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108 Colum. L. Rev. 1803 (2008)
The Promise and Peril of Corporate Governance Indices

handle is hein.journals/clr108 and id is 1841 raw text is: COLUMBIA LAW REVIEW VOL. 108 DECEMBER 2008 NO. 8 ARTICLES THE PROMISE AND PERIL OF CORPORATE GOVERNANCE INDICES Sanjai Bhagat* Brian Bolton** Roberta Romano*** In recent years, financial economists and commercial providers of gov- ernance services have created measures of corporate governance quality that collapse into one number (a governance rating or index) the multiple dimen- sions of a company's governance, measures which commercial providers mar- ket to institutional investors as aids for portfolio and proxy voting decisions. The aim of this Article is twofold: to analyze the effectiveness of corporate governance indices in predicting corporate performance and to consider the implications for public policy that follow from that assessment. We highlight methodological shortcomings of the extant research that claims to have identi- fied a relation between particular governance measures and corporate per- formance. Our core conclusion is that there is no consistent relation between governance indices and measures of corporate performance. Namely, there is no one best measure of corporate governance: The most effective govern- ance system depends on context and on firms' specific circumstances. It would therefore be difficult for an index, or any one variable, to capture nuances critical for making informed decisions. As a consequence, we con- clude that governance indices are highly imperfect instruments for determin- ing how to vote corporate proxies, let alone for making portfolio investment decisions, and that investors and policymakers should exercise caution in attempting to draw inferences regarding a firm's quality or future stock mar- ket performance from its ranking on any particular corporate governance measure. Most important, because there is considerable variation in the rela- tion between indices and measures of corporate performance, our analysis suggests that corporate governance is an area where a regulatory regime of * Professor of Finance, University of Colorado at Boulder Leeds School of Business. ** Assistant Professor of Finance, University of New Hampshire Whittemore School of Business & Economics. *** Oscar M. Ruebhausen Professor of Law, Yale Law School; Research Associate, National Bureau of Economic Research; Fellow, European Corporate Governance Institute. We would like to thank Jon Macey; Paul Mahoney; and participants at presentations at the Columbia, Stanford, Western Ontario, and Yale law schools, the Concordia UniversityJohn Molson School of Business, and the Chinese University of Hong Kong for helpful comments, as well as attendees at the 2006 Canadian Law and Economics Association meeting, where an early version of the paper was presented as the dinner address. 1803