Italy's small and midsize companies have historically been overlooked by fund managers, who are wary of their low liquidity and poor standards of governance. In an effort to allay these concerns, the Mercato Italiano di Borsa, Italy's stock exchange, launched the STAR¹ exchange, a separate market for small and midsize companies that follow strict governance requirements. Its performance thus far provides more evidence that good governance pays. To be listed on the STAR exchange, a company must float at least 35 percent of its new issues on the open market, include a minimum number of independent nonexecutive directors on its board, and ensure that the compensation of management and directors reflects its performance. These companies must also adhere to more rigorous disclosure requirements than do their counterparts on the Borsa.

The STAR exchange now lists 37 companies, with a total market capitalization of $7.5 billion. They outperformed their counterparts on the Borsa by 16.5 percent from April 2001 to March 2002 (exhibit), and the weighted average of their market-to-book ratios is 3.8,² compared with 2.1 for all companies listed on the Borsa. Bovespa, Brazil's stock exchange, seeing a future for such markets, has opened a similar exchange,...