CORPORATE GOVERNANCE AND THE ABNORMAL RETURNS TO ACQUISITION ANNOUNCEMENTS

The modern corporation is a complex organization of interlocking relationships. For publicly held companies, one of the most important relationships is between the owners and managers of the firm. This relationship is a classic example of the principal-agent relationship and is characterized by a potential misalignment of goals where the agent may behave in his own interest instead of acting in the principal's interest. A firm's corporate governance structure can be used to reduce the total agency costs of a firm through the monitoring of management actions and by aligning the managers' self-interests with those of shareholders.

The board of directors has the responsibility to represent shareholders by monitoring top management. They do this by hiring and firing management, designing the executive compensation contract, and voting on major firm decisions. However, recent events from Enron to WorldCom indicate that the board may not always adequately monitor management. These events have stirred calls for board reform and the effect of board structure on corporate decision making is an important and widely debated topic.