Governing Misvalued Firms

Equity overvaluation is thought to create the potential for managerial misbehavior, while monitoring and corporate governance curb misbehavior. We combine these two insights from the literatures on misvaluation and governance to ask, when does governance matter? Examining firms with standard long-run measures of corporate governance as they are shocked by plausible misvaluation, we provide consistent evidence that firm performance is impacted by governance when firms become overvalued—overvaluation causes weaker performance in poorly governed firms. Our findings imply that firm oversight is important during market booms, just when stock prices suggest all is well.