A blog on financial markets and their regulation
Did 7th January tell us about anything about the governance discount?
March 2, 2009Posted by on
On January 7, 2009, when the fraud at Satyam was revealed,
investors did not think of Satyam as an unfortunate exception; most of
them thought of it as symptomatic of the problems that could be
lurking in many other leading Indian companies. Stocks of several
other companies fell dramatically on that day in a manner that did not
seem to reflect industry specific shocks. Within the information
technology industry itself to which Satyam belonged, some stocks with
a reputation for above average corporate governance rose while some other
stocks fell dramatically.
To those who believe in the strong form efficiency of stock
markets, it is tempting to believe that the market was telling us
something about the perceived governance weaknesses of some Indian
companies. In this context, it is worthwhile to ask whether the
reaction of the market on that day was a panic reaction that was
reversed over a period of time.
On January 7, 2009, nine out of the fifty stocks in the S&P CNX
Nifty Index fell by more than 10% while the index itself fell by
6%. The median stock in the 50 stock index fell by only 5% while the
median price decline of these nine stocks was 15%. I looked at what
happened to these nine stocks week after week up to the end of
February. Far from reversing course, these stocks extended their
losses. While the index fell by 11% and the median stock in the Nifty
fell by 17% from pre-Satyam levels, the median fall for the nine
stocks was 37%. That is right, the median of these nine stocks
underperformed the index by a whopping 26%. Only one of these nine
stocks fell less than the index; the other eight underperformed the
index by margins ranging from 12% to 35%.
In the case of the real estate stocks, is it possible to argue that
the fall was industry wide; though one could counter argue that in
this case, the entire industry was perceived to be plagued by
governance problems. In most other cases, the market perception about
governance appears to be the dominant theme. Of course, even if we
believe that the market is telling us something, we do not know
whether what it is saying is right or not.