Did 7th January tell us about anything about the governance discount?

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.

Posted at 8:57 pm IST on Mon, 2 Mar 2009         permanent link

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