A common strategy in corporate governance research is to build a corporate governance index and then see whether the index predicts firm value or performance. These indices are imperfect, but their use is widespread because researchers lack good alternatives. A major concern with governance indices is what they actually measure. The concept of governance is abstract and latent rather than concrete and observable, and we are not sure how to proxy for this vague concept using observable measures. This raises concerns about the degree to which the proxy (a governance index) measures what it claims to be measuring. The fit between the observable proxy or “construct” (the governance index) and the underlying concept (governance) is known as construct validity. This core issue is rarely addressed in corporate governance research. Larcker, Richardson and Tuna (2007) and Dey (2008) are exceptions.
In our paper we discuss what can usefully be said about which of the many possible governance indices are sensible constructs. We conduct an exploratory analysis of how to tackle this question, using tools drawn from the causal inference, education and psychology literatures.
