If management uses this power judiciously it could pos sibly lead to an

If management uses this power judiciously it could

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If management uses this power judiciously, it could pos- sibly lead to an increase in overall shareholder wealth; if management, however, uses this power to maintain pri- vate benefits of control, then this provision would dimin- ish shareholder wealth. In either case, it is apparent that classified boards enhance the power of managers and weaken the control rights of large shareholders, which is all that matters for constructing the index. (Gompers, Ishii, and Metrick, 2003, p. 114) Most provisions other than classified boards can be viewed by the same logic. Almost every provision ena- bles management to resist different types of shareholder activism, such as calling special meetings, changing the firm's charter or bylaws, suing directors, or replacing them all at once. GIM, however, note two exceptions: secret ballots (confidential voting) and cumulative vot- ing. A secret ballot or confidential voting designates a third party to count proxy votes and, therefore, prevents management from observing how specific shareholders vote. Cumulative voting enables shareholders to concen- trate votes for directors so that a large minority share- holder can ensure some board representation. These two provisions are usually proposed by shareholders and opposed by management because they enhance share- holder rights and diminish the power of management. GIM add one point to the Govemance Index when firms do not have each of these provisions. For all other provi- sions, GIM add one point when firms do have each of them. The Govemance Index is the sum of one point for the presence (or absence) of each provision. III. Empirical Results A. Summary Statistics Exhibit 3 shows the summary statistics for the sample firms. The full sample is divided into 3 subsamples- industrial, financial, and utility. Firm size is shown in this table both in terms of sales and total assets. It appears that financial firms are considerably larger than industrial and utility firms both in sales and in total assets. I employ
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16 JOURNAL OF APPLIED FINANCE — FALL/WINTER 2006 Exhibit 2. Individual Governance Provisions Employed in the Construction ofthe Governance Index The detailed explanation for each govemance provision is available in the Appendix of Gompers, Ishii, and Metrick (2003) Delay Blank Check Classified Board Special Meeting Written Consent Protection Compensation Plans Contracts Golden Parachutes Indemnification Liability Severance Voting Bylaws Charter Cumulative Voting Secret Ballot (Confidential Voting) Supermajority Unequal Voting Other Anti-greenmail Directors' duties Fair Price Pension Parachutes Poison Pill Silver Parachutes State Anti-greenmail Law Business Combination Law Cash-out Law Directors' Duties Law Fair Price Law Control Share Acquisition Law the EBIT/sales ratio to measure profitability. Leverage is calculated as long-term debt divided by total assets as in Defond (1992). Finally, the market-to-book ratio is the market value of equity (share price times number of shares outstanding) divided by the book value of equity.
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