Momentum Returns and Corporate Governance

Abstract

We hypothesize that corporate governance affects, first, how a firm is perceived by investors in terms of risk, transparency, and valuation and, second, investors’ decisions to buy/sell past winning/losing stocks during good and bad times. Implementing momentum strategies on portfolios of US stocks with different corporate governance scores demonstrate that past winners and losers with weak shareholder rights exhibit significant positive excess returns during expansionary and recessionary periods, respectively. This is consistent with the return behavior of winners and losers when momentum is applied across all stocks. Overall, investors are less (more) reluctant to sell (buy) losing (winning) stocks of weak compared to strong shareholder rights companies. Results show that stocks with weak shareholder rights may be less informationally efficient and subject to biased valuations.