In this study we construct, for the first time in Israel, an index for ranking the quality of corporate governance of Israeli firms. The index, based mainly on principles that are common in existing international indices, focuses on four main topics (the abilities of the board of directors, audit and control, ethics and honesty, and transparency), and it includes 19 variables. An empirical analysis of 173 public companies (included in the TASE 100 and YETER 150 at the end of 2005) finds the following: 1. Disperse ownership companies and companies with a higher return on equity have better quality corporate governance; 2. There is a significant positive correlation between our index ranking the quality of corporate governance and a firm's relative value (Tobin's Q); The causality of this relation is, however, unknown, i.e., we do not show or argue that better corporate governance increases firm valuation; 3. The existence of an ethical code, few transactions with interested parties, early publication of periodical reports and the inclusion of a small number of directors who are also employees of the corporation, are components of the index that are most strongly correlated with the value of the firm; 4. Dual companies have a higher level of corporate governance and higher Q values.

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