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Review of Quantitative Finance and Accounting

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01-08-2012 | Original Research

Corporate governance and the stock market reaction to new product announcements

Authors: Wen-Chun Lin, Shao-Chi Chang

Published in: Review of Quantitative Finance and Accounting | Issue 2/2012

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Abstract

This study examines the explanatory power of corporate governance mechanisms on the wealth effect of firms’ new product strategies. We show that board size, board independence, audit committee independence, CEO equity-based pay, analyst following and shareholder rights are all of significance in explaining the variations in the wealth effect of new product introductions. Our results reveal that the new product strategies announced by firms with better corporate governance mechanisms tend to receive higher stock market valuations than those of firms with poorer governance mechanisms. This study provides empirical support for the notion that enhanced governance mechanisms can reduce both agency and information asymmetry problems for firms announcing new products.

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If such announcements occur after the close of trading on the previous day, then the impact on share prices will be felt on the day in which the announcements appear in the publication. If the announcements are released prior to the close of trading hours, any immediate valuation effect will be reflected in the share prices on the day prior to the announcement appearing in print.

Tobin’s Q is technically defined as the ratio of the market value of a firm to the replacement cost of its assets, as the difference between market value and replacement value is dependent upon the profitability of both the firm’s assets in place and its expected investment opportunities. If the profitability of the firm’s assets in place is high, its investment opportunities will also be expected to earn a high rate of return; thus, the firm will have a high Tobin’s Q (Lang and Litzenberger 1989).

This follows the approach used in Masulis et al. (2007), Giroud and Mueller (2011), and Chen et al. (2010).

Woolridge (1988) demonstrates that between 1972 and 1984, the 2 day (–1, 0) average cumulative market-adjusted return for a sample of product-announcing firms is 0.84 per cent, whilst Chen et al. (2002) show that for a sample of firms announcing new product introductions between 1991 and 1995, the two-day (–1, 0) average cumulative abnormal return is 0.59 per cent, with significance at the 1 per cent level; our mean two-day abnormal return is 0.54 per cent, with significance at the 1 per cent level. The magnitude of the abnormal return found in this study is therefore very much in line with those found in prior studies.

Other studies, such as Gompers et al. (2003), Masulis et al. (2007) and Giroud and Mueller (2011), refer to companies with a G-index score of 5 or less as democracies and to companies with a G-index score of 14 or greater as dictatorships. We have also used 5 and 14 as the cut-off G-index scores in our sensitivity analysis. The conclusions in our study remain unchanged.

We have also used median and top tercile as the cut-off Herfindahl index values in our sensitivity analysis. The conclusions in our study remain unchanged.

Qualitatively similar results are obtained if the Herfindahl index is measured by the sum of the squared market shares of all Compustat firms based on the industry classification of their Compustat four-digit SIC code (as in Lang and Stulz 1992, and Song and Walkling 2000).

Our results are similar when the competitive structure of an industry is measured by the product uniqueness (as in Masulis et al. 2007 and Chen et al. 2010).

We also obtained similar results when we used net sales and the number of employees to measure the size of the firm.

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Title: Corporate governance and the stock market reaction to new product announcements
Authors: Wen-Chun Lin
Shao-Chi Chang
Publication date: 01-08-2012
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 2/2012
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-011-0248-x

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