Governing misvalued firms

Equity overvaluation is thought to create the potential for manager misbehavior, while monitoring and corporate governance curb misbehavior. Thus, the effects of corporate governance should be greatest when firms become overvalued. We test this simple yet powerful idea. Using proxies of firm and industry price deviations from fundamentals and standard measures of corporate governance, we demonstrate that firm performance seems most impacted by governance when firm and industry deviations are high. Our findings suggest that misvaluation may modulate the fundamental governance relationship between shareholders and CEOs.