The IR papers: an academic look at the capital markets

Jan 01, 2010
<p>Good governance may not lead to higher shareholder value</p>

Objects of investment desire
What’s the biggest non-financial decision driver among individual investors? Recent behavioral research has focused on factors like brand familiarity and social/ethical responsibility. But one Finnish researcher says the personal appeal of a company’s product design can trump them all by a long shot.

‘In pursuit of satisfaction of self-expressive and emotional needs, people invest in companies that sell personally relevant products with likeable designs,’ says Jaakko Aspara, assistant professor at the Helsinki School of Economics. ‘That can matter a lot more to the average individual investor than abstract ethical considerations. Financial research may have gone too far with social responsibility issues. We should look closer – into the personal and tangible appeal of the firm’s products – to find out what motivates investors besides money.’

To assess product design’s influence on investment choice, Aspara conducted three studies, two in the form of investor surveys and another as a randomized experiment. The findings show that product design-related factors positively affect investors’ optimism about future returns. These factors seem more powerful than the familiarity effect and even elicit investor preparedness to accept modestly lower financial returns.

‘Design, by addressing the personal meanings and emotions that people attach to products, can create strategic distinction for the company not only in the product markets, but also in the stock markets,’ says Aspara. ‘It can be a major driver of investor appeal. Entire business models can be constructed based on appealing product visions.’

Aspara suggests companies emphasize their product design in investment ads, such as IPO situations. ‘Investment in the company should be framed not only as a chance to achieve good financial returns but also as an opportunity to express one’s identification with and liking for the current or future products of a particular company,’ he concludes.

Reality reexamined
Many studies indicate that companies with good governance earn much higher long-term stock returns than those with poor practices – but it turns out that they’re all wrong. A forthcoming paper in the Review of Financial Studies highlights statistical problems with tests used in previous research and finds there are ‘zero long-term abnormal returns for portfolios sorted by governance.’

‘Good governance companies may or may not have a higher Tobin’s Q [a measure of company value] but there is no difference in long-term stock returns,’ explains Shane Johnson, professor of finance at Texas A&M University. ‘Investors buying into good governance firms should not expect returns to be any different from those of bad governance firms.’

He adds that investors appear to quickly and correctly price any corporate governance changes into a stock and should expect only normal returns. At the same time, touting good governance will have a muted effect unless companies actually do something new.

According to Johnson and study co-authors Theodore Moorman and Sorin Sorescu, firms with strong or weak shareholder rights differ in how they cluster across industries but previous studies used tests that did not sufficiently account for this effect. ‘Even mild clustering can have a huge impact on test results,’ says Johnson.

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