Research: Stock Prices Rise In Wake Of Media Coverage Of Inept Boards Of Directors

UNIVERSITY PARK, PA (September 27, 2007) – Media coverage of the ineffectiveness of corporate boards of directors forces those boards to take corrective actions and increases shareholder profits in the months after the negative publicity, according to new research co-authored by a professor at Penn State's Smeal College of Business.

In a new paper forthcoming in the Journal of Financial and Quantitative Analysis, Henock Louis, associate professor of accounting at Smeal, and his co-authors look at the impact of the media on managers' and investors' behavior by examining how media exposure of board ineffectiveness affects corporate governance, investor trading behavior, and security prices.

Their study is based on BusinessWeek's past publications of the worst boards of directors.

The authors find that, among the 50 unique firms that appeared on the magazine's worst board lists in 1996, 1997, and 2000, 34 (or 68 percent) took observable steps to improve their governance structures.

Of those 34, 82 percent replaced their chief executive officer, president, or board members, 18 percent increased the number of outside board members, and 12 percent instituted some broad corporate governance changes. Firms that appeared on the worst board lists significantly increased the number of outside directors and were significantly more likely to abandon their staggered board structures after the negative public exposure.

Managers are not the only ones to react to the media publicity, however. Shareholders also take some action, ultimately causing the stock price to rise in the wake of the negative media coverage.

The authors find that individual investors tended to overreact and sell, or at least stop buying, shares of the companies whose boards were called out by BusinessWeek. This activity puts downward price pressure on the stocks, which is quickly countered by trading activity by institutional investors.

These savvier investors, who perhaps already know about the ineffectiveness of various boards prior to the publicity generated by the magazine, buy up the worst-board firms, leading to a price reversal and a profit for shareholders in the months following the list's publication.

"The worst-board firms experience very strong stock performance in the week after and over the four months subsequent to the BusinessWeek publication," Louis and his co-authors write. They suspect that this is because these savvier investors may anticipate that the negative publicity will spur the worst-board firms to take some corrective actions.

Ultimately, they conclude "that media releases of (noisy) information affect the behavior of market participants and that exposing board ineffectiveness forces targeted firms to take corrective actions and enhances shareholder wealth."

"Managers' and Investors' Responses to Media Exposure of Board Ineffectiveness" is co-authored by Louis, Jennifer Joe of Georgia State University, and Dahlia Robinson of Arizona State University.

A draft of the paper can be found online at papers.ssrn.com/sol3/papers.cfm?abstract_id=714501.

About Henock Louis
Louis has been on the Smeal faculty since 2001, specializing in the teaching and study of financial accounting and corporate finance. His current research focuses primarily on corporate governance, managerial financial reporting incentives, market anomalies, and signaling. Louis holds a master's degree in accounting and a Ph.D. in finance from the University of Mississippi and a Ph.D. in accounting from The Ohio State University.