N° 16-54: Does Corporate Governance Matter? Evidence from the AGR Governance Rating

Poor corporate governance permits unreliable financial reporting by a firm's management. The AGR governance rating is based on the premise that a more accurate assessment of the effects of corporate governance can be formulated by taking this output of corporate governance into account in addition to traditional governance inputs such as board structure. We document that the time series variation in a firm's AGR score reliably forecasts the firm's Return on Assets (ROA) and other measures of firm performance. A portfolio going long shares of better governed firms with high AGR scores and shorting shares of poorly governed firms with low AGR scores generates a risk-adjusted return of approximately 5% per year. Most of this return differential originates with firms having poor corporate governance. Overall, our results are consistent with a causal link between corporate governance and future firm and stock price performance.