Relative Governance Kose

Using data on antitakeover provisions and headquarters location for a large sample of U.S. public corporations, this paper documents robust evidence of complementarity between rmlevel and local corporate governance. In particular, we nd that: 1) good governance begets good governance i.e., rms are less likely to adopt antitakeover provisions in areas with good governance; 2) good rm-level governance increases rm value only if local governance is good. This result holds across a variety of measures of rm value, which include the returns to a buyand-hold portfolio that longs good and shorts bad governance rms; the short term own and peer announcement returns of the passage of state business combination laws, poison pill adoption, and board declassi cation; Tobins Q, operating performance, the value of cash holdings, and acquirer returns. A contribution of the paper is to develop a novel triple-di¤erence estimator that addresses causality by exploiting exogenous variation in local governance generated by the passage of state business combination laws. Our results suggest that in order to understand the governance-performance relationship the literature needs to go beyond the standard single- rm assumption. External governance mechanisms play an important role in public corporations. Theory and empirics (Manne (1965), Scharfstein (1988), and Gompers, Ishii, and Metrick (2003), Bebchuk, Cohen, and Ferrell (2004)) suggest that antitakeover provisions (ATPs) weaken rm governance by shielding management from the external discipline of the takeover market. This "agency" view, which is rmly established among academics, has been traditionally developed within a single- rm, partial equilibrium setting that ignores interactions among rms. However, rms do interact at several levels: local (see Marshall (1890), and, more recently, Brown, Ivkovíc, Smith, and Weisbenner (2004), and Hong, Kubik and Stein (2004)), industry (through product markets and relationships with customers and suppliers), and in the takeover market (see Eckbo (1983), Song and Walking (2006)). This paper lls the gap in the literature and explores the intriguing possibility that interactions among rms may give rise to governance spillovers, or externalities. Interactions among rms can arguably give rise to either positive or negative spillovers. For example, negative spillovers may arise from interactions in the takeover market. Since takeover targets are to some extent fungible within industries (Eckbo (1983), Song and Walking (2006)) and geographic areas (Kedia, Panchapagesan, and Uysal (2006)), antitakeover provisions may divert takeover pressure toward other targets,1 thus e¤ectively strengthening the deterrence e¤ect of own ATPs. This reasoning implies that rms facing stronger peer governance, i.e., fewer peers with ATPs, may have higher agency costs of ATPs. On the other hand, positive spillovers may arise if, for example, rms can free-ride on the strong governance of their peers. This free-riding may occur whenever rms bene t from having business relations, such as customer or supplier links, with better governed and, thus, more e¢ cient peers. This paper examines empirically the importance of governance spillovers, using direct tests based on the interaction between a rms own governance and the governance of its peers. This intuition is analogous to the classical diversion of crime idea (Shavell (1991)): a thief is less likely to steal a car protected by an antitheft device if there are other unprotected cars nearby.