Does Corporate Governance Matter to Canadian Investors?

Does Corporate Governance Matter to Canadian Investors? Stephen R. Foerster and Brian C. Y. Huen* Richard Ivey School of Business The University of W...
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Does Corporate Governance Matter to Canadian Investors?

Stephen R. Foerster and Brian C. Y. Huen* Richard Ivey School of Business The University of Western Ontario London, Ontario, Canada, N6A 3K7

Abstract This paper investigates the relationship between measures of corporate governance (for the largest 270 Canadian firms) and measures of stock returns. Firms that interlist on the New York Stock Exchange are rated higher on a “governance score” than firms that either interlist on Nasdaq or list only in Canada. Markets react significantly to information released related to governance ranking of firms. A value-weighted portfolio of 54 stocks rated in the top quintile (based on the governance score) outperforms other portfolios over a five-year period. After controlling for a variety of well-documented risk proxies, the top quintile portfolio outperforms the other four portfolios combined by an average of almost 9% per year. Our study suggests that good corporate governance does appear to matter to Canadian investors.

Current version: May 9, 2003 JEL Classification Codes: G34, G12, G14. Key Words: corporate governance; stock returns; interlisting.

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Professor of Finance and MBA 2003 graduate, respectively. We wish to thank the Social Sciences and Humanities Research Council for financial support. Address correspondence to: Steve Foerster, phone: 1519-661-3726; fax 1-519-661-3485; e-mail: [email protected].

Does Corporate Governance Matter to Canadian Investors?

1. Introduction Corporate governance refers to the process whereby suppliers of capital (shareholders) attempt to ensure that managers of the firms in which they invest provide a sufficient return. Corporate governance address the agency problem whereby the shareholders (principals) are the ultimate owners of the firm and want to ensure that managers (agents), who are separate from the shareholders, act in the shareholders’ best interests rather than the interests of managers.

Recent high-profile scandals (e.g., Enron, Worldcom, and Tyco) have focused increased attention on the agency problem and corporate governance mechanisms. Subsequent to these incidents, U.S. lawmakers responded with tougher regulations known as the Sarbanes-Oxley Act of 2002. The act covers a number of areas related to governance including: public company accounting oversight boards, auditor independence, corporate responsibility, and enhanced financial disclosure. Canadian regulators and standard setters, including the Toronto Stock Exchange (TSX), Ontario Securities Commission (OSC) and other provincial regulators, and the Canadian Institute of Chartered Accountants (CICA) have been in the process of drafting parallel initiatives. 1 In September 2002, CICA issued a request for comments on proposed new independence standards. In October 2002, the Auditing and Assurances Standards Oversights Council was established to provide input and direction to those setting auditing standards. In 1

See KPMG (2003), Comparison of U.S. and Canadian Regulatory Changes, http://www.kpmg.com/aci/international_canada.htm, accessed May 7, 2003.

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November 2002, the TSX proposed revisions to its TSX Company Manual that would impact on listed issuers. While Canada has not fully enacted such regulations, cross- listed firms are subject to many of the regulation.

The study of the agency problem is not a new area and has been examined over seventy years ago by Berle and Means (1932), and over a quarter century ago by Jensen and Meckling (1976). A growing body of literature has investigated both theoretically and empirically the area of agency costs (see Shleifer and Vishny (1997) for a survey). While this literature is quite substantial, fewer studies have attempted to provide a direct link between corporate governance metrics and stock valuation. In addition, while much attention has been focused on the U.S. there has been very little academic research (with the exception of King and Segal (2003)) investigating governance and stock valuation primarily in a Canadian context.

Our study attempts to provide a vigorous investigation in search of a link between corporate governance measures and stock valuation in Canada but we recognize that any such search should be embarked upon with a number of important caveats. First, a search for any causal link is inherently difficult since governance structures of firms are not “given” or exogenous variables but rather can be considered endogenous variables. For example, it may be the case that because firms have better governance practices, they are valued more favourably by investors. Alternatively, firms that are valued more favourably may respond by improving governance practices. Yet another possibility is that such governance factors may be influenced by considerations not directly related to

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attempting to maximize shareholder value. In addition, while on the one hand investors of firms with better governance practices may be rewarded with higher stock returns, poorer governance may be viewed as an increased risk factor and thus investors will only invest in such firms if expected returns are higher. While we make no claim about the direction of any link between governance and value, our goal is to empirically investigate whether governance does matter to Canadian investors and whether any association between governance and stock performance can be established.

A second major challenge in this area relates to the measurement of “good governa nce.” While the literature has provided some guidance in terms of important governance factors, there is no universally accepted definition of what identifiable and measurable factors constitute good governance, or how any such measures should be weighted as part of the construction of an overall governance index. Thus any such measure will invariably have a subjective component and failure to find a link between governance and valuation could be due to the lack of a precise operational definition of governance.

A third challenge relates to timing. Should we expect to find any link between corporate governance and short-term stock performance, or longer-term performance? Is there an ideal time frame? If the time frame is too short, any return performance may be idiosyncratic. If the time frame is too long, then any measures of corporate governance may be changing.

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A fourth challenges relates to the measurement of value and performance. Some studies focus on valuation metrics such as market-to-book ratios or price-to-earnings ratios as proxies for relative values. Such measures rely on accounting-based data which clearly can have some limitations. Another simple approach of focusing on actual stock performance and examining “raw” returns ignores the possibility that returns can be driven by various risk factors inherent in stock investments (although theories as well as empirical investigations provide some directions in terms of risk-adjustments). Thus given these challenges, it may be surprising to find any links between governance and stock performance.

Nonetheless, in terms of addressing each of the challenges, we proceed as follows to perform a rigorous investigation of the relationship between this governance measure and stock valuation and performance in Canada. First, consistent with Gompers et al. (2003), we “let the data decide” in terms of the direction of perceived causality between governance and performance. Second, rather than create our own index, we rely on a recently developed and independent Canadian governance index presented in a Globe and Mai, Report on Business article investigating Canadian corporate governance. The investigation recently developed a corporate governance ranking of 270 of Canada’s largest firms, i.e., those in the S&P/TSX index as of September 1, 2002 (see McFarland (2002) and McFarland, Church and Nguyen (2002)). Third, we investigate a number of different time periods from three- months to five years. In addition, we use the release of the Globe and Mail article as an event study date to examine the awareness in the marketplace to governance factors and investigate the market’s reaction to this “new”

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information. Fourth, we rely on the well-known Fama-French (1993) factors to control for risk in our regression analysis. Despite all the challenges we find evidence that corporate governance does seem to matter to Canadian investors.

Our paper is organized as follows. Section 2 briefly reviews the literature. Section 3 describes our data and methodology. Section 4 presents our results. Section 5 presents our conclusions and suggestions for future research.

2. Review of Related Literature While the literature on corporate governance is quite broad, few studies have examined a direct link between corporate governance and stock valuation and performance. In a U.S. context, Core, Holthausen and Larcker (1999) focus on one key component related to corporate governance, CEO compensation, and attempt to measure the predicted “excess” compensation of CEOs as a function of board struc ture and ownership structure variables (i.e., in excess of controls for standard economic determinants of compensation). The predicted excess compensation measure is then used as an independent variable (along with control variables such as standard deviation of stock returns, market value, marketto-book and year and industry factors) to explain stock returns over subsequent one, three, and five-year periods. They find the predicted excess compensation variable to be significant and negative. In other words, when CEO compensation is determined to be excessive, the impact on stock returns is negative.

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Gompers, Ishii and Metrick (2003) investigate a relationship between a broader measure of governance, as captured by their “Governance Index”, and stock valua tions and returns. The Governance Index includes 24 factors, most related to management’s options to resist hostile takeovers, including poison pills, golden parachutes, and antigreenmail provisions. After controlling for a number of well-known risk-related factors (see Fama and French (1993) and Carhart (1997)), they measure “alphas” and find that a portfolio of firms with the strongest shareholders rights outperforms a portfolio with the weakest shareholder rights by 8.5% per year during the 1990s.

Internationally, a German study by Drobetz, Schillhofer and Zimmermann (2003) develops a corporate governance rating for German firms and documents a positive relationship between the governance measure and firm value. The governance measure includes 30 variables related to corporate governance commitment, shareholders’ rights, transparency, management and supervisory board matters and auditing. Return expectations are proxied by historical returns and valuation measures such as dividend yields and price-earnings ratios.

In a Canadian context, King and Segal (2003) focus on a comparison of firms that interlist in the U.S. versus both non- listing Canadian firms as well as U.S. firms. They find that Canadian firms trade at valuation discounts (as measured by price-to-book or price-earnings ratios) relative to U.S. firms. Those Canadian firms that cross- list are able to mitigate the valuation discount. An explanation for their results is that U.S. exchanges have more stringent listing requirements and thus encourage better corporate governance.

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McFarland, Church and Nguyen (2002) conclude that most Canadian corporations meet neither U.S. requirements nor existing Toronto Stock Exchange guidelines.

3. Data and Methodology The corporate governance survey conducted by the Globe and Mail, Report on Business and published on October 7, 2002, was used as the ranking system of corporate governance effectiveness in the study. The detailed Globe and Mail rankings are listed in Appendix A. The companies involved in the study, totaling 270 Canadian publicly listed entities, were ranked based on four key factors that were considered to be critical to corporate governance effectiveness: board composition (out of 40), board compensation (out of 23), shareholder rights (out of 22), and public disclosure (out of 15). These scores were then added to determine a total score. Board composition examined the percentage of a firm’s directors, audit committee, compensation committee and nominating committee that are fully independent, and other board factors such as whether the role of chairman and CEO are separate. Compensation measured whether directors and the CEO were required to own their own stock and other factors such as whether the firm gives loans to directors and officers (a practice which can become excessive). Shareholder rights examined whether directors stood for reelection annually, whether stock options were excessively dilutive, whether options were repriced and whether a firm had nonvoting or subordinate voting shares. Disclosure examined whether a firm had a full statement of corporate governance practices and other disclosure practices including whether a firm fully explains which directors are related and why.

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The criteria for data collection were determined in order to provide a view of probable connection between share performance and corporate governance effectiveness in shortterm, long-term and event-driven periods. As a result, the following time periods were considered as significance time periods for data compilation and analysis: •

January 1997 to December 2002: This time frame was used to provide a view of the long-term share price performance of the companies in the universe.



January 2002 to December 2002: This time frame covered the calendar year around the Globe and Mail ranking.



October 5, 2002 to October 8, 2002: This time frame was the basis for an event-study of the impact of the release of the Globe and Mail article (dated Monday, October 7, 2002). The period covers prices from the close of trade before the release of the article to the close of trade on the day subsequent to the release.



October 5, 2002 to January 5, 2003: This time frame examines the quarter following the release of the Globe and Mail article.

Detailed share performance data was obtained from Datastream International. 2

Two sets of regression analyses were performed. The first set of regressions is based on the following equation: Rit = a + b GSi + ei,

(1)

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There were five companies for which historical share price information could not be extracted from Datastream because of various events such as merger and acquisition, bankruptcy and other forms of consolidation: Cognicase Inc., Co-Steel Inc., ELK Point Resources Inc., Meota Resources Corp. and Isotechnika Inc. The historical share price information for these companies was extracted using various sources such as Bloomberg, Reuters and Yahoo! Finance.

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where Rit is the aggregate excess return (over the aggregate period t) of individual firm i and GSi is the governance score index for firm i. Excess returns were measured in two methods: first, in excess of the market return (TSX total return) or second, in excess of the TSX industry sub-index. The various return periods included the five- year period January 1998 to December 2002, the one-year period January 2002 to December 2002, the three-month period October 5, 2002 to Janaury 5, 2003 (R-3mo), or the two-day “event” period (close of trading on Friday, October 5, 2002 to close of trading on Tuesday, October 8, 2002).

The second set of regressions is based on the following equation: Rit = a + b1 RMRFt + b2 SMBt + b3 HMLt + eit ,

(2)

where Rit is the return measure for portfolio i in month t in excess of the t-bill return, and RMRF, SML, and HML are the well-known Fama and French (1993) factors estimated based on our sample of Canadian data (270 firms) and represent the total return on the TSX index in excess of the Canadian t-bill return (RMRF), the return on the smallest (market value) quintile portfolio less the return of the largest quintile portfolio in the sample (SMB), and the return on the highest book-to-market quintile portfolio less the return on the lowest book-to-market quintile portfolio (HML). Portfolio returns are a weighted-value of 54 stocks (one- fifth of the overall sample of 270 firms) based on rankings of the governance score (GS) index. Firms in the Q1 portfolio have the highest average GS, while firms in the Q5 portfolio have the lowest GS. This regression equation and methodology is similar to one employed in Gompers et al. (2003).

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4. Results Individual firm summary statistics are presented in Table 1. The table includes measures of the governance score (GS) index, monthly returns for the five-year period January 1998 to December 2002 (R-5yr), the one-year period January 2002 to December 2002 (R1yr), the three- month period October 5, 2002 to January 5, 2003 (R-3mo), market-tobook ratios (MB) and market value of equity in millions of dollars (MV) as of December 31, 2002 for 270 Canadian firms. The average GS is 60.8, with a range of 36 to 96. The top quintile cutoff is a score of 74. The average five-year return is a cumulative 66.4%. The average return during 2002 was -2.8%, with a strong last quarter of 2002 average return of 15.1%. The average market-to-book ratio was 2.1 and the average market value of equity was $2.67 billion.

Correlations among the individual firm measures are presented in Table 2. The governance score (GS) index, perhaps not surprisingly, is positively and significantly related to the size measure. In other words, larger firms tend to have stronger governance practices. In addition, a larger GS is associated with firms that list on the NYSE, which is consistent with the more stringent listing requirements on the NYSE. However, there is not an association with simply listing on any U.S. exchange, such as Nasdaq. Thus it may be important to distinguish between the individual exchange requirements themselves rather than geographic location. Both the five-year and one- year return are positively and significantly related to measures of the market-to-book ratio suggesting that “value” stocks performed better over those time periods. Larger firms tended to be cross-listed on the NYSE.

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The individual firm regression results based on equation (1) are presented in Table 3. The first panel presents results based on excess of market returns while the second panel is based on excess of industry returns. None of the five-year or one- year results are significant although there is a small but significant relationship between the excess of industry returns and the GS index over the final quarter of 2002, the period subsequent to the release of the Globe and Mail article. The event study results based on the two-day period (close of trading on Friday, October 5, 2002 to close of trading on Tuesday, October 8, 2002) around the release of the article suggest a positive and significant relationship between the stock performance and the GS index, although the adjusted R2 is quite small. This result suggests a possible market inefficiency or a market reaction to the publicity. Interestingly, the article was based on public information but apparently was “news” to the marketplace in terms of a relative rank ing of governance.

Given the amount of “noise” in the individual firm data, it is perhaps not surprising to find weak results. In order to reduce the noise, and consistent with other researchers, we analyze the data by forming value-weighted portfolios of firms based on the GS index. 3 Summary statistics of the five quintile portfolio returns and the Fama-French factors are presented in Table 4. The top quintile portfolio actually exhibits the highest average return and the lowest total risk (as measured by standard deviation). Curiously the second highest average return is exhibited by the bottom quintile portfolio. At this stage,

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Note that there is a possible survivorship bias in our analysis since we are employing the GS index developed in October 2002 to investigate returns over the 1998 to 2002 period. It is possible that firms that scored higher on the GS index as of 2002 may not have scored as high in 1998, or vice versa.

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however, and inferences are only conjectural since we have not formally accounted for risk.

Portfolio regression results based on the equation (2) are presented in Table 5, which includes a number of risk proxies. Alpha is interpreted as a monthly abnormal portfolio return after controlling for market return, size, and book-to- market risk factors. The only significant alpha is uncovered in the top quintile portfolio (Q1). The average abnormal monthly return is 0.98%. The average alpha of the remaining four portfolios is 0.24%. The difference of 0.73% is approximately 8.8% on an annual basis. These results suggest that the market does care about the governa nce practices of Canadian firms and investors in firms with stronger governance practices are rewarded over the long-term.

5. Conclusions Does corporate governance matter to Canadian investors? In the very short-run, perceptions do matter. Markets react statistically significantly, but only marginally economically to “news” related to corporate governance rankings. In the longer-term, good governance matter as well, although one must be careful to adjust for risk and to also consider a long enough time period. We can conjecture that during the “technology bubble” of the late 1990s, many firms with very weak corporate governance practices (and certainly those listed on the Nasdaq rather than the NYSE) rewarded their investors handsomely for several years. Cynics have suggested that governance awareness comes in cycles and corresponds to periods of depressed markets. Whether the apparent

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increased attention on corporate governance is a “fad” or is here to stay, only time will tell.

There are a number of suggestions for future research in the area of corporate of governance. We can search for a stronger link between governance and stock valuation in Canada in a number of ways. First, while the index we employ in this study is a good attempt at measuring the corporate governance practices in Canada, it is possible that further refinements can be made. In addition, the measure can be updated on a regular basis. Second and related to the previous point, while we have attempted to measure returns over a number of time periods, there may be longer periods that are more appropriate and we may be able to enrich this type of study by incorporating the changing dynamics of corporate governance through periodic (e.g., annual) changes in the index. Third, as more theories are developed related to corporate governance, new factors can be added as possible explanatory variables. Fourth, alternative measures of risk factor proxies can be examined, such as Carhart’s (1997) four- factor model. Thus the search for a strong link between governance and stock performance continues.

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References Berle, Adolph, and Gardiner Means, 1932, The Modern Corporation and Private Property, (Macmillan, New York). Carhart, Mark, 1997, On persistence in mutual fund performance, Journal of Finance 52, 57-82. Core, John E., Robert W. Holthausen, and David F. Larcker, 1999, Corporate governance, chief executive officer compensation, and firm performance, Journal of Financial Economics 51, 371-406. Drobetz, Wolfgang, Andreas Schillhofer, and Heinz Zimmerman, 2003, Corporate Governance and Expected Stock Returns: Evidence From Germany, European Corporate Governance Institute, working paper. Fama, Eugene F., and Kenneth R. French, 1993, Common risk factors in the returns on bonds and stocks, Journal of Financial Economics 33, 3-53. Gompers, P., L. Ishii, and A. Metrick, 2003, Corporate Governance and Equity Prices, Quarterly Journal of Economics 118, 107-155. Jensen, Michael, and William Meckling, 1976, Theory of the firm: managerial behavior, agency costs, and ownership structure, Journal of Financial Economics 3, 305-360. King, Michael R., and Dan Segal, 2003, Valuation of Canadian vs. U.S. Listed Equity: Is There a Discount?, University of Toronto, working paper. McFaland, Janet, 2002, How ROB created the rating system, Globe and Mail Report on Business, B6. McFarland, Janet, Elizabeth Church, and Lily Nguyen, 2002, Board Games, Globe and Mail Report on Business, B1, B8. Schleifer, Andrei, and Robert Vishny, 1997, A survey of corporate governance, Journal of Finance 52, 737-783.

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Appendix A Data from “Board Games”, Globe and Mail, Report on Business, October 7, 2002 1 = Board composition (out of 40) 2 = Compensation (out of 23) 3 = Shareholder rights (out of 22) 4 = Disclosure (out of 15) Total (out of 100) Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

Company Manulife Financial Corp TransAlta Corp TransCanada PipeLines Ltd Canada Life Financial Corp Finning International Inc Bank of Montreal CAE Inc Abitibi-Consolidated Inc BCE Inc Canadian Imperial Bank of Commerce Methanex Corp Dofasco Inc Suncor Energy Inc Rothmans Inc Royal Bank of Canada Canadian Pacific Railway Ltd Inco Ltd O&Y Properties Corp Toronto-Dominion Bank Hudson's Bay Co CP Ships Ltd Sun Life Financial Services of Canada Potash Corp. of Saskatchewan Talisman Energy Inc Emera Inc Shell Canada Ltd Fairmont Hotels & Resorts Inc Air Canada Laurentian Bank of Canada Petro-Canada Stelco Inc Bank of Nova Scotia Moore Corp. Ltd MDS Inc Kingsway Financial Services Inc Enbridge Inc Placer Dome Inc Canadian Western Bank Agrium Inc Stantec Inc

1 40 40 38 38 38 36 37 38 34 38 38 36 34 37 33 37 31 40 33 40 37 33 40 36 38 38 28 36 40 38 37 30 35 34 32 29 40 38 37 36

2 23 22 20 22 22 22 23 16 23 19 18 20 23 13 22 19 20 15 19 14 18 22 15 17 13 12 23 20 9 14 20 19 17 17 13 20 9 12 13 14

3 18 22 22 20 20 20 20 22 22 20 22 22 20 22 20 20 20 20 22 20 20 18 14 20 22 22 20 17 20 20 20 20 14 20 20 20 20 20 20 20

4 15 12 13 13 11 12 9 12 9 10 9 9 9 13 10 9 13 8 9 8 7 9 12 8 8 8 9 7 11 7 2 9 12 7 13 9 9 7 7 7

Total 96 96 93 93 91 90 89 88 88 87 87 87 86 85 85 85 84 83 83 82 82 82 81 81 81 80 80 80 80 79 79 78 78 78 78 78 78 77 77 77

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41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90

Alcan Inc SNC-Lavalin Group Inc Uni-Select Inc Loblaw Cos. Ltd Co-Steel Inc Domtar Inc ATS Automation Tooling Systems TVX Gold Inc Nexen Inc BC Gas Inc Westport Innovations Inc Boardwalk Equities Inc Western Oil Sands Inc Richelieu Hardware Ltd Maple Leaf Foods Inc Manitoba Telecom Services Inc Vasogen Inc Precision Drilling Corp Aliant Inc Canadian National Railway Co Mosaic Group Inc Nortel Networks Corp Heroux-Devtek Inc Ipsco Inc MacDonald Dettwiler & Associates Ltd Cable Satisfaction International Enerflex Systems Ltd Concert Industries Ltd Slocan Forest Products Ltd Toromont Industries Ltd National Bank of Canada Forzani Group Ltd Tembec Inc Biomira Inc Goldcorp Inc ELK Point Resources Inc Nova Chemicals Corp Gennum Corp Slater Steel Inc Westaim Corp Mullen Transportation Inc Kasten Chase Applied Research Ltd Masonite International Corp WestJet Airlines Ltd QLT Inc Canfor Corp Meridian Gold Inc Telus Corp Stressgen Biotechnologies Canadian 88 Energy Corp

34 33 32 27 38 36 34 33 27 38 38 37 34 32 35 34 33 31 30 31 38 34 32 36 36 35 35 33 31 31 32 35 34 33 31 30 27 28 31 33 26 36 28 24 34 36 33 32 34 33

14 14 15 16 10 12 16 12 17 7 13 16 12 15 20 14 13 13 17 13 7 20 13 11 10 12 9 11 13 13 15 7 9 10 9 13 14 13 10 17 16 11 13 19 7 7 11 11 8 7

22 20 22 22 22 22 20 22 20 20 16 14 20 20 9 20 20 20 22 20 20 10 20 20 14 14 20 20 20 20 14 20 20 20 20 20 20 22 20 14 20 20 20 20 14 20 20 11 14 20

7 9 7 10 5 5 5 8 11 9 7 7 8 7 9 5 7 9 4 8 7 8 7 5 11 10 7 7 7 7 9 8 7 7 10 7 9 7 8 5 7 1 7 5 13 5 4 13 11 7

77 76 76 75 75 75 75 75 75 74 74 74 74 74 73 73 73 73 73 72 72 72 72 72 71 71 71 71 71 71 70 70 70 70 70 70 70 70 69 69 69 68 68 68 68 68 68 67 67 67

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91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140

Industrial-Alliance Life Insurance Co Cameco Corp Cott Corp Fording Inc Exfo Electro Optical Engineering Inc AnorMed Inc Vincor International Inc Jean Coutu Group Inc Echo Bay Mines Ltd Niko Resources Global Thermoelectric Inc Hemosol Inc Canadian Tire Corp Molson Inc Tesco Corp Patheon Inc George Weston Ltd TVA Group Inc Brookfield Properties Co Lorus Therapeutics Inc Agnico-Eagle Mines Ltd Vector Aerospace Corp NQL Drilling Tools Inc Trojan Technologies Inc Kinross Gold Corp Imperial Oil Ltd Compton Petroleum Corp Creo Inc Van Houtte Inc Vermilion Resources Ltd Cognicase Inc Hurricane Hydrocarbons Norske Skog Canada Inc Pan American Silver Corp Husky Injection Molding Systems Ltd North American Palladium Ltd Com Dev International Ltd Wi-Lan Inc Theratechnologies Inc Baytex Energy Ltd Cara Operations Ltd Teknion Corp Aber Diamond Corp Hydrogenics Corp Iamgold Corp GSI Lumonics Inc Sleeman Breweries Ltd Zenon Environmental Inc GTC Transcontinental Group Ballard Power Systems Inc

33 19 31 19 31 37 28 23 22 22 37 31 30 26 25 24 23 30 22 36 33 30 29 28 23 22 37 33 29 29 28 26 24 21 17 23 28 28 25 21 28 26 24 24 24 29 28 30 28 21

9 17 13 22 14 10 13 17 12 13 10 10 14 17 13 12 14 16 13 10 7 7 11 9 13 13 7 13 10 13 8 13 11 15 17 6 12 13 16 13 14 17 13 12 10 10 12 8 7 11

18 20 11 20 11 14 20 19 22 20 14 20 12 12 20 20 22 14 22 16 20 20 20 20 22 20 14 10 17 14 20 20 22 20 22 22 20 14 14 20 11 11 20 18 14 12 12 17 15 20

7 11 12 6 10 5 5 7 10 11 4 4 9 10 7 9 6 5 8 2 4 7 4 7 6 9 5 7 7 7 7 4 6 7 7 11 2 7 7 8 9 7 4 7 13 9 8 4 9 7

67 67 67 67 66 66 66 66 66 66 65 65 65 65 65 65 65 65 65 64 64 64 64 64 64 64 63 63 63 63 63 63 63 63 63 62 62 62 62 62 62 61 61 61 61 60 60 59 59 59

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141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190

Biovail Corp Hummingbird Ltd Linamar Corp Axcan Pharma Inc Intrawest Corp Fortis Inc International Forest Products Trican Well Service Ltd DuPont Canada Inc AEterna Laboratories Inc Assante Corp Bonavista Petroleum Ltd Quebecor World Inc BCE Emergis Inc Nexfor Inc Torstar Corp Paramount Resources Ltd Falconbridge Ltd Magellan Aerospace Corp Ultra Petroleum Corp Thomson Corp CHC Helicopter Corp Brascan Corp Corel Corp Dundee Realty Corp Noranda Inc Sears Canada Inc Magna International Inc Tundra Semiconductor Corp Maax Inc Stratos Global Corp Cognos Inc Transat AT Inc Ensign Resource Service Group Glamis Gold Ltd Meota Resources Corp Burntsand Inc Labopharm Inc ID Biomedical Corp Persona Inc Research in Motion Ltd Ivanhoe Mines Ltd./CA Isotechnika Inc Onex Corp CGI Group Inc ATI Technologies Inc Cascades Inc AUR Resources Inc Sierra Wireless CFM Corp

19 26 17 29 29 28 28 21 24 21 17 17 22 15 19 23 18 14 11 13 21 28 21 27 21 13 18 16 27 24 21 20 19 17 17 16 31 26 24 22 22 21 19 22 24 20 12 15 29 17

9 12 16 11 5 6 9 13 9 14 12 13 12 16 10 12 16 14 20 13 11 10 11 10 10 12 13 15 13 9 9 12 17 12 13 11 7 9 12 6 8 11 7 11 15 14 16 15 9 16

20 14 20 14 20 20 15 20 20 15 22 20 16 20 22 15 20 20 20 20 22 11 17 14 20 22 20 12 10 14 20 14 14 20 20 22 14 14 14 20 14 14 20 15 9 14 20 20 10 14

11 7 5 4 4 4 6 4 5 7 6 7 7 6 6 6 2 8 5 10 2 7 6 4 4 8 4 11 4 7 4 8 4 5 4 5 1 4 3 5 9 7 7 5 4 4 4 2 3 4

59 59 58 58 58 58 58 58 58 57 57 57 57 57 57 56 56 56 56 56 56 56 55 55 55 55 55 54 54 54 54 54 54 54 54 54 53 53 53 53 53 53 53 53 52 52 52 52 51 51

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191 192 193 194 195 196 197 198 199 200 201 202 203 204 205 206 207 208 209 210 211 212 213 214 215 216 217 218 219 220 221 222 223 224 225 226 227 228 229 230 231 232 233 234 235 236 237 238 239 240

Ketch Energy Bombardier Inc Lionore Mining International Ltd Quebecor Inc Zarlink Semiconductor Inc Gildan Activewear Inc Pivotal Corp Canam Manac Group Inc Extendicare Inc Dorel Industries Fairfax Financial Holdings Inc Penn West Petroleum Ltd Tesma International Inc Power Financial Corp Descartes Systems Group Inc Barrick Gold Corp Wescast Industries Inc Aastra Technologies Ltd Corus Entertainment Inc Intertape Polymer Group Inc Sceptre Investment Counsel Ltd Royal Group Technologies Ltd TLC Vision Corp Sobeys Inc CanWest Global Communications Corp AltaGas Services Inc Geac Computer Corp. Ltd Husky Energy Inc Dundee Bancorp Inc ShawCor Ltd Rogers Wireless Communications Inc Empire Co. Ltd Inex Pharmaceuticals Corp Leitch Technology Corp CCL Industries Teck Cominco Ltd Shoppers Drug Mart Corp Decoma International Inc Angiotech Pharmaceuticals Inc Martinrea International Inc Saputo Inc Cogeco Cable Inc Leon's Furniture Ltd Gabriel Resources Ltd Four Seasons Hotels Inc Dimethaid Research Inc Cogeco Inc Cinram International Inc Rogers Communications Inc Guardian Capital Group Ltd

16 15 12 15 26 27 26 21 20 19 19 13 12 11 22 19 20 11 25 23 20 18 16 15 16 18 21 15 22 14 12 12 27 24 20 17 12 17 14 11 11 19 9 16 21 14 15 12 14 25

7 16 16 22 9 10 2 10 7 15 13 12 16 15 12 4 5 15 7 7 13 16 13 9 11 13 12 6 9 15 7 13 -1 4 10 13 7 10 10 7 15 8 11 11 8 14 12 6 14 11

20 16 20 10 10 9 14 17 15 9 17 20 17 22 14 20 17 14 12 16 6 9 10 22 17 14 10 22 9 9 18 19 14 14 12 14 20 11 14 20 14 16 22 14 6 14 15 20 9 2

8 4 3 4 6 4 8 2 8 7 1 5 5 2 2 6 7 9 4 2 9 5 9 2 3 2 4 4 7 8 9 2 6 4 4 2 7 7 7 7 5 2 2 3 9 2 2 6 6 5

51 51 51 51 51 50 50 50 50 50 50 50 50 50 50 49 49 49 48 48 48 48 48 48 47 47 47 47 47 46 46 46 46 46 46 46 46 45 45 45 45 45 44 44 44 44 44 44 43 43

19

241 242 243 244 245 246 247 248 249 250 251 252 253 254 255 256 257 258 259 260 261 262 263 264 265 266 267 268 269 270

Sherritt International Corp Open Text Corp Canadian Natural Resources Ltd Metro Inc West Fraser Timber Co. Ltd Canadian Medical Laboratories Ltd Astral Media Inc CryoCath Technologies Inc MDC Corp. Inc Shaw Communications Inc Mosaid Technologies Inc Corby Distilleries Ltd CryptoLogic Inc Alimentation Couche Tard Inc Celestica Inc Acetex Corp BakBone Software Inc St. Lawrence Cement Inc Investors Group Inc Atco Ltd FirstService Corp Canadian Utilities Ltd Hub International Ltd Pangeo Pharma Inc Power Corp. of Canada Crystallex International Corp Great-West Lifeco Inc Rand A Technologies Corp Bema Gold Corp Alliance Atlantis Communications Inc

18 15 13 20 13 11 28 21 20 20 19 18 18 15 17 13 13 12 6 17 23 11 11 11 5 11 4 22 11 14

4 10 13 10 6 9 5 1 7 5 8 2 4 14 10 12 13 6 13 7 9 9 6 10 16 11 8 4 5 12

12 14 14 6 20 20 6 14 6 14 10 19 14 10 7 14 14 19 20 12 6 16 20 14 16 14 22 10 18 6

9 4 3 7 4 2 2 5 8 2 4 2 5 2 7 2 1 4 2 4 2 4 3 4 2 2 3 1 2 4

43 43 43 43 43 42 41 41 41 41 41 41 41 41 41 41 41 41 41 40 40 40 40 39 39 38 37 37 36 36

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Table 1 Individual Firm Summary Statistics Summary statistics of the governance score (GS) index (see Appendix A), monthly returns for the five- year period January 1998 to December 2002 (R-5yr), the one- year period January 2002 to December 2002 (R-1yr), the three-month period October 5, 2002 to January 5, 2003 (R-3mo), market-to-book ratios (MB) and market value of equity in millions of dollars (MV) as of December 31, 2002 for 270 Canadian firms, with available data where appropriate.

Governance score (GS) Jan/98-Dec/02 return (R-5yr) Jan/02-Dec/02 return (R-1yr) Oct/02-Dec/02 return (R-3mo) Market/book ratio (MB) Market value, $millions (MV)

Mean 60.84 66.36% -2.79% 15.12% 2.13 2,665

Std. Dev. Minimum Maximum 13.95 36.00 96.00 240.05% -98.20% 3034.00% 53.16% -98.78% 305.59% 31.51% -83.33% 254.86% 2.05 -11.61 13.00 50,092 4 38,993

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Table 2 Individual Firm Correlations Correlations among the governance score (GS) index (see Appendix A), monthly returns for the five- year period January 1998 to December 2002 (R-5yr), the one-year period January 2002 to December 2002 (R-1yr), the three- month period October 5, 2002 to January 5, 2003 (R-3mo), market-to-book ratios (MB) and market value of equity in millions of dollars (MV) as of December 31, 2002 and dummy variables for stocks listed exclusively on the Toronto Stock Exchange (TSX), interlisted on Nasdaq (Nasdaq), and interlisted on the New York Stock Exchange (NYSE) for 270 Canadian firms, with available data where appropriate. P- values are indicated in parentheses.

GS R-5-yr R-1yr R-3mo MB MV TSX Nasdaq NYSE

GS 1.000 -0.048 (0.477) 0.064 (0.300) -0.014 (0.824) 0.032 (0.623) 0.329 (0.000) -0.147 (0.016) -0.174 (0.004) 0.309 (0.000)

R-5-yr

R-1yr

R-3mo

MB

MV

1.000 0.128 (0.058) -0.051 (0.455) 0.282 (0.000) 0.013 (0.843) 0.067 (0.326) -0.059 (0.388) -0.027 (0.693)

1.000 -0.085 (0.165) 0.393 (0.000) 0.033 (0.594) -0.007 (0.908) -0.078 (0.203) 0.073 (0.235)

1.000 0.030 (0.644) 0.041 (0.507) -0.206 (0.001) 0.188 (0.002) 0.073 (0.231)

1.000 0.052 (0.420) -0.035 (0.585) -0.008 (0.908) 0.045 (0.489)

1.000 -0.285 (0.000) -0.148 (0.016) 0.440 (0.000)

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Table 3 Individual Firm Regressions Regression results based on the equation Rit = a + b GSi + e where Rit is the aggregate return of individual firms in excess of either the market (TSX total return) or the industry sub- index over the indicated period. Various return periods include the five-year period January 1998 to December 2002 (R-5yr), the one- year period January 2002 to December 2002 (R-1yr), the three- month period October 5, 2002 to January 5, 2003 (R-3mo), or the two-day period (close of trading on Friday, October 5, 2002 to close of trading on Tuesday, October 8, 2002). The independent variable is the governance score (GS) index (see Appendix A). T-statistics are indicated in parentheses, whereby *, **, and *** indicate significance at the 10%, 5%, and 1% confidence levels respectively. The adjusted-R2 is also reported.

Parameter estimates (t-stats) intercept (t-stat) GS (t-stat) Excess of market R-5-yr R-1yr R-3mo R-2day Excess of industry R-5-yr R-1yr R-3mo R-2day

adj R2

1.0746 -0.0448 0.0197 -0.0485

(1.47) (-0.31) (0.23) (-3.03)

-0.0075 (-0.64) 0.0023 (0.99) -0.0002 (-0.17) 0.0005 (2.03)**

-0.0028 -0.0001 -0.0036 0.0116

1.3249 0.2359 -0.1933 -0.0391

(1.77) (1.90) (-2.30) (-2.55)

-0.0131 (-1.09) -0.0018 (-0.90) 0.0026 (1.95)* 0.0004 (1.79)*

0.0009 -0.0007 0.0104 0.0082

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Table 4 Portfolio Summary Statistics Summary statistics of monthly portfolio returns whereby each portfolio is a weightedvalue of 54 stocks based on rankings of the governance score (GS) index (see Appendix A). Firms in the Q1 portfolio have the highest average GS, while firms in the Q5 portfolio have the lowest GS. RMRF, SML, and HML are the Fama and French (1993) factors estimated based on the sample of Canadian data and represent the total return on the TSX index in excess of the t-bill return (RMRF), the return on the smallest (market value) quintile portfolio less the return of the largest quintile portfolio in the sample (SMB), and the return on the highest book-to- market quintile portfolio less the return on the lowest book-to- market quintile portfolio (HML).

Q1 Q2 Q3 Q4 Q5 RMRF SMB HML

Mean Std. Dev. Minimum Maximum 1.07% 5.11% -22.95% 11.27% 0.45% 11.73% -35.59% 26.76% 0.49% 5.87% -16.91% 20.03% 0.39% 6.35% -18.49% 15.01% 0.83% 5.64% -20.49% 13.56% -0.06% 5.83% -20.49% 11.66% 0.41% 11.30% -16.63% 48.73% -1.45% 6.60% -14.44% 20.42%

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Table 5 Portfolio Regressions Regression results based on the equation Rit = a + b1 RMRFt + b2 SMBt + b3 HMLt + eit where Rit is the monthly portfolio return in excess of the t-bill return. Each portfolio is a weighted-value of 54 stocks based on rankings of the governance score (GS) index (see Appendix A). Firms in the Q1 portfolio have the highest average GS, while firms in the Q5 portfolio have the lowest GS. RMRF, SML, and HML are the Fama and French (1993) factors estimated based on the sample of Canadian data and represent the total return on the TSX index in excess of the t-bill return (RMRF), the return on the smallest (market value) quintile portfolio less the return of the largest quintile portfolio in the sample (SML), and the return on the highest book-to- market quintile portfolio less the return on the lowest book-to- market quintile portfolio. T-statistics are indicated in parentheses, whereby *, **, and *** indicate significance at the 10%, 5%, and 1% confidence levels respectively. The adjusted-R2 is also reported. Alpha is interpreted as a monthly abnormal portfolio return.

Q1 Q2 Q3 Q4 Q5

alpha 0.0098 0.0045 -0.0026 0.0017 0.0063

(t-stat) (2.30)*** (0.50) (-0.49) (0.37) (1.56)

RMRF 0.7708 1.5032 0.5703 0.7778 0.8290

(t-stat) (9.68)*** (8.74)*** (5.74)*** (8.97)*** (10.89)***

SMB -0.1781 0.0577 0.2586 0.0973 -0.0293

(t-stat) (-3.51)*** (0.53) (4.08)*** (1.76)* (-0.60)

HML 0.0860 0.1881 -0.2347 0.0762 0.0510

(t-stat) (1.00) (1.01) (-2.19)** (0.81) (0.62)

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adj R2 0.631 0.674 0.565 0.717 0.723

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