The core corporate governance puzzle: Contextualizing the link to performance

Merritt B. Fox, Ronald J. Gilson, Darius Palia

Research output: Contribution to journalReview articlepeer-review


There is a puzzle at the core of corporate governance theory. Prior scholarship reports a strong relationship between firms best at creating shareholder value and those rated highly by the established corporate governance indices. Little work explores why, however. We hypothesize that the link between governance and performance depends centrally on context. We illustrate the importance of context by exploring circumstances when a firm's governance structure can operate as a signal of the quality of its management. The idea is that better managers are on average more likely to choose a highly rated governance structure than are bad managers because a structure garnering a high rating increases the risk of job loss more for bad managers than for good ones. Conversely, the choice of a poorly rated governance structure signals negative information about managerial quality because good managers would not wish to make a false negative signal. Signals of managerial quality can take on particular significance under certain circumstances. This Article tests empirically the hypothesis that a particular context-the existence of an especially high information asymmetry between a firm's insiders and the market concerning the quality of its management-is a situation in which a change in the firm's governance structure will become a stronger signal concerning its management's quality. The test compares ordinary times with the years 2000-2002, a period of unprecedented corporate accounting scandals that led to greater than usual uncertainty as to which firms had the better managers.

Original languageEnglish (US)
Pages (from-to)1995-2059
Number of pages65
JournalBoston University Law Review
Issue number5
StatePublished - 2019

All Science Journal Classification (ASJC) codes

  • Law


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