Original Article

Journal of Accounting,
Auditing & Finance
Investor Protection and the 1–22
ÓThe Author(s) 2020
Substitution Effect of Article reuse guidelines:
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Corporate Governance and DOI: 10.1177/0148558X20936792
journals.sagepub.com/home/JAF

Product Market Competition

on Firm Value

Joseph R. Rakestraw1

Abstract
International research has firmly established that a substitute relationship exists between
corporate governance and product market competition on firm value. In this study, I reexa-
mine this substitution effect in an international setting, allowing the relation to vary with
investor protection. As hypothesized, I find that investors place a higher value on the sub-
stitution effect of corporate governance and product market competition in countries
where the legal and regulatory mechanisms to protect investors are weak. This finding sug-
gests that country-level investor protection has a moderating role in affecting the substitu-
tion between product market competition and corporate governance on firm value. These
results, which are robust to several sensitivity tests and alternative specifications, are con-
sistent with an equity agency cost benefit, resulting from product market competition and
corporate governance, which is valued more by investors where investor protection is
weak.

Keywords
product market competition, firm value, investor protection, legal origin, equity agency
costs, corporate governance

Introduction
Product market competition is known to have both negative and positive effects on a firm’s
value. The negative effects include a decrease in pricing power, which decreases profits
(Porter, 1980), and an increase in a firm’s risk of filing for bankruptcy (Schmidt, 1997).
The positive effects include a reduction in equity agency costs, achieved by aligning the
managers’ incentives with those of the firm’s investors. Raith (2003) found that managers
of firms in competitive markets have an incentive to reduce inefficiency and are motivated
to seek out profit-maximizing, positive net-present-value projects, which will benefit their

1
Florida Atlantic University, Boca Raton, USA

Corresponding Author:
Joseph R. Rakestraw, Assistant Professor of Accounting, Florida Atlantic University, 777 Glades Road, KH 120,
Boca Raton, FL 33431, USA.
Email: jrakestraw@fau.edu
2 Journal of Accounting, Auditing & Finance

investors. Consequently, equity agency costs are reduced when product market competition
is high. That product market competition can thus act as a substitute for corporate govern-
ance has been firmly established (Ammann et al., 2013; Byun et al., 2012; Chou et al.,
2011; Giroud & Mueller, 2011). Theoretical research suggests that such competition has a
disciplining effect on managers (Hart, 1983; Raith, 2003), whereas some empirical studies
find that the incentives produced by intense product market competition can even be pow-
erful enough to counteract poor corporate governance (e.g., Giroud & Mueller, 2011).
Other research suggests that any reductions in equity agency costs due to increased
product market competition are limited to firms in countries with strong investor protection
mechanisms (Allen & Gale, 2000). Legal and regulatory mechanisms that ensure managers
act in their investors’ best interests are also known to lower equity agency costs. Mclean
et al. (2012) found that strong investor protection promotes more accurate share prices,
more efficient investment, and a reduction in financial constraints. Allen and Gale (2000)
suggested that, in countries where such legal and regulatory mechanisms are weak, the
expected negative future profitability from product market competition may overshadow
any benefits from reduced equity agency costs.
This study reexamines the substitution effect of corporate governance and product
market competition on firm value, while taking into consideration country-level legal and
regulatory mechanisms to protect investors. I use an international setting consisting of
diverse markets, where differential effects of product market competition and corporate
governance on firm value are likely to exist. I expect to find a general substitution effect of
competition and corporate governance on firm value that is consistent with prior research
(e.g., Ammann et al., 2013; Byun et al., 2012; Chou et al., 2011; Giroud & Mueller, 2011).
However, investors should value this substitution effect more where investor protection is
weak. Where investor protection is strong, the low equity agency cost benefits of product
market competition and corporate governance will be valued less because other mechan-
isms (i.e., the country-level legal and regulatory mechanisms to protect investors) already
lessen equity agency costs. Therefore, I predict that investor protection has a moderating
role in affecting the substitution effect between product market competition and corporate
governance on firm value.
I begin by categorizing weak and strong investor protection environments using the
legal origin of each firm’s country of domicile to assess the level of investor protection
laws and regulations under which the firm operates (La Porta et al., 1998). Legal origin is
directly related to the strength of the legal rights available to investors, which allow them
to extract from management their returns on investment. Without a legal right to compel
management to pay dividends, shareholders’ protections will, ceteris paribus, be lower.
Research shows that public companies domiciled in countries with a common law legal
origin have stronger legal investor protection mechanisms (La Porta et al., 1998). The abil-
ity of investors to extract returns on investment from management through strong investor
protections should discipline management to act in the best interests of investors rather
than shirking managerial responsibilities or expropriating assets from the firm. This effect
will lessen the value of both corporate governance and product market competition because
all three mechanisms (i.e., investor protection, corporate governance, and product market
competition) lessen equity agency costs.
To test the robustness of my results, I recategorize firms into weak and strong investor
protection environments using the principal component of the indices of anti-director
rights, disclosure requirements, and liability standards (La Porta et al., 2006). I use the
Herfindahl–Hirschman Index (HHI) at the country-industry-year level as a proxy for
Rakestraw 3

product market competition and, in the robustness tests, the four-firm sales concentration
ratio. Firm value is proxied by annual stock market return in primary tests and Tobin’s Q
in robustness tests.
I regress the firm value proxies on product market competition, interacted with corporate
governance, in both weak and strong investor protection environments. I find the substitu-
tion effect of corporate governance and product market competition on firm value to be
less valuable in countries with strong investor protection environments, as defined by legal
origin (i.e., common law or noncommon law). This result suggests that country-level inves-
tor protection has a moderating role in affecting the substitution effect between product
market competition and corporate governance on firm value. These results hold under sev-
eral robustness tests and alternative specifications, including alternate estimations of prod-
uct market competition, firm value, and investor protection.
This study makes several contributions to the existing literature. First, the tests are spe-
cifically designed to examine cross-setting variation regarding the importance of product
market competition to firm value, focusing on differences in country-specific interactions.
The results are consistent with the notion that country-specific factors interact in important
ways with the relation between product market competition and firm value.
Second, while a significant body of literature exists which clearly demonstrates a substi-
tute effect of product market competition and corporate governance on firm value in many
different settings, including samples from the United States (Chou et al., 2011; Giroud &
Mueller, 2011), samples from Korea differentiating on corporate governance (Byun et al.,
2012), and samples from multicountry regions such as the European Union (EU; Ammann
et al., 2013), this study extends this line of research by showing that country-level investor
protection has a moderating role on the substitution effect between product market compe-
tition and corporate governance on firm value. My results support the theory that lower
equity agency costs arise from product market competition and corporate governance and
show that country-level investor protection mechanisms have an important effect on this
relationship by also reducing equity agency costs.
Given that these results explain cross variation in firm value, investors may find them
useful when considering the relationships among corporate governance, product market
competition, investor protection, and firm value. The primary investor protection mechan-
ism used in this study (common law legal origin) is fixed and is evident to investors when
they are making investment allocation decisions.
My results are also useful to regulators when creating standards and rules to protect
investors. Firms in common law countries are known to have stronger investor protection
mechanisms (La Porta et al., 1998). Although regulators in noncommon law legal origin
countries obviously cannot change their legal origin, they may want to strengthen their pro-
tection of investors. To the extent that product market competition and corporate govern-
ance enhance firm value in noncommon-law countries by reducing equity agency costs,
regulators in noncommon-law countries can lower equity agency costs by creating stan-
dards and rules that promote competition and enhance corporate governance.
The remainder of this article is organized as follows. In ‘‘Literature Review and
Hypothesis Development’’ section, I outline the theoretical and empirical evidence regard-
ing product market competition and develop the hypothesis of the study. In ‘‘Research
Design’’ section, I outline the estimates of product market competition, investor protection,
corporate governance, and firm value; I also develop the research design used to test the
hypothesis. I detail the sample construction in ‘‘Sample’’ section and describe the results in
4 Journal of Accounting, Auditing & Finance

‘‘Results’’ section. Finally, I provide a summary and concluding comments in

‘‘Conclusion’’ section.

Literature Review and Hypothesis Development

Product Market Competition
According to classic theories, product market competition can be thought of as a rivalry
among existing firms within an industry (Porter, 1980). This rivalry materializes in several
ways, such as through advertising, price discounts, improvements in quality, and new prod-
ucts. The intensity of product market competition is heightened when numerous competi-
tors exist in one industry, competitors are close in size or power, the industry faces slow or
negative growth, barriers to exiting the industry are high, or rivals are committed to a lead-
ership position in the industry (Porter, 1980). Any of these conditions will negatively affect
industry profitability.
In addition to product market competition from existing firms within an industry, firms
face competition from potential new firms entering the industry (Porter, 1980). This threat
puts pressure on prices, as incumbent firms must hold down profits or boost investment to
keep new firms from entering the industry. The threat of entry depends on the barriers or
costs to enter the market. When barriers to entry are high, the threat of entry is low,
because a new firm needs to expend significant resources simply to enter the market.
However, when barriers to entry are low, new firms may quickly enter the market, taking
profit margin away from incumbent firms. It is easier for new firms to enter an industry
with little or no fixed costs, versus an industry with significant fixed costs.
Profitability is often used as a proxy for the level of product market competition, as
demonstrated by Karuna (2007), who uses the industry-average price-cost margin to repre-
sent the level of product substitutability, which is a proxy for higher competition. This
theory rests on the widely employed Lerner index (Lerner, 1934), which is considered a
measure of a firm’s monopoly power.1 The Lerner index measures a firm’s ability to price
above its costs, leading to the interpretation that firms with more monopoly power can
charge higher prices relative to their marginal costs. Conversely, a firm with low pricing
power faces higher product market competition and is unable to price its products signifi-
cantly above marginal costs.
Complementing Porter (1980), who predicted that profits will suffer in more competitive
industries, introductory economics textbooks typically argue that higher product market
competition decreases economic profits and consequently lowers firm value (e.g., Hall &
Lieberman, 2008).2 In a perfectly competitive market, if incumbent firms begin to earn a
positive economic profit, then new firms will enter the market, removing any profits earned
by the incumbent firms. Alternatively, when firms oversupply the market and economic
profits turn negative, some incumbent firms will exit the market, supply will decrease,
prices will increase, and the market will return to the overall condition of zero economic
profit.
Another stream of research hypothesizes that equity agency costs are lower in competi-
tive industries. Raith (2003) found that markets with higher product substitutability, along
with free entry and exit, become more competitive, resulting in falling prices for goods
sold. The reduction in prices causes firm profits to fall as well, inducing some firms to exit
the market. Firms remaining in the market produce a larger relative output and, therefore,
have an incentive to reduce costs to increase their market share and profitability.
Rakestraw 5

Consequently, increased product market competition often leads a firm to strengthen man-
agerial incentives to reduce costs, which should result in managers working harder to
ensure the firm stays profitable, and thus may lower equity agency costs, as equity holders
are reassured that managers are working hard in the investors’ best interests.
Research on the effects of competition employs this equity agency cost theory to suggest
that product market competition reduces managerial ‘‘shirking’’ or ‘‘slack’’ (e.g., Giroud &
Mueller, 2011; Hart, 1983; Karuna, 2007; Schmidt, 1997). Hart (1983)3 suggested that
there are two types of firms in an industry: managerial firms where a principal-agent prob-
lem exists and entrepreneurial owner-managed4 firms. His hidden information model shows
that when costs fall, commonly affecting all firms within an industry, the managers at
entrepreneurial firms expand their output. This expansion of output increases the aggregate
industry supply, thus causing product prices to fall, which in turn puts pressure on manag-
ers at all firms within the industry (i.e., both managerial and entrepreneurial firms) to work
harder. Thus, average managerial slack is lower in competitive markets when compared
with monopolistic markets.
Explicit managerial incentives are also found to be more prevalent in markets with
higher levels of product market competition. Karuna (2007) defined managerial incentives
in terms of equity-based pay-performance sensitivity and estimates product market compe-
tition by using the price-cost margin as a proxy for product substitutability, market size as
a measure of the density of consumers in an industry, and entry costs as a measure of the
barriers to entry for new entrants to the industry. He finds that managerial incentives
increase in more competitive industries, which should lead to lower equity agency costs as
investors in these firms are reassured that managers are working harder to ensure the firm
remains profitable.

Hypothesis Development
Giroud and Mueller (2011) provided empirical evidence, based on a U.S. sample, which
demonstrates that firms in noncompetitive industries benefit more from good corporate
governance than do firms in competitive industries. The authors document that the stock
market return from a high (low) corporate governance hedge portfolio,5 as measured by the
G-Index (Gompers et al., 2003), is small and insignificant (large and significant) in indus-
tries with the highest (lowest) product market competition. They find that firms with poor
corporate governance have lower firm value, make more value-destroying acquisitions, and
are more likely to be targeted by activist hedge funds—but these results hold true only in
low or noncompetitive industries. Their findings suggest a substitute relationship between
corporate governance and product market competition. Specifically, product market compe-
tition and corporate governance each discipline managers to act in the best interests of
investors. In a similar vein, Chou et al. (2011), using sales concentration as a measure of
product market competition in a sample consisting of all firms listed on the NYSE, AMEX,
and NASDAQ from 1990 to 2005, found that firms in competitive industries have relatively
weak corporate governance. Their findings also suggest a substitute relationship between
product market competition and corporate governance.
Studying firms from Korea, Byun et al. (2012) found that members of business groups
enjoy increased firm value from internal corporate governance mechanisms regardless of
competitive pressure, while nonmember firms only experience such increased firm value if
the market is less competitive. Their study is important because it differentiates between
external and internal mechanisms of corporate governance; it also extends the research of
6 Journal of Accounting, Auditing & Finance

the substitution effect of product market competition and corporate governance into a less-
developed, emerging capital market, when compared with the studies of U.S. firms.
In an international setting, Ammann et al. (2013) largely applied the research design of
Giroud and Mueller (2011) to a sample of firms from 14 countries in the EU. Consistent
with the substitution effect of product market competition and corporate governance, they
find that corporate governance increases firm value in concentrated, noncompetitive indus-
tries. Ammann et al. (2013) made several notable contributions. First, they combine listed
and nonlisted firms in their measure of competition, thereby providing more extensive cov-
erage of the firms that may provide competitive pressure within an industry. Second, they
combine 64 different governance attributes into an additive corporate governance index.
Finally, and of most importance to the present study, they use observations from a cross
section of countries.
While previous research on firms based in the U.S. and in several other countries
robustly supports the substitution effect of corporate governance and product market com-
petition on firm value, no studies have examined how investor protection at the country
level affects this relationship. La Porta et al. (2002) provided theoretical and empirical
analysis on the relation between investor protection and valuation. In many countries, firms
have large controlling shareholders who can exercise control over minority shareholders
(La Porta et al., 1999). A controlling shareholder or another insider can more easily expro-
priate the assets of the minority shareholders if the legal protections for minority sharehold-
ers are weak. As a result, where such investor protection mechanisms are weak, investors
may be less willing to accept the inherent risk of investment, due to the potential for expro-
priation of their investment by insiders. Where investor protection is strong, the risk of
expropriation of minority shareholder assets is lessened, leading to broader markets and
more valuable securities within those markets. Firm value increases because minority
shareholders are reassured that more of the firm’s profits will be returned to them in the
form of dividends, rather than being expropriated by managers or controlling shareholders.
The ability of investors to extract returns on investment from management by compelling
management to pay dividends should discipline management to act in the best interests of
investors rather than shirking managerial responsibilities or expropriating assets from the
firm. This investor protection through legal mechanisms empowering investors to extract
returns on investment should lead to lower equity agency costs.
Leuz et al. (2003) investigated the relation between investor protection and earnings
management. Insiders can use earnings management to conceal the firm’s actual perfor-
mance, thereby benefiting themselves at the expense of their shareholders. Insider benefits
can include excess perquisite consumption or expropriation of assets. Leuz et al. (2003)
found that investor protection reduces insiders’ need to manage earnings. Other empirical
research supports the capital market benefits of investor protection. Mclean et al. (2012)
investigated the relationship between firm-level resource allocation and investor protection.
They find that strong investor protection promotes more accurate share prices, more effi-
cient investment, and a reduction in financial constraints. Their findings are consistent with
the notion that investor protection encourages more accurate financial reporting by manag-
ers, improves firms’ access to external financing, and reduces the likelihood that managers
and controlling shareholders expropriate firm assets.
Given that corporate governance, product market competition, and investor protection
all reduce equity agency costs, the substitution effect of competition and corporate govern-
ance would presumably be more valuable to investors where investor protection mechan-
isms to discipline managers are weak. This suggests that country-level investor protection
Rakestraw 7

mechanisms play a moderating role in the substitution effect between product market com-
petition and corporate governance on firm value. Therefore, I investigate the substitute rela-
tionship between corporate governance and competition between firms in countries with
different levels of investor protection mechanisms which leads to my hypothesis in alterna-
tive form:

Hypothesis 1 (H1): The substitute relationship between corporate governance and

product market competition is valued more (less) by investors in low (high) inves-
tor protection environments.

Although I hypothesize that product market competition has equity agency cost benefits,
an alternative theory suggests that any reduction in equity agency costs from increased
managerial effort may depend on the strength of the legal and regulatory mechanisms for-
cing managers to act in the best interests of investors. This suggestion is consistent with
Allen and Gale (2000), who posit that firms in countries with the strongest mechanisms to
ensure managers act in the best interests of their investors experience the greatest benefits
from any reduced equity agency costs that result from higher product market competition.
Although these mechanisms are strong in the United States, they may be less so interna-
tionally, due to institutional and cultural differences. Thus, potentially important differences
may exist between countries concerning the extent to which product market competition
reduces equity agency costs.

Research Design
To examine the effect on firm value of the substitute relationship between corporate gov-
ernance and product market competition in different investor protection environments, I
classify firms based on two different measures of investor protection. The primary measure
of investor protection is an indicator variable equal to one if the legal origin of a firm’s
country of domicile is common law (COMMON_LAW), zero otherwise. Countries with
common law legal origin have the strongest legal protection mechanisms for investors and
lower concentrations of ownership, suggesting that small and insignificant investors are
only willing to invest in countries where their rights are protected (La Porta et al., 1998).
The second measure of investor protection (INV_PROTECT), which I use as a robustness
check, is calculated as the principal component of the indices of anti-director rights, disclo-
sure requirements, and liability standards (La Porta et al., 2006). The anti-director rights
index (ANTI_DIR) is formed by adding one for each of the following conditions: (a) share-
holders are allowed to mail their proxy vote; (b) deposit of shares is not required prior to
general shareholders’ meetings; (c) cumulative voting or proportional representation of
minorities on the board of directors is allowed; (d) there exists an oppressed minority
mechanism; (e) the minimum percentage of share capital that allows a shareholder to
request an extraordinary shareholders’ meeting is less than or equal to 10%; and (f) share-
holders’ preemptive rights can only be waived by a shareholders’ meeting (Djankov et al.,
2008). Disclosure requirements are measured as the mean of six different factors, measur-
ing (a) the requirement of the delivery of a prospectus for new issues; (b) prospectuses dis-
close compensation information of key officers and directors; (c) equity ownership
information is disclosed; (d) equity ownership information of key officers and directors is
disclosed; (e) contracts outside the ordinary course of business are disclosed; and (f) pro-
spectuses disclose transactions between the issuer and related parties, including large
8 Journal of Accounting, Auditing & Finance

shareholders, officers, and directors (La Porta et al., 2006). Liability standards are mea-
sured as the mean of three different factors, measuring procedural difficulty in recovering
losses from the issuer, the distributor, or the accountant in civil liability cases resulting
from misleading statements in the prospectus (La Porta et al., 2006). For the legal origin
measure of investor protection (COMMON_LAW), I estimate low (high) investor protection
as the country’s legal origin being noncommon law (common law). For INV_PROTECT, I
split the sample at the median to estimate low/high investor protection conditions.
For each low and high investor protection condition, I estimate the following model
based on the model in Table V of Giroud and Mueller (2011, p. 582):
X
RETURNi, t = a0 + a1 (Gi, t 3 Ci, t ) + an Controlsn, i, t + ei, t , ð1Þ

where RETURN is a measure of the 1-year stock market return adjusted for splits and stock
dividends, G is the tercile of firm-specific corporate governance (CORP_GOV), and C is a
vector of indicator variables measuring low HHI, medium HHI, and high HHI. I use the
shareholder rights index from Thomson Reuters Datastream Asset4 database as the proxy
for corporate governance (CORP_GOV). The Datastream shareholders rights index
(Datastream code: CGSR) measures management commitment and effectiveness to follow-
ing best-practice corporate governance principles related to shareholder policy and equal
treatment of shareholders. It is derived from individual corporate governance principles,
such as whether the firm has a policy for equal treatment of minority shareholders or if the
firm monitors shareholder rights.
Control variables include main effects for HHI (i.e., HHI at the medium and HHI at the
high level), the natural log of total assets in U.S. dollars (ASSETS), the market-to-book
value of equity (MTB), the price of common stock (STOCK_PRICE), the 1-year lagged
stock market return (RETURN_LAG), total annual trading volume (VOLUME), dividend
yield (YIELD), annual sales growth (SALES_GROWTH), and the anti-director rights index
(ANTI_DIR). I estimate Equation 1 using Fama–Macbeth annual cross-sectional regressions
(Fama & MacBeth, 1973). Consistent with my hypothesis, I predict a1 will be lower in the
high HHI condition in the high investor protection environment, when compared with the
high HHI condition in the low investor protection environment. I test the difference in coef-
ficients using a Chow test to lend support to the hypothesis that the substitute relationship
between corporate governance and product market competition is valued more (less) by
investors in low (high) investor protection environments.

Sample
Sample data are obtained from the Compustat Global database of firms for fiscal years
2002 to 2016 as described in Table 1.6 U.S. firms are not included in the sample because
of the study’s international nature. The product market competition measures are calculated
before any subsequent data limitations are imposed to ensure that the greatest number of
firms is included in the product market competition measure sample.7 The sales concentra-
tion product market competition measure (HHI) is calculated from a sample of 355,453
firm-year observations. Once the product market competition measure is calculated, data
restrictions are imposed to create a final sample. Firm-years are excluded if they are miss-
ing values for any of the required variables. The single largest missing data item is
CORP_GOV from the Thomson Reuters Datastream Asset4 database, which leaves 26,348
firm-year observations in the final sample.
Rakestraw 9

Table 1. Sample Selection.

Description Observations removed Observations

Firm-year observations used in competition estimates 355,453
Less:
Missing data to calculate necessary variables 172,750 182,703
Observations missing corporate governance data 156,355 26,348
(CORP_GOV) from Datastream Asset4 Database
Equals: Observations used in primary analyses 26,348

Note. This table reports the number of observations removed from the sample to arrive at the final sample used in
the primary analyses.

To better understand the international nature of the sample, I report sample data by
country in Panel A of Table 2. The sample represents 38 countries, with Japan having the
largest number of firm-year observations (4,930) and Sri Lanka having the least (14). The
means by country for RETURN, CORP_GOV, HHI, and COMMON_LAW for the sample
are reported in Table 2, Panel A. Panel B of Table 2 reports the number of observations,
the mean, and the median of RETURN, CORP_GOV, and HHI by the primary investor pro-
tection measure (COMMON_LAW). The legal origin investor protection measure
(COMMON_LAW) is fixed across time for all observations. Panel B shows that 58% (42)
of the sample is from noncommon law (common law) countries and that common law
countries have higher average annual returns (RETURN) and higher average corporate gov-
ernance (CORP_GOV) values, while the average product market competition measure
(HHI) is comparable at 0.54 (0.56) for noncommon law (common law) observations. Thus,
cross-sectional variation exists between the observations across differing investor protection
environments. Finally, sample data by industry (untabulated) show that the sample repre-
sents 65 different industries at the two-digit SIC (Standard Industrial Classification) level,
with Chemicals and Allied Products having the largest number of observations (2,420) and
Forestry having the least (2). Fishing, Hunting, and Trapping has a perfectly concentrated
industry with only 29 total observations (only one observation exists within each country,
thereby making it perfectly concentrated) and the most competitive industry is the Railroad
Transportation Industry. Average returns range from a high of 69.89% in the Forestry
industry to a low of 6.65% in the Miscellaneous Services industry. Also, 15,366 observa-
tions are domiciled in noncommon law legal origin countries while 10,982 observations are
domiciled in common law legal origin countries. Overall, there appears to be a sufficient
distribution of observations to conduct empirical tests generalizable to many different
industries and countries.
I report descriptive statistics in Table 3 to better understand the distribution of the vari-
ables used in the study. The dependent variable (RETURN) has a mean of 15.40%, which
appears reasonable when compared with previous international studies. TOBINSQ is used
as an alternate measure of firm value, and it has a lower degree of variability which is
expected because it is derived from total firm value as opposed to the market-based value
underlying the primary dependent variable, RETURN. Summary statistics of the investor
protection and other control variables also appear reasonable.
To better understand the relationships between the variables used in the study, I report
correlation statistics in Table 4. Many of the variables are correlated at the 10% level of
significance or better, which are in bold. The product market competition variable (HHI)
10 Journal of Accounting, Auditing & Finance

Table 2.

Panel A: Summary Statistics by Country.

Country N RETURN CORP_GOV HHI COMMON_LAW
Australia 3,347 17.95 56.50 0.51 Yes
Austria 137 18.93 43.97 0.94 No
Belgium 223 12.02 50.69 0.86 No
Brazil 682 13.86 52.13 0.58 No
Chile 351 15.10 24.69 0.67 No
Colombia 79 17.52 53.13 0.69 No
Denmark 201 23.80 52.42 0.82 No
Egypt 61 27.66 17.10 0.79 No
Finland 255 13.42 48.64 0.84 No
France 865 9.23 40.40 0.72 No
Germany 968 13.98 44.48 0.67 No
Greece 167 5.44 40.13 0.76 No
Hong Kong 436 23.58 37.60 0.77 Yes
India 811 30.20 37.67 0.36 Yes
Indonesia 335 39.08 22.49 0.56 No
Ireland 214 19.32 57.08 0.90 Yes
Israel 140 15.39 53.30 0.55 Yes
Italy 367 0.50 44.43 0.73 No
Japan 4,930 10.42 24.07 0.32 No
Korea 1,165 20.40 19.50 0.56 No
Malaysia 429 12.57 39.86 0.49 Yes
Mexico 236 24.86 24.40 0.64 No
Netherlands 400 9.91 45.83 0.79 No
New Zealand 411 12.95 46.75 0.85 Yes
Norway 198 18.82 62.35 0.76 No
Peru 96 30.15 23.49 0.50 No
Philippines 209 29.38 25.80 0.54 No
Portugal 121 7.42 53.43 0.81 No
Singapore 393 13.69 40.50 0.64 Yes
South Africa 1,131 18.70 45.33 0.66 Yes
Spain 464 8.16 50.97 0.65 No
Sri Lanka 14 35.69 47.37 0.39 Yes
Sweden 534 16.41 36.27 0.82 No
Switzerland 569 12.00 48.84 0.79 No
Taiwan 1,518 16.30 31.78 0.38 No
Thailand 340 26.56 59.17 0.67 Yes
Turkey 235 17.36 65.05 0.74 No
United Kingdom 3,316 13.31 52.49 0.52 Yes

Note. Panel A of this table reports, by country, the number of observations, the means of RETURN, CORP_GOV, and
HHI, and if the country has a common law legal origin (COMMON_LAW). All continuous variables are winsorized at
the 1st and 99th percentiles. All variables are defined in the appendix.
(continued)

has significant correlations with many of the variable used in the study although none of
the correlations are alarmingly high (i.e., highest is .13). COMMON_LAW and
INV_PROTECT show a high level of correlation (.76), suggesting that these estimates also
measure similar constructs. These correlations suggest that these constructs, while different
in scope, are sufficient measures to determine the robustness of the primary findings.
Rakestraw 11

Table 2. (continued)

Panel B: Summary Statistics by Legal Origin.

No Yes
COMMON_LAW M Median M Median
RETURN 13.92 7.68 17.49 7.68
CORP_GOV 34.14 26.15 50.45 26.15
HHI 0.54 0.50 0.56 0.50
N 15,366 10,982

Note. Panel B of this table reports mean and median values of RETURN, CORP_GOV, and HHI by COMMON_LAW
(yes or no) legal origin. All continuous variables are winsorized at the 1st and 99th percentiles. All variables are
defined in the appendix.

Table 3. Summary Statistics.

Variable N M SD 25th percentile Median 75th percentile

RETURN 26,348 15.40 51.29 214.44 8.27 34.97
CORP_GOV 26,348 40.94 28.67 15.43 36.84 65.84
HHI 26,348 0.55 0.31 0.29 0.50 0.88
COMMON_LAW 26,348 0.42 0.49 0.00 0.00 1.00
INV_PROTECT 26,348 0.54 0.21 0.42 0.51 0.78
TOBINSQ 26,348 2.39 6.26 1.01 1.29 1.89
ASSETS 26,348 9.40 19.96 0.94 2.89 8.01
MTB 26,348 4.50 16.57 0.99 1.71 3.07
PRICE 26,348 4,385.31 21,837.38 4.80 27.31 464.65
VOLUME 26,348 933.40 2,141.43 66.82 231.04 761.72
YIELD 26,348 1.43 1.62 0.00 0.99 2.38
SALES_GROWTH 26,348 0.12 0.36 20.01 0.06 0.17
ANTIDIR 26,348 4.17 0.78 3.50 4.50 5.00

Note. This table reports the mean, standard deviation, 25th percentile, median, and 75th percentile for the
variables used in subsequent analyses. All continuous variables are winsorized at the 1st and 99th percentiles. All
variables are defined in the appendix.

Results
Background Tests
Table 5 reports the results of my tests of the substitute relationship between corporate gov-
ernance and product market competition. I run the tests in Table 5 to establish some bench-
marks with prior research, and these tests are not the primary tests of this article. The tests
in Models 1 and 2 are replications of those presented in Table V of Giroud and Mueller
(2011, p. 582).
In Model 1, I regress firm value (RETURN) on corporate governance (CORP_GOV) and
find a negative relation, which is somewhat surprising. This result is notably different from
the findings of both Giroud and Mueller (2011) and Ammann et al. (2013), who each
found an insignificant relation between corporate governance and firm value. This
12 Journal of Accounting, Auditing & Finance

Table 4. Correlations.

Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
RETURN (1) —
CORP_GOV (2) 2.05 —
HHI (3) 2.01 .13 —
COMMON_LAW (4) .03 .28 .07 —
INV_PROTECT (5) .03 .17 2.06 .76 —
TOBINSQ (6) .08 .01 .00 2.04 .03 —
ASSETS (7) 2.07 .06 .07 2.18 2.19 2.05 —
MTB (8) .06 .01 .02 2.03 .03 .95 2.04 —
PRICE (9) .03 2.11 .01 2.17 2.16 .04 .06 .04 —
VOLUME (10) 2.01 .07 2.02 2.06 .01 .17 .28 .17 .03 —
YIELD (11) 2.09 .07 .03 .15 .15 2.12 .31 2.09 2.04 .12 —
SALES_GROWTH (12) .16 .01 2.03 .12 .12 .03 2.07 .01 .00 2.01 2.07 —
ANTI_DIR (13) .02 2.01 2.13 .48 .47 .02 2.04 .03 .05 2.06 .24 .01

Note. This table reports Pearson correlations for all variables used in the analyses. Correlations significant at the
\10% level are in bold. All continuous variables are winsorized at the 1st and 99th percentiles. All variables are
defined in the appendix.

discrepancy may be due to two reasons. First, my sample period is from 2002 to 2016
while Giroud and Mueller (2011) used a sample from 1990 to 1999 and Ammann et al.
(2013) used a sample from 2003 to 2007.8 Second, Giroud and Mueller (2011) and
Ammann et al. (2013) used data from well-developed economies and stock markets (i.e.,
the US and the EU, respectively), while my data are from a more economically and cultu-
rally diverse sample of firms (e.g., Colombia, Egypt, and Malaysia). To investigate whether
the level of economic development of the different countries has any effect on the differ-
ence between my findings in Table 5 and the prior research, I rerun Model 1 on observa-
tions taken only from two highly developed, common law countries, Australia and the
United Kingdom; the untabulated results are insignificant for both countries (p values of
.143 and .758, respectively), which comports with the findings cited above (Ammann et al.,
2013; Giroud and Mueller, 2011).
In Model 2 of Table 5, I allow the relation between corporate governance and firm
value to vary based on the level of product market competition in the industry. This repli-
cation is consistent with the results of Giroud and Mueller (2011, Table V) and shows that
the negative relation between corporate governance and firm value is most negative in the
most competitive tercile—low HHI indicator variable—and least negative (i.e., closest to
0) in the most concentrated tercile—high HHI indicator variable.
Finally, I run Model 3 of Table 5 to test that the investor protection proxy does not have
an identical relationship to firm value as the corporate governance proxy (CORP_GOV)
and, therefore, provides incremental value to the understanding of the substitute relation
between corporate governance and product market competition on firm value. In Model 3
of Table 5, the data show that legal origin (COMMON_LAW), which I use as a proxy for
investor protection, is not a substitute for corporate governance, as the results in Model 3
are markedly different from those in Model 2. The results of Model 3 allow me to establish
ex ante that investor protection is not a substitute for corporate governance.
Rakestraw 13

Table 5. Interactive Regressions Testing Substitute Effect of Corporate Governance and Product
Market Competition on Firm Value.

Model (1) (2) (3)

Dependent variable RETURN
CORP_GOV 20.049**
(22.30)
HHI (medium) 0.110 1.946
(0.04) (0.79)
HHI (high) 21.554 1.511
(20.40) (0.53)
CORP_GOV (tercile) 3 HHI (low) 22.907*
(22.14)
CORP_GOV (tercile) 3 HHI (medium) 22.019**
(22.54)
CORP_GOV (tercile) 3 HHI (high) 21.413*
(21.78)
COMMON_LAW 3 HHI (low) 4.835
(1.48)
COMMON_LAW 3 HHI (medium) 3.337
(1.20)
COMMON_LAW 3 HHI (high) 2.421
(0.93)
ASSETS 20.095*** 20.094*** 20.079**
(23.21) (23.25) (22.34)
MTB 0.171*** 0.167*** 0.170***
(3.83) (3.85) (3.96)
STOCK_PRICE 0.000 0.000 0.000*
(1.72) (1.68) (1.91)
RETURN_LAG 0.003 0.003 0.004
(0.05) (0.04) (0.06)
VOLUME 20.000 20.000 20.000
(20.25) (20.29) (20.33)
YIELD 21.715*** 21.677*** 21.839***
(23.45) (23.33) (23.85)
SALES_GROWTH 22.058*** 22.179*** 21.321***
(11.47) (11.90) (11.34)
ANTIDIR 1.492 1.668 0.590
(1.09) (1.38) (0.49)
Intercept 8.117 10.090 7.395
(1.09) (1.43) (1.44)
Observations 26,348 26,348 26,348
Adjusted R2 .099 .106 .111

Note. This table reports parameter estimates and t-statistics from a model testing the influence of corporate
governance (CORP_GOV) individually in Model 1, the interaction of corporate governance with product market
competition (HHI) in Model 2, and the interaction of common law legal origin (COMMON_LAW) with product
market competition (HHI) on firm value (RETURN). The dependent variable is RETURN. Reported parameters and
t-statistics are estimated using annual Fama and MacBeth (1973) regressions. Significance (two-tail) is denoted at
the 10%, 5%, and 1% levels by *, **, and ***, respectively. All continuous variables are winsorized at the 1st and
99th percentiles. All variables are defined in the appendix.
14 Journal of Accounting, Auditing & Finance

Primary Results
The previous tests first established a relationship that is consistent with existing research
on the substitute relation between corporate governance and product market competition on
firm value and that investor protection does not act as a substitute for corporate governance
in empirical tests which suggests that investor protection may provide incremental value to
our understanding of the substitute effect. In Table 6, I report the same regression as in
Model 2 of Table 5; however, in this case, the sample is split on COMMON_LAW which I
use to test H1. I separate the sample into high and low investor protection regimes to test
whether investor protection has a moderating role in the substitution effect between product
market competition and corporate governance on firm value. I predict that the substitute
relationship between corporate governance and product market competition is valued more
by investors in countries where other mechanisms to discipline managers are weak.
Investor protection is strong, and equity ownership is more diverse in common law coun-
tries. These facts suggest that the coefficient on the interaction of the tercile of
CORP_GOV and high HHI indicator variable will be greater (lesser) in the noncommon
law (common law) condition. Table 6 shows regression results which confirm this expecta-
tion and provide support for H1. The interaction between corporate governance tercile and
the high HHI indicator variable is 21.062 in the noncommon law countries, but in the
common law countries it is 22.389. This difference represents an economically significant
1.327% difference in annual return. I test the statistical significance of this difference with a
Chow test; as reported at the bottom of Table 6, this result is significant at the 5% level (p =
.0165). These findings suggest that, consistent with the hypothesis of this article, equity mar-
kets place a higher value on the substitute relationship between corporate governance and
product market competition where other investor protection mechanisms are weak. This
result, in turn, suggests that investor protection plays a moderating role in how firm value is
affected by the substitute effects of product market competition and corporate governance.
The results for the control variables are largely consistent with expectations. The coeffi-
cients are positive for both market-to-book value of equity (MTB) and annual sales growth
(SALES_GROWTH) and negative for larger firms as measured by total assets (ASSETS)
which is not surprising. One surprising finding is that lagged stock price return
(RETURN_LAG) is not a significant predictor of RETURN, which suggests a lack of persis-
tence in annual returns in this sample. Finally, dividend yield (YIELD) is negatively related
to the dependent variable, RETURN, in the common law sample in Model 2. This result
suggests that in the noncommon law sample in Model 1, where there are fewer investor
protection mechanisms, investors may perceive the payment of dividends as a significant
reduction in agency costs; on the contrary, in strong investor protection environments (i.e.,
common law countries), the payment of dividends may be perceived instead as indicating a
lack of investment opportunities.

Additional Analyses
To confirm that the results are not spurious, I run several alternative specifications of the
main tests. To produce the results in Table 7, I median-split the sample on the level of
investor protection (INV_PROTECT), instead of by legal origin (COMMON_LAW) as in
Table 6. I predict that, where other investor protection mechanisms are weakest, equity
markets will place a higher value on the substitute relationship between corporate govern-
ance and product market competition. If so, the coefficient on the interaction of the tercile
Rakestraw 15

Table 6. Interactive Regressions Testing Substitute Effect of Corporate Governance and Product
Market Competition on Firm Value in High/Low Investor Protection Countries.

Model (1) (2)

Dependent variable RETURN
COMMON_LAW No Yes
HHI (medium) 0.121 22.930
(0.05) (20.81)
HHI (high) 23.119 23.657
(20.95) (20.79)
CORP_GOV (tercile) 3 HHI (low) 23.732** 23.762*
(22.68) (21.99)
CORP_GOV (tercile) 3 HHI (medium) 22.674** 22.454**
(22.64) (22.84)
CORP_GOV (tercile) 3 HHI (high) 21.062 22.389*
(21.62) (21.92)
ASSETS 20.087** 20.037
(22.63) (20.59)
MTB 0.127** 0.366***
(2.41) (6.07)
STOCK_PRICE 0.000* 0.025***
(1.80) (3.03)
RETURN_LAG 20.052 0.024
(20.56) (0.49)
VOLUME 20.000 0.000
(20.58) (0.47)
YIELD 20.988 22.665***
(21.66) (24.03)
SALES_GROWTH 31.866*** 15.408***
(7.09) (8.02)
ANTI_DIR 0.202 20.171
(0.12) (20.06)
Intercept 13.409* 24.465
(1.87) (1.69)
Observations 15,366 10,982
Adjusted R2 .148 .118
Difference in: CORP_GOV (tercile) 3 HHI (high) 21.327**
Chow test F-stat (5.58)

Note. This table reports parameter estimates and t-statistics from a model testing the influence of corporate
governance (CORP_GOV) and product market competition (HHI) on firm value (RETURN) in different investor
protection environments (COMMON_LAW). The dependent variable is RETURN. Reported parameters and t-
statistics are estimated using annual Fama and MacBeth (1973) regressions. Significance (two-tail) is denoted at the
10%, 5%, and 1% levels by *, **, and ***, respectively. All continuous variables are winsorized at the 1st and 99th
percentiles. All variables are defined in the appendix.

of CORP_GOV and the high HHI indicator variable will be greater (lesser) in the low
(high) investor protection condition. The results presented in Table 7 confirm this expecta-
tion. The interactive term of the tercile of CORP_GOV and high HHI indicator variable is
positive (negative and significant) in the low (high) investor protection condition. The dif-
ference between the low and high investor protection conditions is over 3% of annual
16 Journal of Accounting, Auditing & Finance

Table 7. Interactive Regressions Testing Substitute Effect of Corporate Governance and Product
Market Competition on Firm Value in High/Low Investor Protection Countries.

Model (1) (2)

Dependent variable RETURN
INV_PROTECT (median-split) Low High
HHI (medium) 2.327 23.814
(0.83) (21.18)
HHI (high) 22.460 21.603
(20.58) (20.45)
CORP_GOV (tercile) 3 HHI (low) 23.060* 23.689**
(22.07) (22.24)
CORP_GOV (tercile) 3 HHI (medium) 22.818** 21.639
(22.41) (21.18)
CORP_GOV (tercile) 3 HHI (high) 0.098 23.505**
(0.15) (22.15)
ASSETS 20.068** 20.097*
(22.33) (21.92)
MTB 0.293*** 0.109**
(3.74) (2.65)
STOCK_PRICE 0.000* 0.001
(1.83) (0.81)
RETURN_LAG 20.050 0.015
(20.55) (0.28)
VOLUME 20.000 20.000
(20.63) (20.43)
YIELD 21.209* 21.878***
(22.11) (23.60)
SALES_GROWTH 31.076*** 18.061***
(5.84) (8.95)
ANTI_DIR 1.087 2.097
(0.81) (1.34)
Intercept 7.759 13.479
(0.97) (1.38)
Observations 13,186 13,162
Adjusted R2 .159 .104
Difference in: CORP_GOV (tercile) 3 HHI (high) 23.603*
Chow test F-stat (3.63)

Note. This table reports parameter estimates and t-statistics from a model testing the influence of corporate
governance (CORP_GOV) and product market competition (HHI) on firm value (RETURN) in different investor
protection environments (INV_PROTECT). The dependent variable is RETURN. Reported parameters and t-statistics
are estimated using annual Fama and MacBeth (1973) regressions. Significance (two-tail) is denoted at the 10%, 5%,
and 1% levels by *, **, and ***, respectively. All continuous variables are winsorized at the 1st and 99th
percentiles. All variables are defined in the appendix.

returns, which is economically significant. Furthermore, the Chow test, reported at the
bottom of Table 7, confirms the difference is statistically significant (p = .0536).
In the final tabulated tests, I use a different proxy for firm value to check the robustness
of the primary findings. All previous tests used the annual common stock return (RETURN)
as the dependent variable. In Table 8, I estimate the same regressions as in Table 6, but
change the firm value proxy to the lead value of Tobin’s Q (TOBINSQ). I also include a
Rakestraw 17

Table 8. Interactive Regressions Testing Substitute Effect of Corporate Governance and Product
Market Competition on Firm Value in High/Low Investor Protection Countries.

Model (1) (2)

Dependent variable TOBINSQ
COMMON_LAW No Yes
HHI (medium) 20.285 20.122
(20.85) (21.45)
HHI (high) 20.188 0.087
(20.60) (0.66)
CORP_GOV (tercile) 3 HHI (low) 20.195 20.041
(20.99) (21.19)
CORP_GOV (tercile) 3 HHI (medium) 0.038 0.006
(0.63) (0.20)
CORP_GOV (tercile) 3 HHI (high) 0.042 20.069**
(1.18) (22.52)
ASSETS 20.018 0.028
(21.11) (0.97)
TOBINSQ_LAG 0.644*** 0.686***
(10.16) (13.55)
STOCK_PRICE 20.000 0.002
(20.95) (1.05)
RETURN_LAG 0.006 20.006
(1.20) (21.09)
VOLUME 0.000 20.000
(0.98) (21.04)
YIELD 20.017 0.011
(20.70) (0.26)
SALES_GROWTH 0.227 20.064
(1.07) (21.48)
ANTI_DIR 20.019 0.050**
(20.31) (2.56)
Intercept 1.017** 0.573***
(2.44) (3.79)
Observations 12,088 11,894
Adjusted R2 .809 .886
Difference in: CORP_GOV (tercile) 3 HHI (high) 20.111*
Chow test F-stat (3.50)

Note. This table reports parameter estimates and t-statistics from a model testing the influence of corporate
governance (CORP_GOV) and product market competition (HHI) on firm value (TOBINSQ) in different investor
protection environments (COMMON_LAW). The dependent variable is TOBINSQ. Reported parameters and
t-statistics are estimated using annual Fama and MacBeth (1973) regressions. Significance (two-tail) is denoted at
the 10%, 5%, and 1% levels by *, **, and ***, respectively. All continuous variables are winsorized at the 1st and
99th percentiles. All variables are defined in the appendix.

concurrent estimation of Tobin’s Q (TOBINSQ_LAG) as an independent variable, in addi-

tion to the lagged return (RETURN_LAG). The results presented in Table 8 confirm my pri-
mary findings. The interactive term of the tercile of CORP_GOV and the high HHI
indicator variable is positive (negative and significant) in the noncommon law (common
law) condition. The difference between the noncommon law and the common law condi-
tions is 0.111, which is statistically significant (p = .0585).
18 Journal of Accounting, Auditing & Finance

Finally, I conduct several untabulated analyses as robustness tests. First, I removed

financial firms,9 due to their highly regulated status, and all observations from the year
2008, due to the global economic crisis, and rerun the primary analysis presented in Table
6. The market-based value of financial firms is often significantly affected by influences
beyond product market competition, corporate governance, and investor protection. For
example, when central banks change borrowing rates or when regulatory bodies enact regu-
lations, these events have effects on the value of financial institutions which are beyond the
scope of this article. Furthermore, the market-based value of financial firms was signifi-
cantly affected by the financial crisis of 2008. When financial firms are removed from the
analysis in Table 6, the inferences presented remain in the same direction and level of sig-
nificance, while the Chow test becomes more significant (F = 6.37; p = .0108) when com-
pared with the results tabulated in Table 6 (F = 5.58; p = .0165). When the 2008
observations are removed, the inferences presented in Table 6 also remain in the same
direction and level of significance (Chow test F = 5.06; p = .0237). In my final untabulated
robustness test, I use the ratio of the sales of the top four firms in an industry to the sales
of all firms in the industry as a proxy for competition instead of the HHI used in the pri-
mary tests and find that the primary results are robust to this alternative specification
(Chow test F = 2.98; p = .0837).
Collectively, the primary results and the various robustness tests suggest that equity mar-
kets place a higher value on the substitute relationship between corporate governance and
product market competition in countries where other investor protection mechanisms are
weak. This finding is consistent with the hypothesis of the article and shows that country-
level investor protection has a moderating role in affecting the substitution between product
market competition and corporate governance on firm value.

Conclusion
This study reexamines the substitution effect of corporate governance and product market
competition on firm value, considered in relation to investor protection. I use an interna-
tional setting consisting of diverse markets, where differential effects of product market
competition and corporate governance on firm value are likely to exist and where there are
substantial variations in the factors affecting these constructs. I categorize firms as operat-
ing within low or high investor protection environments based on the level of laws and reg-
ulations to protect investors in their country of domicile. I use the HHI at the country-
industry-year level as proxies for product market competition. My findings confirm prior
research by indicating that there exists a general substitution effect of competition and cor-
porate governance on firm value. However, I find that investors value this substitution
effect more where investor protection is weak. Where investor protection is strong, the low
equity agency cost benefit of product market competition and corporate governance is
valued less, because other mechanisms (i.e., laws and regulations to protect investors)
already lessen equity agency costs. This suggests that country-level investor protection
mechanisms play a moderating role in the substitution effect between product market com-
petition and corporate governance. My results hold under several robustness tests and alter-
native specifications, including alternate estimations of product market competition, firm
value, and investor protection.
I acknowledge several caveats related to this research. First, the results depend on the
measurement of product market competition; I use two different measures of competition
in an attempt to alleviate this concern. However, the findings in this study are limited to
Rakestraw 19

the extent that competition may manifest through forces I have not included. Second, the
results are sensitive to the number of private firms within an industry. The sample consists
of public firms with data on traded equity or debt that is available in Compustat Global and
for which corporate governance measures are available in the Thomson Reuters Datastream
Asset4 databases. It is conceivable that private firms may influence the results by providing
competitive pressure on the public firms included in the sample. Research including private
firms is a potential avenue for future research.

Appendix. Variable Definitions.

Variable Definition
ANTI_DIR Formed by adding one for each of the following conditions: (a)
shareholders are allowed to mail their proxy vote; (b) deposit of
shares is not required prior to general shareholders’ meetings; (c)
cumulative voting or proportional representation of minorities on the
board of directors is allowed; (d) there exists an oppressed minority
mechanism; (e) the minimum percentage of share capital that allows a
shareholder to request an extraordinary shareholders’ meeting is less
than or equal to 10%; or (f) shareholders’ preemptive rights can only
be waived by a shareholders’ meeting. Source: Djankov et al. (2008).
ASSETS Natural log of total assets in U.S. dollars (AT). Source: Compustat.
COMMON_LAW Indicator variable equal to one if firm’s country of domicile has a
common law legal origin, zero otherwise. Source: La Porta et al.
(1998).
CORP_GOV Measure of a company’s management commitment and effectiveness
toward following best practice corporate governance principles
related to a shareholder policy and equal treatment of shareholders
(CGSR). It reflects a company’s capacity to be attractive to minority
shareholders by ensuring minority shareholders equal rights and
privileges and by limiting the use of anti-takeover devices. Source:
Thomson Reuters Datastream Asset4 Database.
HHI Herfindahl–Hirschman Index (HHI), which is defined as the sum of the
squared sales ratios. Sales ratio is defined as firm sales divided by sum
of all sales in the same country-industry-year (SALE). Source:
Compustat.
INV_PROTECT Principal component of the indices of anti-director rights, disclosure
requirements, and liability. Source: La Porta et al. (2006).
MTB Market value of equity (PRCCD 3 CSHR) scaled by book value of equity
(CEQ). Source: Compustat.
RETURN Common stock annual return measured as the 1-year percentage
change in price (PRCCD). Source: Compustat.
STOCK_PRICE Common stock price (PRCCD). Source: Compustat.
SALES_GROWTH Sales (SALE) minus prior year sales divided by prior year sales. Source:
Compustat.
TOBINSQ Total assets (AT) less book value of equity (CEQ) plus market value of
equity (PRCCD 3 CSHR) scaled by total assets (AT). Source:
Compustat.
VOLUME Total annual shares traded in millions (CHSTRD). Source: Compustat.
YIELD Dividend yield defined as total dividends (DVC) scaled by stock price
(PRCCD). Source: Compustat.
20 Journal of Accounting, Auditing & Finance

Author’s Note
This article is based in part on my dissertation completed at Virginia Tech. I am grateful for the gui-
dance of my dissertation committee members: Robert M. Brown, Raman Kumar (Finance), John J.
Maher (chair), Sarah E. Stein, and Michael C. Wolfe. I also appreciate helpful comments from Bharat
Sarath (editor), an anonymous reviewer, Brooke Beyer, Gia Chevis, Bryan Cloyd, Bowe Hansen,
Kathleen Harris, Julia Higgs, Eric Johnson, Scott Johnson, Mark Kohlbeck, Mitch Oler, Ann Tarca
(discussant), Maria Vulcheva (discussant), James Wainberg, workshop participants at Baylor
University, the College of William and Mary, Eastern Michigan University, Florida Atlantic
University, Mississippi State University, Oregon State University, University of Kentucky, University
of North Carolina at Charlotte, University of Wyoming, and Virginia Tech, and conference attendees
at the 2015 AAA International Accounting Section Midyear Meeting and the 2015 AAA Annual
Meeting.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/
or publication of this article.

Funding
The author(s) received no financial support for the research, authorship, and/or publication of this
article.

ORCID iD
Joseph R. Rakestraw https://orcid.org/0000-0003-0076-2438
Notes
1. The Lerner (1934) index is measured as (Price  Marginal Cost)=Price with the interpretation
that firms with more (less) monopoly power have a higher (lower) index. For example, see
Epifani and Gancia (2011), Kutlu and Sickles (2012), and Weyl and Fabinger (2013).
2. Economics presents two models, representing the two opposite extremes of competition. The
first model assumes perfect competition between firms, whereas the second is characterized by
single-firm monopoly. The market condition of perfect competition produces exactly zero eco-
nomic profit, whereas monopolies can earn positive economic profits in the long run. In a per-
fectly competitive market, there are many buyers and sellers, each buys or sells only a fraction
of the total market, products are substitutable, and there is ease of entry into the market (see, for
example, Hall & Lieberman, 2008).
3. Hart (1983) made several assumptions, including that there is no owner monitoring of managers,
owners only have information related to firm performance and no information related to costs,
managerial compensation is derived from a single profit target, and there exists a common com-
ponent to costs across firms in the same industry (i.e., when one firm’s costs are high, other
firms in the same industry will also have high costs).
4. ‘‘Entrepreneurial’’ firms do not necessarily have to be owner-managed, but are assumed to be
run in the best interests of the owners, which is to maximize profit.
5. That is, a hedge portfolio which buys long (sells short) firms with a G-Index less than 5 (greater
than 14).
6. Ali et al. (2009) showed that industry concentration measures calculated exclusively with
Compustat data are poor proxies for actual levels of industry concentration; this is a known lim-
itation of the findings in the current study. I attempt to alleviate this concern by using different
measures of product market competition. U.S. Census data are a better proxy for product market
Rakestraw 21

competition, but data analogous to U.S. Census data are not available in all of the countries
investigated here. Several studies have used private firm data to better approximate industry con-
centration when investigating one country (e.g., Ammann et al., 2013; Byun et al., 2012), but pri-
vate firm data are also not available for all of the countries in the current study. Investigating
only one country or continent limits the generalizability of a study’s findings; investigating a
large number of firms from different countries with diverse economies is one of the primary con-
tributions of the current study.
7. While a firm may be missing from the final data set due to a number of data limitations, I use
the maximum number of firm-year observations to calculate product market competition. For
example, a firm that is missing a necessary data item (e.g., CORP_GOV) still provides competi-
tive pressure to the remaining firms in its industry.
8. In robustness tests reported later in this section, I test whether observations during the great
recession (2008) affect the primary results reported in the article and they do not.
9. Financial firms remaining in the final sample are those from two-digit SIC (Standard Industrial
Classification) industries 64 (Insurance Agents Brokers and Service), 65 (Real Estate), and 67
(Holding and Other Investment Offices).

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