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Corporate governance and firm operating performance


Using a unique dataset provided by Institutional Shareholder Services (ISS), we relate 51 governance provisions to firm operating performance as proxied by return on assets and return on equity. We identify six corporate governance provisions that are significantly and positively linked to return on assets, return on equity or both using at least two of our six regressions. We examine nine governance provisions that have been recently mandated by the three major U.S. stock exchanges, and we find none of them to be significantly and positively related to firm operating performance. Our results reveal that the governance provisions recently mandated by the U.S. stock exchanges are less closely linked to firm operating performance than are those not so mandated.

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  1. 1.

    Three other governance provisions in our sample were required by regulatory or quasi-regulatory bodies. The Sarbanes-Oxley Act of 2002 required auditors to provide (at most) limited non-audit services to clients and audit committees to be independent. The Financial Accounting Standards Board required companies to recognize stock option expense for fiscal years ending on or after June 15, 2005.

  2. 2.

    ISS provides 61 individual measures and three combination measures. We omit the combination factors and we separate one provision into two (poison pill and blank check preferred stock). We omit ten of the 61 provisions that only apply to a subset of firms; four related to charter/bylaw measures (poison pill with TIDE provision, poison pill with sunset provision, poison pill with a qualified offer clause, and poison pill has trigger threshold), and six related to the state of incorporation (not incorporated in a state with a control share acquisition statute or company opted out, not incorporated in a state with a control share cash-out statute or company opted out, not incorporated in a state with a freeze-out provision or company has opted out, not incorporated in a state with a fair price provision or company has opted out, not incorporated in a state with state stakeholder laws or company opted out, and not incorporated in a state that endorses poison pills). Consistent with Gompers et al. (2003), we omit the ISS provision for dual class capital structure as well as firms that have dual class capital structures.

  3. 3.

    ISS does not code its data as representing minimally acceptable governance but ISS Corporate Governance: Best Practices User Guide and Glossary (2003) provides ample information for one to determine what ISS considers to be minimally acceptable governance. We code a firm’s governance as acceptable (coded 1) or unacceptable (coded 0).

  4. 4.

    The exchange provisions were approved in late 2003, whereas our governance dataset is as of February 1, 2003, which largely reflects data for the 2002 proxy season. Conducting an examination of a post-exchange listing requirement period would be problematic as there is little cross-sectional variation in mandated governance provisions.

  5. 5.

    While conceptually similar, one may argue that ROE is relatively better as it measures operating performance from shareholders’ point of view (i.e., interest expense is removed from earnings). Consistent with this view, Ohlson (1995) and Frankel and Lee (1998) use ROE in their theoretical and empirical valuation models, respectively.

  6. 6.

    ISS defines 23 unique industry groups based on 4-digit Global Industry Classification Standard (GICS) codes developed by Standard & Poor’s and Morgan Stanley Capital International. The 23 ISS industry groups are: Automobiles & Components, Banks, Capital Goods, Commercial Services & Supplies, Consumer Durables & Apparel, Diversified Financials, Energy, Food & Drug Retailing, Food Beverage & Tobacco, Health Care Equipment & Services, Hotels Restaurants & Leisure, Household & Personal Products, Insurance, Materials, Media, Pharmaceuticals & Biotechnology, Real Estate, Retailing, Software & Services, Technology Hardware & Equipment, Telecommunication Services, Transportation, and Utilities.

  7. 7.

    Bebchuk et al. (2005) run 24 regressions using IRRC data so their remaining summary measures sum up the other 23 factors. We run 51 regressions using ISS data so our remaining summary measures sum up the other 50 factors.

  8. 8.

    We use the stepwise selection in SAS, which is a variant of the forward-selection technique, where variables already in the model do not necessarily stay there. In order to stay in the model, a coefficient must be significant at the 10% two-tailed level.

  9. 9.

    The reforms proposed by NYSE and NASDAQ were approved by the SEC on November 4, 2003 (see, while the reforms proposed by AMEX were approved by the SEC on December 1, 2003 (

  10. 10.

    The equity based reforms proposed by NYSE and NASDAQ were approved by the SEC on June 30, 2003 (see, while the equity based reforms proposed by AMEX were approved by the SEC on October 9, 2003 (see

  11. 11.

    Given the small within-sample variability of occurrence of these measures, it is not surprising that we find many factors to be unrelated to operating performance. However, not all factors adhered to by few firms are unimportant for facilitating operating performance. For example, we find that company is not authorized to issue blank check preferred stock is associated with both return on assets and return on equity in spite of the fact that this factor occurs only 9.93% of the time in our sample (Table 1).


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Corresponding author

Correspondence to Lawrence D. Brown.

Additional information

Data availability: The financial statement data are available from Compustat. The corporate governance data are provided by Institutional Shareholder Services.

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Brown, L.D., Caylor, M.L. Corporate governance and firm operating performance. Rev Quant Finan Acc 32, 129–144 (2009).

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  • Corporate governance
  • Firm operating performance
  • U.S. stock exchanges

JEL Classifications

  • D21
  • G34
  • M41
  • M42