We investigate which provisions, among a set of twenty-four governance provisions
followed by the Investor Responsibility Research Center (IRRC), are correlated with
firm value and stockholder returns. Based on this analysis, we put forward an entrenchment
index based on six provisions - four constitutional provisions that prevent a majority
of shareholders from having their way (staggered boards, limits to shareholder bylaw
amendments, supermajority requirements for mergers, and supermajority requirements
for charter amendments), and two takeover readiness provisions that boards put in
place to be ready for a hostile takeover (poison pills and golden parachutes). We
find that increases in the level of this index are monotonically associated with
economically significant reductions in firm valuation, as measured by Tobin's Q.
We present suggestive evidence that the entrenching provisions cause lower firm valuation.
We also find that firms with higher levels of the entrenchment index were associated
with large negative abnormal returns during the 1990-2003 period. Moreover, examining
all sub-periods of two or more years within this period, we find that a strategy
of buying low entrenchment firms and selling short high entrenchment firms out-performs
the market in most such periods and does not under-perform the market even in a single
sub-period. Finally, we find that the provisions in our entrenchment index fully
drive the correlation, identified by prior work, that the IRRC provisions in the
aggregate have with reduced firm value and lower stock returns during the 1990s;
we do not find any evidence that the other eighteen IRRC provisions are negatively
correlated with either firm value or stock returns during the 1990-2003 period.
The data on which this paper is based is available for downloading at Lucian Bebchuk's