Rev Quant Finan Acc (2012) 39:273291

DOI 10.1007/s11156-011-0248-x
ORIGINAL RESEARCH

Corporate governance and the stock market reaction

to new product announcements
Wen-Chun Lin Shao-Chi Chang

Published online: 21 July 2011

Springer Science+Business Media, LLC 2011

Abstract This study examines the explanatory power of corporate governance mechanisms on the wealth effect of firms new product strategies. We show that board size, board
independence, audit committee independence, CEO equity-based pay, analyst following
and shareholder rights are all of significance in explaining the variations in the wealth
effect of new product introductions. Our results reveal that the new product strategies
announced by firms with better corporate governance mechanisms tend to receive higher
stock market valuations than those of firms with poorer governance mechanisms. This
study provides empirical support for the notion that enhanced governance mechanisms can
reduce both agency and information asymmetry problems for firms announcing new
products.
Keywords

Corporate governance  New product introduction  Wealth effect

JEL Classification G14  G30

1 Introduction
In this study, we set out to explore the impact of corporate governance on the wealth effect
of firms new product introductions, arguing that corporate governance mechanisms can
reduce agency costs and provide certification of the quality of information contained
in new product announcements, and propose that new product announcements by firms

W.-C. Lin (&)

Department of Finance, College of Management, Providence University, No. 200, Chungchi Road,
Taichung, Taiwan
e-mail: wjlin@pu.edu.tw
S.-C. Chang
Department of Business Administration, College of Management, National Cheng Kung University,
No. 1, University Road, Tainan, Taiwan
e-mail: schang@mail.ncku.edu.tw

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with better corporate governance mechanisms are likely to receive a more positive stock
market reaction.
New product introductions play a crucial role in developing and maintaining the
competitive advantage of a company. Firms that are able to deliver more new products to
the market generally create better opportunities for differentiation and competitive
advantage. However, new product introductions do not necessarily create firm value, per
se, as the development of new products is often risky, with failure rates reaching as high as
60 per cent (Pauwels et al. 2004). In addition, the commercialization of new products does
not guarantee financial success, as the additional sales revenues from new products may be
insufficient to cover the significant development and launch costs (Chaney et al. 1991).
Furthermore, the competitive advantage from new products may quickly disappear, largely
as a result of the rapid imitation of such products by competitors, or the effects of short
product life cycles.
Although prior studies generally document positive stock market reactions to
announcements of new product introductions (Woolridge 1988; Kelm et al. 1995; Chen
and Ho 1997), considerable variations are found in terms of individual announcing firms.
Chen (2008) finds that new product announcements provide only about 58 per cent of US
firms with positive abnormal returns, whilst Chen and Ho (1997) report similar evidence
for Singaporean firms. Determining why there are discrepancies in how investors perceive
and evaluate new products based upon their initial announcements would seem to be of
considerable interest to both academics and business professionals alike. This study
investigates the issue from the perspective of the impact a firms corporate governance
mechanisms may have on this.
As new product development generally involves greater information asymmetry
between managers and externaland potentially adversarialparties such as investors,
analysts, suppliers, employees, unions and competitors, it is difficult for outsiders to make
effective valuations of new product announcements. One reason is that new products are
usually unique to the developing firms, making it extremely difficult to assess their value
based upon observations of the performance of similar products in other comparable firms.
Furthermore, information disclosure of new product introductions is not mandatory (Eccles
and Kahn 1998), causing disclosure incentives for different firms to be quite diverse:
Whilst some firms may provide information on a voluntary basis in order to reduce
information asymmetry, other firms may disclose quite specific information to deliberately
overstate the value of their products (Eagly et al. 1978; Frost 1997; Koch 2002; Mercer
2004). Thus, outsiders evaluating a new product announcement are not only facing the
issue of information asymmetry, but must also attempt to identify the underlying motives
of those firms that do voluntarily disclose information. As such, the quality of corporate
governance may convey important signals of the underlying motives of new product
investments and may provide important certification effects on information that is voluntarily disclosed as well as on new product announcements.
Agency problems may further complicate the valuation of new product introductions
(Wu 2008); indeed, it has been demonstrated within the prior literature that with the separation of ownership and control, managers may make capital and human resource
investment decisions for their private interests at the expense of shareholder wealth (Wei
and Zhang 2008). For example, managers cannot hedge their investment risk as easily as
risk-neutral shareholders can, who can diversify their risk by holding diversified portfolios.
As a result, they may reduce such risks by investing in projects which are less risky, but
which also yield lower returns. Another agency issue is that of poorly functioning internal

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control, which Jensen (1993) argues is the reason why R&D investments in many large firms
fail to lead to any increase in firm value.
Thus, well-functioning corporate governance mechanisms play crucial roles in mitigating agency costs (Claessens et al. 2002; Brunello et al. 2003; Singh and Davidson
2003). Firstly, such mechanisms provide internal and external monitoring which discourages the pursuit of private interests by managers, thereby maintaining management
discipline. Several studies find that firms with boards and audit committees that are more
independent than otherwise similar firmswhere such independence is measured by the
number of outside directorsdemonstrate less earnings management and higher quality
disclosures (Beasley 1996; Fama and Jensen 1983; Gibbs 1993; Klein 2002; Wild 1996).
This is because the board of directors is the highest internal control mechanism responsible
for monitoring the actions of senior managers. Klein (2002) further states that the structuring of boards with greater independence from the CEO will be more effective in
monitoring the corporate financial accounting process. Furthermore, less earnings management is also discernible amongst firms with boards and audit committees which possess
greater financial expertise, and which meet more frequently (Xie et al. 2003). Kim et al.
(2006) find that firms with an audit committee and/or a larger percentage of outside
directors command higher market valuations, arguing that these effects occur because
investors place a higher valuation on the same earnings stream for such firms.
Other studies suggest that corporate governance mechanisms help to deal with agency
problems and the subsequent implementation of efficient investment decisions through
aligning the interests of managers and shareholders (Cornett et al. 2003; Gompers et al.
2003; Pantzalis et al. 1998; Luo and Hachiya 2005). This can be achieved through substantial stock concentrations and management stockholdings (Hill and Snell 1988) and
effective incentive contracts that include the appropriate compensation of managers relative to the performance of the firmsuch as through equity-based compensation plans
(Bizjak et al.1993; Coles et al. 2001). These mechanisms are effective as they cause the
personal wealth of a CEO to be increasingly dependent on the value of the firm. For
example, if compensation plans place significant emphasis on short-term stock returns, and
little or no emphasis on future performance, managers may exhibit prejudiced behavior
towards either over- or under-investment, while by implementing the above corporate
government mechanisms the CEO will have less incentive to pursue investments in projects which do not increase shareholder value.
Prior studies argue that corporate governance is an important consideration in corporate investment, including mergers and acquisitions (Agrawal and Mandelker 1987;
Datta et al. 2001), corporate diversification (Hill and Snell 1988; Denis et al. 1997;
Anderson et al. 2000) and firm restructuring (Gibbs 1993; Hoskisson et al. 1994).
However, to the best of our knowledge, no previous study has investigated the influence of corporate governance on the reaction by the stock market to new product
introductions. We therefore examine the relationship between corporate governance
mechanisms (specifically board size and independence, audit committee independence,
CEO equity-based compensation, analysts following, and shareholder rights) and the
announcement effects on stock prices of announcing firms using a sample of new
products announcements by US firms.
The remainder of this paper is organized as follows: Sect. 2 provides the development of
our hypotheses. The sample selection and variable measure are presented in Sect. 3,
followed in Sect. 4 by the analysis of our empirical results. Finally, the conclusions drawn
from this study are discussed in the closing section.

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2 Hypothesis development
According to agency theory, boards of directors exist to ensure that shareholder interests
are appropriately pursued and to monitor managers on behalf of shareholders. This is
necessary because the relationships between managers and shareholders with regard to the
organizational processes and outcomes are fundamentally different (Daily et al. 2003;
Jensen and Meckling 1976). While ordinary shareholders may be considered risk neutral,
as they can diversify their risks through their portfolios (Wiseman and Gomez-Mejia
1998), managers are more likely to be risk-averse, as they cannot diversify their risks so
easily. For example, in terms of innovations, failures will not only reduce a firms shortterm performance and thereby lower management compensation, but they can also damage
the reputation of the executives involved and thereby increase their risk of unemployment.
To counter such risk aversion, stakeholders may be heavily reliant on corporate governance mechanisms, using monitoring or incentives to align their risk differentials.
However, whilst increased monitoring can, to some degree, help to resolve agency conflicts, its effectiveness is also limited by potential information asymmetry. In this study, we
examine specific governance mechanism characteristics, discussing the relationship
between the monitoring and information certification effects of governance and the stock
market reaction to new product introductions.
2.1 Board size
A corporate board improves the performance of a firm by monitoring the quality of
managerial decisions and providing specialized resources (Monks and Minow 1995). The
effect of board size on firm performance is, however, inconclusive. A larger board is
valuable for the breadth of its services, and often shows that a firm has directors from a
wide variety of backgrounds (Chaganti et al. 1985). Furthermore, since innovation projects
usually involve greater uncertainty in the development and commercialization stages, the
wider range of knowledge and services offered by a larger board could be of considerable
benefit in guiding investment decisions. Nevertheless, Lipton and Lorsch (1992) and
Jensen (1993) argue that large boards are more difficult to coordinate, and can be less
effective as a controlling body, whilst Yermack (1996) and Lee and Lee (2009) also argues
that board size is inversely related with firm value. Thus, as the impact of board size on the
reaction by the stock market to new product introductions remains ambiguous, we propose
the following two alternative hypotheses:
Hypothesis 1a: board size is positively associated with stock market reaction to new
product introductions.
Hypothesis 1b: board size is negatively associated with stock market reaction to new
product introductions.
2.2 Board independence
The second corporate mechanism we examine in this study is board independence. Not
only do independent directors provide professional expertise, but they can also independently oversee and monitor senior management. Therefore, it is argued in numerous studies
that the effectiveness of corporate governance is positively associated with board independence. For example, both Fama (1980) and Fama and Jensen (1983) argue that independent boards are more likely to make decisions that are consistent with the maximization
of shareholder wealth. Weisbach (1988) and Lee and Lee (2009) suggests that a board

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which is dominated by independent directors is more likely to respond to poor performance

by dismissing the CEO;. Weisbach (1993) goes on to argue that independent directors are
effective in monitoring the decisions taken by managers, suggesting that with a rise in the
number of independent directors, there is a corresponding reduction in the probability of a
hostile takeover.
Furthermore, the independence of the board has been found to have a positive correlation
with the quality of the information disclosed by a firm, where Farber (2005) and Beasley et al.
(2000) show that firms which fraudulently manipulate their financial statements have fewer
independent board members. Klein (2002) also suggests that firms which have more independent board members are less likely to encounter earnings management problems.
However, Hermalin and Weisbach (1991) argue that it may be difficult for independent
directors to monitor senior management officials since they can often control the boardselection process, whilst independent directors may have problems in ascertaining the
value of the day-to-day operations of the company. Hermalin and Weisbach (1991) also
argue that an independent board only affects extraordinary events, such as unusually poor
performance. The net effect of board independence is therefore ambiguous. Therefore, we
follow the prior studies to hypothesize that:
Hypothesis 2a: board independence is positively associated with stock market reaction
to new product introductions.
Hypothesis 2b: board independence is negatively associated with stock market reaction
to new product introductions.
2.3 Audit committee independence
An audit committee is a sub-committee of a companys main board of directors which is
established to increase the credibility of audited financial statements as well as to help the
board meet its responsibilities. The members of the audit committee meetg regularly to
review the companys financial statements and to audit its processes and internal control
systems. Independent directors are expected to improve the effectiveness of the audit board as
a monitoring device, for example by making it more difficult for departing CEOs to
manipulate accruals (Reitenga and Tearney 2003), thus reducing the likelihood of fraudulent
financial reporting (Beasley 1996; Beasley et al. 2000). As such, we expect to find a positive
relationship between independent directors on the audit committee, along with increases in
both the monitoring effect and the wealth effect of firms announcing new product strategies:
Hypothesis 3: audit committee independence is positively associated with stock market
reaction to new product introductions.
2.4 CEO equity-based pay
Well-designed executive compensation plans, which include equity ownership, can help to
align the interests of managers and shareholders (Datta et al. 2001; Masulis et al. 2007;
Bauman and Shaw 2006). The alignment of shareholder interests with managerial incentives suggests a positive relationship between a firms performance and its governance
structure, essentially because the latter is designed to reduce the agency costs arising from
the separation of ownership and control. Murphy and Dial (1995) show that stock-based
compensation is important in executing corporate downsizing, resulting in the transference
of resources to higher-valued opportunities, whilst Datta et al. (2001) show that an
acquiring firms compensation structure influences both the stock price and responses to
acquisition announcements by the bidding firms.

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Based on the above, investors can assume that firms whose CEOs pay is equity-based
will pursue new product innovations that are expected to increase firm value (and thus
CEO wealth). We therefore construct the following hypothesis:
Hypothesis 4: CEO equity-based pay is positively associated with the stock market
reaction to new product introductions.
2.5 Analyst following
By collecting, analyzing and disseminating information on a firm, analysts play a crucial
role in helping to the reduce agency costs associated with the separation of ownership and
control (Jensen and Meckling 1976) as they are seen as vital instruments of an efficient and
secure informational marketplace through both providing market information and effectively monitoring and disciplining managerial behavior (Healy and Palepu 2001; Best et al.
2003). As such, analysts may elicit managerial responsiveness, and thereby reduce the
probability of resource-wasting investments (Moyer et al. 1989). For example, the results
presented by Yu (2008) show that more comprehensive analyst coverage is consistent with
less earnings management, and that changes in analyst coverage are inversely related to
changes in earnings management. This leads us to our fifth hypothesis:
Hypothesis 5: analyst following is positively associated with stock market reaction to
new product introductions.
2.6 Shareholder rights
The shareholder rights can restrain management empire building, in that firms that make
value-destroying investment (Mitchell and Lehn 1990). Furthermore, the ability of
shareholder rights can provide managers with the appropriate incentives to maximize
shareholder wealth (Cheng et al. 2006; Masulis et al. 2007). We use Gompers et al.s
(2003) G-index to proxy for the shareholder rights of corporate governance. The index is
based on 24 antitakeover provisions and measures the power-sharing relationship between
investors and management. A higher G-index score indicates lower shareholder rights and
greater management power. Based on agency theory, a new product announcement by a
firm with a higher G-index score (less shareholder rights) is expected to exhibit a lower
wealth effect as it is thus more difficult or costly to remove management that is acting
opportunistically. On the other hand, a firm with stronger shareholder rights (a lower
G-index score) is more likely to have stronger monitoring and control processes in place,
leading to more effective and efficient managerial decision making. Accordingly, the sixth
hypothesis proposed in this study is:
Hypothesis 6: G-index scores are negatively associated with stock market reaction to
new product introductions.

3 Sample and variables

3.1 Data sample
This study collects an initial sample of announcements of new product introductions by
firms listed on the New York Stock Exchange (NYSE) or the American Stock Exchange
(AMEX), covering the 8 year period from 1997 to 2004; the data is collected from the

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LexisNexis Academic NEWS database. In order to be included in the final sample, the new
product announcements have to meet specific criteria, as follows: In order to avoid any
confounding events which might distort the measurement of announcement returns, we
exclude those announcements by firms that made other major announcementssuch as
announcements of quarterly earnings, mergers and acquisitions or changes in dividends
either 5 days before or 5 days after the announcement of the new product. Furthermore, in
order to ensure that the new product announcements are not affected by information leaked
ahead of time, we discard any new product announcements if there has been news items
reported in major newspapers up to 1 year prior to the announcement date. We also
exclude the announcing firms if no data is available on the firms from the return files of the
Center for Research in Securities Prices (CRSP). Finally, we exclude those announcements
where the corporate governance measures (to be described below) are unavailable. Our
final sample is comprised of 1,945 new product announcements made by 341 different
firms.
3.2 Stock market reaction
We employ standard event-study methodology to examine the response in stock prices to
announcements of new product introductions, with Day 0 being defined as the day on
which the announcement first appears in any major publication. The abnormal return is
calculated as the difference between the actual return and the expected return generated by
the market model, with the value-weighted CRSP index being used as a proxy for market
returns. The estimation of the parameters of the market model is based upon data covering
the period from 200 to 60 days prior to the initial announcement date.
Abnormal returns and cumulative abnormal returns are generated for each announcing
firm over the period from 10 days before to 10 days after the initial announcement date.
Cumulative abnormal returns over different event windows are then calculated by summing the daily abnormal returns during the event periods. We calculate the 2 day period
abnormal returns (1, 0)1 by summing the abnormal returns on the announcement day, and
1 day prior to the announcement date, in order to estimate the wealth effect of new product
introductions.
3.3 Measuring corporate governance
Our analysis of corporate governance is undertaken using the six different measures of
Board Size, Board Independence, Audit Committee Independence, CEO Equity-based Pay,
Analyst Following and G-index Score. The corporate governance data are obtained from
the IRRC Board datasets, Compustat ExecComp and the I/B/E/S database, with the measures being estimated as at the end of the fiscal year prior to the new product
announcements.
We follow prior studies and measure Board Size as the number of directors on the board
during the fiscal year preceding the new product announcement (Lehn and Zhao 2006;
Masulis et al. 2007). Independent directors are defined as those who hold no executive
position, have held no such position in the past, and are unrelated to any executive or
1

If such announcements occur after the close of trading on the previous day, then the impact on share prices
will be felt on the day in which the announcements appear in the publication. If the announcements are
released prior to the close of trading hours, any immediate valuation effect will be reflected in the share
prices on the day prior to the announcement appearing in print.

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director in the announcing firm. Board Independence is measured as the ratio of independent directors on the board for the fiscal year preceding the new product announcement,
and following Klein (2002), we measure Audit Committee Independence as the ratio of the
number of independent directors to the number of directors on the audit committee. CEO
Equity-based Pay is measured, following Datta et al. (2001) and Masulis et al. (2007), as
the ratio of equity-based compensation within the overall compensation package, with
equity-based pay being defined specifically as the value of all stock options and restricted
stock grants. Analyst Following is a measure of external monitoring which is defined as the
average number of analyst forecasts taking place during the fiscal year prior to the new
product announcement. Finally, we use Gompers et al.s (2003) G-index as a proxy to
measure the power-sharing relationship between investors and management. Each firms
G-index Score is the sum of points, where one point is awarded for the presence of each of
the 24 provisions included.
3.4 Measuring control variables
The control variables included in the regression analyses are a firms Investment Opportunities (where Tobins Q is used as a proxy), Free Cash Flow, Debt Ratio, Firm Size,
Relative R&D Intensity and Industry Competitiveness (where the Herfindahl Index, is used
as a proxy), all of which have been found within the prior literature to be important in
explaining the stock market reaction to new product announcements. All of the data on
these control variables are obtained from the Compustat files.
Investment Opportunities. The degree of availability of investment opportunities can be
an important consideration in assessing the value of corporate innovations. Innovations by
firms with good investment opportunities are generally regarded as worthwhile, whereas
those by firms with poor investment opportunities are not. Therefore, share price responses
to new product announcements are expected to have a positive correlation with a firms
investment opportunities.
Investment opportunities are estimated in this study using a firm measure of Tobins Q,
where a high Tobins Q represents a high degree of investment opportunities. Given a lack
of availability of data,2 we estimate Tobins Q as the ratio of the market-to-book value of
the firms assets, where the market value of assets is the book value of assets minus the
book value of common equity plus the market value of common equity. This measure has
been widely used in many of the prior studies as a means of estimating growth opportunities (Agrawal and Knoeber 1996; Barclay and Smith 1995a, 1995b; Denis 1994;
Holderness et al. 1999; Kang and Stulz 1996). Our Tobins Q variable is calculated as the
average ratio for the three fiscal years prior to the announcement date.
Free Cash Flow. The degree of availability of free cash flow can also be an important
consideration in determining the value-enhancing potential of corporate innovations.
Jensen (1986) argues that managers endowed with higher free cash flow will invest
wastefully, as opposed to ensuring that it is returned to shareholders. Therefore, the
potential agency costs of innovations can be higher for firms with higher free cash flow.

Tobins Q is technically defined as the ratio of the market value of a firm to the replacement cost of its
assets, as the difference between market value and replacement value is dependent upon the profitability of
both the firms assets in place and its expected investment opportunities. If the profitability of the firms
assets in place is high, its investment opportunities will also be expected to earn a high rate of return; thus,
the firm will have a high Tobins Q (Lang and Litzenberger 1989).

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On the other hand, innovations by firms with lower free cash flow raise the likelihood of
the firm seeking new external financing. As free cash flow theory predicts that the market
response to a new product will be inversely related to the firms free cash flow, any new
external financing provides a monitoring function, and the firms willingness to undergo
such monitoring can be seen as providing a favorable signal (Szewczyk et al. 1996). In this
study, Free Cash Flow is defined as operating income before depreciation minus interest
expense, taxes, preferred dividends and common dividends divided by the book value of
total assets for the fiscal year preceding the announcement (Lang et al. 1991; Lehn and
Poulsen 1989).
Debt Ratio. Jensen (1986) suggests that a firms debt ratio can be regarded as an
alternative measure of free cash flow. Firms with greater free cash flow will invariably opt
for higher levels of debt within their overall capital structure since this provides a credible
pre-commitment to paying out their excess cash flow, thereby lowering the expected costs
of such free cash flow. The Jensen theory thus suggests a positive relationship between the
market response to corporate announcements of new products and the debt ratio of the
announcing firm. The Debt Ratio is measured in the present study as the ratio of the book
value of long-term debt to the book value of total assets for the fiscal year prior to the
announcement (Lang and Stulz 1992).
Firm Size. Innovations by larger firms have less unanticipated information than those of
smaller firms, essentially because information production and dissemination is a positive
function of firm size (Atiase 1985; Hertzel and Smith 1993; Kang and Stulz 1996); we
therefore expect to find an inverse relationship between firm size and the evaluation by the
market of a firms new product. In the present study, Firm Size is measured as the natural
logarithm of the book value of total assets for the fiscal year preceding the announcement
(Chen et al. 2002).
Relative R&D Intensity. Since firms with greater relative R&D intensity may occupy
leading positions in technological advances (Baysinger and Hoskisson 1989; Kelm et al.
1995), we expected to find a positive correlation between a firms relative R&D intensity
and the wealth effect of stockholders when firms announce new products. Following Chan
et al. (1990) and Szewczyk et al. (1996), we measure the R&D intensity of a firm as the
ratio of its R&D expenditure to sales in the fiscal year 1. We then estimate the R&D
intensity of the industry as the ratio of R&D expenditure to the net sales of all firms with
the same primary Compustat four-digit SIC code. Finally, a firms Relative R&D Intensity,
which is a measure of the firms financial resources allocated to R&D relative to that of its
peers, is calculated as the ratio of the firms R&D intensity to the R&D intensity of the
industry in which the firm is located.
Industry Competitiveness. Woolridge and Snow (1990) present that the announcement
of strategic investment decisions may release an unexpected improvement in the investing
firms cash flow that derives from an increase in its market share. The investing firm within
an imperfect competitive environment may gain at the expense of rival firms. As such, this
study expects that the stock price reaction to new product announcements will be more
positive in industries with a lower degree of competition. The level of industry competitiveness is represented in this study by the Herfindahl Index, which is measured as the sum
of the squared proportion of industry sales. The data is collected from Compustat for a total
of 48 industries based upon the industry classification of Fama and French (1997).3
Although this index is essentially a measure of concentration, it has, nevertheless, been
3

This follows the approach used in Masulis et al. (2007), Giroud and Mueller (2011), and Chen et al.
(2010).

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Table 1 Sample distribution

Year
1997

1998

1999

2000

2001

2002

2003

2004

Total

No. of announcements

282

229

288

212

128

169

259

378

1,945

Share of sample (%)

14.5

11.8

14.8

10.9

6.6

8.7

13.3

19.4

100.0

Our study sample is comprised of a total of 1,945 new product announcements made between 1997 and 2004
by 341 firms listed on either the NYSE or the AMEX

widely used as a proxy for competitiveness largely because of the inverse relationship
generally found between the degree of concentration and the degree of competition.

4 Empirical results
Table 1 presents the sample distribution, by year of announcement, which shows that about
33 per cent of the sample announcements occurred in 2003 and 2004.
Table 2 provides the descriptive statistics and Pearsons correlation coefficients for all
of the corporate governance and control variables adopted in this study. Our sample firms
have an average of ten directors on their boards, with a mean proportion of independent
directors of 71 per cent, and about 88 per cent of all directors on the audit committees
being totally independent. The mean ratio of equity-based compensation is 0.59 and the
average number of analyst following is 18.58.
4.1 Overall sample
The abnormal returns for new product announcements are presented in Table 3, which
shows that the average 2 day announcement period abnormal return is 0.54 per cent
(t = 7.02), with a statistical significance at the 0.1 per cent level. We also calculate the
median abnormal returns of each window and conduct significance tests using the nonparametric Wilcoxon z-statistic, and the results are very similar. This finding is consistent
with Woolridge (1988) and Chen et al. (2002).4 Our results also indicate, however, that
there is a particularly high variation in the announcement effect amongst our sample firms;
the proportion of firms receiving positive market reactions is only 51 per cent. We find no
significant abnormal returns for other days surrounding the announcements. This suggests
that the impact of new product announcements is captured in the CAR (1, 0).
4.2 Analysis of subsamples based on the governance mechanism
To test the impact of the corporate governance mechanism on the stock price response of
new product announcement, we divide the sample firms into two governance sub-groups
based upon their better or poorer corporate governance levels. We then calculate the
4

Woolridge (1988) demonstrates that between 1972 and 1984, the 2 day (1, 0) average cumulative
market-adjusted return for a sample of product-announcing firms is 0.84 per cent, whilst Chen et al. (2002)
show that for a sample of firms announcing new product introductions between 1991 and 1995, the two-day
(1, 0) average cumulative abnormal return is 0.59 per cent, with significance at the 1 per cent level; our
mean two-day abnormal return is 0.54 per cent, with significance at the 1 per cent level. The magnitude of
the abnormal return found in this study is therefore very much in line with those found in prior studies.

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1,918

1,868

1,847

1,899

1,924

1,880

1,945

1,945

1,945

1,945

1,945

1,945

1. Board size

2. Board independence

3. Audit Committee
independence

4. CEO equity- based pay

5. Analyst following

6. G-Index

7. Tobins Q

8. Free cash flow

9. Debt ratio

10. Firm size (US$ millions)

11. R&D intensity

12. Herfindahl index

0.06

1.23

24,451

0.32

0.10

2.24

8.71

18.58

0.59

0.88

0.71

10.33

Mean

0.04

3.05

64,967

0.54

0.07

1.26

2.39

9.50

0.30

0.18

0.15

2.63

S.D.
0.09

0.55

***

0.01

0.02

0.10

0.04

0.30

0.13

0.06

0.34

0.24***

0.18***

0.13***

0.07***

0.06**

*** indicates that the correlation coefficient is greater than 0.5 with significance at the 1 per cent level

Obs.

Variables

Table 2 Summary statistics and correlations

0.04*

0.23

0.20

0.13

0.17

0.02

0.23

0.06***

0.09

0.12

0.15

0.07

0.03

0.21

0.07

0.03

0.08

0.15

0.03

0.04

0.15

0.13

0.13

0.10

0.16***

0.15

0.01

0.0003

0.13

0.01

0.08
0.05

0.65***

0.01
0.13

0.04

0.11

0.04

0.57***
0.23

11

10

0.03

0.09***

0.02

0.10***

0.05**

0.02

0.08***

0.13***

0.00

0.02

0.17***

12

Corporate governance and the stock market reaction

283

123

284

W.-C. Lin, S.-C. Chang

Table 3 Cumulative abnormal returns for firms making new product announcements
Period relative
to announcement

(10, 4)

Cumulative abnormal returnsa

b

Mean (%)

t-statistic

Median (%)

Proportion of positive
abnormal returns (%)
p-value for the
Wilcoxon z-statistic

0.15

0.94

0.11

0.412

49

(3)

0.05

0.74

0.03

0.888

49

(2)

0.06

0.92

0.14

0.098

47

0.08

0.000

51

(1, 0)

0.54

7.02***

(1)

0.01

0.09

0.06

0.438

49

(2)

0.04

0.61

0.12

0.462

47

(3)

0.06

0.94

0.18

0.006

46

(4, 10)

0.25

1.56

0.07

0.238

49

This table examines the cumulative abnormal returns surrounding the announcements of 1,945 new
product introductions which took place between 1997 and 2004

The p-value refers to the t-statistic

*** indicates p \ 0.01

stock market reaction to the new product introduction and examine the mean and median
difference in the stock market reaction between the groups with these better and poorer
governance levels. We expect to find a more positive market reaction to new product
introductions by the better governance group than those by the poorer governance group.
To examine the effects of Board Size, we separate the firms into smaller or larger boards
(Panel A of Table 4) based upon the sample median size of ten board members. The results
show that firms with smaller boards experience a significantly positive mean announcement effect of 0.86 per cent (t = 7.78), whilst the mean announcement effect of firms with
larger boards is 0.30 per cent (t = 3.12). The mean difference in CAR between firms with
smaller and larger boards is 0.56 per cent (t = 3.80). The results suggest that corporate
governance is more effective in firms with small boards, and that this may provide
investors with a more positive signal on the valuation of new products. Our finding is
consistent with the argument of Yermack (1996), which small boards can more effectively
monitor the investment decisions taken by managers.
The effect of Board Independence, measured by the ratio of independent board members, is examined in Panel B of Table 4. The sub-samples of greater (lesser) independence
contain firms with ratios of independent board members higher (lower) than the sample
median of 75 per cent. The results show that following the announcement of new product
introductions, firms with a greater number of independent members experience a significantly positive mean abnormal return of 0.75 per cent (t = 7.66), whilst the return for firms
with less independent directors is 0.36 per cent (t = 3.64). The mean difference between
the sub-groups is 0.39 per cent (t = 2.79), which is found to have statistical significance at
the 1 per cent level.
The effects of Audit Committee Independence are examined in Panel C of Table 4,
which shows that whilst firms in both sub-samples receive a significantly positive stock
market reaction, the mean abnormal return is significantly greater for firms with greater
audit committee independence than for those firms with less audit committee independence. The evidence is consistent with the results presented in Panels A and B of Table 4,
and suggests that the independence of directors is an important consideration in investors
value assessment of new product introductions.

123

Corporate governance and the stock market reaction

Table 4 Announcement period
abnormal returns of announcers,
by corporate governance
mechanisms

285

Panel A: board size (median = 10)

Small

Large

Difference

Mean

0.86

0.30

0.56

t-statisticb

(7.78)***

(3.12)***

(3.80)***

Median

0.22***

0.06

0.28**

No. of observationsa

1,051

867

Panel B: board independence (median = 75%)

Greater

Less

Difference

Mean

0.75

0.36

0.39

t-statisticb

(7.66)***

(3.64)***

(2.79)***

0.27***

0.02*

0.25**

954

914

Median
a

No. of observations

Panel C: audit committee independence (median = 1)

Greater

The analysis of the sub-samples

is undertaken based upon the
relative corporate governance
variables from Panels A to E,
with the 2 day (1, 0) average
announcement period abnormal
returns being generated for each
announcing firm over the period
1 day prior to the initial
announcement date
a

The number of observations

varies across panels as a result
of the unavailability of certain
governance variables
b

For the comparison of the

means, we report the mean
difference and the t-statistic
under the assumption of unequal
variances; the results are similar
to those obtained under the
assumption of equal variance.
The non-parametric Wilcoxon
z-statistic is employed to test the
median difference
* indicates p \ 0.1

** indicates p \ 0.05
*** indicates p \ 0.01

Less

Difference
0.46

Mean

0.82

0.36

t-statisticb

(8.77)***

(3.27)***

(3.18)***

Median

0.21***

0.05**

0.17*

No. of observationsa

1,169

678

Panel D: CEO equity-based pay (median = 0.65)

High

Low

Difference
0.51

Mean

0.84

0.34

t-statisticb

(7.51)***

(3.82)***

(3.56)***

Median

0.25***

0.01*

0.24**

No. of observationsa

933

966

Panel E: analyst following (median = 17.33)

Greater

Less

Difference

Mean

0.74

0.41

0.33

t-statisticb

(6.66)***

(4.45)***

(2.20)**

Median

0.27***

0.04

0.32**

No. of Observationsa

954

970

Panel F: G-index score (median = 9.00)

Low

High

Difference

Mean

0.63

0.30

0.33

t-statisticb

(6.48)***

(2.48)**

(2.15)**

Median

0.26***

0.16

0.42**

No. of observationsa

1,243

637

123

286

W.-C. Lin, S.-C. Chang

The impact of CEO Equity-based Pay is examined in Panel D of Table 4, from which
we can see that the mean abnormal return for those firms whose CEOs received high
proportions of equity-based compensation (0.84 per cent) is significantly greater than the
mean for firms with low proportions of CEO equity-based compensation (0.34 per cent).
This result highlights the importance of equity-based compensation in mitigating the
agency problem.
The impact of Analyst Following on the announcement effect of new product introductions is examined in Panel E of Table 4. Those firms described as having a greater
analyst following were those with a greater number of analyst reports than the sample
median of 17.33 during the fiscal year prior to the announcement of the new product
introduction. As shown in the table, the mean abnormal returns for firms with greater
(lesser) analyst following are 0.74 per cent (0.41 per cent), with the difference being found
to be statistically significant at the 5 per cent level.
Finally, we use the G-index Score as a proxy for shareholder rights, and use it to
examine the impact of governance on the wealth effect of new product announcing firms.
The results presented in Panel F of Table 4 show that the group with lower G-index scores
experiences a significantly positive mean announcement effect (0.63 per cent), while the
mean announcement effect for the group with a greater G-index score is positive (0.30 per
cent).5 The mean difference in abnormal returns between the two groups is 0.33 per cent
and significant at the 5 per cent level. We further calculate the median CARs of the
subsamples in each panel, and find very similar results.
In summary, the results in Table 4 provide clear support for our hypotheses that corporate governance measures are generally of significance in explaining the stock market
reaction to new product announcements. However, it is important to note that we did not
control for other potential factors that may also influence stock market responses.
4.3 Cross-sectional regression analyses
In order to further examine the impact of corporate governance on the stock market
reaction to the new product introductions, we employed the following cross-sectional
regression model:
CARi a b1 CGi b2 CG  High HHI b3 Tobin0 s Qi b4 Free Cash Flowi
b5 Debt Ratioi b6 Firm Sizei b7 Relative R&D Intensityi
b8 Herfindahl Indexi ei
where CAR refers to the 2 day (1, 0) announcement-period abnormal returns for a firm
introducing a new product; CG refers to the corporate governance variable; High_HHI is
equal to 1 if the industrys Herfindahl index is in the top quartile of all industries;6 Tobins
Q refers to the ratio of the market-to-book value of the firms assets; Free Cash Flow is the
free cash flow of the firm; Debt Ratio is the ratio of the book value of long-term debt to the
book value of total assets; Firm Size refers to the natural logarithm of the book value of
total assets; Relative R&D Intensity is the ratio of the firms R&D intensity to the R&D
5

Other studies, such as Gompers et al. (2003), Masulis et al. (2007) and Giroud and Mueller (2011), refer to
companies with a G-index score of 5 or less as democracies and to companies with a G-index score of 14 or
greater as dictatorships. We have also used 5 and 14 as the cut-off G-index scores in our sensitivity analysis.
The conclusions in our study remain unchanged.

We have also used median and top tercile as the cut-off Herfindahl index values in our sensitivity analysis.
The conclusions in our study remain unchanged.

123

Corporate governance and the stock market reaction

287

intensity within the industry in which the firm is located; and Herfindahl Index refers to the
Herfindahl index7 of the firm.
The literature suggests that industry competition could also influence the impact of
corporate governance on abnormal returns (Giroud and Mueller 2011). Shleifer and Vishny
(1997) present that managers of firms in competitive industries are likely to reduce slack
and put valuable resources into efficient uses. Giroud and Mueller (2011) argue that firms
in noncompetitive industries, where low competitive pressure results in managers reducing
their effort, corporate governance plays a relatively more important role. To consider the
mediation effect of product market competition,8 we included the interaction term
(CG 9 High_HHI) in the regressions.
The results of the multivariate cross-sectional regression analyses of the 2 day (1, 0)
announcement-period abnormal returns are presented in Table 5, for both the corporate
governance measures and the control variables. It is important to note that the observations
are found to vary across regression models, essentially due to data availability limitations.
The effects of the size of the board are tested in Model 1, with the results showing that
the coefficient of Board Size is 1.438 (t = 3.96), which is negatively and statistically
significant at the 1 per cent level. This result suggests that the announcement effect is more
favorable for firms with a smaller board size. The coefficient of Board Independence in
Model 2 is 0.010 (t = 1.93), which indicates that the number of independent directors has a
positive correlation with the stock market reaction to new product announcements. The
importance of Audit Committee Independence is examined in Model 3, with the findings
suggesting a strong positive relationship between the independence of the audit committee
and the reaction by the market to new product introductions. The influence of CEO Equitybased Pay is tested in Model 4, with the results revealing a positive effect. Model 5
examines the influence of analyst reports, with the coefficient on Analyst Following being
found to be 0.863 (t = 5.08) and demonstrating a significantly positive correlation with the
wealth effect of new product announcements. Model 6 shows that the G-index Score is
significantly negatively related to the announcement of firms cumulative abnormal
returns. That is, the announcement effect is significantly more favorable for announcing
firms with greater shareholder rights. The results are again consistent with the prediction
for the role of corporate governance in explaining the wealth effects of new product
introductions.
The control variables in the models show signs that are generally consistent with the
prior studies. However, all except Firm Size are found to be insignificant in the present
study, while Firm Size is found to be statistically significant with and a negative correlation
with abnormal returns during the announcement period of new product introductions.9 This
indicates that new product introductions by larger firms may contain less unanticipated
information than those of smaller firms, and. This is essentially attributable to the fact that
information production and dissemination remains a positive function of firm size (Hertzel
and Smith 1993; Kang and Stulz 1996).

Qualitatively similar results are obtained if the Herfindahl index is measured by the sum of the squared
market shares of all Compustat firms based on the industry classification of their Compustat four-digit SIC
code (as in Lang and Stulz 1992, and Song and Walkling 2000).

Our results are similar when the competitive structure of an industry is measured by the product
uniqueness (as in Masulis et al. 2007 and Chen et al. 2010).

We also obtained similar results when we used net sales and the number of employees to measure the size
of the firm.

123

123

5.48***

0.008

1,918

No. of observationsa

0.27
1,847

0.005

2.847

1.31

0.94

1.85*

1,899

0.001

0.568

0.017

0.064

0.30

0.71

1.33

The number of observations varies across regressions as a result of the non-availability of certain governance variables

*** indicates p \ 0.01

** indicates p \ 0.05

* indicates p \ 0.10

The dependent variable is the 2 day (1, 0) announcement period cumulative abnormal return (CAR)

1,868

0.001

0.553

0.022

0.088

1,924

0.012

1.879

0.017

0.338

0.081

0.87

0.67

4.68***

0.57

0.65

1,880

0.002

1.392

0.020

0.134

0.030

0.422

0.018

Adjusted R2

0.09

0.71

1.05

0.19

0.773

2.07**

0.209

0.016

0.050

0.026

0.23

0.135

Herfindahl index

0.13

0.35

0.38

0.258

0.33

0.003

0.051

0.93

0.020

0.021

0.52

1.086

0.55

Relative R&D intensity

0.069

0.41

0.033

Firm size

0.05

0.460

0.10

0.008

2.577

Debt ratio

0.52

0.006

0.69

5.08***

3.28***

0.616

0.49

0.053

0.863

1.665

Coeff.

Free cash flow

1.40

2.32**

2.02**

t-stat.

0.030

0.401

0.624

0.981

Coeff.

Tobins Q

0.80

2.26**

1.69*

t-stat.

0.001

0.002

0.009

1.044

Coeff.

Model 6

0.078
0.79

1.93*

0.88

t-stat.

Model 5

0.016

0.002

0.010

0.485

Coeff.

Model 4

CG 9 High_HHI

0.17

3.96***

t-stat.

Model 3

G-Index

Log(analyst following)

CEO equity-based pay

Audit committee
independence

Board independence

3.751

1.438

Log(board size)

Coeff.

Coeff.

t-stat.

Model 2

Model 1

Intercept

Variables

Table 5 Cross-sectional regression analyses of announcement-period abnormal returns

0.60

0.82

2.59***

0.20

0.30

0.25

0.05

2.37**

4.05***

t-stat.

288
W.-C. Lin, S.-C. Chang

Corporate governance and the stock market reaction

289

5 Conclusions
This study examines the relationship between corporate governance and the market
reaction to new product announcements. We investigate a sample of US firms announcing
new product introductions between 1997 and 2004, with the results revealing that new
product announcements are generally associated with significantly positive abnormal
returns. The results further indicate that those firms with a small board size, greater board
independence, a more independent audit committee, higher CEO equity incentives, more
analyst coverage and greater shareholder rights (represented by a lower G-index score) see
greater announcement effects. The evidence is consistent with the hypothesis that better
corporate governance mechanisms reduce agency costs, whilst also increasing the value
creation of new product introductions through monitoring and alignment mechanisms.
Our findings suggest that corporate governance factors are important for investors in
assessing the valuation effect of innovation. Financial markets consider not only innovation-specific information, but also factors relating to managerial incentives. Better governance mechanisms convey positive information to investors that investments are not
being made for the personal interests of managers. This is an effect which is expected to be
of greater importance in cases where there is strong information asymmetry between firms
and investors. Managers are advised to take this signaling effect of corporate governance
into consideration in all areas relating to information disclosure.

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