Product-market competitiveness and investor reaction to corporate governance failures

Is industry competition a substitute for the quality of corporate governance? If so, and if self-serving behavior by corporate executives at presumably well governed firms is a greater surprise to investors, then the price reaction to the news of governance failure should vary by the degree of competition prevailing in the firm's industry. For a sample of firms that backdated employee stock options, we find that firms operating in more competitive industries experienced significantly larger wealth declines upon revelation of the news of governance failure (backdating of stock option grants). We interpret our findings to suggest that the quality of corporate governance is less critical for firms operating in more competitive product markets since product market competition acts as an implicit substitute for the performance discipline imposed by high quality of corporate governance.