Gompers, Ishii, and Metrick (2003) and Bebchuk, Cohen, and Ferrell (2004) document that valuation multiples during the 1990s are significantly related to governance indices purporting to measure the quality of a firm’s governance structure. The results are consistent with two hypotheses: (i) governance affects valuation multiples and (ii) valuation multiples affect governance. We find evidence consistent with the latter explanation. Specifically, we find that (i) valuation multiples during the early 1980s, a period preceding the adoption of the provisions comprising the governance indices, are highly correlated with valuation multiples during the 1990s, (ii) valuation multiples during the early 1980s are significantly related to governance indices during the 1990s, and (iii) after controlling for valuation multiples during 1980-1985, no significant relation exists between contemporaneous valuation multiples and governance indices during the 1990s. The results support the hypothesis that causation runs from valuation multiples to governance, not vice versa.
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