Corporate governance efficiency: an indexing approach using the stochastic frontier analysis

Purpose – The purpose of this paper is to identify efficient governance using a governance efficiency score based on recommendations provided by codes of best practices in order to determine “good governance”. Design/methodology/approach – Based on a sample of 320 US listed firms from 1994‐2001, governance practices were synthesized by an index computed according to a parametric method, the stochastic frontier analysis, which allows taking into account the relation between inputs (governance axes) and outputs (performance). Findings – The use of a latent classis in the specification of the model allowed detecting two groups of firms according to their specific characteristics. The results of affectation equation show that the probability of being in the highest performing group is more important when the firm size, the dividend yield and the return on equity (ROE) are high, while a high leverage level decreases the chance to be in the non‐performing group. Moreover, the model allows establishing a dualist description of the two groups which point out two opposite governance systems. The non‐performing system is characterized by a managerial discretion, an ownership concentration, a dominance of the board by the CEO and a manager entrenchment. However, the highest performing system is characterized by an inside control efficiency and an inside financial control efficiency. Research limitations/implications – The sample choice presents a selectivity bias. Firms of the sample present some particularities in relation to other US firms, which limits the study generalisation. This study can also be the object of replications in other contexts. Originality/value – This work is a demarcation in relation to previous works studying corporate governance quality, and particularly the relation between governance and performance. It provides a new econometric approach to develop a synthetic index to evaluate corporate governance firms' practices, wedged on performance level achieved by different firms.