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Corporate Governance and Firm Value: The Case of Venezuela

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DOI: 10.1111/j.1467-8683.2008.00680.x · Source: RePEc

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194 CORPORATE GOVERNANCE

Corporate Governance and Firm Value:

The Case of Venezuela
Urbi Garay and Maximiliano González*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: We examine the relationship between corporate governance and firm value, and evaluate the
relatively understudied governance practices in Venezuela.
Research Findings/Results: We construct a corporate governance index (CGI) for publicly-listed firms that is free of
self-selection and self-reported bias and find that its mean value is below the emerging market average in general, and
below the Latin American average in particular. This weak investor protection environment makes Venezuela a good setting
to study how corporate governance practices affect firm value. We show that an increase of 1 per cent in the CGI results in
an average increase of 11.3 per cent in dividend payouts, 9.9 per cent in price-to-book, and 2.7 per cent in Tobin’s Q. These
findings are robust after considering the potential endogeneity of our regression variables.
Theoretical Implications: Results contrast to those reported in the US due to the higher interfirm variations in CGI. Our
findings are consistent with the theoretical models that relate good corporate governance practices to higher investor
confidence, and with the agency model of dividend payout. Furthermore, we conjecture that our results are generalizable
mainly to other countries where investor protection is low.
Practical Implications: Two direct insights to policy makers and practitioners follow from our analysis: first, managers in
weak investor protection environments could differentiate their firms adopting corporate policies to improve their gover-
nance structure; and second, our measure of governance practices gives investors a quantitative tool to better assess
Venezuelan firms.

Keywords: Corporate governance rating/index, corporate performance, South America

INTRODUCTION initiatives will depend on the real impact that they may have
on the financial performance and market valuation of the

M ore companies in a growing number of countries are

increasingly attempting to adopt better corporate
governance practices. In the case of Latin America, the
Andean Development Corporation (Corporación Andina de
Fomento – CAF) recently presented an outline for a corporate
governance Andean Code (CAF, 2005). Furthermore, the
larger companies of the region, especially those that belong
to the financial sector, are in the process of adopting other
international codes of best corporate governance practices,
such as the Sarbanes-Oxley Act and the Principles of
Corporate Governance developed by the Organization for
Economic Co-operation and Development (OECD, 1999). It
is not difficult to predict that the success or failure of these
* Address for correspondence: Suite 11629, 6910 N.W. 50 Street, Miami, FL/33166. Tel:
571339 4999 (ext. 3369); Email: mgf@adm.uniandes.edu.co
companies that adopt them.
La Porta, López-de-Silanes, Shleifer and Vishny (1997,
1998, 2000a) show that the legal framework that firms and
investors face differs significantly around the world, in
part, because of differences in legal origin. They argue that
investors are less protected in French Civil Law countries,
compared with countries from the Common Law origin.
All countries in Latin America have the same legal origin,
which is French Civil Law. They also find that Latin
American countries perform even worse than the average
French Civil Law countries in terms of investor rights, and
argue that this helps explain the low level of financial
development and the small size of stock exchanges of these
countries. Chong and López-de-Silanes (2007) confirm
these findings for a more recent period. Furthermore,
according to Djankov, La Porta, López-de-Silanes and

© 2008 The Authors

Volume 16 Number 3 May 2008 Journal compilation © 2008 Blackwell Publishing Ltd
doi:10.1111/j.1467-8683.2008.00680.x
Electronic copy available at: http://ssrn.com/abstract=1755611
CORPORATE GOVERNANCE AND FIRM VALUE
Shleifer (2008) Venezuela exhibits one of the worst scores
in terms of investor protection.
The weak investor protection inherent in many Latin
American countries offers an opportunity for firms to dif-
ferentiate themselves from the rest and to send strong and
credible signals to attract investors by self-adopting good
corporate governance practices and policies, thus partially
compensating investors for the weak legal environment
in which these firms operate. Klapper and Love (2004)
and Durnev and Kim (2005) show that corporate gover-
nance provisions matter more in countries with weak legal
protection.
We know relatively little about the potential impact that
the adoption of corporate governance practices may have on
company value in Latin America (see Chong and López-de-
Silanes, 2007, for a recent review of this evidence). Measur-
ing this effect is important for the region because the success
or failure of implementing good corporate governance prac-
tices may be greater if the market rewards those companies
that adopt them. In the case of the US, the empirical evi-
dence shows either no effect or an economically small effect.1
Black (2001) argues that perhaps these weak results in the
US arise because the variation in firm governance is small
given that the minimum quality of corporate governance,
which is set by law and by norms, is very high in that
country. On the other hand, interfirm governance variation is
found to be much larger in Venezuela. This should not come
as a surprise, as a country with weaker laws and norms
offers a wider range for governance differences between
firms and, therefore, the potential for stronger results on
the effects of governance on firm value. Furthermore, even
though Venezuela is the fourth largest economy in Latin
America (after Brazil, Mexico, and Argentina), relatively
little is known about corporate governance practices in this
country. In sum, Venezuela represents a very strong case
study.
We evaluate the current state of corporate governance
practices in Venezuela by constructing a corporate gover-
nance index (CGI) for all firms listed in the Caracas Stock
Exchange (CSE) as of the end of 2004 and comparing the
results to other emerging and Latin American countries.
We then evaluate whether firm dividend payout policies,
price-to-book multiple, and Tobin’s Q (TQ) are related to our
CGI. By undertaking a single country-study approach, we
attempt to perform a straightforward empirical test that has
the advantage of avoiding some of the potential econometric
problems involved in cross-country studies such as the
omitted variable bias and the usually high across-firm
heterogeneity.
In general, we find a positive and strong relation between
our index of corporate governance and the payout ratio,
price-to-book multiple, and TQ for firms in Venezuela. From
the composition of the index, we find that the subindexes on
ethics and conflicts of interest, composition and perfor-
mance of the board of directors, and shareholders’ rights
explain much of the cross-sectional difference in payout
ratio; on the other hand, the subindex regarding ethics and
conflicts of interest can explain much of the results when
price-to-book and TQ are used as dependent variables.
These results add to the growing literature that supports
the idea that in countries with relatively low investor pro-
© 2008 The Authors
Journal compilation © 2008 Blackwell Publishing Ltd
Electronic copy available at: http://ssrn.com/abstract=1755611
195
tection, good corporate governance practices and policies
could be used as an efficient mechanism for firms that want
to distinguish themselves to attract investors. Although our
results are tentative given the small size of the CSE, they
passed a series of robustness checks that attempted to tackle,
among other potential problems, the issue of endogeneity, a
common concern found in this literature.
Our paper is similar to Black (2001) and Judge, Naoumova
and Koutzevol (2003) who tested the relation between cor-
porate governance and firm value in Russia, a transition
economy characterized by weak investor protection. Both
papers have a small sample and Russia, like Venezuela, is
also a country that scores low in terms of investor protection
and exhibits a high interfirm variation in corporate
governance practices. Our paper is also related to recent
country studies done in Latin America2 and especially with
Garay and González (2005), who also studied the case of
Venezuela.
The evidence reported in this paper is important not only
for Venezuela but also for other emerging markets in the
process of attempting to improve their corporate governance
practices. The evidence we show here adds to the growing
literature worldwide that indicates that firms can differenti-
ate themselves by adopting better corporate governance
practices and policies. That is, even in a weak investor pro-
tection environment, firms can increase their market value
by adopting good corporate governance measures.
The rest of the paper is organized as follows: first, we
review the growing literature on corporate governance and
market valuation, concentrating on recent papers that are
based on Latin America. Second, we construct a CGI for
Venezuela and compare it with other emerging economies
and, more importantly, to other Latin American countries.
Third, we present the data and conduct our econometric
analysis testing the relation between a firm’s dividend
payout ratio, price-to-book, and TQ, and our CGI. Fourth,
we perform a number of robustness checks to our main
findings. In the last section we present the conclusions and
policy recommendations, as well as its potential practical
applications and suggestions for future studies.
LITERATURE REVIEW
Many definitions of corporate governance stress the poten-
tial conflicts of interest between insiders (managers, boards
of directors, and majority shareholders) and outsiders
(minority shareholders and creditors) of the company. The
set of internal and external mechanisms to balance these
conflicts of interest is what it is usually known as corporate
governance.
The effect that a set of good corporate governance prac-
tices may have on firm’s value is, however, an empirical
question. Recently, different studies, trying to measure
quantitatively the quality of corporate governance, have
created indexes based on legal, accounting, and firm-level
financial information. Gompers, Ishii and Metrick (2003)
construct a CGI based on 24 governance rules for 1,500
large US firms, and show that firms with higher corporate
governance scores had higher firm value.
La Porta et al. (1997) study a sample of 49 countries and
conclude that countries with legal systems based on Civil
Volume 16 Number 3 May 2008
196
Law, especially the French legal system, provide less pro-
tection to investors and have less developed capital
markets, particularly when compared with countries from
the Common Law origin. These authors also conclude that
dividend policy constitutes an essential tool to reduce
agency conflicts to minority investors.3
These findings are consistent with the theoretical model
presented in La Porta, López-de-Silanes, Shleifer and
Vishny, (2002), where the positive effects of good corporate
governance practices on firm valuation are explained by
higher investor confidence. This situation lowers the cost of
capital and, ultimately, increases firm value. Also, these
results are consistent with the agency model of dividend
payout in the corporate governance framework developed in
La Porta, López-de-Silanes, Shleifer and Vishny (2000b).
Since the seminal empirical papers of La Porta et al.
(1997, 1998, 2000a) showing that laws that protect investors
differ significantly across countries, in part because of dif-
ferences in legal origin, the academic focus has shifted to
study corporate governance in the international setting.4
Klapper and Love (2004) was among the first and more
comprehensive papers focusing on corporate governance in
emerging markets. Using firm-level evidence on corporate
governance practices for 495 companies from 25 emerging
markets, they show that better corporate governance is
highly correlated with better operating performance and
market valuation.
Many country-studies have used a methodology that is
very similar to that of Klapper and Love (2004). For example,
Black, Jang and Kim (2006a) constructed a CGI for South
Korea; and Black (2001) and Black, Love and Rachinsky
(2006b) both studied how their CGI affects firm value in
Russia. The empirical evidence for Latin America has also
grown rapidly in recent years. Leal and Carvalhal-da-Silva
(2005) studied Brazil, Chong and López-de-Silanes (2006)
studied Mexico, Lefort and Walker (2005) studied Chile,
and Garay and González (2005) studied Venezuela. All these
papers show that, on average, a good set of corporate gover-
nance practices and policies is positively related to firm value.
These findings in Latin America are especially important
because the weak investor protection inherent in this region
offers an opportunity for firms to differentiate themselves
to attract investors by self-adopting good corporate gover-
nance practices. Easterbrook and Fischer (1991) argue that
firms themselves, when it is optimal to do so, could offer
private contracts with better terms than can be offered by the
rigid legal system. In the same manner, Diamond (1989,
1991) presents a theoretical discussion of the effects of a
firm’s reputation on its access to external financing, and
Coffee (1999) argues for a “global convergence” in corporate
governance that is independent of the local legal environ-
ment. Empirically, Klapper and Love (2004) and Durnev and
Kim (2005) find that corporate governance practices play a
more important role in countries where legal protection
is weak. That is, firm-level improvements in corporate
governance could, in some way, bypass the obstacles and
inefficiencies of a country’s legal system.
That makes Venezuela a good setting to corroborate the
effect good corporate governance practices have on firm
valuation, given the overall low scores this country exhibits
in terms of investors’ protection and the high interfirm
Volume 16 Number 3 May 2008
CORPORATE GOVERNANCE
variation in corporate governance practices observed in this
country. This suggests the following hypothesis:
Hypothesis 1: Better corporate governance practices will be
positively related to firm valuation in Venezuela.
This paper is similar to Garay and González (2005) because
both papers use firm-level data for Venezuelan listed firms.
However, the two papers differ in three important aspects.
First, we present a more detailed analysis of each of the
questions in our CGI and exclude all questions that are not
directly applicable to the Venezuelan market. In contrast,
Garay and González (2005) used a standard and more
general questionnaire that was very similar to the one used
by Klapper and Love (2004). Second, we answered the ques-
tions directly and therefore our paper is less likely to suffer
from self-selection and self-reported bias. Third, here we
have directly addressed the endogeneity issue, a typical
concern in this type of empirical analysis. Moreover, the
focus in Garay and González (2005) was not to test whether
corporate governance affects market valuation but if finan-
cial performance somehow affects CEO turnover.
Corporate Governance Index (CGI)
Most studies on firm-level evidence on corporate governance
practices gather their information using questionnaires filled
by the companies themselves. This methodology presents
various potential problems, among others: a low response
rate, especially from those companies whose corporate gov-
ernance practices are poor (self-selection bias); and, for the
firms that do respond to the questionnaire, there is a tendency
to present themselves not as they are at the moment when the
questionnaire is being completed, but as they want to see
themselves in the future (self-report bias). In our paper we
follow a different route to construct our CGI. In the same
spirit of Leal and Carvalhal-da-Silva (2005), we answer the
questions ourselves using publicly available information.
From Leal and Carvalhal-da-Silva (2005)’s 24 questions we
ended up with 17 questions that are applicable to the
Venezuelan setting.5 Each one of these 17 questions was
answered using publicly available information. We then
grouped the questions into four subindexes, namely: infor-
mation disclosure (five questions), composition and perfor-
mance of the board of directors (five questions), ethics and
conflicts of interest (three questions), and shareholders’
rights (four questions). We report our results for each sub-
index in Table 1 for the 46 companies listed in the CSE in the
year 2004.6
The disclosure subindex shows that only 19.6 per cent of
the firms disclose penalties against management in case of
deviating from the corporate governance policy; 82.6 per
cent report their audited financial statements on time; only
17.4 per cent use international accounting standards; 84.8
per cent hire internationally recognized auditors; and 50
per cent disclose information on managerial compensation.
The arithmetic mean for this subindex is 50.9 per cent.
According to the composition and performance of the
board of directors’ subindex, for 60.9 per cent of the firms in
the sample, the chairman of the board is also the CEO or
general manager; 56.5 per cent have monitoring committees;
© 2008 The Authors
Journal compilation © 2008 Blackwell Publishing Ltd
CORPORATE GOVERNANCE AND FIRM VALUE 197

TABLE 1
Corporate Governance Index (CGI)
These questions were answered by the authors for each of the 46 Venezuelan firms that were listed in the Caracas Stock
Exchange (BVC) in 2004 to determine for each firm its CGI. The answer to each question is either “Yes” or “No.” If the
answer is “Yes,” we add 1, and if the answer is “No,” we add 0. All answers are based on publicly available information. The
primary sources of information are firms’ financial statements, bylaws, minutes of meetings, and annual reports available at
the CNV. At the end of each question, there are remarks in italics on whether what is stated in the question is stipulated in
the Venezuelan Code of Commerce.

Arithmetic Affirmative
N Questions mean answers

SUBINDEX – DISCLOSURE 50.9%

1 Does the company indicate in its charter, annual reports, or in any other manner, the 19.6% 9/46
penalties against the management in case of breach of its desired corporate
governance practices? Required by Generally Accepted Auditing Standards.
2 Does the company present reports of its audited financial statements on time? Required 82.6% 38/46
by the CNV.
3 Does the company use international accounting standards? Required by Generally 17.4% 8/46
Accepted Auditing Standards.
4 Does the company use any recognized auditing firm? Required by the CNV and by 84.8% 39/46
Generally Accepted Auditing Standards.
5 Does the company disclose, in any form whatsoever, the compensation of the general 50.0% 23/46
manager and of the board of directors? Required by the CNV.
SUBINDEX – COMPOSITION AND PERFORMANCE OF THE BOARD OF DIRECTORS 54.4%
6 Are the chairman of the board of directors and the general manager two different 60.9% 28/46
people? Not required by any legal instrument.
7 Does the company have monitoring committees, such as appointment or compensation 56.5% 26/46
or auditing committees, or all of these? The auditing committee is established in the
Venezuelan Code of Commerce.
8 Is the board of directors clearly comprised of external directors and possibly independent 32.6% 15/46
ones? Stipulated in the Code of Commerce, but not limited to the fact that they be independent.
9 Is the board of directors comprised of five to nine members, as per recommendation 73.9% 34/46
of good international corporate governance practices? Not required by any legal
instrument or regulatory entity.
10 Is there a permanent auditing committee? Stipulated in the Code of Commerce. 47.8% 22/46
SUBINDEX – EHTICS AND CONFLICTS OF INTEREST 39.9%
11 Is the company free of any penalty or fine for breach of good corporate governance 82.6% 38/46
practices or of any rules of the CNV during the last year? CNV rules.
12 Taking into account the agreements among shareholders, are the controlling 30.4% 14/46
shareholders owners of less than 50% of the voting shares? Not established in any legal
instrument or by any regulatory entity.
13 Is the capital/voting rights ratio of controlling shareholders higher than 1? Not 6.5% 3/46
established in any legal instrument or by any regulatory entity.
SUBINDEX – SHAREHOLDERS’ RIGHTS 16.3%
14 Does the company charter or any other verifiable means facilitate the voting process of 28.3% 13/46
the shareholders beyond that established by law? Stipulated in the Code of Commerce.
15 Does the company charter guarantee additional voting rights to that established by law? 13.0% 6/46
Stipulated in the Code of Commerce.
16 Are there pyramidal structures that reduce concentration of control? Not established in 15.2% 7/46
any legal instrument or by any regulatory entity.
17 Are there agreements among shareholders that reduce concentration of control? Not 8.7% 4/46
established in any legal instrument or by any regulatory entity.
AVERAGE CGI (equally weighting the four subindexes) 40.3%

Source: Comisión Nacional de Valores (CNV), Código de Comercio, www.economatica.com. The questionnaire is adapted from Leal and
Carvalhal-da-Silva (2005) to the Venezuelan setting.

© 2008 The Authors Volume 16 Number 3 May 2008

Journal compilation © 2008 Blackwell Publishing Ltd
198
32.6 per cent have external directors7; 73.9 per cent have a
board composed of between 5 to 9 members; and 47.8 per
cent have a permanent audit committee. The arithmetic
mean for this subindex is 54.4 per cent.
The ethics and conflicts of interest’s subindex shows that
82.6 per cent of the companies are free from penalties or fines
on the part of the regulatory agency (the Comisión Nacional de
Valores); there exists a shareholder that controls less than 50
per cent of the firm’s shares in 30.4 per cent of the firms in
the sample; and in 6.5 per cent of the firms, the capital to
voting rights ratio of majority shareholders is higher than 1.
The arithmetic mean for this subindex is 39.9 per cent.
Finally, the shareholders’ rights subindex shows that only
28.3 per cent of the firms in the sample facilitate the voting
process beyond what is required by law; only 13.0 per cent
have voting rights beyond that required by law; only 15.2 per
cent do not exhibit a pyramidal structure that reduces the
concentration of control8; and 8.7 per cent report special
agreements among shareholders that reduce the concentra-
tion of control. The arithmetic mean for this subindex is a
very low 16.3 per cent.
Taking together these averages, we can conclude that only
around half of the firms in our sample comply with the
requirements of the disclosure of the composition and per-
formance of the board of directors and more work needs to
be done in terms of ethics and conflicts of interest, and,
especially, in terms of shareholders’ rights. At the firm level
the highest overall CGI was 71.7 per cent and the lowest
was 16.7 per cent. We found a much larger variation in
Venezuelan firms’ corporate governance practices when
compared with the US (results are not reported here). The
average CGI in the sample is a low 40.3 per cent.
In Table 2 Panel A we compare our CGI with the results
reported by Klapper and Love (2004) who analyzed 495
firms in 25 emerging countries,9 Lefort and Walker (2005)
who studied 181 firms in Chile, and Leal and Carvalhal-da-
Silva (2005) who studied 214 firms in Brazil. Table 2 shows
that Venezuela is 14 percentage points below the emerging
market average and 19 percentage points below Chile, which
is the leading country in Latin America in terms of financial
development and investor protection (Chong and López-de-
Silanes, 2007). The Venezuelan average is closer to the one
reported for Brazil.
In Panel B we summarize the results obtained for each
subindex and compare them with the results presented in
Garay and González (2005) and in Lefort and Walker (2005)
for Venezuela and Chile, respectively. Overall, the CGI we
obtained produces a score 14 percentage points below the
CGI reported by Garay and González (2005). As mentioned
before, this difference could represent an overestimation on
that paper due to the self-selection and self-reported bias
generated when firms’ executives completed the question-
naires. Only in the composition and performance of the board
of directors (Board) subindex do we find similar results.
We also include in this panel the score reported by Lefort
and Walker (2005) for Chile. The CGI for Chile is close to 20
percentage points higher than the CGI for Venezuela. Only
in the subindex of ethics and conflicts of interest (Ethics) are
the scores relatively close.
Finally, in Table 2 Panel C we show the correlation matrix
among the subindexes. As expected, all subindexes are posi-
Volume 16 Number 3 May 2008
CORPORATE GOVERNANCE
tively and significantly related to the overall CGI. Chong and
López-de-Silanes (2006) report a similar finding for Mexico,
even though their corporate governance components are not
exactly comparable to ours, and Leal and Carvalhal-da-Silva
(2005) do not provide a correlation matrix for Brazil. On the
other hand, each of our subindexes shows little correlation
with the other subindexes (none of the correlation coeffi-
cients are statistically different from zero). Interestingly, each
subindex seems to be taking into account a different dimen-
sion of the overall governance of the firm.
Overall, these results confirm that Venezuela represents a
good case study to test whether firms can somehow bypass a
poor investor protection environment by voluntarily adopt-
ing good corporate governance practices. A relatively high
CGI is an indicator that firms can use to attract investors. We
want to verify whether investors in Venezuela recognize this
signal by assigning a higher market valuation to such firms.
DATA
Having shown that Venezuela is a strong case study to test
whether corporate governance is related to firm valuation
and dividend payout, in this section we present the depen-
dent, independent, and control variables used to formally
test our hypothesis.
Dependent Variables
We use three alternative dependent variables to test our
hypothesis. First, we use the dividend payout ratio (DPR),
which is measured as the quotient between cash dividends
and net earnings. La Porta et al. (2000b) show that firms in
countries where investors are better protected exhibit higher
dividend payouts than firms in countries where investors
are poorly protected. On the other hand, Black et al. (2006a)
and Leal and Carvalhal-da-Silva (2005) do not find support
for this hypothesis in the cases of South Korea and Brazil,
respectively.
The second dependent variable is the price-to-book ratio
(price-to-book value or PBV), measured as the quotient
between per share market price and book value. The price-
to-book is a valuation measure that has been used in
corporate governance studies by authors such as Leal and
Carvalhal-da-Silva (2005) for Brazil. Finally, we use the TQ as
the third of our dependent variables. This variable was com-
puted as the market value of the firm’s assets (book value
of assets - book value of equity + market value of equity)
divided by the book value of assets. TQ can be considered
the classic valuation measure and has been used extensively
in the corporate governance literature (see, for instance,
Morck, Shleifer and Vishny, 1988; La Porta et al., 2002;
Gompers et al., 2003).
Information regarding each one of these variables
was obtained from the CSE Anuario (2004 – yearbook) and
corresponds to year-end values. Economatica’s database was
also used in some cases to confirm the validity of stock
market prices data.
Independent Variables
As we mentioned in the previous section, the CGI was
constructed based on 17 questions pertaining to different
© 2008 The Authors
Journal compilation © 2008 Blackwell Publishing Ltd
CORPORATE GOVERNANCE AND FIRM VALUE 199

TABLE 2
Comparative Analysis
In this table we compare our corporate governance index (CGI) to similar studies done in other emerging markets. Panel A
presents basic statistics comparing 25 different emerging markets (Klapper and Love, 2004) together with the CGI calculated
for Chile (Lefort and Walker, 2005) and Brazil (Leal and Carvalhal-da-Silva, 2005). Panel B divides the CGI into its four
subindexes and compares the values with a similar study for Venezuela (Garay and González, 2005) and Chile (Lefort and
Walker, 2005). Panel C shows the correlation matrix of each of the subindexes (p-values are reported below each correlation
coefficient).

Panel A: Comparative statistics for the Venezuelan CGI versus other emerging market studies

Leal and
Description This paper Klapper and Love (2004) Lefort and Walker (2005) Carvalhal-da-Silva (2005)

Mean 40.34 54.11 58.86 41.67

Median 40.47 54.97 NR 41.67
Standard deviation 12.11 14.00 NR 8.33
Minimum 16.67 11.77 NR 16.67
Maximum 71.67 92.77 NR 79.17
Country Venezuela 25 EM Chile Brazil
Observations 46 374 181 214

Source: The above-mentioned papers. All numbers (except the number of observations) are expressed in percentages.
EM = Emerging Markets; NR = not reported.

Panel B: Comparative subindex for the Venezuelan CGI versus other studies in Venezuela and in Chile

This paper (46 firms) Garay and González (2005) Lefort and Walker (2005)

Subindex Questions Score (%) Questions Score (%) Questions Score (%)
Ethics 3 39.9 7 46.0 7 37.6
Board 5 54.4 25 56.0 26 64.9
Shareholders 4 16.3 24 54.0 20 59.7
Disclosure 5 50.8 14 60.8 14 73.4
Overall CGI 17 40.3 70 54.3 67 58.9
Panel C: Subindex correlation matrix

CGI Disclosure Board Ethics Shareholders

CGI 1
Disclosure 0.41 1
0.02
Board of directors 0.75 0.29 1
0.00 0.10
Ethics and conflicts of interest 0.41 -0.12 0.12 1
0.02 0.56 0.53
Shareholders’ rights 0.34 -0.27 -0.18 0.09 1
0.05 0.13 0.31 0.64

corporate governance practices. We answered these ques-
tions for each of the 46 Venezuelan firms that were listed in
the CSE in 2004 to determine for each firm its CGI. The answer
to each question is either “Yes” or “No.” If the answer is
“Yes,” we add 1 and if the answer is “No,” we add 0. All
answers are based on publicly available information. These 17
questions were answered after reviewing each firm’s finan-
cial statements, bylaws, minutes of the boards of directors
and shareholders’ meetings, and annual reports available at
the Comisión Nacional de Valores library.

© 2008 The Authors Volume 16 Number 3 May 2008

Journal compilation © 2008 Blackwell Publishing Ltd
200
We then grouped the questions in four subindexes: infor-
mation disclosure (DIS, five questions), composition and
performance of the board of directors (BOA, five questions),
ethics and conflicts of interest (ETH, three questions), and
shareholders’ rights (SHA, four questions).
Control Variables
We use the following three variables as controls: company
size (CS), measured as the natural logarithm of the book
value of assets, return on assets (ROA), measured as oper-
ating earnings (EBIT) divided by total assets, and leverage
(LEV), measured as the quotient between total debt and total
assets. Information regarding each one of these variables
was obtained from the CSE Anuario (2004 – yearbook) and
corresponds to year-end values.
ECONOMETRIC ANALYSIS
In order to perform the statistical tests and the multivariate
regressions, a preliminary analysis of the information avail-
able was carried out following a procedure similar to that
used by Black et al. (2006a), in order to exclude from the
sample all those companies with missing information or
whose standardized errors exceeded the standard deviations
in +/- 1.96 in each of the variables used. Also, companies
without any market transaction during the year were
deleted from the sample. From this analysis a total of 13
companies were excluded, therefore the sample was reduced
to 33 companies.10 Of these 33 companies, 12 were banks, 2
were bank-related financial institutions, and 19 were firms
that belonged to the industrial and service sectors.
In Table 3 we report the descriptive statistics for the vari-
ables used in the analysis that follows. Panel A includes
statistics for the complete sample of 33 firms, while panel B
shows the descriptive statistics for the reduced sample of 19
nonfinancial institutions.
In our complete sample the average firm pays 20 per cent
of its net income in dividends, has a price-to-book multiple
equal to 1.07 and a TQ equal to 0.95. When we restrict our
sample to only nonfinancial firms, the mean values of these
three variables decline slightly to 16 per cent, 0.85 per cent,
and 0.90 per cent, respectively.
In terms of our CGI, the reduced sample of 33 firms shows
an average value equal to 8.30 over a maximum of 17 points
(one point for each question answered as “yes”), or 49 per
cent in percentage terms.11 For the nonfinancial sample, the
CGI declines to 7.95; this is consistent with the fact that
financial institutions are more regulated and are subject to
more scrutiny in terms of information disclosure and other
legal requirements. The nonfinancial sample tends to be
more profitable in terms of ROA. The firms included in the
complete sample tend to be larger and, as expected, more
leveraged.
In Table 4 we report a pair-wise correlation matrix for the
variables used in this study. It shows that the CGI is posi-
tively correlated to the three alternative dependent variables
previously defined (dividend payout, price-to-book, and
TQ), not only in the complete sample (Panel A), but also in
the sample restricted to nonfinancial institutions (Panel B).
Volume 16 Number 3 May 2008
CORPORATE GOVERNANCE
In the first case, the correlation is always statistically signifi-
cant, and in the second case, it is statistically significant
for the dividend payout. With respect to the firm’s size
(CS), consistent with the findings obtained by Leal and
Carvalhal-da-Silva (2005), we obtain a positive and signifi-
cant coefficient for both samples. That is, larger firms tend to
exhibit better corporate governance practices.
In Panel C we also report the correlation coefficients
between the performance measures and each of the corpo-
rate governance subindexes. The Board, the Ethics and
Conflicts of Interest, and the Shareholders’ rights subin-
dexes are positive and significantly related to dividend
payout. For the other two performance measures, only the
Ethics and Conflicts of Interest subindex shows a significant
correlation coefficient. The Disclosure subindex did not
show significant coefficients in any of the three performance
measures.
Dividend Payout Ratio
In Table 5 we show the results of Ordinary Least Squares
(OLS) regressions for the dividend payout ratio on the CGI,
and the control variables for 2004. Model 1 includes the CGI
as the sole explanatory variable.12 Here, an increase of one
point in the CGI causes an increase of 11.3 per cent in the
dividend payout ratio. This result is statistically significant
(t = 3.69, p < .01) and almost triples the 4.32 per cent increase
found by Garay and González (2005), also for Venezuela.
However, this result differs from that of Leal and Carvalhal-
da-Silva (2005) for Brazil, who did not find a significant
relation between these parameters. Models 2, 3, and 4
include one control variable in the estimation. In each case
the positive sign and the statistical significance of CGI is
preserved (t = 3.50, p < .01; t = 2.93, p < .01; and t = 3.99,
p < .01, respectively). Model 5, which includes all control
variables considered together, also shows a positive and
statistically significant sign for CGI (t = 3.69, p < .05).13
Table 5 also shows that results are maintained and that the
economic impact is stronger when financial institutions are
excluded from the sample (Panel B). Also, in both samples we
reject the hypothesis that dividend payout and CGI are inde-
pendent variables using a nonparametric test (Spearman).
Finally, we regressed dividend payout for the whole
sample with each of the subindexes (Panel C) and also con-
sidering the four subindexes together (we show in Table 2
Panel C that there was very little correlation among the
subindexes). These results confirm that three of the subin-
dexes (board of directors, ethics and conflicts of interest, and
shareholders’ rights) independently affect, in a positive
and statistically significant way, the firm’s dividend payout
(t = 1.91, p < .05; t = 2.19, p < .05 and t = 2.33, p < .05, respec-
tively). On the other hand, the disclosure subindex does not
affect in any significant way the dividend payout. These
results serve as a preliminary evidence to conclude that the
factor driving CGI are the subindexes on board of directors,
ethics and conflicts of interest, and shareholders’ rights.
Price-to-Book Value
In Panel A of Table 6 we present our OLS estimation of
price-to-book on the CGI, and the control variables for 2004.
© 2008 The Authors
Journal compilation © 2008 Blackwell Publishing Ltd
CORPORATE GOVERNANCE AND FIRM VALUE 201

TABLE 3
Descriptive Statistics
The variables are identified as follows: dividend payout ratio (DPR), price-to-book value (PBV), Tobin’s Q (TQ), corporate
governance index (CGI), return on assets (ROA), company size (CS), and leverage (LEV). The total sample is composed of
33 companies (Panel A) and it is reduced to 19 companies (Panel B) when financial firms are excluded. All numbers represent
2004 values.

Panel A: Complete sample

Variable Observation Mean Standard deviation Minimum Maximum

Dependent variables
DPR 33 0.20 0.39 0.00 1.86
PBV 33 1.07 0.48 0.13 2.43
TQ 33 0.95 0.16 0.71 1.35
Independent variable
CGI 33 8.30 1.90 5.00 13.00
CGI01 33 0.49 0.11 0.29 0.76
Control variables
ROA 33 0.08 0.09 -0.01 0.34
CS 33 26.88 2.09 22.15 30.47
LEV 33 0.59 0.29 0.02 0.90

Panel B: Sample excluding financial institutions

Variable Observation Mean Standard deviation Minimum Maximum

Dependent variables
DPR 19 0.16 0.45 0.00 1.86
PBV 19 0.85 0.40 0.13 1.60
TQ 19 0.90 0.19 0.71 1.35
Independent variable
CGI 19 7.95 1.81 5.00 13.00
CGI01 19 0.47 0.11 0.29 0.76
Control variables
ROA 19 0.14 0.15 0.01 0.55
CS 19 26.08 2.06 22.15 29.52
LEV 19 0.43 0.24 0.02 0.85

Model 1 includes the CGI as the sole explanatory variable. An
increase of one point in the CGI causes an average increase of
9.9 per cent in the PBV. This result is statistically significant
(t = 2.37, p < .05), and its magnitude more than doubles the
4.2 per cent increase calculated by Garay and González (2005)
also for Venezuela. Leal and Carvalhal-da-Silva (2005) did not
find a significant relationship between these two variables in
Brazil. Models 2, 3, and 4 include one control variable. In each
of these models, CGI maintains the sign and its statistical
significance in Model 2 (t = 2.17, p < .05) and Model 4
(t = 2.19, p < .05), and it is marginally statistically significant
in Model 3 (t = 1.70, p < .10). Model 5, which includes all
control variables together, also shows a statistically signifi-
cant sign for CGI (t = 2.08, p < .05). Using a nonparametric
test (Spearman) we reject, at the 5 per cent confidence level,
the hypothesis that PBV and CGI are independent.
Results using the reduced sample of nonfinancial institu-
tions were not included because the regression, as a whole,
was not statistically significant in any of the models. The
small size of the CSE may help explain the lack of statistical
power. We also regressed PBV on each of the subindexes
and considering the four subindexes together (results avail-
able from the authors). Although all subindexes were posi-
tive, only ethics and conflicts of interest was statistically
significant. In the case of Brazil, although Leal and
Carvalhal-da-Silva (2005) also found that the coefficients of
each of the subindexes were positive, these authors also
found that none of the components of the CGI was statisti-
cally significant explaining PBV. Similar results were
obtained by Chong and López-de-Silanes (2006) for the case
of Mexico, although we must advise that their CGI compo-
nents classification is different (more disaggregated) than

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202 CORPORATE GOVERNANCE

TABLE 4
Correlation Matrix
This table presents the pair-wise correlation matrix for the variables used in this study. The variables are identified as follows:
Dividend payout ratio (DPR), price-to-book value (PBV), Tobin’s Q (TQ), corporate governance index (CGI), return on assets
(ROA), return on equity (ROE), company size (CS), and leverage (LEV). Panel A presents the results using all firms in the
sample; Panel B presents the results excluding financial firms; and Panel C presents the correlation coefficients of each
performance measure with each of the subindexes.
p-values are reported below each correlation coefficient.

Panel A: Complete sample

DPR PBV TQ CGI ROA ROE CS LEV

DPR 1
PBV 0.37 1
0.04
TQ 0.50 0.64 1
0.00 0.00
CGI 0.55 0.39 0.32 1
0.00 0.03 0.07
ROA -0.11 -0.18 -0.07 -0.17 1
0.56 0.34 0.72 0.34
ROE -0.10 0.20 0.14 0.10 0.62 1
0.59 0.26 0.44 0.60 0.00
CS 0.33 0.28 0.17 0.54 -0.49 0.06 1
0.06 0.11 0.34 0.00 0.00 0.74
LEV -0.17 0.27 0.26 0.14 -0.37 0.37 0.55 1
0.36 0.13 0.15 0.45 0.04 0.04 0.00

Panel B: Sample excluding financial institutions

DPR PBV TQ CGI ROA ROE CS LEV

DPR 1
PBV 0.40 1
0.09
TQ 0.48 0.74 1
0.04 0.00
CGI 0.74 0.27 0.32 1
0.00 0.26 0.18
ROA -0.17 -0.01 0.04 -0.17 1
0.49 0.96 0.86 0.49
ROE -0.22 -0.01 0.02 -0.16 0.94 1
0.36 0.70 0.93 0.51 0.00
CS 0.41 -0.01 0.04 0.55 -0.48 -0.35 1
0.08 0.96 0.86 0.01 0.04 0.14
LEV -0.22 -0.31 0.11 -0.19 -0.17 0.06 0.31 1
0.36 0.20 0.66 0.43 0.49 0.81 0.20

Panel C: Performance variables correlation with subindexes

DPR PBV TQ

Disclosure -0.01 0.18 0.15

0.94 0.33 0.40
Board of directors 0.33 0.16 0.19
0.07 0.37 0.28
Ethics and conflicts of interest 0.38 0.41 0.34
0.04 0.02 0.05
Shareholders’ rights 0.39 0.14 0.02
0.03 0.44 0.92

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Journal compilation © 2008 Blackwell Publishing Ltd
CORPORATE GOVERNANCE AND FIRM VALUE 203

TABLE 5
Dividend Payout Regressions
Ordinary Least Squares regressions results of the dividends payout ratio (DPR) on the corporate governance index (CGI) for
five different model specifications. The variables are identified as follows: return on assets (ROA), company size (CS),
leverage (LEV), disclosure subindex (DIS), board of directors subindex (BOA), ethics and conflicts of interest subindex
(ETH), and shareholders’ rights subindex (SHA). Panel A presents the results using all firms in the sample; Panel B presents
the results excluding financial firms; and Panel C presents the results using as independent variable each subindex
coefficients.
†p < .10, *p < .05, **p < .01. The t-values are reported below each estimated coefficient.
Panel A: Complete sample

Variables Model 1 Model 2 Model 3 Model 4 Model 5

CGI 0.11** 0.11** 0.11** 0.12** 0.09*

(3.69) (3.50) (2.93) (3.99) (2.58)
ROA -0.44 -0.45
(-0.91) (-.91)
CS 0.01 0.05
(0.24) (1.12)
LEV -0.33† -0.53*
(-1.69) (-2.25)
Cons. -0.74** -0.66* -0.92 0.60* -1.44
(-2.82) (2.38) (-1.17) (2.24) (-1.56)
Obs. 33 33 33 33 33
F 13.60** 7.18** 6.62** 8.61** 5.24**
R2 0.31 0.32 0.31 0.36 0.43
Adj. R2 0.28 0.28 0.26 0.32 0.35
Spearman’s rho 0.58**

Panel B: Sample excluding financial institutions

Variables Model 1 Model 2 Model 3 Model 4 Model 5

CGI 0.18** 0.18** 0.18** 0.18** 0.18*

(4.51) (4.35) (3.64) (4.24) (2.91)
ROA -0.34 -0.34
(-0.68) (-0.58)
CS 0.00 0.00
(0.01) (0.02)
LEV -0.16 -0.17
(-0.50) (-0.42)
Cons. -1.29** -1.22** -1.30 -1.19** -1.13
(-3.92) (-3.48) (-1.32) (-3.03) (-0.92)
Obs. 19 19 19 19 19
F 20.38** 10.11** 9.59** 9.87** 4.55*
R2 0.55 0.56 0.55 0.55 0.57
Adj. R2 0.52 0.50 0.49 0.50 0.44
Spearman’s rho 0.56**

Panel C: Subindexes

Variables Model 1 Model 2 Model 3 Model 4 Model 5

DIS 0.01 0.02

(0.07) (0.18)
BOA 0.10* 0.11*
(1.91) (2.31)
ETH 0.23* 0.18†
(2.19) (1.92)
SHA 0.15* 0.16**
(2.33) (2.82)
Cons. 0.23 -0.08 -0.06 0.08 -0.52
(0.71) (-0.51) (-0.45) (0.97) (-1.61)
Obs. 33 33 33 33 33
F 0.01 3.67* 4.78* 5.45* 4.51**
R2 0.00 0.11 0.13 0.15 0.39
Adj. R2 -0.03 0.08 0.11 0.12 0.31
Spearman’s rho 0.16 0.48** 0.25† 0.19

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204 CORPORATE GOVERNANCE

TABLE 6
Price-to-Book Value (PBV) and Tobin’s Q (TQ) Regressions
Ordinary Least Squares regressions results of PBV and TQ on the corporate governance index (CGI) for five model
specifications. The variables are identified as follows: return on assets (ROA), company size (CS), and leverage (LEV).
†p < .10, *p < .05, **p < .01. The t-values are reported in the parenthesis behind each estimated coefficient.

Panel A: Dependent variable PBV

Model 1 Model 2 Model 3 Model 4 Model 5

CGI 0.10* 0.09* 0.09† 0.09* 0.11*

(2.37) (2.17) (1.7) (2.19) (2.08)
ROA -0.82 -0.84
(-1.27) (-1.17)
CS 0.02 -0.04
(0.50) (-0.71)
LEV 0.37 0.44
(1.35) (1.30)
Cons. 0.24 0.39 -0.27 0.08 1.12
(0.65) (1.03) (-0.25) (0.21) (0.84)
Obs. 33 33 33 33 33
F 5.59* 3.66* 2.85† 3.79* 2.23†
R2 0.15 0.20 0.16 0.20 0.24
Adj. R2 0.13 0.14 0.10 0.15 0.13
Spearman’s rho 0.36*

Panel B: Dependent variable TQ

Model 1 Model 2 Model 3 Model 4 Model 5

CGI 0.03† 0.03 0.03 0.03 0.04*

(1.85) (1.67) (1.53) (1.68) (2.00)
ROA -0.25 -0.30
(-1.12) (-1.25)
CS 0.00 -0.03
(0.02) (-1.26)
LEV 0.12 0.19
(1.29) (1.59)
Cons. 0.73** 0.77** 0.72† 0.68** 1.27**
(5.84) (5.92) (1.93) (5.21) (2.79)
Obs. 33 33 33 33 33
F 3.43† 2.35 1.66 2.58† 1.89
R2 0.10 0.14 0.10 0.15 0.21
Adj. R2 0.07 0.08 0.04 0.10 0.10
Spearman’s rho 0.33†

ours, making comparisons between the two works more
difficult to interpret.
Tobin’s Q Ratio
Panel B of Table 6 shows the results of the TQ regressions on
the CGI and the control variables. In Model 1 we report,
using the CGI as the sole explanatory variable, that an
increase of one point on the CGI causes an average increase
of 2.7 per cent in the TQ. This result is marginally statistically
significant (t = 1.85, p < .10), being consistent with the results
obtained by Garay and González (2005) for Venezuela and
by Leal and Carvalhal-da-Silva (2005) for Brazil, who found
an increase in TQ of 2.24 per cent and 3.1 per cent, respec-
tively. Klapper and Love (2004) also found a positive and
significant relation between the TQ and the CGI for their
sample of emerging market firms.
Models 2, 3, and 4 include one control variable in the
estimation and Model 5 includes all the control variables
considered together. The CGI maintains the sign in each of
the models but the coefficient is statistically significant only
in Model 5 (t = 2.00, p < .05). Also, using a nonparametric
test (Spearman), we marginally reject the hypothesis that the
TQ and CGI are independent at the 10 per cent confidence
level. We do not show the results of the sample excluding
the financial institutions because they were not statistically
significant in any of the models. Once again, the small size
of the CSE may help explain the lack of statistical power.
We also regressed the TQ to each of the subindexes and
also considering the four subindexes together (results avail-
able from the authors). Although all subindexes were posi-

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Journal compilation © 2008 Blackwell Publishing Ltd
CORPORATE GOVERNANCE AND FIRM VALUE
tive, and as it was the case when PBV was used as the
dependent variable, only the ethics and conflicts of interest
subindex was statistically significant. There exists a vast
literature on the potential effects of conflicts of interest
between controlling and outside shareholders on firm value
and profitability. For instance, Morck et al. (1988) find, for a
sample of US firms, that profitability first rises as ownership
concentration increases (a finding that is consistent with the
incentive hypothesis), and then falls after a certain point.
These authors contend that this fall in profitability is due to
an “excessive” voting power concentration or entrenchment,
which leads to a fall in corporate value as the likelihood of
expropriation increases. Lins (2003) analyzes 18 emerging
markets and finds that the evidence in favor of entrench-
ment is stronger than it is for incentives. This author also
argues that, in countries were legal protection is weak, the
existence of large nonmanagerial block holders helps miti-
gate the potentially negative effect of control concentration
on firm value.
In the case of Brazil, although Leal and Carvalhal-da-Silva
(2005) also found that the coefficients of each of the subin-
dexes were positive, they reported that only the disclosure
component of the CGI was statistically significant explaining
TQ. Similar results were obtained by Chong and López-de-
Silanes (2006) for Mexico.
Overall, we find a positive and significant relation
between dividend payout ratio and firm valuation (PBV and
TQ) and our CGI. Firms with a better CGI tend to pay more
dividends and are more valuable for investors in terms of
their price-to-book multiple and their TQ ratio. Results also
suggest that in a weak investor protection environment such
as Venezuela’s, firms are able to send strong signals to the
market by voluntarily improving their corporate governance
practices, something that allows them to differentiate from
the rest.
ROBUSTNESS CHECKS
In this section we perform several robustness checks to
validate our previous results.
Huber/White/Sandwich Estimator of Variance
The first robustness check we perform consists in estimating
once again all the regression coefficients but this time using
the Huber/White/Sandwich estimator of variance. This pro-
cedure generates larger standard errors and, therefore, the
estimated t-values are much smaller than those obtained by
the traditional OLS procedure. The signs and the statistical
significance of the main results remain (results are not
shown but are available upon request).
Endogeneity
Many empirical studies on corporate governance are subject
to criticism, given the likely endogeneity of the CGI that is
present in this type of studies.14 For example, firms that need
to finance their growth could be tempted to improve their
corporate governance practices in order to reduce their
cost of capital. This expected growth should therefore be
© 2008 The Authors
Journal compilation © 2008 Blackwell Publishing Ltd
205
priced in the firm’s valuation, creating a positive correlation
between the CGI and value ratios such as TQ. If this occurs
then valuable firms will choose to adopt better governance
practices and not the other way around.
In the previous section we attempted to mitigate this
problem by adding several control variables that could
proxy for growth opportunities such as size, operating per-
formance, and leverage to our regression model and showed
that our results were not spuriously caused (at least not by
these omitted variables). However, including control vari-
ables in the regressions is not enough to dissipate the likely
endogeneity between a firm’s value and its CGI.
The first step we followed to tackle the possible existence
of endogeneity in our model consisted in estimating all the
regressions but this time using financial information corre-
sponding to the year 2005. In this approach, we regressed
the three alternative dependent variables (dividend payout,
price-to-book, and TQ) for 2005 against the 2004’s CGI. Signs
for all coefficients were preserved but statistical significance
was lost, something that can be understandable given the
small sample size.15
The second step was to construct the CGI for the year
2006, even though we were only able to compute a prelimi-
nary index for that year given that not all the necessary
information was either still available or was final. Following
the approach of Chong and López-de-Silanes (2006), we
averaged the CGI for 2004 and 2006 and run each model
again. In this new set of results we obtained smaller coeffi-
cients. For example, when estimating dividend payout
we obtained a statistically significant lower coefficient,
0.0945 (t = 2.50, p < .05), versus the original 0.1135 shown in
Table 5; when estimating PBV we obtained a marginally sta-
tistically significant lower coefficient, 0.901 (t = 1.85, p < .10),
versus the original 1.1484 shown in Table 6; and, when
estimating TQ, we obtained also a marginally statistically
significant lower coefficient, 0.0293 (t = 1.78, p < .10),
versus the original 0.0271 shown also in Table 6. Although
the coefficients obtained under this approach were some-
how smaller, they were all positive and kept their statistical
significance.
Although this set of results somehow reduced our endo-
geneity concerns, they were not able to eliminate them given
the low statistical power of the model. However, the fact that
both the positive signs of our CGI were preserved and that
similar statistical significance was verified when we used the
average CGI provides a base to be optimistic regarding the
direction of the causality of our test.
The next step we followed to tackle the endogeneity
problem was to find instruments or a group of exogenous
variables which are related to CGI but that are not neces-
sarily related to any of the three alternative dependent
variables. More specifically, we used the following three
measures: first, a dummy variable called ADRUSA that takes
the value of 1 if the company had American Depositary
Receipts (ADRs) outstanding in the period 2000–2002 and
0 otherwise. The second measure is a variable called
CHAIND, which is the percentage change in board indepen-
dence from the year 2000 to the year 2002. We proxy board
independence, following Garay and González (2005), as the
difference between the fraction of outside directors minus
the fraction of inside directors in the board. A director is
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206 CORPORATE GOVERNANCE

classified as an outsider if he or she does not hold any TABLE 7

administrative position in the firm (e.g., any management or Instrumental Variable Regressions
consulting duties) or if his or her last name was the same as In Panel A we use percentage change in board independence
the last name of the CEO or the Chairman of the Board. from year 2000 to 2002 (CHAIND), a dummy variable that
Finally, we constructed a dummy variable called FORCED measures whether the firm had American Depositary
which takes the value of 1 if there is a CEO turnover between Receipts (ADRs) outstanding in the US during the period
the years 2002 and 2004 and the departing CEO did not 2000–2002 (ADRUSA), and a dummy variable whether the
remain in the board afterwards.16 CEO had been removed from office in the period 2000–2002
Reese and Weisbach (2002) argue that the better a firm’s and whether he or she had not remained on the board of
corporate governance is, the more likely it will issue ADRs directors (FORCED), to estimate the corporate governance
in the US. Therefore, we predict a positive relation between index (CGI). In Panel B we use the instrumented CGI
ADRUSA and CGI. On the other hand, we argued that the (CGI_hat) to estimate dividend payout ratio (DPR), price-to-
change in board independence (CHAIND) and the power book value (PBV), and Tobin’s Q (TQ).
of the board to remove nonperforming CEOs (FORCED) †p < .10, *p < .05, **p < .01. The other variables are defined in
should be positively related to our CGI (Weisbach and Table 5. The t-values are reported in the parenthesis below
Hermalin, 2003). Although there is a clear relation be- each estimated coefficient.
tween these three instruments and our measure of corpo-
rate governance, we do not see any strong theoretical or
empirical justification to argue that these instruments are Panel A: Fist stage, estimation of CGI_hat
also related to dividend payout and the other two valuation
variables. In Panel A of Table 7 we show the regression Variables Estimation
results. CHAIND -1.24†
In the first stage, FORCED had the greater impact in (-1.84)
the estimation of CGI with a coefficient of 3.573 (t = 2.24, ADRUSA 1.26
p < .05). The other two variables did not behave as well: the (1.55)
coefficient of ADRUSA, although positive, was not signifi- FORCED 3.57*
cant (t = 1.55) and the coefficient of CHAIND was negative (2.24)
and marginally significant (t = –1.84, p < .10).17
Cons. 7.84**
For the second stage, we use the instrumented CGI
(CGI_hat) as an independent variable to estimate DPR, PBV, (16.27)
and TQ. Results are shown in Panel B. In all three cases Obs. 23
we obtained a positive and statistically significant relation F 4.09*
between the dividend payout ratio and our three valuation R2 Adjusted 0.30
measures with the instrumented CGI. In the case of DPR, the
coefficient was equal to 0.166 and it was statistically signifi- Panel B: Second stage, estimation using CGI_hat
cant (t = 2.92, p < .01). For PBV, the coefficient we obtained
was 0.118 and it was statistically marginally significant DPR PBV TQ
(t = 1.87, p < .10). Finally, in the case of TQ the coefficient was
equal to 0.071 and it was statistically significant (t = 2.38,
Variables
p < .05).
Taking into account the small number of observations CGI_hat 0.17** 0.12† 0.07*
used (only 23 firms) and the resulting low statistical power (2.92) (1.87) (2.38)
of our estimates (results were also confirmed using the Cons. -1.19** 0.11 0.35
nonparametrical Spearman’s test), the results reported in (-2.45) (0.21) (1.49)
Table 7, although tentative, give some additional evidence Obs. 23 23 23
that the causality goes from CGI to DPR, PBV, and TQ, and F 8.54** 3.50† 5.68*
not the other way around. R2 0.30 0.09 0.25
Different Definitions of the CGI Robust standard errors No Yes Yes
Spearman’s rho 0.34† 0.40* 0.44**
The CGI used in this paper was computed as the arithmetic
sum of the points received by each question in the question-
naire. Since each subindex has a different number of ques-
tions, CGI is not equally weighted. In fact, the weight
implicitly assigned to each subindex is as follow: disclosure three different specifications: first, we construct an equally
subindex, 0.2941 (5 out of 17 questions); composition and weighted CGI, that is, we assign a weight of 0.25 to each
performance of the board of directors, 0.2941 (5 out of 17 subindex; second, we construct a CGI for the year 2006 and
questions); ethics and conflicts of interest, 0.1765 (3 out of run this index with 2004 financial data. Although all coeffi-
17 questions); and shareholders’ rights, 0.2353 (4 out of 17 cients in the regressions were still positive, we ended up
questions). losing much of the statistical significance; third, we average
To verify that our results are not driven by this particular the 2006 and 2004 CGI (valued-weighted and equally
weighting, we run our regressions again but this time using weighted) and run the results with 2004 financial data,

Volume 16 Number 3 May 2008 © 2008 The Authors

Journal compilation © 2008 Blackwell Publishing Ltd
CORPORATE GOVERNANCE AND FIRM VALUE
recovering all the previous results.18 These different defini-
tions of our CGI show that our results are not driven by the
way we construct the index.
Overall, although we recognize that our findings are still
tentative given the small number of observations, the main
results that indicate a positive and significant relation
between our CGI and the three alternative dependent vari-
ables (dividend payout, price-to-book, and TQ) are robust.
These results suggest that corporate governance has a strong
effect in firm valuation in the case of Venezuela. Moreover,
firms could benefit from voluntary improvements in their
own corporate governance practices as this allows them to
differentiate themselves from other firms and send strong
signals to attract investors (see Klapper and Love, 2004;
Durnev and Kim, 2005). These results are important not only
for Venezuelan firms but also for firms in other emerging
economies that offer weak investor protection.
CONCLUSIONS AND POLICY
RECOMMENDATIONS
Until now, firm-level data on corporate governance practices
in Latin America has been almost nonexistent. In this paper
we have documented the state of the understudied corporate
governance in Venezuela. To this end, we constructed an
index of corporate governance practices for listed firms in
this country and found a very large variation in corporate
governance practices among firms. At the firm level, the
highest score was 71.67 per cent and the minimum value was
16.67 per cent. The mean CGI value was 40.34 per cent, which
gives Venezuela a score below the emerging market average.
Our study also suggests that certain governance practices
need to be urgently improved, particularly in the sharehold-
ers’ rights category. Scores on the other three corporate
governance subindexes (disclosure, composition and perfor-
mance of the board of directors, and ethics and conflicts of
interest) were also low. These results are also consistent with
the finding that Latin American financial markets in general
and, Venezuelan markets in particular, have been character-
ized as having the weakest legal protection to outside inves-
tors and where the problems of investor expropriation are
most severe.
Our hypothesis was supported by the data. Results pre-
sented here suggest that firms in Venezuela may reduce their
cost of capital and enhance their market valuation when they
improve their corporate governance practices, a finding that
is consistent with the theoretical model presented in La Porta
et al. (2002), where the positive effects of good corporate
governance practices on firm valuation are explained by the
higher confidence of investors that controlling shareholders
will have fewer means to expropriate the firm’s cash flows.
This higher investor confidence makes them more willing to
provide capital to the firm and at a lower cost, something that
it is ultimately reflected in higher valuation. The empirical
evidence presented for Venezuela also provides support to
the outcome agency model of dividend payments specified
by La Porta et al. (2000b), where firms with better corporate
governance practices should distribute more profits to share-
holders and thus exhibit higher dividend payouts.
More specifically, results showed a positive and strong
relation between the CGI we computed and the market valu-
© 2008 The Authors
Journal compilation © 2008 Blackwell Publishing Ltd
207
ation variables. For example, an increase of 1 per cent in the
CGI index would result in an increase of 11.3 per cent in the
dividend payout ratio, 9.9 per cent in the price-to-book mul-
tiple, and 2.7 per cent in the TQ. These findings are very
strong and contrast to those reported in studies done in the
US, where the high average firm level of corporate gover-
nance practices and the low variation in intrafirm gover-
nance has made it difficult for researchers to disentangle the
effects between corporate governance practices and firm
value. We conjecture that our results are generalizable
mainly to other countries where investor protection is low.
In countries where investor protection is high (mainly devel-
oped countries, particularly Common Law origin countries),
firms have significantly less ability to reduce their cost of
capital by voluntarily improving their corporate governance,
thereby sending a signal to investors. This is because the
positive role for firm-level efforts to improve governance
practices is helpful precisely when a firm is trying to escape
a poor institutional environment.
We ran a series of robustness checks to validate our find-
ings attempting to tackle the possible existence of endoge-
neity in our results and confirmed that the relation goes from
better CGI to higher dividend payout and higher market
valuation. Even though these results seem to confirm that
better corporate governance is valued by the market in
Venezuela, we are conscious of the limitations that a small
stock exchange (and the resulting small sample size) such as
the CSE impose on an econometric study such as ours. Also,
the relative illiquidity and inefficiency of emerging stock
markets documented by Demirguc-Kunt and Levine (1995)
and Harvey (1995), among other authors, reduces the power
of market-related variables such as price-to-book and TQ
when used in studies performed on these markets.
Improvements in investor protection will be crucial to
attract the increasing amounts of capital needed to sustain
the high rates of growth of emerging economies in the 21st
century. The success of the recently created Novo Mercado
(New Market) in Brazil is a step in that direction (see Leal and
Carvalhal-da-Silva, 2005). Firms that choose to list their stocks
on the Novo Mercado must adhere to a set of corporate
governance practices, which are more rigid than those
required by the Brazilian legislation. As Chong and López-
de-Silanes (2007) argue, integration to international financial
markets does not exclude the need for broader local financial
markets, as access to international markets (through the issu-
ance of ADRs, for example) is not appropriate for all firms.
As more knowledge of the positive effects of corporate
governance practices on firm value become available in
countries with weak investor protection such as Venezuela,
firms interested in raising capital may decide to voluntarily
improve their governance structures. Moreover, the large
value impacts of governance behavior has the practical
implication that investors should pay close attention to
firm-level corporate governance practices, measured by our
index, to obtain another quantitative measure to assess firm
value in Venezuela.
As more years of corporate governance data become avail-
able in Venezuela, studies that employ these larger databases
may help to shed further light on these important issues, and
may allow a more careful analysis on which risk factors more
strongly affect firm value. It would also be interesting to
Volume 16 Number 3 May 2008
208
analyze the effect of corporate governance practices on
performance-related variables, such as ROA, return on
equity, and gross margin (see, for instance, Bhagat and Black,
1999; Klapper and Love, 2004; Judge et al., 2003). We can also
envision a study across countries and legal systems, similar
to that performed by Klapper and Love, but constructing a
CGI using the methodology we have followed here. A dis-
advantage of our method is that it may require visits, or at
least direct inquiries, to the securities and exchange commis-
sions of the respective countries, as we did in the case of
Venezuela, as the information required to answer some of the
questions is generally not readily available.
Finally, analysts in Venezuela expect investor protection to
continue to worsen since President Hugo Chavez still has five
more years left of his constitutional term and has promised
a radicalization of his so-called “Socialism of the 21st Cen-
tury”, which has been weakening property rights (see, for
example, The Economist, November 29, 2007 and December 6,
2007). In this deteriorating environment, we conjecture that
the signaling effect that a firm may send to investors by
improving its corporate governance practices would be more
appreciated by the market as investor protection worsens in
Venezuela (i.e., we would expect to see a higher effect of GCI
on TQ and price-to-book). This conjecture is based on the
results reported by Klapper and Love (2004), in which the
authors find that firm-level corporate governance practices
matter more in countries with weak legal frameworks, as
firms need to adapt to overcome an institutional environment
that places them at a disadvantage in terms of their ability to
attract capital. Companies in Venezuela would therefore need
to work harder to raise capital by offering a better “package”
of protective measures to investors as the institutional
environment deteriorates in the country.
ACKNOWLEDGEMENTS
We acknowledge the helpful comments and suggestions
received from two anonymous referees, Chris Mallin
(former Editor), William Judge (current Editor), participants
in the 2006 Business Association of Latin American
Studies conference, and participants in the 2007 Financial
Management Association conference. Germán González,
Yelhis Hernández, and Jacelly Céspedes provided excellent
research assistance. We also thank Econoinvest for financial
support.
NOTES
1. See Bhagat and Black (1999) and Weisbach and Hermalin (2000)
for a summary of the empirical findings in the US.
2. See Chong and López-de-Silanes (2007) for a summary of these
papers.
3. The tension between minority and controlling shareholders is
typical of French Civil Law countries given the high level of
firm’s ownership, pyramidal structures, and family manage-
ment that is common in these countries (La Porta, López-de-
Silanes, Shleifer and Vishny, 1999).
4. See Shleifer and Vishny (1997) and Denis and McConnell (2003)
for a survey of the international evidence.
5. For example, question 15 in Leal and Carvalhal-da-Silva
(2005) asks: “Does the company use arbitration instead of (a)
Volume 16 Number 3 May 2008
CORPORATE GOVERNANCE
normal legal procedure in case of bad corporate governance
practices?” Venezuelan firms do not use arbitration to solve
any legal dispute; therefore, if we apply this question, all the
firms in our sample will have a “no” answer. This and other
six questions were dropped from our questionnaire for
similar reasons.
6. According to Standard and Poor’s Emerging Stock Markets
Factbook (2004) there were 59 firms listed in the CSE in 2004.
The factbook does not provide the names of these companies.
However, the Anuario de la Bolsa de Valores de Caracas (2004)
presents the names and financial information of the 46 firms
whose stocks were listed on the CSE in 2004. We suspect the
difference between the two publications arises because Stan-
dard and Poor’s may be counting twice those companies that
have two stock classes.
7. It is difficult to conclude from public information that external
directors are truly independent.
8. Information regarding the ownership structure of Venezuelan
firms was obtained from Garay and González (2005).
9. The only two Latin American countries included in their study
were Brazil and Chile.
10. We decided to run the regressions with the smaller and cleaner
data set although results do not change significantly when all
companies for which the necessary data could be found are
included in the regressions.
11. Note that considering the 46 firms listed on the CSE and
reported in Table 2, the mean value for the CGI was 40.34
per cent.
12. We run these and the other regressions (using PBV and TQ as
alternative dependent variables) assigning different weights to
each component of the CGI (see the section on robustness
checks). Basic results remain.
13. Note that CGI is correlated to CS (rho = 0.539) and CS is corre-
lated to LEV (rho = 0.554). This situation makes the interpreta-
tion of Models 3 and 5 problematic because of the potential
presence of multicollinearity in the regressors. However, even
if multicollinearity is present, these models are still Best Linear
Unbiased Estimators (BLUE) although they would have a large
variance, making precise estimation of the coefficients more
difficult (Gujarati, 2003).
14. This is a serious problem because it violates the crucial assump-
tion that the regressors are either no stochastic or, if stochastic,
are distributed independently of the stochastic disturbance
term. Therefore, when endogeneity is present, the estimated
coefficients are not only biased but are also inconsistent
(Gujarati, 2003).
15. To save space, all results for this set of robustness checks are not
shown in tables. However, they are available from the authors.
16. The corporate governance variables were taken from the data-
base used in Garay and González (2005) from the year 2000 to
the year 2002. Ten firms in our database were lost due to
missing information.
17. Taking out ADRUSA or CHAIND from the regression equa-
tions does not affect the main results.
18. All these results are available from the authors.
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Urbi Garay is a Full Professor of Finance at the Instituto de
Estudios Superiores de Administración (IESA) in Caracas,
Venezuela. He has a Ph.D. in Finance from the University of
Massachusetts, Amherst (2000), a Master in International
and Development Economics from Yale University (1994),
and received his undergraduate degree in Economics from
Universidad Católica Andrés Bello (1991) in Caracas. Dr.
Garay teaches Investments, Derivatives, International
Finance, and Research Seminar in Finance. He has published
articles in Emerging Markets Finance and Trade, the Journal of
Alternative Investments, and Derivatives Use, Trading and
Regulation, among other journals, and has a chapter (co-
authored with Maximiliano González) on corporate gover-
nance in Venezuela in Investor Protection and Corporate
Governance (edited by Alberto Chong and Florencio López-
de-Silanes, 2007).
Maximiliano González is an Associate Professor of Finance
at the Universidad de los Andes in Bogotá, Colombia. He
has a Ph.D. in Finance from Tulane University (2002), an
MBA from IESA (1998) in Caracas, Venezuela, and received
his undergraduate degree in Management Science from Uni-
versidad Metropolitana (1994) in Caracas. Dr. González
teaches Corporate Finance, Derivatives, Applied Game
Theory, and Research Seminar in Finance. He has published
articles in Emerging Markets Finance and Trade, International
Review of Financial Analysis, Corporate Governance: An Inter-
national Review, and Derivatives Use, Trading and Regulation,
among other journals, and has a chapter (co-authored with
Urbi Garay) on corporate governance in Venezuela in the
book Investor Protection and Corporate Governance (edited by
Alberto Chong and Florencio López-de-Silanes, 2007).
Volume 16 Number 3 May 2008
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