Scholars, practitioners and policymakers continue to debate what constitutes “good” corporate governance. Academic efforts to evaluate the effect of governance provisions such as dual class voting structures, staggered boards of directors and separating the positions of CEO and Chairman of the Board, have produced inconsistent or inconclusive results. The consequence is that the debate over corporate governance is increasingly political and discordant.
We offer a way to address this debate. The rise of index-based investing provides a market-based alternative to governance regulation. Through the creation of bespoke governance index funds, asset managers can offer investors the opportunity to choose an index that corresponds to their governance preferences. We term this approach synthetic governance. At the same time, synthetic governance offers a new tool to collect evidence on the economic impact of corporate governance by providing a market-based tool for evaluating the relationship between corporate governance and stock returns.
We illustrate the potential of synthetic governance with the creation of a new governance-based index, the Dual Index, which selects portfolio companies on the basis of a dual class voting structure. We compare the performance of the Dual Index to various benchmarks and demonstrate the potential, through governance-based indexing, for investors to realize superior returns. We further modify the Dual Index by implementing synthetic sunsets to highlight the value creation of dual-class companies in their early years and provide evidence on the appropriate length of a time-based sunset provision. Finally, we expand our analysis of synthetic governance with a second index – the Split Index – which tests the effect of separating the positions of CEO and Chairman of the Board. We conclude that synthetic governance offers a meaningful way for investors and issuers to more economically adopt and invest in governance provisions. We thus provide a way out of the corporate current war over what exactly constitutes “good” governance.
Anh, Byung Hyun; Fisch, Jill E.; Patatoukas, Panos N.; and Davidoff Solomon, Steven, "Synthetic Governance" (2020). Faculty Scholarship at Penn Law. 2186.