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January 06, 2020 02:46 PM

Investors focus more on negative corporate governance ratings – study

Brian Croce
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    Investors are more concerned about the implications of bad governance ratings than they are encouraged by evidence of improved governance, according to research from Paul Guest, professor of corporate finance, and Marco Nerino, a doctoral student, at King's Business School in London.

    In studying the share price performance of 3,616 U.S. firms that had seen a change in their governance ratings issued by Institutional Shareholder Services, the authors found that large governance ratings downgrades are associated with negative returns of -1.14% over the three days after the announcement, but that upgrades did not result in a significant market reaction.

    The research of ratings issued by other providers also showed a negative return for governance analysts who do not provide a proxy advisory service, which suggests that investors value the substantive information and analysis behind the governance revised rating and are not simply trying to anticipate the share price impact of a negative proxy vote, the authors said.

    When reviewing governance ratings upgrades, the authors examined if whether the reasons why there was no positive impact on share price stemmed from companies leaking good news to the market or if because investors were suspicious of good news due to the ratings providers performing other services to the companies involved.

    "We found no evidence of good news leaking ahead of announcements, and even smaller companies that weren't likely to be clients of the ratings provider weren't rewarded with a boost in share price when their governance ratings were upgraded," the authors said in a news release.

    "Whether they are right or wrong to do so, investors seem to be using governance ratings to put a price on the downside risks of pursuing the wrong strategy, rather than trying to understand the positive benefits that might come from better governance," they added.

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