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(originally published by Booz & Company)


The Adverse Effects of Overvalued Stock

“Overall, this body of work suggests that overvalued companies with high pay-for-performance are ripe for managerial short-termism or misbehavior,” the authors write, implying that “firms with this combination should find better corporate governance and oversight.”

Indeed, they say, the “relationship between high price deviations and governance and firm ROA, incentives and stock performance are all remarkably consistent with the theoretical idea [that] the misvaluation causes bad behavior and better governance helps counter it.”

Bottom Line:
When a stock is overvalued, managers may have more incentives to act at odds with shareholders’ interests, dragging down a company’s overall performance. Strong governance, however, can offset that effect. Board vigilance is therefore crucial when soaring stock prices conflict with a firm’s fundamental value.

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