This article looks at how a negative third-party quality signal, in the form of external monitoring of firm performance by an investor group, prompts a response from both institutional investors and the firms publicly identified as poor performers. Using a sample of 93 firms placed on the Focus List of the Council of Institutional Investors from 2000 to 2005 and a comparison group of 96 firms in the bottom quartile in stock performance from the S&P500, the authors find that institutional investors respond to this negative third-party signal by reducing their holdings in firms that received this public repudiation. However, this reduction in holdings is moderated by the independence of the board of the targeted firm. This result suggests institutional investors pay particular attention to the governance characteristics of underperforming firms. Lastly, the authors found that targeted firms with more independent boards respond by increasing the intensity of incentives of the CEO, thus signaling their responsiveness to investor concerns.
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