Data Description

rate to any portfolio in the mean-standard deviation plane. Bekaert and Urias (1996) suggest that one can assess the economic significance of the shift in the mean-variance frontier by evaluating the change in the Sharpe ratio. Petrella (2005) also uses the Sharpe ratio to measure the diversification benefits of investing in European small cap stocks. If the Sharpe ratio has a positive change after adding the new portfolio, it implies that the new tangency portfolio provides an extra return for a unit increase in standard deviation. We measure the percentage change in the Sharpe ratio to assess the economic significance of adding the new stock portfolio to a set of benchmark portfolios to gain diversification benefits.

To consider the risk deduction due to the shift in the GMV portfolio is another measure of diversification benefits when adding the new stock portfolio to benchmark portfolios.

The measure is defined as the difference in standard deviation between the GMV portfolio composed of the benchmark portfolios and the GMV portfolio composed of the benchmark plus the G-index stocks portfolios. As Petrella (2005) points out, the risk deduction measure assumes that investors are only concerned with minimizing risk and do not care about returns. Though this assumption is pretty strong, the risk deduction measure is independent of the expected return estimation and it is more difficult to estimate an expected return than a variance or standard deviation (see Merton (1980) and Jorion (1985)).

3.3 Data Description

Our initial sample consists of all firms that have a corporate governance index (G-index). The corporate governance index (G-index) is constructed by GIM based on the investor rights and takeover protections provided by the Investor Responsibility Research Center (IRRC). ⁷ A G-index of a firm represents the number of provisions restricting

7 The publications issued by the IRRC provide 24 distinct corporate-governance provisions that include 22  

firm-level provisions and six state laws (four of the laws are analogous to four of the firm-level provisions).

The restrictions, for example, include poison pills, golden parachutes, supermajority requirements, and

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        shareholder rights that the firm applies, not requiring any judgments about the efficacy or wealth effects of these provisions but only on the impact on the balance of power. The G-index value ranges from 0 to 24 by adding one point for every provision. The IRRC released their surveys of shareholder rights and antitakeover provisions on September 1990, July 1993, July 1995, February 1998, January 2000, January 2002, and January 2004. The surveys are not issued every year, and thus we follow GIM using IRRC data of each year to classify multiple years, assuming that the adoption of anti-takeover provisions for every firm is stable and constant in the short run. For example, the G-index of 1990 is used for the period from 1990 to 1993 until the edition became available, and so on. Following GIM, we define the portfolio with the strongest shareholder rights (G<=5) as the “Democracy”

portfolio and the portfolio with the weakest shareholder rights (G>=14) as the

“Dictatorship” portfolio.

We use value-weighted monthly returns collected from the Center for Research in Security Prices (CRSP) for the period from 1990/09 to 2005/12, and we match our data with the G-index data provided by Fama and French. There are a total of 9150 observations. In addition, we exclude financial firms (SIC 6000-6999) and utilities (SIC 4900-4999) because of the special financial structures, regulatory requirements, and accounting standards of these types of organizations.

The data of the benchmark assets composed of ADRs are collected from the CRSP and the Bank of New York. We use the ADR data in the NYSE, the NASDAQ and the AMEX that are initially a total of 314 ADRs of 39 countries. Panel A of Table 1 presents the number of ADRs issued by each country, and Panel B of Table 1 reports the effective date of each country. We use a total of 126 ADRs for 12 countries (Australia, Chile, Denmark, Ireland, Italy, Japan, Mexico, Netherlands, Norway, South Africa, Spain, and the United Kingdom)  

classified boards.  

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which have an effective date available from 1990/09 as the first benchmark portfolio, and a total of 151 ADRs of 13 countries (the previous 12 countries plus China) which have an effective date since 1993/08. The addition of the China ADRs is because we are interested in China’s booming development in recent years and the investment benefits that many researchers have investigated. Additionally, we use the value-weighted and the equally-weighted monthly returns of ADRs acquired from the CRSP. The purpose of an equally-weighted portfolio is to eliminate the impact of some extreme firm sizes (the capitalization of a firm) on returns. In order to be easy for illustration, we define the benchmark portfolios of 12 countries as the “12ADRs” and the benchmark portfolios of the previous 12 countries plus China as the “13ADRs”.

<Table 1 is inserted about here >

We replicate the GIM return results in Table 2, and we demonstrate the return results of GIM data which are still held for our sample. GIM’s Table VI shows that taking a long position in Democratic firms and a short position in Dictatorship firms can obtain an abnormal return of 0.71 percent per month from 1990/09 to 1999/12.⁸ Our replication of GIM’s results report abnormal returns of 0.69 percent per month, which is quite close to the 0.71 percent abnormal returns of GIM and is also statistically significant. Furthermore, we also analyze the period following the original sample period (2000/1-2005/12) and the combined sample period (1990/09-2005/12) that earn -0.07 percent and 0.42 percent per month respectively.

<Table 2 is inserted about here >

Figure 1 shows the difference of the Democracy and Dictatorship portfolio that follows

8 The model extends the Fama-French (1993) three-factor model with an addition of a momentum factor. For  

details on the construction of the factors, see Fama and French (1993) and Carhart (1997). Our factor returns for SMB and HML are provided from Ken French. The momentum returns were calculated by the authors using the procedures of Carhart (1997).

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the CGR’s Figure 1. It shows the development of the value of Democracy, Dictatorship and the hedge portfolios from 1990/09 to 2005/12, assuming $1 is invested in the portfolio in 1990/09. The upper line plots the value of the Democracy portfolio, and the middle line and the bottom line plot the value of Dictatorship and the value of hedge portfolios respectively.

The same results of the CGR, the graph indicates that nearly all of the positive returns to the hedge portfolio documented by GIM from 1990 to 1999 occur from 1997 to 1999. The hedge portfolio gains nearly flat returns prior to 1997 and gains negative returns after 1999.

<Figure 1 is inserted about here >

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