Corporate governance indices and construct validity

• Author: Bernard Black,Burcin Yurtoglu,Vikramaditya Khanna,Antonio Gledson Carvalho,Woochan Kim
• Date: 01 November 2017
• DOI: http://doi.org/10.1111/corg.12215
• Published date: 01 November 2017

SPECIAL ISSUE ARTICLE

Corporate governance indices and construct validity

Bernard Black

1,5

|Antonio Gledson de Carvalho

2

|Vikramaditya Khanna

3

|

Woochan Kim

4,5

|Burcin Yurtoglu

6

1

Pritzker School of Law and Kellog School of

Management, Northwestern University,

Chicago, Illinois, USA

2

Fundacao Getulio Vargas, School of Business

at Sao Paulo, Brazil

3

University of Michigan Law School, Ann

Arbor, Michigan, USA

4

Korea University Business School, Seoul,

South Korea

5

European Corporate Governance Institute

(ECGI), Brussels, Belgium

6

WHU –Otto Beisheim School of

Management, Vallendar, Germany

Correspondence

Bernard S. Black, Pritzker School of Law,

Northwestern University, 375 East Chicago

Ave, Chicago, IL 60611, USA

Email: bblack@northwestern.edu

Abstract

Manuscript Type: Conceptual and empirical.

Research Question/Issue: Many studies of firm‐level corporate governance rely on

aggregate “indices”to measure underlying, unobserved governance. But we are not confident

that we know how to build these indices. Often we are unsure both as to what is “good”

governance, and how one can proxy for this vague concept using observable measures. We

conduct an exploratory analysis of how researchers can address the “construct validity”of

firm‐level governance indices, which poses a major challenge to all studies that rely on these

indices.

Research Findings/Insights: We assess the construct validity of governance indices for four

major emerging markets (Brazil, India, Korea, and Turkey), developed in prior work. In that work,

we built country‐specific indices, using country‐specific governance elements that reflect local

norms, institutions, and data availability, and showed that these indices predict firm market value

in each country. The use of country‐specific indices puts great stress on the construct validity

challenge of assessing how well a governance measure matches the underlying concept. We

address here how well these four country‐specific indices, and subindices for aspects of

governance such as board structure or disclosure, coherently measure unobserved, underlying

actual governance.

Theoretical/Academic Implications: We provide guidance on how researchers can

address the construct validity of corporate governance indices.

Practitioner/Policy Implications: The uncertain construct validity of most corporate gov-

ernance indices suggests caution in relying on research using these indices as a basis for firm‐level

governance changes, or country‐level legal reforms.

KEYWORDS

CorporateGovernance indices, constructvalidity, boardsof directors, disclosure,shareholder rights,

ownership structure

1|INTRODUCTION

A common strategy in research on firm‐level corporate governance is

to build corporate governance indices and then see whether they pre-

dict firm value or performance. These indices are imperfect, but their

use is widespread because researchers lack good alternatives (Bhagat,

Bolton, & Romano, 2008). One concern with governance indices is

what they actually measure. The concept of firm‐level governance is

abstract and latent rather than concrete and observable, and

researchers are forced to proxy for this vague concept using

observable measures. This raises concerns about the degree to which

the proxy (a governance index) relates to the underlying concept it

claims to measure (governance). The fit between the observable proxy

or “construct”and the underlying concept is known as construct valid-

ity. (For background on construct validity, see Shadish, Cook, & Camp-

bell, 2002; Strauss & Smith, 2009.) This core issue is rarely addressed

in corporate governance research. Larcker, Richardson, and Tuna

(2007) and Dey (2008) are exceptions.

1

We discuss here what can usefullybe said about whether governance

indices are sensible constructs, which are likely to do a reasonable job of

Received: 12 September 2016 Revised: 24 May 2017 Accepted: 22 June 2017

DOI: 10.1111/corg.12215

Corp Govern Int Rev. 2017;25:397–410. © 2017 John Wiley & Sons Ltdwileyonlinelibrary.com/journal/corg 397