that favour management. From the late 1980s onwards, many firms adopted defences against hostile takeovers, creating significant variation in shareholder rights by the 1990s. The research examines whether these differences influenced firm value, returns, and operating performance.

Data

Data were sourced from the Investor Responsibility Research Center (IRRC), which tracked 24 governance provisions across about 1,500 large firms from 1990. These included firm-level charter and bylaw provisions and state takeover laws. Firms were assigned a Governance Index (G), where higher scores represented weaker shareholder rights. The index ranged from 1 to 24. Firms in the lowest decile of G formed the “Democracy Portfolio”, while those in the highest decile formed the “Dictatorship Portfolio”. The sample covered over 90% of the total market capitalisation of major exchanges.

Governance: Empirical relationships

Between 1990 and 1999, the Democracy Portfolio significantly outperformed the Dictatorship Portfolio, with abnormal returns of about 8.5% per year. A $1 investment in Democracy firms in 1990 would have grown to $7.07 by 1999, compared with $3.39 in Dictatorship firms. Democracy firms also had higher valuations, stronger profitability, and better sales growth.

Governance was correlated with firm value as measured by Tobin’s Q. In 1990, a one-point increase in G was associated with a 2.2 percentage point lower Q. By 1999, this penalty had widened to 11.4 percentage points. Democracy firms showed higher Q values than Dictatorship firms throughout the decade.

Operating performance supported these findings. Firms with stronger shareholder rights had higher profit margins and sales growth, though evidence for return on equity was weaker. High-G firms exhibited higher capital expenditure and more acquisitions, suggesting potential agency costs.

Governance: Three hypotheses

The study considered three possible explanations:

1. Weak shareholder rights increased agency costs, underestimated by investors in 1990.
2. Governance provisions were adopted by managers who foresaw poor performance in the 1990s and sought protection.
3. Provisions were correlated with other firm characteristics that drove returns, such as industry or S&P 500 inclusion.

Governance: Tests

Evidence supported Hypothesis I, as higher G was linked to greater capital expenditure and acquisition activity, consistent with inefficient investment. There was no evidence for Hypothesis II, as insider trading data showed no systematic relationship with governance. Hypothesis III found partial support: industry composition and other characteristics explained up to one-third of the performance differences, but most abnormal returns remained unexplained.

Conclusion

The research finds a strong and consistent relationship between corporate governance and equity performance. Firms with strong shareholder rights generated higher returns, valuations, and operating performance in the 1990s. While causality cannot be firmly established, evidence suggests weak governance increased agency costs and contributed to underperformance. By the end of the decade, markets appeared to partially price in these governance effects.

The findings indicate that governance structures can materially influence firm outcomes. An 11.4 percentage point difference in firm value per additional governance provision highlights the potentially large long-term benefits of reducing restrictions on shareholder rights.