Journal of Financial Economics 105 (2012) 412–435

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Journal of Financial Economics

journal homepage: www.elsevier.com/locate/jfec

Do controlling shareholders’ expropriation incentives imply

a link between corporate governance and firm value?
Theory and evidence$
Kee-Hong Bae a, Jae-Seung Baek b, Jun-Koo Kang c,n, Wei-Lin Liu c
a
Schulich School of Business, York University, Canada
b
Department of International Business, Hankuk University of Foreign Studies, South Korea
c
Nanyang Business School, Nanyang Technological University, Singapore

a r t i c l e in f o abstract

Article history: We develop and test a model that investigates how controlling shareholders’ expro-
Received 17 August 2010 priation incentives affect firm values during crisis and subsequent recovery periods.
Received in revised form Consistent with the prediction of our model, we find that, during the 1997 Asian
28 April 2011
financial crisis, Asian firms with weaker corporate governance experience a larger drop
Accepted 15 July 2011
in their share values but, during the post-crisis recovery period, such firms experience
Available online 16 February 2012
a larger rebound in their share values. We also find consistent evidence for Latin
JEL classification: American firms during the 2001 Argentine economic crisis. Our results support the view
G15 that controlling shareholders’ expropriation incentives imply a link between corporate
G21
governance and firm value.
G32
& 2012 Elsevier B.V. All rights reserved.
G33
G34

Keywords:
Expropriation
Corporate governance
Firm value
Asian financial crisis
Controlling shareholder
Cash flow rights
Control rights

$
We thank an anonymous referee for many detailed and helpful
suggestions. We are grateful for comments from Jay Choi, Jordan Siegel,
and seminar participants at the first International Conference on
Corporate Governance and Emerging Markets, the 2010 China Interna-
tional Conference in Finance, the 2010 International Conference on
Asia-Pacific Financial Markets, and the 2011 Asian Finance Association
International Conference. Jae-Seung Baek acknowledges financial sup-
port from the Hankuk University of Foreign Studies Research Fund, and
Jun-Koo Kang acknowledges financial support from the Nanyang Tech-
nological University Academic Research Fund Tier 1. All errors are our
own.
n
Corresponding author.
E-mail address: jkkang@ntu.edu.sg (J.-K. Kang).
1. Introduction
Researchers have extensively examined the link
between corporate governance and firm value during an
economic crisis. Previous studies show that firms with
weaker corporate governance suffer more during such a
period. One potential explanation for this finding is that,
during a crisis period, controlling shareholders’ incentives
to expropriate minority shareholders tend to go up as
the expected return on investment falls (Johnson, Boone,
Breach, and Friedman, 2000; Mitton, 2002; Baek,
Kang, and Park, 2004). This view implies that controlling

0304-405X/$ - see front matter & 2012 Elsevier B.V. All rights reserved.
doi:10.1016/j.jfineco.2012.02.007
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
shareholders’ incentives to expropriate minority share-
holders are the key channel through which corporate
governance affects firm value during a crisis period. We
term this conjecture the expropriation hypothesis.
However, the positive relation between the quality of
corporate governance and the change in firm value during
a crisis period is also consistent with several alternative
explanations. One such explanation is an information-
based argument. For example, prior to the 1997 Asian
financial crisis, the relation-based financial system in East
Asia worked well and, thus, investors might have ignored
the weaknesses of East Asian firms. Alternatively, perhaps
investors did not have full information on whether or not
their funds were being deployed appropriately, but the
crisis exposed the inherent weakness in the corporate
governance systems of East Asian countries, triggering
greater investor awareness of the problems in the region.
This increased awareness led to investors’ pulling out
(Rajan and Zingales, 1998). This argument suggests that
greater investor awareness of the weakness in corporate
governance is the main driving force that links corporate
governance to the change in firm value during the crisis
period. According to this view, the poor performance of
firms with weak corporate governance during a crisis
period is not necessarily due to increased expropriation,
but rather to investors’ paying more attention to corpo-
rate governance problems that have been hidden.
Another potential explanation is that the governance
measures used in previous studies are somehow closely
correlated with firms’ sensitivity to business conditions.
For example, in our sample firms, we find a strong
negative correlation between firm-level governance mea-
sures and systematic risk as estimated by the market
model beta. This finding suggests that the performance of
poorly governed firms is more sensitive to change in
market conditions, implying that firms with weaker
corporate governance suffer more when the market per-
forms poorly.
Finally, it could simply be that investors overreact to a
shock, and the degree of investors’ overreaction is more
pronounced for poorly governed firms. Like other expla-
nations, overreaction also implies a positive relation
between the change in a firm’s value and the quality of
its corporate governance during a crisis.
While both the expropriation hypothesis and the
alternative explanations have important implications for
the link between corporate governance and firm value
during a crisis, previous research has largely overlooked
these alternative explanations in examining that link. In
this paper, we reevaluate the validity of the expropriation
hypothesis by developing and testing a model that con-
siders the expropriation incentives of controlling share-
holders not only during the crisis period, but also during
the subsequent recovery period. In our tests, we explicitly
consider the possibility that firms with weaker corporate
governance suffer more during economic crisis periods
because of the alternative reasons.
The novelty of using the post-crisis recovery period is
that the prediction of the expropriation hypothesis regard-
ing the relation between the quality of corporate govern-
ance and the change in firm value during this period is
413
exactly opposite to that during the crisis period. If control-
ling shareholders’ increased incentive to expropriate min-
ority shareholders during the crisis period is the main
reason for the poor performance of firms with weak
corporate governance, we would expect these firms to
experience a larger percentage increase in value during
the recovery period than do firms with good corporate
governance. This prediction does not imply that poor
corporate governance enhances firm value during the
recovery period. Instead, our model suggests that the
greater rebound in the stock prices of firms with weaker
corporate governance during the recovery period is a
reflection of the firms’ more rampant asset diversion
problem during the crisis period, which severely limits
their ability to take full advantage of the substantially
improved investment opportunities when recovery begins.
The rationale for this prediction is as follows. During
the crisis period, because of the significant decline in
firms’ profit prospects and poorer investment opportu-
nities, controlling shareholders have stronger incentives
to divert firm resources for their own benefits. Conse-
quently, firms with weaker corporate governance experi-
ence more asset diversion and larger decline in firm value
than those with better corporate governance. However, as
the economy recovers, firms’ profit outlook and invest-
ment opportunities improve substantially. Because con-
trolling shareholders can benefit more from profitable
firm investments than from expropriation during this
recovery period, the improved economic conditions alle-
viate controlling shareholders’ incentives to expropriate
minority shareholders. Because firms with weaker corpo-
rate governance had more extant asset diversion before
the recovery period, during the recovery period they have
limited resources for undertaking all the profitable invest-
ments available and are thus forced to undertake only the
most profitable ones. As a result, during the recovery
period, on a per dollar basis, firms with weaker corporate
governance realize higher returns on investments than
those with better corporate governance and, thus, experi-
ence greater percentage increases in firm value.
The case of Samsung Fine Chemical (SFC) illustrates
how firms with weak corporate governance experience
large declines in firm value during the crisis period but
have strong rebounds as the economy recovers. In 1996, a
year before the onset of the Asian financial crisis, the
controlling shareholders of Samsung Group directly and
indirectly (through firms affiliated with the business
group) own 0.07% and 8.49%, respectively, of the out-
standing shares of SFC, and the affiliated firms addition-
ally hold 32.47% of its outstanding shares. This ownership
structure (i.e., divergence between ownership and con-
trol) allows controlling shareholders to exercise full con-
trol over SFC despite holding a relatively small portion of
its cash flow rights. During the crisis period, the stock
price of SFC plummeted from 29,500 won in July 1997
by almost 74% to just above 7,700 won by the end of
September 1998. However, as the economy recovered, the
stock price of SFC bounced back strongly, reaching 26,600
won (an increase of 245%) by the end of December 1999.
In comparison, the increase in the Korean stock market
index during the same period was 152%.
414 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
To test the model predictions, we first analyze a
sample of 608 Korean firms listed on the Korea Stock
Exchange (KSE) during the 1997–1998 financial crisis
and the 1998–1999 post-crisis recovery periods. As a
further test, we then examine 598 firms listed on seven
other East Asian stock markets during the same periods
and 302 firms listed on four Latin American stock
markets during the 2001–2002 Argentine crisis and the
2002–2003 post-crisis recovery periods. We require
sample firms to have data available for both the crisis
and recovery periods, because otherwise our results
could be driven by different firms being in the two
periods. We find strong support for the expropriation
hypothesis: Compared with well-governed firms, poorly
governed firms drop more in stock price during the crisis
period but experience significantly more increase in
stock prices during the recovery period.
Our finding that poorly governed firms experience a
greater rebound in stock prices during the recovery period
is inconsistent with the information-based explanation. The
information-based explanation suggests that greater inves-
tor awareness of corporate governance problems revealed
during a crisis period is the main reason for the poor
performance of firms with weak corporate governance.
Because the economic recovery does not change investor
awareness of these firms’ corporate governance, this expla-
nation also suggests that, during the recovery period, the
rebound in the stock prices of poorly governed firms should
be modest or at least no greater than that of well-governed
firms. Our evidence shows the opposite results. During the
recovery period, the stock return performance of firms with
weaker corporate governance is better than that of firms
with better corporate governance.
We also find that, for Korean sample firms, those with
weaker corporate governance suffer larger loss of
accounting profits during the crisis period but experience
a greater rebound in accounting profits during the recov-
ery period. This result provides further evidence that is
consistent with our model.
To control for the alternative explanations (i.e., risk
and overreaction) in addressing the link between corpo-
rate governance and firm value, we include beta and past
holding period returns as explanatory variables in the
regressions of stock returns during both the crisis and
recovery periods. If poorly governed firms have a higher
sensitivity to changes in market conditions, they are likely
to suffer more when the market performs poorly but
perform better when the market recovers. Similarly, firms
whose stock prices drop more during the crisis period
could perform better during the recovery period because
of the contrarian effects in stock returns that have been
emphasized in the asset pricing literature. Consistent with
these arguments, we find that the coefficients on beta and
past holding period returns have the predicted signs
in both crisis and recovery period regressions. However,
controlling for beta and overreaction effects does not
attenuate the impact of governance variables on the stock
return.
To provide further support to the expropriation
hypothesis, we present ancillary evidence showing that
the bad news announcements about the deteriorating
economic environment in Korea (e.g., a downgrade of
the sovereign rating of Korea by Moody’s or other rating
agencies, nationalization of the commercial bank by the
Korean government, chaebol bankruptcy, etc.) affect firms
with weak corporate governance more negatively than
they do those firms with good corporate governance. In
contrast, the good news announcements that are asso-
ciated with brighter prospects for future investment
opportunities (e.g., an upgrade of the sovereign rating of
Korea by Moody’s or other rating agencies, settlement of
the negotiation on foreign debt payments, abolition of
restrictions on foreign direct equity investment, etc.)
affect firms with weak corporate governance more posi-
tively than they do those firms with good corporate
governance. To the extent that these news events are
largely unexpected and thus represent relatively exogen-
ous shocks that significantly affect the expected return on
investment, our results further confirm the expropriation
hypothesis in explaining the link between corporate
governance and firm value.
We perform several robustness checks on the data. We
use various measures of the quality of corporate govern-
ance and find evidence that is consistent with the expro-
priation hypothesis. We also experiment with alternative
time periods for the shock and recovery periods and find
robust results.
Our findings have an important implication for the
growing literature on law and finance. The existing
literature has demonstrated the importance of investor
protection in the various aspects of financial markets. For
example, La Porta, Lopez-de-Silanes, Shleifer, and Vishny
(LLSV, 1997, 1998), show that countries with better
investor protection have larger and deeper capital mar-
kets. Markets with better investor protection also have
higher valuation of listed firms relative to their assets
(LLSV, 2002; Claessens, Djankov, and Lang, 2000), a larger
number of listed firms (LLSV, 1997), and higher quality of
accounting information (Hung, 2001; Ball, Robin, and Wu,
2002; Fan and Wong, 2002; Leuz, Nanda, and Wysocki,
2003). Furthermore, better investor protection enables
firms to make greater use of external finance (LLSV,
1998) and larger investments from external funds (Rajan
and Zingales, 1998; Demirgüc- -Kunt and Maksimovic,
1998). In contrast, poor investor protection increases
liquidity costs (Brockman and Chung, 2003) and impedes
informed arbitrage that capitalizes on firm-specific infor-
mation, thereby resulting in less efficient stock prices
(Morck, Yeung, and Yu, 2000). Finally, Djankov, La Porta,
Lopez-de-Silanes, and Shleifer (2008) develop the anti-
self-dealing index and show that it predicts a variety of
stock market outcomes. As LLSV (2000) argue, the funda-
mental premise of this literature is the importance of
investor protection in preventing the expropriation of
minority investors. Our evidence shows that investor
expropriation is the main channel through which corpo-
rate governance affects firm value.
Although our results for the recovery period generally
support the expropriation hypothesis, they are also con-
sistent with controlling shareholders’ propping behavior
[negative tunneling in which controlling shareholders use
their private cash to temporarily prop up troubled group
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
affiliates (Friedman, Johnson, and Mitton (2003)]. During
the recovery period, controlling shareholders in business
groups could use their private funds to prop up affiliated
firms so as to bring in more capital quickly or to build a
reputation that can be used to raise outside capital. Such
propping activities improve firm value and lead to large
rebounds in the stock prices, thereby benefiting a firm’s
outside shareholders. Even though propping reduces con-
trolling shareholders’ current wealth, in the long run it can
produce a net benefit to controlling shareholders by
enhancing the values of their options to expropriate firms’
future profits (Friedman, Johnson, and Mitton, 2003).
While we do not explicitly model this propping-based
explanation as an alternative to our expropriation hypoth-
esis, our results during the recovery period are consistent
with both the expropriation and propping arguments.1
The rest of the paper proceeds as follows. In Section 2, we
develop a simple model of managerial expropriation. In
Section 3, we discuss the data, variables, and sample char-
acteristics. Section 4 follows with a discussion of the main
results for the cross-sectional determinants of firm perfor-
mance in Korea during the crisis and post-crisis periods.
Section 5 presents the results of robustness tests and shows
further evidence supporting the expropriation hypothesis. In
Section 6, we report the results from the out-of-sample tests
using other Asian and Latin American firms. Finally, we
present summary and concluding remarks in Section 7.
2. A simple model of managerial expropriation
In this section, we develop a simple model of manage-
rial expropriation during crisis and recovery periods. To
simplify the analysis, we consider a one-period model in
which a firm has an investment project and initial capital
pffiffi
endowment of winit . The payoff from the project is p I,
which depends on both the investment amount, I, and
investment p profitability,
ffiffi p. The net present value of the
project is p II.
We assume that the profitability of the firm’s project is
independent of the level of managerial expropriation but
depends only on whether the firm is in the crisis period or
the recovery period. In practice, a firm’s profitability is likely
to be affected by both macroeconomic conditions and its
managerial decisions. However, given that the economic
conditions significantly affect a firm’s investment opportu-
nities and its profit prospects, a reasonable assumption is
that macro-factors play a key role in determining its profit-
ability. Thus, in our model, the firm’s manager cannot affect
the profitability of its investment, but he can alter only the
extent of expropriation and thus the level of investment.
Furthermore, although the firm can obtain winit from
internal operations as well as external financing, given the
difficulties in obtaining external financing during a crisis,
we assume that the firm obtains the entire winit from its
previous operations.2
1 4
See Bae, Cheon, and Kang (2008) for evidence on propping in
Korean markets.
2
We find that, during our sample period of 1997–1999, our sample
median Korean firm could not issue any bonds and had difficulty
extending its long-term bank debt. Moreover, although the median
415
Finally, because we intend to apply our model to
both the crisis and the recovery periods, ideally we need
a two-period dynamic model, which begins with the crisis
period and ends with the recovery period. However,
mainly for ease of exposition, we focus on a one-period
model and assume that winit for the crisis period is
exogenously given. However, we link the crisis period to
the recovery period by assuming the firm’s initial invest-
able capital for the recovery period is equal to the capital
produced from its investment during the crisis period.
That is, winit for the recovery period is equal to the cash
flow generated from the firm’s investment in the crisis
period.3
Following LLSV (2002), we assume that the firm has
one controlling shareholder who is also the firm’s man-
ager. The manager owns a fraction of the firm and can
divert the firm’s capital to benefit himself at the expense
of minority shareholders.4
Diversion of firm resources generally requires costly
transactions (Burkart, Gromb, and Panunzi, 1998; Johnson,
Boone, Breach, and Friedman, 2000; LLSV, 2002). However,
as the manager commands greater expropriation power,
he incurs less cost and derives more benefits from divert-
ing capital. We assume that the manager receives a benefit
of mðwinit wÞ^ from expropriating winit w ^ amount of capi-
tal, where m is the manager’s expropriation power.
The manager first decides how much of the firm’s
initial capital winit to expropriate and then how much of
the remaining capital to invest in the project. When the
manager expropriates winit w ^ amount of capital, the
remaining capital available for investment is w. ^ Because
winit is unaffected by the manager’s decisions in the
current period, choosing winit w ^ is equivalent to choosing
^ Thus, the manager’s optimal choices are determined by
w.
the following problem:
pffiffi
MaxI, w^ fa½w
^ þðp IIÞ þ mðwinit wÞg,
^ ð1Þ
Subject to I r w
^ ð2Þ
and
^ Z 0:
winit w ð3Þ
pffiffi
In Eq. (1), a½w
^ þ ðp IIÞ is the manager’s share of the
firm’s end-of-period value, and mðwinit wÞ
^ is his gain from
expropriation. Condition (2) states that investment I
(footnote continued)
Korean firm managed to issue a small amount of equity during the
recovery period of 1998–1999 (the number of shares issued as a
percentage of total shares outstanding was only a little over 10% of
the figure in the pre-crisis period of 1995–1996), it could not issue any
equity during the crisis period of 1997–1998.
3
To the extent that firms are unlikely to be able to forecast how
long the unanticipated economic crisis will last at its onset, planning
ahead for recovery could be very challenging for firms. Furthermore,
intuitions following our analysis suggest that a full-fledged dynamic
model is not likely to change the key features of our predictions based
on the one-period model.
Managerial expropriation can take many forms. For example, it can
take subtle legal forms, such as dilutive share issues that discriminate
against minority shareholders and mergers between affiliated firms to
siphon resources out of the bidder or the target. It can also take the form
of outright theft or fraud.
416 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
should be smaller than the amount of capital available for
investment after managerial expropriation, w. ^ Condition
^ be smaller
(3) is the capital constraint that requires that w
than the firm’s initial investable capital.
To solve for the manager’s optimal decisions, consider
first his choice of w.^ From the manager’s objective func-
tion in Eq. (1), a dollar increase in w ^ reduces his gains
from expropriation by m but increases his gains from
managerial equity holding by a. If m r a, the manager has
no incentive to expropriate minority shareholders. In the
rest of the analysis, we follow Johnson, Boone, Breach, and
Friedman (2000) by assuming that a is small enough so
that m 4 a. Under this assumption, the amount of expro-
priation is always non-negative (i.e., wr^ winit ).
When m 4 a, the manager chooses to minimize w ^ so
that constraint (2) is binding:
^ ¼ I:
w ð4Þ
Condition (4) says that the manager expropriates all of
the firm’s capital except for the minimum amount needed
for investment.
pffiffi Given Eq.
pffiffiffiffi (4), the firm’s end-of-period
value, wþ^ ðp IIÞ, is p w ^ , so the manager’s objective
function in Eq. (1) becomes
pffiffiffiffi
ap w ^ þ mðwinit wÞ:
^ ð5Þ
Maximizing the payoff in Eq. (5) subject to constraint
^ denoted as w
(3) shows that the optimal level of w, ^ n , is
given by
^ n ¼ Minfðap=2mÞ2 ,winit g:
w ð6Þ
Eq. (6) identifies the key factors that affect the manager’s
incentive to divert the firm’s capital. First, when the firm’s
initial capital winit is large relative to ðap=2mÞ2 , then
w^ n ¼ ðap=2mÞ2 . Thus, as managerial equity ownership a
increases, the profitability of the firm’s project p improves,
or as managerial expropriation power m declines, the firm’s
investment w ^ n increases while managerial expropriation
winit w ^ n decreases. The intuition for this result is straight-
forward. As a or p increases, or as m declines, the manager’s
benefits from the firm’s investment, the first term in
Eq. (5), increase relative to his gain from expropriation,
the second term in Eq. (5), resulting in greater managerial
incentive to invest in the project and weaker incentive to
expropriate capital. Second, when the firm has limited
initial capital such that winit o ðap=2mÞ2 , then w ^ n ¼ winit . In
this case, there is no managerial expropriation.
To separately examine the implications of the model
for the crisis and recovery periods, denote the profitability
for the crisis and recovery periods as pc and pr , respec-
tively; the investable capital at the beginning of the crisis
and recovery periods as wcinit and wrinit , respectively; and
the optimal investment in the crisis and recovery periods
as w ^ cn and w ^ rn , respectively.
To solve for the manager’s optimal decisions during
the crisis period, we assume that at the beginning of the
crisis period the firm is endowed with a large amount of
initial investable capital.
Assumption 1. For the crisis period, wcinit 4 ðapc =2mÞ2 :
Assumption 1 is motivated by the fact that the external
shock at the beginning of the crisis substantially reduces
the profit prospect of the firm’s investment, causing pc to
be very small. Thus, wcinit , which corresponds to the capital
generated from the firm’s operations during the pre-crisis
period, is likely to exceed the capital needed for invest-
ment during the crisis period.
It follows from Eq. (6) and Assumption 1 that the
manager’s optimal choice of investment during the crisis
period is w^ cn ¼ ðapc =2mÞ2 . The resulting managerial expro-
priation is
c
^ n ¼ wcinit ðapc =2mÞ2 :
wcinit w ð7Þ
The amount of capital produced from the investment is
qffiffiffiffiffiffi
c
p w ^ cn ¼ aðpc Þ2 =2m: ð8Þ
qffiffiffiffiffiffi
pc w c
^ n is also the value of the firm at the end of the crisis
period.
When the recovery period begins, the firm’s initial
capital wrinit is equal to the capital produced during the
qffiffiffiffiffiffi
crisis period, pc w ^ cn in Eq. (8), that is,
wrinit ¼ aðpc Þ2 =2m ð9Þ
To solve for the manager’s optimal decisions during
the recovery period, we assume that, at the beginning of
the recovery period, the firm has limited capital available
for investment.
Assumption 2. For the recovery period, wrinit o ðapr =2mÞ2 .
This assumption is motivated by the fact that the
economic recovery substantially improves the firm’s
investment prospect, so the profitability of the firm’s
project during the recovery period, pr , is expected to be
significantly larger than that during the crisis period, pc . It
follows from Eq. (6) and Assumption 2 that during the
recovery period the manager has few incentives to expro-
priate and the optimal investment is
^ rn ¼ wrinit
w ð10Þ
Therefore, firm value at the end of the recovery period
pffiffiffiffiffiffiffiffiffiffi
is pr wrinit .
We can summarize the above discussions of manage-
rial expropriation during the crisis and recovery periods
as follows.
Proposition 1. During the crisis period, the managerial
incentive to expropriate minority shareholders increases with
the manager’s expropriation power and decreases with his
equity ownership in the firm. However, during the recovery
period, the manager has few incentives to expropriate min-
ority shareholders.
Proposition 1 is similar to the Jensen (1986) free cash
flow argument in that excess cash and low growth
opportunities result in agency problems. During the crisis
period, the firm tends to have a relatively large amount of
initial investable capital, but few profitable investment
opportunities. This opens the door for agency conflicts,
such as managerial expropriation and investment in
negative net present value projects. Expropriation is
possible due to the manager’s significant controlling
power, but his equity ownership alleviates the extent
of expropriation by aligning his interests with those of
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
minority shareholders. However, coming off the crisis and
entering the recovery period, the firm is likely to have
better investment prospects but with limited investable
capital due to the extant managerial expropriation during
the crisis period. Thus, during the recovery period, the
manager has few incentives to engage in expropriation.
The above analysis provides two testable predictions
on the relations between change in firm value and the
manager’s expropriation power and equity ownership. For
the crisis period, the firm is initially worth wcinit and is
qffiffiffiffiffiffi
worth pc w ^ cn at the end of the period. Thus, the percen-
tage change in firm value over this period is
 qffiffiffiffiffiffi 
pc w^ cn wcinit =wcinit ð11Þ
qffiffiffiffiffiffi
^ cn is decreasing in the
We know from Eq. (8) that pc w
manager’s expropriation power but increasing in his
equity ownership, so the change in firm value should also
be decreasing in his expropriation power but increasing
in his equity ownership. The following prediction sum-
marizes the dependence of the change in firm value
during the crisis period on the manager’s expropriation
power and equity ownership.
Prediction 1. The change in firm value during the crisis is
negatively related to the manager’s expropriation power
but is positively related to his equity ownership in
the firm.
At the beginning of the recovery period, the firm value
is wrinit , and at the end of the recovery period, it is
pffiffiffiffiffiffiffiffiffiffi
pr wrinit . Thus, during the recovery period, the change
in firm value is
 qffiffiffiffiffiffiffiffiffiffi   qffiffiffiffiffiffiffiffiffiffi 
pr wrinit wrinit =wrinit ¼ pr = wrinit 1: ð12Þ
Recall from Eq. (9) that wrinit is decreasing in the
manager’s expropriation power but increasing in his
equity ownership. Thus, Eq. (12) leads to the following
testable prediction.
Prediction 2. The change in firm value during the recovery
period is positively related to the manager’s expropriation
power but is negatively related to his equity ownership in
the firm.
Prediction 2 does not mean either that during the
recovery period managerial expropriation contributes to
firm value or that managerial equity ownership reduces
firm value. During the recovery period the manager has
few incentives to expropriate. The role of managerial
expropriation power and managerial equity ownership in
explaining the change in firm value during the recovery
period comes indirectly from their influence on the level of
initial investable capital, which is determined by the
capital produced from investment during the crisis period.
During the crisis period, as the manager’s expropriation
power increases or equity ownership declines, or both, his
incentives to expropriate minority shareholders increase
and thus he allocates less capital to investments, resulting
in a smaller amount of investable capital available when
the recovery arrives. As illustrated in Fig. 1, because of the
417
NPV of Investment
Investment (I )
Fig. 1. Concavity in the firm’s production technology. wrinit is the initial
capital endowment and amount of investmentpin
ffiffi the recovery period.
The net present value (NPV) of the project is p II, which depends on
both investment amount (I) and investment profitability (p).
concavity in the firm’s production technology, there is
decreasing return to investment. Thus, for firms with high
managerial expropriation power or low managerial equity
ownership, or both, the limited amounts of initial invest-
able capital produce, on a per dollar investment basis, a
large increase in firm value.
3. Data, key variables, and sample characteristics
In this section we describe the data, variables, and
sample characteristics.
3.1. Data
Our initial sample consists of 608 nonfinancial firms
listed on the KSE during 1997–1999, which covers both
the crisis and recovery periods. To check the robustness of
our results, we perform an out-of-sample test using 598
other East Asian firms from Hong Kong, Indonesia, Malay-
sia, Philippines, Singapore, Taiwan, and Thailand during
the same periods and 302 Latin American firms from
Argentina, Brazil, Chile, and Mexico during the 2001
Argentine economic crisis and recovery periods. We dis-
cuss the results of using these alternative samples in
Section 5. Because focusing on a single nation allows
examination of corporate governance and firm-specific
measures at a level of detail that would be hard to
aggregate across countries, our main analysis is based
on the single country of Korea.
Fig. 2 shows the changes in the Korea Composite Stock
Price Index (KOSPI) from January 1996 to December 1999.
The KOSPI is a market capitalization-weighted price index
of all firms listed on the KSE and is the index that is most
widely used to evaluate market performance.
At the end of January 1996, the KOSPI was 879. It went
through periods of ups and downs, reaching its highest
point at the end of June 1997, when it stood at 944.
The first event that appears to trigger the Asian financial
crisis is the announcement on July 2, 1997 regarding the
Thai Baht’s devaluation (Chowdhry and Goyal, 2000). After
that, the KOSPI started to fall until September 1998, at
418 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
Korea Composite Stock Price Index
1,200
1,000
800
600
400
200
0
January June December
1996 1996 1996
Fig. 2. Changes in the Korea Composite Stock Price Index (KOSPI) from January 1996 to December 1999. The KOSPI is a market capitalization-weighted
price index of all firms listed on the Korea Stock Exchange and is the index that is most widely used to evaluate the market performance. The KOSPI data
are from the daily return files of the Korea Investors Service—Stock Market Analysis Tool and Stock Database of the Korea Securities Research Institute.
which point the index level had dropped to 406. Thus, as
in the previous study by Baek, Kang, and Park (2004), we
set the period from July 1997 to September 1998 as the
crisis period.
In October 1998, the Korean stock market recovered its
previous losses. In particular, during 1999, investor opti-
mism gained momentum and the stock market perfor-
mance was spectacular. At the end of 1999, the KOSPI
reached a new high of 1214. This movement in the KOSPI
suggests that investors would have realized a holding
period return of about 300% if they had invested in the
market portfolio from October 1998 to December 1999.
Thus, we set the period from October 1998 to December
1999 as the recovery period.
3.2. Key variables
We measure the change in firm value during the crisis
(recovery) period by the holding period stock return from
the beginning of the crisis (recovery) to the end of crisis
(recovery) and use it as the dependent variable. The
explanatory variables include the following.
3.2.1. Expropriation variables
As a direct empirical measure of the manager’s expro-
priation power (variable m in our model), we use the
disparity between cash flow rights and voting rights of the
controlling shareholders. The controlling shareholders
with high ownership disparity could have strong incen-
tives to siphon resources out of the firm to benefit
themselves. We measure the cash flow rights of the
controlling shareholders (defined as owner-managers
and their family members) as the sum of the direct equity
ownership and the product of the ownership stakes
obtained indirectly. We obtain the information on these
stakes by tracing up to two layers along the control chain
in a pyramid structure. We measure voting rights as the
June December June December June December
1997 1997 1998 1998 1999 1999
sum of direct equity ownership and the minimum value of
ownership in the chain of voting rights. We use both total
and block ownership to estimate voting rights. By obtain-
ing data on total holdings, we can accurately measure the
controlling shareholders’ voting rights. We compute the
divergence between cash flow rights and control rights as
the logarithm of the ratio of voting rights to cash flow
rights (disparity variable).
We use equity ownership by controlling shareholders
as the measure for managerial equity ownership (variable
a in our model). Following Mitton (2002) and Baek, Kang,
and Park (2004), we use two additional variables related
to block holdings as alternative measures of equity own-
ership. The first measure is the sum of block holdings by
all shareholders who own 5% or more of issued shares.
The second measure is the block holdings by the largest
shareholder owning 5% or more of issued shares. We
further separate the block holdings by the largest share-
holder into two components, the largest managerial
block ownership and the largest nonmanagerial block
ownership.
As an alternative measure for controlling shareholders’
expropriation power m, we use the extent of a firm’s
diversification. The degree of expropriation could be more
severe for highly diversified firms, as these firms tend to
suffer more from information asymmetry and agency costs
(Mitton, 2002; Lins and Servaes, 1999). To measure diver-
sification, we use a dummy variable that takes a value
of zero if 90% or more of a firm’s sales come from one three-
digit Standard Industrial Classification (SIC) and a value of
one otherwise. We then interact this diversification dummy
with the diversity of investment opportunities. To measure
the diversity of investment opportunities, we follow Rajan,
Servaes, and Zingales (2000). We first identify competing
undiversified firms for each segment of diversified firms at a
four-digit SIC level and then measure the standard deviation
of the Tobin’s q (book value of debt plus market value of
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
equity divided by total assets) of matched undiversified
firms for all segments of a diversified firm. We define
diversified firms with standard deviations above (below)
the median for all diversified firms as having a high (low)
variation of investment opportunities.
3.2.2. Risk and overreaction variables
We use beta as the key measure of firm risk. We
estimate beta by the slope of the market model regres-
sion. To estimate beta before the crisis (recovery)
period, we use two-year daily stock returns preceding
the crisis (recovery) period. We also include as a risk
variable firm-specific risk measured as the standard
deviation of residual errors from the market model
regression.
A contrarian (overreaction) effect in stock returns
predicts that better-performing firms before the crisis
period drop more during the crisis period and worse-
performing firms during the crisis period perform better
during the recovery period. To control for such a contra-
rian effect, we use past holding period returns (HPR) as
our key measure. We compute the HPR of firm i between
t1 and t2 as
HPRi ðt 1 ,t 2 Þ ¼ ð1þ Ri,t1 Þð1 þ Ri,t1 þ 1 Þð1þ Ri,t1 þ 2 Þ
ð1þ Ri,t1 þ 3 Þ    ð1þ Ri,t2 Þ21
where Ri,t is the daily return of firm i at time t. As past
holding period returns for the shock and recovery periods,
we use the HPR during year 1996 and the HPR during the
shock period, respectively.
3.2.3. Control variables
As in Baek, Kang, and Park (2004), we control for several
other variables that could affect firm performance during
the crisis and recovery periods. First, we control for firm
size (logarithm of total assets). Larger firms tend to have
easy access to external finance and suffer less from infor-
mation asymmetry. Thus, we expect larger firms to be less
vulnerable to external shock. To control for the nonlinear
effect of firm size on HPR, we include the square of the
logarithm of total assets as an additional control variable.
In addition, we control for leverage (total debt/total
assets). Because highly leveraged firms have difficulty
obtaining external financing during a crisis, we expect
such firms to experience a larger drop in equity value.
In Korea, a large business group is often referred to as a
chaebol. The Korea Fair Trade Commission (KFTC) ranks
business groups according to the size of their total assets
and identifies the 30 largest business groups. Chaebol
firms that belong to the 30 largest business groups
operate in many different industries, are bound together
by a nexus of explicit and implicit contracts, maintain
substantial business ties with other firms in their group,
and are mostly family controlled.5 They are also charac-
terized by an extensive arrangement of pyramidal or
multilayered shareholding agreements and the existence
5
Fogel (2006) shows that greater oligarchic family control over
large corporations, which is the case for chaebol firms, is associated with
worse social economic outcomes.
419
of cross-debt guarantees among member firms.6 If the
chaebol affiliation allows risk sharing among chaebol firms,
we expect chaebol firms to suffer less during a crisis. We use
a dummy variable that equals one if a firm belongs to one of
the 30 largest business groups and zero otherwise.
We expect firms with high foreign ownership and
those having a listed American Depositary Receipt (ADR)
to suffer less during a crisis. To control for these effects,
we use equity ownership by foreign investors and a
dummy variable that takes the value of one if the firm
has an ADR listed in the United States.
We control for inefficiency in resource allocation
among member firms within the same chaebol by includ-
ing the ratio of financial securities invested in affiliated
(nonaffiliated) firms to the firm’s total assets.
Finally, we control for other determinants of firms’
stock returns, including future investment opportunity
(Tobin’s q), liquidity [ratio of cash flow (operating income
plus depreciation) to total assets], and industry effects
(industry dummies).
3.3. Sample characteristics
Table 1 provides summary statistics of our sample
firms as of the end of fiscal years 1996 and 1997. We
obtain the daily stock return data from the Stock Database
of the Korea Securities Research Institute, which includes
all firms listed on the KSE, and financial data from the
Listed Company Database of the Korean Listed Companies
Association.
The average ratio of voting rights to cash flow rights is
3.22 in 1996 and 1.91 in 1997. Closely examining the ratio
of voting rights to cash flow rights shows that outlier
problems are much more severe in 1996 than in 1997.
When we delete observations in which the ratio of voting
rights to cash flow rights is larger than the 99th percentile
of the sample, the average ratio in 1996 becomes 2.31, but
the average ratio in 1997 is 1.85.
In 1996, the average equity ownership by controlling
shareholders and the average equity ownership by
affiliated firms are 20.51% and 8.79%, respectively. The
corresponding values in 1997 are 19.69% and 10.91%. Tests
of differences in mean and median equity ownership by
controlling shareholders between 1996 and 1997 do not
reject the null hypothesis that they are equal, but those in
mean and median equity ownership by affiliated firms
between 1996 and 1997 reject the null hypothesis that
they are equal. These results suggest that during the crisis
period, instead of using their own wealth, controlling
shareholders use the resources of member firms to
increase their control power in the chaebol.
The sum of block ownership by all shareholders
averages 30.96% in 1996 and 31.15% in 1997. The average
of largest blockholder concentration, as measured by the
block holdings of the largest shareholder owning 5% or
6
Chang (2003) examines the simultaneous relation between own-
ership and firm performance for chaebol affiliates. He shows that using
insider information, chaebol families and their affiliates take higher
ownership stakes in more profitable and more promising firms and
transfer profits to affiliates through intragroup trade.
420 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435

Table 1
Summary statistics.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. The summary statistics are the values at the end of fiscal
years 1996 and 1997, except for beta and firm-specific risk, which we estimate by using two-year daily returns preceding the crisis and recovery periods.
Previous HPR are the holding period returns during the year of 1996 and HPR during the shock period (July 1997–September 1998). Cash flow rights of
controlling shareholders are the sum of direct equity ownership and the product of the ownership stakes obtained indirectly along the chain of a pyramid
structure for controlling shareholders. Voting rights of controlling shareholders are the sum of direct equity ownership and the minimum of the level of
ownership in the pyramid structure. Equity ownership by controlling shareholders is the sum of equity ownership by controlling families and affiliated
firms. The sum of block ownership is the sum of block holdings by all shareholders owning 5% or more of issued shares. Block ownership by the largest
shareholder denotes block holdings by the largest shareholder who owns 5% or more of issued shares. The largest managerial blockholder concentration
refers to block holdings by owners involved with management, and largest nonmanagerial blockholder concentration refers to block holdings by other
largest shareholders. Beta is estimated by the slope of the market model regression. Firm-specific risk is estimated by the standard deviation of residual
errors from the market model regression. We measure Tobin’s q as the book value of debt plus market value of equity divided by total assets. Financial
investment in affiliated (nonaffiliated) firms means financial securities invested in affiliated (nonaffiliated) firms. The firm is considered to be diversified
if 10% or less of that firm’s sales come from one three-digit Standard Industrial Classification.

Variable A: 1996 (N ¼ 608) B: 1997 (N ¼ 608) Test of difference

(A-B): p-value

Mean Median Mean Median t-test Wilcoxon

Z-test

Expropriation variables
Voting rights/cash flow rights of controlling shareholders (owner-managers and their family 3.219 1.000 1.906 1.000 0.003 0.001
members)
Cash flow rights of controlling shareholders (percentage) 22.101 22.330 24.668 24.460 0.001 0.001
Voting rights of controlling shareholders (percentage) 25.064 24.990 29.203 28.015 0.001 0.001
Equity ownership by controlling shareholders (percentage) 29.295 28.090 30.698 28.580 0.019 0.001
By ownermanagers and their family members 20.510 20.020 19.691 18.770 0.585 0.331
By affiliated firms 8.785 0.000 10.911 3.955 0.004 0.001
Sum of block ownership by all shareholders (percentage) 30.956 29.620 31.151 29.150 0.817 0.721
Block ownership by the largest shareholder (percentage) 19.289 16.915 20.970 19.380 0.008 0.004
By managers 11.303 9.440 12.427 11.000 0.083 0.028
By non-managers 7.987 8.700 8.544 6.643 0.288 0.052
Equity ownership by foreign investors (percentage) 5.006 1.620 4.694 1.070 0.478 0.010

Control variables
Market model beta 0.849 0.915 0.904 0.945 0.001 0.015
Firm-specific risk 0.071 0.068 0.069 0.056 0.535 0.001
Previous HPR 0.174 0.035  0.696  0.754 0.001 0.001
Total assets (billion won) 621.001 156.781 713.327 174.626 0.001 0.001
Total debt/total assets 0.701 0.699 0.733 0.715 0.057 0.005
Cash flow ((operating income þ depreciation)/total assets) 0.055 0.054 0.047 0.052 0.038 0.045
Tobin’s q 1.087 0.997 0.946 0.883 0.001 0.001
Financial investment in affiliated firms/total assets 0.079 0.047 0.069 0.040 0.014 0.084
Financial investment in unaffiliated firms/total assets 0.020 0.000 0.019 0.000 0.851 0.129
Percentage of firms with an American depositary receipt 2.65 2.82 0.860 –
Percentage of diversified firms 32.28 29.91 0.005 –

more of shares, is 19.29% in 1996 and 20.97% in 1997. The
average largest managerial blockholder concentration, i.e.,
block holdings by owners involved with management, is
11.3% in 1996 and 12.43% in 1997. The corresponding
values for the largest nonmanagerial blockholder concen-
tration, i.e., block holdings by largest shareholders
who are not associated with management, are 7.99% and
8.54%, respectively. The median equity ownership by
foreign investors is 1.62% in 1996 and 1.07% in 1997,
suggesting that, during the crisis, the median foreign
investor reduces her previous holdings by almost 34%.
All of these differences in block ownership and foreign
ownership between 1996 and 1997 are statistically sig-
nificant at the 0.01 level.
Not surprisingly, betas show an increase during the
crisis period. The mean betas are 0.85 in 1996 and 0.9 in
1997. However, firm-specific risk shows little changes.
The past HPR shows that firm value is significantly lower
in 1997 than in 1996. The average of past HPR in 1996 is
0.17, while the corresponding number in 1997 is  0.7.
The average size of firms measured by total assets is 621
billion won in 1996 and 713 billion won in 1997, and the
average leverage ratio is 70.1% in 1996 and 73.3% in 1997. In
1996 and 1997, the ratios of cash flow (operating income
plus depreciation) to total assets average 5.5% and 4.7%,
respectively, and the means of Tobin’s q are 1.1 and 0.95.
The average ratio of financial investment in affiliated (non-
affiliated) firms to total assets is 7.9% (4.7%) in 1996 and 6.9%
(4.0%) in 1997. We note a slight increase in the proportion of
sample firms whose ADR is listed in the United States, from
2.65% in 1996 to 2.82% in 1997. The proportion of diversified
firms decreased from 32.28% in 1996 to 29.91% in 1997.
4. Determinants of firm performance during the crisis
and recovery periods
This section presents the main results of the paper. First,
using univariate tests, we examine the relation between
expropriation variables and firm performance. Then, using
multivariate regression analyses, we show that the most
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435 421

Table 2
Mean and median holding period return (HPR) during the crisis (7/97–9/98) and recovery (10/98–12/99) periods.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. Ownership variables are the values at the end of fiscal
years 1996 (for the shock period) and 1997 (for the recovery period). Cash flow rights of controlling shareholders are the sum of direct equity ownership
and the product of the ownership stakes obtained indirectly along the chain of a pyramid structure for controlling shareholders. Voting rights of
controlling shareholders are the sum of direct equity ownership and the minimum of the level of ownership in the pyramid structure. Equity ownership
by controlling shareholders is the sum of equity ownerships by owner-managers and their family members. ***, **, and * denote significance of the
parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Panel A: HPR by disparity variable

Crisis/recovery periods Disparity between cash flow rights and control rights (voting right/cash flow right) Test of difference: p-value

Low High t-test Wilcoxon Z-test

HPR (7/97–9/98)  0.682  0.735 0.03nn 0.01nn

(  0.739) ( 0.797)
HPR (10/98–12/99) 1.236 1.587 0.00nnn 0.00nnn
(0.507) (0.964)

Panel B: HPR by equity ownership by controlling shareholders

Crisis/recovery periods Equity ownership by controlling shareholders Test of difference: p-value

Low High t-test Wilcoxon Z-test

nnn
HPR (7/97–9/98)  0.729  0.664 0.00 0.00nnn
(  0.786) ( 0.730)
HPR (10/98–12/99) 1.764 0.898 0.00nnn 0.00nnn
(0.834) (0.396)

Panel C: HPR by sum of block ownership by all shareholders

Crisis/recovery periods Sum of block ownership by all shareholders Test of difference: p-value

Low High t-test Wilcoxon Z-test

HPR (7/97–9/98)  0.745  0.646 0.00nnn 0.00nnn

(  0.786) ( 0.731)
HPR (10/98–12/99) 1.701 0.948 0.00nnn 0.02nn
(0.678) (0.529)

Panel D: HPR by largest managerial block ownership

Crisis/recovery periods Largest managerial block ownership Test of difference: p-value

Low High t-test Wilcoxon Z-test

nnn
HPR (7/97–9/98)  0.732  0.661 0.00 0.00nnn
(  0.779) ( 0.725)
HPR (10/98–12/99) 1.857 0.782 0.00nnn 0.00nnn
(0.867) (0.396)

important determinants of firm performance during the
crisis and recovery periods are expropriation variables.
4.1. Univariate test
We partition our sample firms by the sample medians
of key expropriation variables at the end of fiscal years
1996 and 1997, respectively, and then compare the HPR
during the crisis (July 1997 to September 1998) and
recovery (October 1998 to December 1999) periods.
In Panel A of Table 2, we use the ratio of voting rights
to cash flow rights as a key expropriation variable. During
the shock period, firms with high disparity realize an
average (median) HPR of  73.5% (  79.7%), while firms
with low disparity realize an average (median) HPR of
68.2% ( 73.9%). The differences in mean and median
HPR between these two subsamples are significant at the
0.05 level. These results are consistent with Prediction 1
of our model.
During the recovery period, firms with high disparity
realize an average (median) HPR of 158.7% (96.4%),
while firms with low disparity realize an average (med-
ian) HPR of 123.6% (50.7%). The differences in mean
and median HPR between these two subsamples are
significant at the 0.01 level. These results, together with
those during the shock period, suggest that poorly gov-
erned firms suffer more during the shock period but
perform better during the recovery period. This evidence
of reversal in stock returns supports Prediction 2 of
our model.
In Panel B of Table 2, we use equity ownership by
controlling shareholders as our key expropriation vari-
able. We find that firms with lower equity ownership by
controlling shareholders suffer more during the shock
422 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
period but bounce back more during the recovery period,
again supporting Predictions 1 and 2 of our model.
However, the greater reversal of stock prices for firms
with weak governance could be due to factors that are not
related to ownership structure. It could be that ownership
variables are correlated with other aspects of firm char-
acteristics, such as firm risk. For example, firms with high
betas perform worse during the shock period and better
during the recovery period. While not reported in the
paper, we split the sample firms according to the sample
median beta and examine whether stock return perfor-
mance differs according to the beta. During the shock
period, high-beta firms experience a mean (median) loss
of about 71.4% (76.9%), while the corresponding loss is
67.5% (74.5%) for low-beta firms. However, during the
recovery period, this pattern is reversed. High-beta firms
experience a mean (median) gain of about 151.1% (63.9%),
while the corresponding gain is 110.3% (58.9%) for low
beta firms. These findings underscore the importance of
controlling for firm risk in detecting the relation between
firm performance and governance variables.
In Panel C of Table 2, we use sum of block ownership
by all shareholders as our key expropriation variable. We
find that firms with lower block ownership by all share-
holders realize more loss during the shock period but gain
more during the recovery period, supporting the expro-
priation hypothesis.
We further break down block ownership into manage-
rial block ownership and nonmanagerial block ownership
and examine their relation to firm performance. Panel D
of Table 2 shows that firms with lower managerial block
ownership have lower returns during the crisis period and
higher returns during the recovery period. Nonmanagerial
block ownership, however, shows no relation to firm
performance (not reported).
4.2. Cross-sectional variation in HPR
In this subsection we estimate cross-sectional regres-
sion of HPR on firm-specific variables that capture expro-
priation while controlling for other variables that could
affect firm value such as risk and overreaction.
Table 3 shows the results from the cross-sectional
regression. As the dependent variable, Regressions 1
through 3 use the HPR during the shock period, and
Regressions 4 through 6 use the HPR during the recovery
period. Regression 1 includes the logarithm of the ratio of
voting rights to cash flow rights as a key explanatory
variable.7 The coefficient estimate on this variable is
negative and significant, showing that firms with high
disparity between voting rights and cash flow rights
perform worse during the crisis period.
In Regression 2, we include beta, firm-specific risk, and
past HPR as explanatory variables, in addition to owner-
ship disparity. We find that the coefficient estimates on
beta, previous HPR, and ownership disparity are negative
7
In untabulated tests, we also experiment with the difference
between control rights and cash flow rights instead of their ratio as an
alternative measure of the expropriation variable. We obtain similar
results as those reported in the paper.
and significant, showing the importance of including risk
and contrarian variables in the regression.
In Regression 3, we control for all other variables. We
add the logarithm of total assets, squared logarithm of
total assets, total debt over total assets, top 30 chaebol
dummy, equity ownership by foreign investors, ADR
dummy, the ratio of financial investments in affiliated
firms to total assets, the ratio of financial investments in
unaffiliated firms to total assets, Tobin’s q, and the ratio of
cash flow to total assets. We also include four industry
dummy variables (construction, manufacturing, whole-
sale and retail, and transportation and services) to control
for a possible industry effect. To conserve space, we do
not report coefficients on these industry dummies. Con-
trolling for these variables increases the adjusted R2 of the
regression to 11%, suggesting that ownership disparity,
beta, firm-specific risk, and previous HPR, together with
other control variables, are able to capture successfully
the variation of the HPR during the crisis. Adding control
variables does not affect the significance of the disparity
variable. This result is consistent with Prediction 1 of
our model.
Among the control variables, previous HPR, logarithm
of total assets, and leverage variables are negatively and
significantly related to HPR during the shock period. In
contrast, squared logarithm of total assets, chaebol
dummy, and ADR dummy are positively and significantly
related to HPR.
Our regression analyses for the recovery period begin
with Regression 4, in which we regress HPR during the
recovery period on the disparity variable. Supporting
Prediction 2 of our model, the result shows that the
coefficient estimate on the disparity variable is positive
and significant at the 0.01 level.
In Regression 5, we add beta, firm-specific risk, and
previous HPR as explanatory variables. We find that
the coefficient estimate on beta is significantly positive,
whereas the coefficient estimate on previous HPR is
significantly negative.
In Regression 6, we control for other variables. Adding
the control variables does not change the magnitude and
significance levels of our key variables.
In Table 4, we use equity ownership by controlling
shareholders as the key expropriation measure. In Regres-
sion 1, we replace the disparity variable in Regression 1
of Table 3 with equity ownership by controlling share-
holders. Consistent with Prediction 1 of our model, we
find that the coefficient estimate on equity ownership by
controlling shareholders is positive and significant.
In the next model, we add beta, firm-specific risk, and
previous HPR. Beta and previous HPR are negatively
related to HPR during the shock period. In contrast, equity
ownership by controlling shareholders is positively
related to HPR.
In Regression 3, we use the control variables used in
Table 3. Adding the control variables does not change the
significance of these three variables, except that the
coefficient estimate on beta loses its significance.
In Regressions 4 and 5, following Joh (2003), we
examine a nonlinear effect of equity ownership by con-
trolling shareholders on firm value. Morck, Shleifer, and
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435 423

Table 3
Cross-sectional regression of holding period return (HPR) on expropriation, risk, overreaction, and firm characteristic variables.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. Cash flow rights of controlling shareholders are the sum
of direct equity ownership and the product of the ownership stakes obtained indirectly along the chain of a pyramid structure for controlling
shareholders. Voting rights of controlling shareholders are the sum of direct equity ownership and the minimum of the level of ownership in the pyramid
structure. Using two-year daily returns preceding the crisis and recovery periods, we estimate beta by the slope of the market model regression and firm-
specific risk as the standard deviation of residual errors from the market model regression. Previous HPR are the holding period returns during the year of
1996 (for the shock period) and HPR during July 1997 to September 1998 (for the recovery period). Top 30 chaebol dummy is a dummy variable that
equals one if the firm belongs to one of the 30 largest business groups in Korea. ADR dummy equals one if the firm is cross-listed in the US stock
exchanges. We measure Tobin’s q as the book value of debt plus market value of equity divided by total assets. Financial investment in affiliated
(nonaffiliated) firms means financial securities invested in affiliated (nonaffiliated) firms. We measure cash flow as the sum of net income and
depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable HPR (crisis period: 7/97–9/98) HPR (recovery period: 10/98–12/99)

(1) (2) (3) (4) (5) (6)

Intercept  0.673nnn  0.559nnn  0.421 0.956nnn  1.381nn 5.021

(  52.05) (  12.80) (  0.17) (6.79) ( 2.00) (0.20)
Log (voting right/cash flow right)  0.037nn  0.028n  0.037nn 1.173nnn 1.049nnn 1.159nnn
( 2.48) (  1.82) (  2.09) (5.36) (4.79) (4.19)
Beta  0.103nnn  0.069 1.055n 1.772nn
(  2.78) (  1.51) (1.91) (2.52)
Firm-specific risk  0.317  0.040  1.549 1.162
( 0.80) (  0.07) (  0.38) (0.19)
Previous HPR  0.033  0.046n  2.235nnn  2.136nnn
(  1.58) (  1.87) ( 4.97) ( 3.68)
Log (total assets)  0.444n  0.649
(  1.79) (  0.25)
[Log (total assets)]2 0.011n 0.017
(1.68) (0.26)
Total debt/total assets  0.198nnn 0.034
(  2.66) (0.04)
Top 30 chaebol dummy 0.119nnn  0.235
(3.20) (  0.52)
Equity ownership by foreign investors 0.285 0.039n
(1.41) (1.69)
ADR dummy 0.164n 0.732
(1.70) (0.70)
Financial investment in affiliated firms/total assets  0.168  3.292n
(  1.12) ( 1.74)
Financial investment in nonaffiliated firms/total assets  0.085 4.986nn
(  0.51) (2.07)
Tobin’s q 0.004  0.358
(0.11) (  0.44)
Cash flow/total assets 0.385  2.414
(1.26) ( 1.10)
Industry dummies Yes Yes
F-value 6.14 3.74 4.03 28.73 14.55 3.91
Adjusted R2 0.010 0.020 0.107 0.049 0.093 0.097
Sample size 534 526 432 534 526 432

Vishny (1988) present evidence of a nonlinear relation
between management ownership and firm value. They
show that firm value increases in management ownership
at low levels of management ownership and decreases in
management ownership at high levels of management
ownership. Thus, to examine whether ownership effects
on firm value during the crisis vary depending on the size
of controlling shareholders’ ownership, in Regression 4,
we use piecewise linear splines from 0–5%, 5–25%, and
above 25%, and in Regression 5, we include (controlling
shareholders’ ownership)2 and (controlling shareholders’
ownership)3 as additional explanatory variables. In Regres-
sion 4, we find that the coefficient estimate on the above
25% variable is positive and significant while the coefficient
estimates on the 0–5% and 5–10% variables are positive but
insignificant. Thus, the positive effect of equity ownership by
controlling shareholders on firm value shown in Regressions
1 through 3 is particularly evident when ownership con-
centration is high. We also find that, in Regression 5, the
coefficient estimate on equity ownership by controlling
shareholders is positive and significant, but the coefficient
estimates on (controlling shareholders’ ownership)2 and
(controlling shareholders’ ownership)3 are not significant.
Therefore, unlike Joh (2003) who shows a nonlinear effect of
equity ownership by controlling shareholders on firm value,
during the crisis period, ownership concentration seems to
yield a linear effect on firm value.
Regressions 6 through 10 show the results for the
recovery period. The results for Regressions 6, 7, and 8
are remarkably similar to those for Regressions 4, 5, and 6
of Table 3. In particular, the coefficient estimates on equity
ownership by controlling shareholders are negative and
significant, affirming the expropriation incentives of con-
trolling shareholders during the recovery period discussed
 424
Table 4
Cross-sectional regression of holding period return (HPR) on expropriation, risk, overreaction, and firm characteristic variables.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. Equity ownership by controlling shareholders is the sum of equity ownerships by owner-managers and their family
members. Using two-year daily returns preceding each of the crisis and recovery period, we estimate beta by the slope of the market model regression and firm-specific risk as the standard deviation of residual
errors from the market model regression. Previous HPR are the holding period returns during the year of 1996 (for the shock period) and HPR during July 1997 to September 1998 (for the recovery period). Top
30 chaebol dummy is a dummy variable that equals one if the firm belongs to one of the 30 largest business groups in Korea. ADR dummy equals one if the firm is cross-listed in the US stock exchanges. We
measure Tobin’s q as the book value of debt plus market value of equity divided by total assets. Financial investment in affiliated (nonaffiliated) firms means financial securities invested in affiliated (non-
affiliated) firms. We measure cash flow as the sum of net income and depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable HPR (crisis period: 7/97–9/98) HPR (recovery period: 10/98–12/99)

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

nnn nnn nnn

Intercept  0.736  0.616  0.447  0.504  0.503 2.222  0.537 5.404 0.498 4.041
(  34.80) (  12.51) ( 0.18) ( 0.20) ( 0.20) (10.18) (  0.84) (0.21) (0.02) (0.18)

K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435

Equity ownership bycontrolling shareholders 0.231nnn 0.196nn 0.221nn 0.103n  0.045nnn  0.039nnn  0.046nnn  0.014nn
(2.86) (2.31) (1.99) (1.94) ( 5.20) ( 4.51) ( 3.75) (  2.20)
Equity ownership by controlling shareholders: 0 to 5% 0.020 0.038
(0.16) (0.76)
Equity ownership by controlling shareholders: 5 to 25% 0.074  0.094nn
(1.12) (  2.00)
Equity ownership by controlling shareholders: Above 25% 0.126nn  0.121nn
(2.01) (  2.53)
(Equity ownership by controlling shareholders)2  0.240 0.382
( 1.13) (1.26)
3
(Equity ownership by controlling shareholders) 0.164  0.039
(0.68) (  0.95)
Beta  0.093nn  0.050  0.042  0.046 1.298nn 1.704nn 1.266nn 1.294nn
(  2.45) (  1.03) ( 0.87) ( 0.94) (2.37) (2.40) (2.04) (2.08)
Firm-specific risk  0.354  0.142  0.126  0.091 0.633 2.089 1.152 0.963
( 0.88) ( 0.24) ( 0.21) ( 0.15) (0.66) (0.35) (0.22) (0.18)
Previous HPR  0.035n  0.046n  0.051nn  0.052nn  2.068nnn  2.176nnn  1.795nnn  1.844nnn
(  1.65) (  1.86) (  2.06) ( 2.10) ( 4.61) (  3.75) (  3.52) (  3.61)
Log (total assets)  0.478n  0.554nn  0.553nn  0.576 0.006 0.014
(  1.92) (  2.20) ( 2.19) ( 0.22) (0.11) (0.24)
Log (total assets)2 0.012n 0.013nn 0.013n 0.105  0.083  0.235
(1.81) (2.08) (2.07) (0.23) (  0.07) (  0.21)
Total debt/total assets  0.184nn  0.183nn  0.190nnn  0.400  0.157  0.231
(  2.46) (  2.46) ( 2.55) ( 0.47) (  0.21) (  0.31)
Top 30 chaebol dummy 0.106nnn 0.108nnn 0.112nnn 0.148 0.161 0.212
(2.82) (2.88) (2.95) (0.34) (0.42) (0.55)
Equity ownership by foreign investors 0.335n 0.305 0.278 0.035 0.031 0.031
(1.67) (1.49) (1.36) (1.52) (1.56) (1.58)
Equity ownership by affiliated firms 0.117 0.191 0.209  0.003  0.091  0.113
(0.93) (1.47) (1.57) ( 0.26) (  0.85) (  1.04)
ADR dummy 0.171n 0.166n 0.166n 0.351 0.328 0.237
(1.77) (1.72) (1.72) (0.34) (0.36) (0.26)
Financial investment in affiliated firms/total assets  0.161  0.166  0.170  3.973nn  3.144n  3.480nn
(  1.06) (  1.10) ( 1.12) ( 2.08) (  1.90) (  2.09)
Financial investment in nonaffiliated firms/total assets  0.088  0.067  0.052 6.274nnn 4.563nn 4.861nn
( 0.52) ( 0.40) ( 0.31) (2.60) (2.16) (2.30)
Tobin’s q  0.009  0.008  0.008  0.149 0.001 0.065
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435 425

in Section 2. We also find that the coefficient estimates on

 0.149

both the above 25% variable and equity ownership by

(  0.78)
(0.09)

0.093
3.69

432
Yes

controlling shareholders are negative and significant at the

0.05 level in Regressions 9 and 10, further supporting the
expropriation hypothesis. As in the crisis period, we find
no evidence of nonlinear relations between equity own-
0.098
 0.153
(0.01)

(  0.80)

3.56

432
Yes

ership by controlling shareholders and firm value during

the recovery period. Thus, our results suggest that own-
ership effects on firm value differ across the normal and
crisis/recovery periods.8
 0.468
( 0.18)

( 0.98)

0.093
3.61

432
Yes

One concern with our empirical results is that a few

large firms in the Korean equity market dominate other
firms in terms of market capitalization. For instance,
Samsung Electronics has often constituted as much as
14.12
0.090

20% of total equity market capitalization in Korea.

526

Although we control for any nonlinear effect of firm size

on HPR by including squared logarithm of total assets in
the regressions, to further mitigate the concern that our
results are mainly driven by a few extremely large firms,
27.07
0.048
534

we reestimate all regressions in the tables excluding the

ten largest firms from the sample. We also use weighted
least squares to estimate the regressions where the
weight is given by the relative market capitalization.
0.111
0.376
( 0.21)

(1.22)

3.80

432
Yes

Our key results are robust to these alternative tests.

Thus far, our findings indicate that the effects of
governance variables on firm value during the crisis and
recovery periods are opposite to each other. A natural
question that arises is, then, whether over the entire cycle,
0.114
0.342
(1.11)
( 0.20)

3.88

432
Yes

down and up, governance matters for firm value on net.

To address this issue, in untabulated tests, we compute
the holding period return over the entire cycle encom-
passing both the crisis and recovery periods, and we
0.104
0.358
( 0.22)

(1.17)

3.77

432
Yes

regress the computed return on governance variables

and other control variables as in Tables 3 and 4. We find
that neither the disparity variable nor the equity owner-
ship by controlling shareholders is significantly related to
0.023
4.31

the holding period return. This lack of an overall effect of

526

governance on firm value suggests that before the crisis

the stock prices are determined to give a similar expected
risk-adjusted return, irrespective of the strength of firms’
governance. Although firms with poorer governance suf-
0.014
8.20

534

fer more during the crisis period, they also perform better
during the subsequent recovery period. Thus, when one
considers both the crisis and recovery periods, stock
returns are not different across firms with different
governance. These findings help explain why firms with
weak governance are able to survive, together with those
with strong governance, and even predominate in emer-
ging markets.

8
Instead of using a top 30 chaebol dummy, Joh (2003) uses a top 70
chaebol dummy (a dummy that equals one if the firm belongs to one of
Cash flow/total assets

the 70 largest business groups and zero otherwise) in her regression

Industry dummies

analyses. To examine whether our results are robust to using a different

definition of business groups, we replace the top 30 chaebol dummy
Adjusted R2
Sample size

with the top 70 chaebol dummy and reestimate the regressions in

Table 4. In untabulated tests, we find that the coefficient estimates on
F-value

the top 70 chaebol dummy are positive and significant at the 0.10 level
in Regressions 3 through 5, but insignificant in Regressions 8 through 10.
These results are similar to those using a top 30 chaebol dummy.
426 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
5. Sensitivity tests
In this section, we perform various sensitivity checks
on our main results.
5.1. Alternative measures of corporate governance
To further investigate the existence of an expropriation
effect, we use various alternative measures of corporate
governance as explanatory variables. In Regressions 1 and 2
of Table 5, as a measure of good governance we use the sum
of block holdings by all shareholders who own 5% or more
of issued shares. Unlike small shareholders who like to free
ride the corporate governance activities of other share-
holders (Grossman and Hart, 1980), large shareholders have
strong incentives to monitor managerial performance and
take actions that enhance firm value (Shleifer and Vishny,
1986). To the extent that blockholders play an important
role in disciplining corporate managers, they reduce owner-
managers’ incentives to expropriate minority shareholders.
The results are consistent with the prediction of the
expropriation hypothesis. In Regression 1, which uses the
HPR during the shock period as the dependent variable,
the coefficient on block ownership is positive and sig-
nificant at the 0.01 level. In contrast, in Regression 2,
which uses the HPR during the recovery period as the
dependent variable, the coefficient on block ownership is
negative and significant at the 0.01 level.
In the next two regressions, we replace the sum of block
ownership by all shareholders with the largest managerial
block ownership and the largest nonmanagerial block own-
ership. We find that the results for largest managerial block
ownership are similar to those for the sum of block own-
ership by all shareholders. However, the coefficients on the
largest nonmanagerial block ownership are not significant.
In Regressions 5 and 8, we use the extent of a firm’s
diversification as our measure of corporate governance.
The results in Regressions 5 and 7 show that, during the
shock period, the interaction term between the diversifi-
cation dummy variable and the dummy variable indicat-
ing high variation in investment opportunity adversely
affects firm value. However, in Regressions 6 and 8, the
coefficient on this interaction term becomes positive and
significant during the recovery period. These results again
support the expropriation hypothesis.
5.2. Alternative choice of crisis and recovery periods
So far, our analysis has set the crisis period from July
1997 to September 1998 and the recovery period from
October 1998 to December 1999. Here, we examine if our
results are sensitive to the choice of alternative dates for
the crisis and recovery periods.
As an alternative crisis period, we assume that the crisis
started as early as January 1997 and ended in June 1998, and
as an alternative recovery period, we assume that the
reversal started in July 1998. Anecdotal evidence suggests
that some symptoms of crisis arose starting in early 1997. For
example, in January 1997, the Hanbo business group, one of
the fastest growing business groups in Korea, announced its
default, potentially triggering the financial crisis in the
Korean economy. We assume that the crisis ended in June
1998, because the stock market index reached its bottom of
404 in that month.
In untabulated tests, we find that when we use these
alternative periods of shock and recovery, the results are
remarkably similar to those in Table 3. In particular, the
coefficient estimates on the key expropriation variable and
their significance levels are almost the same in two tables.
For instance, the coefficient estimate on the logarithm of the
ratio of voting rights to cash flow rights and its t-statistic in
Regression 1 of Table 3 are  0.037 and  2.48, respectively.
The corresponding numbers for the same variable in unta-
bulated tests are 0.035 and  2.36, respectively. Other
regressions show similar results.
We also examine how long the upswing effects last by
extending the recovery period up to December 2000 (2001).
The results are reported in Table 6. When we redefine the
recovery period to be from October 1998 to December 2000
and reestimate the regressions in Table 3, we find that the
coefficient estimates on the logarithm of the ratio of voting
rights to cash flow rights remain positive and significant,
albeit smaller in magnitude as compared with those reported
in Table 3 (Regressions 1 through 3). When we further
extend the recovery period to the end of 2001, we again find
similar results as those in Table 3, although the statistical
significance of the coefficient estimate on the logarithm of
the ratio of voting rights to cash flow rights becomes much
weaker than that of the regressions in Table 3.
5.3. Effects of managerial expropriation on accounting
profitability
Increased (reduced) expropriation risk can affect firm
value through two channels: An increase (decrease) in risk
premium used in discounting future cash flows and a
decrease (increase) in future cash flows that are expected
to be distributed to investors. Here, we examine whether
poorly governed firms experience a decrease in cash flows
during the shock period and an increase in cash flows during
the recovery period. We use the changes in net income as our
proxy for the changes in cash flows. For the shock period, as
the dependent variable we use the ratio of the change in net
income from 1997 to 1998 to total assets in 1997. For the
recovery period, as the dependent variable we use the ratio of
the change in net income from 1998 to 1999 to total assets in
1998.9 Our independent variables are similar to those used in
Table 3.
9
As expected, the Pearson correlation analysis shows that our measures
for the changes in firm value during the crisis and recovery periods are
highly and significantly correlated with the changes in accounting perfor-
mance (untabulated). For example, HPR during the crisis period is positively
and significantly associated with the ratio of the change in net income from
1996 to 1997 to total assets in 1996 and the ratio of the change in net
income from 1997 to 1998 to total assets in 1997 (0.24 and 0.25,
respectively). The results using earnings before interest and taxes (EBIT)
and cash flow as alternative measures of accounting performance are similar
to those using net income (0.24 to 0.31). We also find that, albeit the relation
is somewhat weak, HPR during the recovery period is positively and
significantly related to the ratio of the change in net income from 1998 to
1999 to total assets in 1998 and the ratio of the change in net income from
1999 to 2000 to total assets in 1999 (0.09 and 0.08, respectively). Spearman
correlation analysis shows similar results.
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435 427

Table 5
Cross-sectional regression of holding period returns (HPR) on expropriation, risk, overreaction, and firm characteristic variables: using alternative
measures of ownership variables.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. The crisis period is from July 1997 to September 1998 and the
recovery period is from October 1998 to December 1999. Sum of block ownership is the sum of block holdings by all shareholders owning 5% or more of issued
shares. Largest managerial blockholder concentration refers to block holdings by owners involved with management, and largest nonmanagerial blockholder
concentration refers to block holdings by other largest shareholders. Cash flow rights of controlling shareholders are the sum of direct equity ownership and the
product of the ownership stakes obtained indirectly along the chain of a pyramid structure for controlling shareholders. Voting rights of controlling shareholders
are the sum of direct equity ownership and the minimum of the level of ownership in the pyramid structure. Equity ownership by controlling shareholders is the
sum of equity ownerships by owner-managers and their family members. Diversification dummy takes the value of zero if 90% or more of a firm’s sales come
from one three-digit Standard Industrial Classification. We classify firms as having high (low) variation if the standard deviation of the Tobin’s q ratios of matched
nondiversified firms for all segments of a diversified firm is above (below) the median for all diversified firms. Using two-year daily returns preceding the crisis
and recovery periods, we estimate beta by the slope of the market model regression and firm-specific risk as the standard deviation of residual errors from the
market model regression. Previous HPR are the holding period returns during the year of 1996 (for the shock period) and HPR during July 1997 to September 1998
(for the recovery period). Top 30 chaebol dummy is a dummy variable that equals one if the firm belongs to one of the 30 largest business groups in Korea. ADR
dummy equals one if the firm is cross-listed in the US stock exchanges. We measure Tobin’s q as the book value of debt plus market value of equity divided by
total assets. Financial investment in affiliated (nonaffiliated) firms means financial securities invested in affiliated (nonaffiliated) firms. We measure cash flow as
the sum of net income and depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable HPR HPR HPR HPR HPR HPR HPR HPR

(7/97– (10/98– (7/97– (10/98– (7/97– (10/98– (7/97– (10/98–
9/98) 12/99) 9/98) 12/99) 9/98) 12/99) 9/98) 12/99)
(1) (2) (3) (4) (5) (6) (7) (8)

Intercept  0.427 21.098  0.481 20.372  0.487 10.105  0.491 4.046

(  0.70) (0.80) (  0.91) (0.78) ( 0.95) (0.39) (  0.98) (0.19)
nnn nnn
Sum of block ownership by all shareholders 0.309  3.767
(2.76) (  3.18)
Largest managerial block ownership 0.501nnn  5.108nnn
(3.42) (  3.01)
Largest nonmanagerial block ownership 0.021  3.752
(0.07) (  1.29)
Log (voting right/cash flow right)  0.036n 1.019nnn
( 1.94) (3.73)
Equity ownership by controlling shareholders 0.197n  3.727nnn
(1.73) (  3.57)
Diversification  high variation  0.099nn 1.118nnn  0.099nn 0.635nn
( 2.34) (3.16) (  2.37) (2.02)
Diversification  low variation  0.025 0.325  0.022  0.017
( 0.80) (0.69) (  0.68) (  0.04)
Beta  0.027 1.481nn  0.046 1.617nn  0.054 1.716nn  0.054 1.382nn
(  0.55) (2.06) (  0.98) (2.29) ( 1.16) (2.46) (  1.10) (2.30)
Firm-specific risk  0.242 0.626  0.270 0.795  0.103 0.029  0.042 0.169
(  0.41) (0.11) (  0.46) (0.13) ( 0.18) (0.01) (  0.07) (0.03)
Previous HPR  0.044n  2.132nnn  0.045n  2.155nnn  0.046n  2.042nnn  0.047n  1.798nnn
( 1.78) (  3.68) (  1.81) (  3.73) ( 1.88) ( 3.55) (  1.89) (  3.75)
Log (total assets)  0.460n  2.092  0.512nn  2.012  0.513nn  1.121  0.529nn  0.430
( 1.80) (  0.79) (  2.01) (0.76) ( 2.01) (  0.43) (  2.10) (  0.20)
[Log (total assets)]2 0.011n 0.052 0.012n 0.049 0.012n 0.027 0.013nn 0.011
(1.70) (0.77) (1.90) (0.73) (1.90) (0.40) (2.00) (0.20)
Total debt/total assets  0.192nnn 0.444  0.185nn 0.474  0.225nnn 0.546  0.207nnn 0.236
( 2.58) (0.48) (  2.48) (0.56) ( 3.02) (0.66) (  2.76) (0.32)
Top 30 chaebol dummy 0.101nnn 0.181 0.109nnn 0.124 0.115nnn  0.290 0.096nnn 0.332
(2.70) (0.42) (2.94) (0.29) (3.05) (  0.65) (2.57) (0.89)
Equity ownership by foreign investors 0.291 0.038nnn 0.343 n
0.032 0.268 0.035 0.332 0.038nn
(1.43) (3.08) (1.69) (1.41) (1.32) (1.57) (1.62) (1.98)
Equity ownership by affiliated firms 0.079  0.867
(0.62) (  0.86)
ADR dummy 0.160 0.364 0.168n 0.484 0.154 0.614 0.168n 0.105
(1.64) (0.35) (1.74) (0.46) (1.59) (0.60) (1.73) (0.12)
Financial investment in affiliated firms/total assets  0.168  2.020  0.113  2.179  0.133  2.013  0.156  3.536nn
( 1.09) (  1.07) (  0.73) (  1.14) ( 0.86) ( 1.08) (  1.03) (  2.22)
Financial investment in nonaffiliated firms/total assets  0.063 4.515n  0.052 4.332n  0.044 2.898  0.067 5.143nnn
(  0.38) (1.88) (  0.31) (1.79) ( 0.26) (1.21) (  0.40) (2.65)
Tobin’s q  0.007  1.120  0.006  1.185 0.023  0.971 0.016 0.055
(  0.18) (  1.37) (  0.16) (  1.45) (0.54) ( 1.19) (0.38) (0.08)
Cash flow/total assets 0.281  1.132 0.323  1.514 0.395  1.722 0.374  0.108
(0.91) (0.52) (1.05) ( 0.70) (1.29) (  0.80) (1.21) (  0.80)
Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes
F-value 3.96 3.18 4.07 2.97 3.84 3.74 3.69 3.75
2
Adjusted R 0.113 0.081 0.122 0.078 0.114 0.105 0.112 0.106
Sample size 420 420 420 420 420 420 420 420
428 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435

Table 6
Cross-sectional regression of holding period returns (HPR) on expropriation, risk, overreaction, and firm characteristic variables: using alternative
definitions of recovery period.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. Cash flow rights of controlling shareholders are the sum
of direct equity ownership and the product of the ownership stakes obtained indirectly along the chain of a pyramid structure for controlling
shareholders. Voting rights of controlling shareholders are the sum of direct equity ownership and the minimum of the level of ownership in the pyramid
structure. Using two-year daily returns preceding the crisis and recovery periods, we estimate beta by the slope of the market model regression and firm-
specific risk as the standard deviation of residual errors from the market model regression. Previous HPR are the holding period returns during the year of
1996 (for the shock period) and HPR during July 1997 to September 1998 (for the recovery period). Top 30 chaebol dummy is a dummy variable that
equals one if the firm belongs to one of the 30 largest business groups in Korea. ADR dummy equals one if the firm is cross-listed in the US stock
exchanges. We measure Tobin’s q as the book value of debt plus market value of equity divided by total assets. Financial investment in affiliated
(nonaffiliated) firms means financial securities invested in affiliated (nonaffiliated) firms. We measure cash flow as the sum of net income and
depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable HPR (recovery period: 10/98–12/2000) HPR (recovery period: 10/98–12/2001)

(1) (2) (3) (4) (5) (6)

Intercept 0.232nnn 0.333nn 0.121 0.361nnn 0.388n 0.241

(7.16) (2.11) (0.02) (8.91) (1.90) (0.52)
Log (voting right/cash flow right) 0.111nn 0.123nnn 0.196nn 0.125nn 0.136nn 0.133n
(2.30) (2.64) (2.51) (2.08) (2.27) (1.69)
Beta  0.171 0.190  0.145 0.027
(  1.35) (1.35) (  0.88) (0.11)
Firm-specific risk  1.486  1.185  1.382  1.988
(  0.25) (  1.32) (  1.16) (  1.32)
Previous HPR  0.189n  0.349nn  0.259n  0.042
(  1.80) (  1.99) (  1.92) ( 0.20)
Log (total assets) 0.045  0.023
(0.09) ( 0.52)
[Log (total assets)]2  0.002 0.019
( 0.17) (0.08)
Total debt/total assets 0.215 0.552nn
(1.28) (2.46)
Top 30 chaebol dummy 0.005  0.037
(0.05) ( 0.35)
Equity ownership by foreign investors 0.009n 0.032nn
(1.94) (2.36)
ADR dummy 0.141 0.777
(0.67) (1.57)
Financial investment in affiliated firms/total assets  0.653n  0.966
(  1.72) (  1.63)
Financial investment in nonaffiliated firms/total assets 0.284 1.092nn
(0.59) (2.38)
Tobin’s q 0.015 0.045
(0.09) (0.42)
Cash flow/total assets  0.412  0.207
( 0.93) ( 0.42)
Industry dummies Yes Yes
F-value 5.27 3.42 3.49 4.32 2.69 2.90
Adjusted R2 0.008 0.019 0.085 0.006 0.014 0.027
Sample size 534 526 432 534 526 432

We report the results in Table 7. Regressions 1 through 4
use the change in net income during the shock period as the
dependent variable. In Regression 1, we use the disparity
variable as an explanatory variable. The coefficient estimate
on the disparity variable is negative and significant at the
0.05 level. Regression 2 adds various control variables used in
Table 3. Adding the control variables does not change the
results. The results for the regression estimates of the
leverage variables and the dummy for the top 30 chaebol
are remarkably similar to those shown in Regression 3 of
Table 3, in which we use HPR during the shock period as the
dependent variable. These results are consistent with those of
Joh (2003).
In Regressions 3 and 4 we replace the disparity vari-
able with equity ownership by controlling shareholders.
The coefficient estimates on equity ownership by control-
ling shareholders are positive and significant.
Regressions 5 through 8 use the change in net income
during the recovery period as the dependent variable. In
Regressions 5 and 6, we find that the coefficient estimates
on the disparity variable are positive and significant at the
0.01 level. In Regressions 7 and 8, we find negative and
significant estimates on equity ownership by controlling
shareholders.
These results are consistent with the predictions of the
model developed in Section 2. The results also suggest
that the expropriation of minority shareholders is the key
factor that determines the link between corporate gov-
ernance and firm value.
5.4. Endogenous issue and event study
The advantage of focusing on a crisis period is that it
allows us to examine unambiguously the effect of
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435 429

corporate governance on firm value. In other words,
because the Asian financial crisis represents an exogenous
shock to the economy, we can largely eliminate any
spurious causality due to the endogeneity problem. In
the context of our model, the exogenous shock ensures
that the managerial equity ownership (a) and expropria-
tion power (m) are independent of the profitability of firm
investment.
However, the effect of corporate governance on firm
value during the recovery period is not free from the
endogeneity problem. For example, it could be that firms
adapt their governance structures in such a way that they
fit better in a recovering economy. That is, if managers are
able to correctly anticipate when recovery will start, they
could try to increase their ability to raise future capital
through increasing a and relinquish some of their expro-
priation power m by adopting more stringent governance
rules. Should that be the case, our model predications
would no longer apply, as variables a and m are deter-
mined in part by the profitability of investment during the
recovery period. Consequently, our findings that poorly
governed firms experience larger increase in their share
values during the recovery period could be subject to
interpretations other than the expropriation hypothesis.
To address the possible endogeneity issue, we consider
other exogenous events during the 1997–1998 period and
examine the relation between the change in firm value due
to such events and a set of governance variables at the fiscal
year-end that immediately precedes the announcement
date of events. For the 1997–1998 period, we select ten
bad news events that signal deteriorating future investment
opportunities in the economy, events that are likely to
provide controlling shareholders strong incentives to expro-
priate. These events include a downgrade of the sovereign
rating of Korea by Moody’s or other rating agencies, the
nationalization of troubled commercial banks by the Korean
government, chaebol bankruptcy, and Russian default on
government bonds. We also select eight good news events
that are associated with brighter prospects for future
investment opportunities, events that are likely to reduce

Table 7
Cross-sectional regression of change in net income on expropriation, risk, overreaction, and firm characteristic variables.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. Cash flow rights of controlling shareholders are the sum
of direct equity ownership and the product of the ownership stakes obtained indirectly along the chain of a pyramid structure for controlling
shareholders. Voting rights of controlling shareholders are the sum of direct equity ownership and the minimum of the level of ownership in the pyramid
structure. Equity ownership by controlling shareholders is the sum of equity ownerships by owner-managers and their family members. Top 30 chaebol
dummy is a dummy variable that equals one if the firm belongs to one of the 30 largest business groups in Korea. ADR dummy equals one if the firm is
cross-listed in the US stock exchanges. We measure Tobin’s q as the book value of debt plus market value of equity divided by total assets. Financial
investment in affiliated (nonaffiliated) firms means financial securities invested in affiliated (nonaffiliated) firms. We measure cash flow as the sum of net
income and depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable Change in net income from 1997 to 1998/total Change in net income from 1998 to 2000/total
assets in 1997 assets in 1998

(1) (2) (3) (4) (5) (6) (7) (8)

Intercept  0.041 4.627  0.175nnn 4.862 0.074nnn  6.053n 0.176nnn  5.700n

( 1.53) (1.26) (  4.24) (1.33) (3.67) ( 1.81) (5.52) (  1.69)
Log (voting right/cash flow right)  0.097nn  0.113nnn 0.116nnn 0.126nnn
( 2.28) (  2.85) (3.59) (3.31)
Equity ownership by controlling shareholders 0.511nn 0.539nnn  0.330nnn  0.410nn
(3.16) (3.27) (  2.64) (  2.50)
Log (total asset)  0.429  0.468 0.600n 0.574n
(  1.14) ( 1.24) (1.76) (1.67)
[Log (total assets)]2 0.011 0.012  0.015n  0.015n
(1.11) (1.21) ( 1.79) (  1.70)
nnn
Total debt/total assets  0.376  0.372nnn 0.453nnn 0.416nnn
(  2.75) ( 2.73) (3.92) (3.55)
Top 30 chaebol dummy 0.188nnn 0.134nn  0.116n  0.058
(3.02) (2.25) ( 1.93) (  0.99)
Equity ownership by foreign investors 0.361 0.428  0.159  0.196
(1.14) (1.36) (  0.53) (  0.64)
Equity ownership by affiliated firms 0.325n  0.113
(1.76) (  0.72)
ADR dummy 0.098 0.065 0.219 0.164
(0.62) (0.42) (1.52) (1.13)
Financial investment in affiliated firms/total assets 0.228 0.260  0.443  0.475n
(0.87) (0.99) ( 1.61) (  1.71)
Financial investment in nonaffiliated firms/total asset  1.878nnn  1.919nnn 2.724nnn 2.887nnn
(  3.26) ( 3.34) (4.53) (4.79)
Tobin’s q  0.058  0.088 0.020 0.044
( 0.93) ( 1.40) (0.19) (0.41)
n
Cash flow/total assets 0.846 0.838n  0.656nn  0.653nn
(1.74) (1.72) ( 2.13) (  2.11)
Industry dummies Yes Yes Yes Yes
F-value 5.20 3.54 10.02 3.50 12.87 6.12 9.43 5.29
Adjusted R2 0.008 0.081 0.028 0.085 0.023 0.142 0.016 0.130
Sample size 498 405 498 405 498 405 498 405
430 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435

Table 8
Fixed effect regression of cumulative abnormal return (CAR) on expropriation, risk, overreaction, and firm characteristic variables.
The sample contains nonfinancial firms listed on the Korea Stock Exchange during 1997–1998. For the period of 1997–1998, we select ten bad news
events that signal deteriorating investment opportunities in the future economy and eight good news events that are associated with brighter prospect for
future investment opportunities as the sample events. See the appendix for the list of these events. We compute the abnormal announcement return by
estimating the market model. We use the KOSPI (Korea Composite Stock Price Index) return as the benchmark. We estimate the market model by using two
hundred trading days of return data ending 20 days before the event announcement. Then, we collect the daily abnormal returns to get the cumulative
abnormal return from day  5 before the announcement date to day þ 5 after the announcement date. We compute the CAR ( 5, 5) for each news event
and for each sample firm. We then pool all CARs across firms and events. The regression includes a dummy variable for each event. We use firm
characteristics and governance variables at the fiscal year-end of 1996 (1997) for the events taking place during 1997 (1998). Cash flow rights of controlling
shareholders are the sum of direct equity ownership and the product of the ownership stakes obtained indirectly along the chain of a pyramid structure for
controlling shareholders. Voting rights of controlling shareholders are the sum of direct equity ownership and the minimum of the level of ownership in the
pyramid structure. Equity ownership by controlling shareholders is the sum of equity ownerships by owner-managers and their family members. Sum of
block ownership is the sum of block holdings by all shareholders owning 5% or more of issued shares. Largest managerial blockholder concentration refers to
block holdings by owners involved with management, and largest nonmanagerial blockholder concentration refers to block holdings by other largest
shareholders. Top 30 chaebol dummy is a dummy variable that equals one if the firm belongs to one of the 30 largest business groups in Korea. ADR dummy
equals one if the firm is cross-listed in the US stock exchanges. We measure Tobin’s q as the book value of debt plus market value of equity divided by total
assets. Financial investment in affiliated (nonaffiliated) firms means financial securities invested in affiliated (nonaffiliated) firms. We measure cash flow as
the sum of net income and depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable CAR ( 5, 5) for bad news events CAR ( 5, 5) for good news events

(1) (2) (3) (4) (5) (6) (7) (8)

Intercept  0.036  0.065  0.054  0.055 0.157n 0.127n 0.136n 0.149n

( 0.49) ( 0.89) ( 0.74) ( 0.74) (1.93) (1.65) (1.77) (1.91)
nnn
Log (voting right/cash flow right)  0.016 0.006
( 3.88) (1.56)
Equity ownership by controlling shareholders 0.060nnn  0.062nnn
(2.67) (  2.58)
Equity ownership by affiliated firms 0.044n  0.008
(1.88) ( 0.33)
Sum of block ownership by all shareholders 0.052nnn  0.038n
(2.71) (  1.92)
Largest managerial block ownership 0.075nn  0.076nn
(2.42) (  2.28)
Largest nonmanagerial block ownership 0.027  0.012
(0.98) (  0.39)
Beta  0.065nnn  0.058nnn  0.056nnn  0.060nnn 0.058nnn 0.060nnn 0.054nnn 0.057nnn
( 6.12) (  5.33) (  5.19) (  5.60) (4.47) (4.77) (4.30) (4.57)
Firm-specific risk  0.022  0.051 0.079  0.071  0.099  0.106  0.094  0.104
(0.19) ( 0.44) ( 0.68) (0.61) ( 0.79) ( 0.88) (  0.78) (  0.86)
nnn nnn nnn
Log (total asset) 0.011 0.010 0.010 0.010nnn  0.009nn  0.008nn  0.009nn  0.009nnn
(3.45) (2.96) (2.92) (3.04) (  2.49) (  2.31) (  2.53) (  2.68)
Total debt/total assets  0.114nnn  0.104nnn  0.101nnn  0.103nnn 0.028n 0.025n 0.031nn 0.032nn
( 8.26) (  7.60) (  7.41) (  7.63) (1.85) (1.68) (2.14) (2.21)
Top 30 chaebol dummy 0.032nnn 0.023nnn 0.019nn 0.023nnn  0.005  0.008  0.001  0.006
(3.92) (2.92) (2.52) (3.02) ( 0.60) ( 0.94) (  0.11) (  0.70)
Equity ownership by foreign investors 0.121nnn 0.172nnn 0.146nnn 0.156nnn  0.032  0.048  0.036  0.050
(3.15) (4.61) (3.98) (4.22) ( 0.72) (  1.19) (  0.92) (  1.27)
ADR dummy 0.020 0.039nn 0.039nn 0.037nn 0.037n 0.037nn 0.037nn 0.038nn
(1.07) (2.19) (2.24) (2.13) (1.77) (2.01) (2.03) (2.09)
Financial investment in affiliated firms/total assets  0.018  0.012  0.032  0.024  0.007 0.012 0.014 0.005
( 0.56) ( 0.37) (  1.01) ( 0.74) ( 0.19) (0.35) (0.39) (0.14)
nnn nnn nnn
Financial investment in nonaffiliated firms/total asset  0.101  0.116  0.116  0.119nnn  0.001  0.020  0.034  0.029
( 2.74) (  3.24) (  3.23) (  3.31) ( 0.02) ( 0.49) (  0.84) (  0.71)
Tobin’s q 0.028nnn 0.028nnn 0.023nn 0.026nnn 0.002 0.010 0.003 0.002
(2.83) (2.77) (2.39) (2.65) (0.14) (0.77) (0.28) (0.14)
Cash flow/total assets 0.083n 0.068 0.068 0.073  0.071  0.074  0.062  0.066
(1.76) (1.45) (1.46) (1.57) (  1.51) (  1.65) (  1.37) (  1.46)
F-test (p-value) for the hypothesis that all event 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
dummies estimates are zero
F-test (F-value) 191.72 188.77 189.29 189.20 33.84 33.18 32.58 32.69
Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes
F-value 77.93 74.76 77.96 74.31 12.41 12.13 12.19 11.76
Adjusted R2 0.276 0.270 0.271 0.270 0.064 0.061 0.059 0.059
Sample size 4,634 4,785 4,760 4,765 3,701 3,960 3,952 3,950

controlling shareholders’ incentives to expropriate. and abolition of restrictions on foreign direct equity
The good news events include an upgrade of the sovereign investment. The appendix describes all these events. To
rating of Korea by Moody’s or other rating agencies, the extent that investors are not able to forecast the
settlement of the negotiation on foreign debt payments, occurrence of these events, they represent exogenous
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
events. Thus, these events provide a natural experiment to
test the link between firm value and corporate governance
without involving the endogeneity issue.
To measure the announcement returns related to good
and bad news events, we compute the abnormal return by
estimating the market model. We use the KOSPI return as
the benchmark. We obtain our estimates of the market
model by using two hundred trading days of return data
ending 20 days before the event announcement. Then, we
sum the daily abnormal returns to get the cumulative
abnormal return (CAR) from day  5 before the announce-
ment date to day þ5 after the announcement date.
Table 8 shows the results for the fixed effect regression
of CARs (  5, 5) on governance and control variables. To
estimate the fixed effect regression, we first compute the
CARs for each news event and for each sample firm. We
then pool all CARs across firms and events. We use as
independent variables the firm characteristics and gov-
ernance variables at the fiscal year-end of 1996 (1997) for
the events that take place during 1997 (1998). Finally, we
add a dummy variable for each event, so that any
common movement in a sample firm’s CARs is captured
by the fixed effect. By testing the joint hypothesis that all
event dummies have zero coefficients, we should then
have a testable hypothesis that common movements
across firms on the same announcement date are statis-
tically significant.
Regressions 1–4 are for the bad news events and
Regressions 5–8 are for the good news events. In Regres-
sion 1, we examine the effect of a disparity variable on the
announcement returns. The coefficient estimate is nega-
tive and significant at the 0.01 level, consistent with the
expropriation arguments discussed in Section 2. In
Regression 2, we replace the disparity variable with
controlling shareholders’ equity ownership. The coeffi-
cient estimate is positive and significant at the 0.01 level.
In Regression 3, we use the sum of block ownership by all
shareholders as a measure of corporate governance. This
variable is again positively and significantly related to
CARs (  5, 5) at the 0.01 level. In Regression 4, we replace
the sum of block ownership with the largest managerial
block ownership and the largest nonmanagerial block
ownership. We find that only the coefficient on the largest
managerial block ownership is positive and significant at
the 0.05 level.
For the good news events in Regressions 5 through 8, we
find that the signs of the coefficient estimates on governance
variables are opposite to those in Regressions 1 through 4.
With the exception of the disparity variable in Regression 5,
which is not significant, the coefficient estimates on all other
governance variables are negative and significant.10
10
Among our exogenous events, some events could be more
exogenous than others. For instance, the Russian default appears to
satisfy the golden standard of exogeneity, as it would be almost
impossible for Korean firms to affect Russian government default. When
we examine the cross-sectional regression of CARs (  5, 5) associated
with this exogenous event only on governance variables, we find that
the CARs ( 5, 5) are negatively and insignificantly related to the
coefficient on ownership disparity. We find that the CARs (  5, 5) are
positively and significantly related to the coefficient on equity owner-
ship by controlling shareholders. When we use CARs (  1, 1) as the
431
Overall, our results in this section provide further
convincing evidence that controlling shareholders’ expro-
priation incentives imply a link between corporate gov-
ernance and firm value.
6. Out-of-sample tests
In this section we further check the robustness of the
results by conducting out-of-sample tests that use firms
in other Asian and Latin American countries.
6.1. Out-of-sample test using firms in other Asian countries
during and after the 1997 Asian financial crisis
We reestimate Tables 3 and 4 using 598 firms from seven
East Asian countries [Hong Kong (145 firms), Indonesia (65
firms), Malaysia (103 firms), Philippines (41 firms), Singapore
(109 firms), Taiwan (105 firms), and Thailand (35 firms)] that
are listed on the stock exchanges during the period from July
1997 to December 1999.
Our sample selection procedures are as follows. We
start with the list of firms analyzed in Claessens, Djankov,
and Lang (2000) and obtain data on the ownership
structures of these firms from the Journal of Financial
Economics website (http://jfe.rochester.edu/data.htm).
We then restrict our sample firms to those whose stock
returns data are available in the Datastream International.
Finally, we obtain financial data from Worldscope. This
selection procedure results in a final sample of 598 firms.
Table 9 shows the results from reestimating the regres-
sions in Table 3 using sample firms from the other seven East
Asian countries. The first three regressions show the impact
of ownership disparity on HPR during the shock period. In
Regression 1, we include as the explanatory variable the
logarithm of the ratio of voting rights to cash flow rights. The
regression controls for country and ten industry dummy
variables, but, for brevity, the estimates are not reported. The
coefficient estimate on the disparity variable is negative and
significant at the 0.05 level. In Regression 2, we add beta,
firm-specific risk, and previous HPR as explanatory variables.
The magnitude and significance level of the estimate on the
disparity variable drop a little, but the estimate is still
significant at the 0.05 level. In Regression 3, we add other
firm-specific variables, including log of total assets, squared
logarithm of total assets, leverage, Tobin’s q, and cash flow
over total assets. We find that the coefficient estimate on the
disparity variable is negative and significant at the 0.10 level.
These results are consistent with Prediction 1 of our model.
The next three regressions show the impact of ownership
disparity on firm value during the recovery period. In all
specifications, we find significantly positive estimates on the
disparity variable at the 0.01 level, supporting Prediction 2 of
our model. The adjusted R2s in Regressions 4, 5, and 6 are
higher than those in Regressions 1, 2, and 3, suggesting that
(footnote continued)
dependent variable, we find a significantly negative (positive) relation
between the CARs (  1, 1) and the disparity (equity ownership by
controlling shareholders) variable. We thank Jordan Siegel for suggesting
Russian government default as the strictly exogenous event.
432 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435

Table 9
Cross-sectional regression of holding period returns (HPR) on expropriation, risk, overreaction, and firm characteristic variables: out-of-sample tests
using firms in seven East Asian countries.
The sample contains nonfinancial firms in seven East Asian countries (Hong Kong, Indonesia, Malaysia, Philippines, Singapore, Taiwan, and Thailand)
that are listed in the stock exchanges during the period from July 1997 to December 1999. Stock return and financial data are obtained from Datastream
and Worldscope, respectively. Data on voting rights and cash flow rights of the largest shareholders are obtained from Claessens, Djankov, and Lang
(2000). Using two-year daily returns preceding the crisis and recovery periods, we estimate beta by the slope of the market model regression and firm-
specific risk as the standard deviation of residual errors from the market model regression. Previous HPR are the holding period returns during the year of
1996 (for the shock period) and HPR during July 1997 to September 1998 (for the recovery period). We measure Tobin’s q as the book value of debt plus
market value of equity divided by total assets. We measure cash flow as the sum of net income and depreciation. nnn, nn, and n denote significance of the
parameter estimates at the 0.01, 0.05, and 0.10 level, respectively.

Variable HPR (crisis period: 07/97–09/98) HPR (recovery period:10/98–12/99)

(1) (2) (3) (4) (5) (6)

Intercept  0.74nnn  0.58nnn  0.75nnn 0.67  1.22  0.91

(  4.26) ( 3.54) ( 3.23) (0.69) ( 1.29) (  0.49)
Log (voting right/cash flow right)  0.13nn  0.10nn  0.07n 1.07nnn 0.96nnn 1.24nnn
(  2.52) ( 2.21) ( 1.67) (3.74) (3.50) (3.91)
Beta  0.15nnn  0.11nnn 0.79nnn 0.53n
( 3.80) ( 3.02) (3.13) (1.67)
Firm-specific risk 0.00 0.00 0.22nnn 0.23nnn
(0.42) (0.09) (5.30) (3.19)
Previous HPR  0.02  0.02  0.82nnn  1.09nnn
( 1.10) ( 1.23) ( 3.43) ( 3.19)
Log (total assets) 0.03  0.55n
(0.84) ( 1.95)
[Log (total assets)]2  0.00 0.04nnn
( 0.37) (2.65)
Total debt/total assets  0.11  0.03
( 1.26) (  0.04)
Tobin’s q  0.00 0.07
( 0.06) (0.40)
Cash flow/total assets 0.71nnn 1.99nn
(3.38) (2.30)
Country dummies Yes Yes Yes Yes Yes Yes
Industry dummies Yes Yes Yes Yes Yes Yes
F-value 9.31 9.62 8.48 12.35 15.62 9.95
Adjusted R2 0.16 0.20 0.26 0.21 0.30 0.30
Sample size 598 585 478 598 585 469

Argentina Merval Stock Price Index

1,200

1,000

800

600

400

200

0
January June December June December June December
2001 2001 2001 2002 2002 2003 2003

Fig. 3. Changes in the Argentina Merval Stock Price Index from January 2001 to December 2003. Merval index is the most important index of the Buenos
Aires Stock Exchange and is a price-weighted index of a portfolio of stocks selected based on their market share, number of transactions, and
quotation price.
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435 433

Table 10
Cross-sectional regression of holding period returns (HPR) on expropriation, risk, overreaction, and firm characteristic variables: out-of-sample tests
using firms in four Latin American countries.
The sample contains nonfinancial firms in four Latin American countries (Argentina, Brazil, Chile, and Mexico) that are listed in the stock exchanges
during the period from January 2001 to July 2003. Stock return and financial data are obtained from Datastream and Worldscope, respectively. Data on
inside ownership (equity ownership held by officers, directors, and their immediate families) are obtained from Worldscope. Using two-year daily
returns preceding the crisis and recovery periods, we estimate beta by the slope of the market model regression and firm-specific risk as the standard
deviation of residual errors from the market model regression. Previous HPR are the holding period returns during the year of 2000 (for the shock period)
and HPR during August 2001 to July 2002 (for the recovery period). We measure Tobin’s q as the book value of debt plus market value of equity divided by
total assets. We measure cash flow as the sum of net income and depreciation. nnn, nn, and n denote significance of the parameter estimates at the 0.01,
0.05, and 0.10 level, respectively.

Variable HPR (crisis period: 01/01–07/02) HPR (recovery period: 08/02–07/03)

(1) (2) (3) (4) (5) (6)

Intercept 0.07  0.04  0.81 3.15nnn 4.32nnn 4.92nnn

(0.23) (  0.11) ( 1.34) (4.48) (4.29) (2.66)
Inside ownership 0.43nnn 0.56nnn 0.45nn  0.66nn  0.83n  0.79n
(3.16) (3.37) (2.59) (  1.99) (  1.86) (  1.66)
Beta  0.20nn  0.13 0.00 0.03
(  2.02) ( 1.21) (0.02) (0.11)
Firm-specific risk  0.02n  0.00 0.00  0.01
(  1.67) ( 0.24) (0.12) (  0.32)
Previous HPR 0.00 0.10  0.13  0.04
(0.04) (1.29) ( 0.69) (  0.21)
Log (total assets) 0.18n  0.10
(1.72) (  0.34)
[Log (total assets)]2  0.01 0.00
( 1.49) (0.08)
Total debt/total assets  0.01 0.02
( 0.44) (0.34)
Tobin’s q  0.01  0.04
( 0.68) (  1.32)
Cash flow/total assets 0.13nn  0.07
(2.06) (  1.21)
Country dummies Yes Yes Yes Yes Yes Yes
Industry dummies Yes Yes Yes Yes Yes Yes
F-value 3.04 3.13 3.03 6.29 5.35 3.92
Adjusted R2 0.07 0.12 0.15 0.16 0.23 0.22
Sample size 302 204 201 302 195 192

NPV of Investment.

the impact of ownership disparity on firm value is greater
during the recovery period than during the shock period.
While not reported, we reestimate the regressions in
Table 4 using our out-of-sample firms. Consistent with
the predictions of our model, we find that equity owner-
ship by the largest shareholder is positively related to the
HPR during the shock period and negatively related to the
HPR during the recovery period.
6.2. Out-of-sample test using firms in Latin American
countries during and after the 2002 Argentine currency crisis
To further test the prediction of our model, we experi-
ment with the Argentine currency crisis of 2002 using the
sample of Latin American firms. In 1991, the Argentine
government passed a convertibility law that linked the peso
to the US dollar at parity. The initial effects of this law on the
Argentine economy were positive, as Argentina’s chronic
inflation was curtailed and foreign investment poured in.
However, as the US dollar appreciated on the world market,
the Argentine peso became stronger as well, which hurt
Argentina’s export trade and caused a protracted economic
downturn with soaring inflation and increasing unemploy-
ment. The continued economic crisis led to the
abandonment of peso–dollar parity in January 2002, which
resulted in almost 40% devaluation of the peso.
Fig. 3 shows the changes in the Merval index (Argen-
tina’s main stock market index) from January 2001 to
December 2003. The Merval index is a price-weighted
index and is considered the most important index of the
Buenos Aires Stock Exchange. At the beginning of January
2001, the Merval index was 464. Although it went
through periods of ups and downs, it showed continuing
downward trends until reaching a low of 313 in June
2002. Since then, the Merval index continued to rise until
reaching its highest level of 1,102 in December 2003
during the past three years. This fluctuation in the Merval
index from 2001 to 2003 suggests that investors would
have realized holding period returns of almost 33% and
250%, respectively, during January 2001–June 2002 and
during July 2002–December 2003, if they had invested in
the market portfolio.
While its impact was not as pervasive as the Asian
financial crisis of 1997, the 2001 Argentine currency crisis
also affected many firms in several Latin American countries.
In particular, Brazil, an important trading partner of Argen-
tina, was severely hit by the crisis. The level of the Brazilian
stock index, BOVESPA, was 17,673 at the beginning of 2001
434 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
but became almost a half of that by September 2002. The
index bounced back to more than 22,000 by December 2003.
The fact that Argentina went through the cycle of economic
crisis and recovery during 2001–2003 and its crisis affected
other Latin American countries (particularly Brazil) makes
the Argentina’s economic crisis particularly suited to our
investigation of the expropriation hypothesis.
We select the sample of Latin American firms as
follows. We start with the list of all Latin American firms
covered in the Worldscope. We then restrict our sample
firms to those whose stock returns data are available in
the Datastream International. Finally, we require the
country to have at least ten firms available in both
Worldscope and Datastream International. This selection
procedure results in a final sample of 302 firms from
Argentina (10 firms), Brazil (185 firms), Chile (92 firms),
and Mexico (15 firms). Because inside ownership (equity
ownership held by officers, directors, and their immediate
families) is the only ownership variable available in
Worldscope, we use it as our main expropriation variable
in testing our model. We set the period from January 2001
to June 2002 as the crisis period and the period from July
2002 to December 2003 as the recovery period.
Table 10 shows the results from reestimating the
regressions in Table 3 using the sample of 302 Latin
American firms. The first three regressions show the
impact of inside ownership on HPR during the crisis
period. In Regression 1, we include only inside ownership
as the explanatory variable. The regression controls for
country and industry dummy variables. The coefficient
estimate on inside ownership is positive and significant at
the 0.01 level. In Regression 2, we add beta, firm-specific
risk, and previous HPR as explanatory variables. We lose
about one hundred sample firms due to lack of data.
Nevertheless, the magnitude and significance level of the
coefficient estimate on inside ownership remain
unchanged. In Regression 3, we add other firm-specific
variables. Because information on depreciation amount is
missing in Worldscope for many of our sample firms, we
are not able to calculate cash flow over total assets and
use it in Regression 3. Thus, to minimize the loss of
sample in estimating the regression, we replace cash flow
over total assets with return on assets. We find that the
coefficient estimate on the ownership variable is positive
and significant at the 0.05 level. These results are con-
sistent with Prediction 1 of our model.
The next three regressions show the impact of inside
ownership on firm value during the recovery period. In all
specifications, we find the significantly negative coeffi-
cient estimates on the ownership variable, which support
Prediction 2 of our model.
Overall, the results using out-of-sample firms provide
further evidence that expropriation risk is the main
channel through which corporate governance affects
firm value.
7. Summary and conclusions
In this paper, we use the experience of East Asian and
Latin American firms during the post-crisis recovery
period to examine the importance of managerial
expropriation in linking corporate governance and firm
value. We find that poorly governed firms, i.e., firms that
have
a high disparity between voting and cash flow rights,
those that have low equity ownership by controlling
shareholders, those that have low block ownership, and
those that are highly diversified, suffer more during the
crisis period but rebound more during the recovery
period. We also find that bad (good) news in the economy
affects firms with weak corporate governance more nega-
tively (positively) than those firms with good corporate
governance. These results support the expropriation
hypothesis.
We also find results that are somewhat consistent with
the explanations based on risk and overreaction. Stock
prices of high-beta firms perform worse during the crisis
period but rebound more during the recovery period.
Similarly, firms whose stock prices drop more during
the pre-crisis (crisis) period perform better during the
crisis (recovery) period, indicating that the contrarian
effects in stock returns play an important role in explain-
ing the cross-sectional variation in firm value during the
aftermath of the Asian financial crisis. However, control-
ling for beta and overreaction effects does not reduce the
importance of governance variables in explaining the
change in firm value.
Our results suggest that controlling shareholders’
incentives to expropriate minority shareholders are a
key factor that implies a link between corporate govern-
ance and firm value during the crisis period.
Appendix A
See Table A1.
Table A1
Major exogenous events in the Korean economy from January 1997 to
December 1998.
Announcement Description of events
date
Bad news
1997/01/23 Hanbo business group announces its default
1997/07/15 Kia business group files for bankruptcy
1997/10/25 S&P downgrades the sovereign rating of Korea
to A þ
1997/11/22 Korean government seeks a rescue package from
the IMF to control the financial crisis
1997/12/09 Korean government announces the nationalization
of the Korea First Bank and the Seoul Bank
1998/03/06 Moody’s downgrades the sovereign rating of Korea
1998/04/04 Moody’s downgrades the sovereign rating of Japan
1998/05/12 Moody’s downgrades credit ratings of 19
commercial banks
1998/08/18 Russia defaults on government bonds
1998/10/13 Moody’s warns of possible downgrades of the
sovereign rating of Korea
Good news
1997/03/25 OECD updates the sovereign rating of Korea
1997/12/25 IMF and G-7 countries make US$10 billion
available to Korea
1998/01/28 Negotiations on foreign debt payments are settled
 K.-H. Bae et al. / Journal of Financial Economics 105 (2012) 412–435
Table A1 (continued )
Announcement Description of events
date
1998/02/17 S&P upgrades the sovereign rating of Korea by
three levels
1998/03/28 Moody’s upgrades the sovereign rating of Korea to
‘‘stable’’
1998/05/16 Restrictions on foreign direct equity investment
are abolished
1998/10/19 S&P upgrades the sovereign rating of Korea to
‘‘stable’’
1998/12/05 Moody’s upgrades the rating of Korea government
bond denominated in Korean won
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