Corporate Governance in Emerging Markets: A Survey

by

Stijn Claessens and Burcin Yurtoglu 1

January 15, 2012

Abstract

This paper reviews recent research on corporate governance, with a special focus on
emerging markets. It finds that better corporate frameworks benefit firms through greater
access to financing, lower cost of capital, better performance, and more favorable
treatment of all stakeholders. Numerous studies show these channels to operate at the
level of firms, sectors and countries—with causality increasingly often clearly identified.
Evidence also shows that voluntary and market corporate governance mechanisms have
less effect when a country’s governance system is weak. Importantly, how corporate
governance regimes change over time and how this impacts firms are receiving more
attention recently. Less evidence is available on the direct links between corporate
governance and social and environmental performance. The paper concludes by
identifying issues requiring further study, including the special corporate governance
issues of banks, and family-owned and state-owned firms, and the nature and determinants
of public and private enforcement.

1
Stijn Claessens, Research Department, International Monetary Fund, University of Amsterdam and CEPR,
email: SClaessens@imf.org. Burcin Yurtoglu WHU – Otto Beisheim School of Management, email:
burcin.yurtoglu@whu.edu. We would like to thank the editor, Jonathan Batten, Melsa Ararat, Craig Doidge and
an anonymous referee for very useful suggestions. The views expressed here are those of the authors and do not
necessarily represent those of the IMF or IMF policy.
1

Electronic copy available at: http://ssrn.com/abstract=1988880

1. Introduction
Corporate governance, a phrase that a decade or two ago meant little to all but a handful of
scholars and shareholders, has become a mainstream concern—a staple of discussion in
corporate boardrooms, academic meetings, and policy circles around the globe. Several events
are responsible for the heightened interest in corporate governance. During the wave of
financial crises in 1998 in Russia, Asia, and Brazil, the behavior of the corporate sector
affected entire economies, and deficiencies in corporate governance endangered global
financial stability. Just a few years later confidence in the corporate sector was sapped by
corporate governance scandals in the United States and Europe that triggered some of the
largest insolvencies in history. And the most recent financial crisis has seen its share of
corporate governance failures in financial institutions and corporations, leading to systemic
consequences. In the aftermath of these events, not only has the phrase corporate governance
become more of a household term, but researchers, the corporate world, and policymakers
everywhere recognize the potential macroeconomic, distributional and long-term
consequences of weak corporate governance systems.
The crises, however, are just manifestations of a number of structural reasons why corporate
governance has become more important for economic development and well-being. The
private, market-based investment process is much more important for most economies than it
used to be, and that process needs to be underpinned by good corporate governance. With
firms increasing in size and the role of financial intermediaries and institutional investors
growing, the mobilization of capital is increasingly one step removed from the principal-
owner. At the same time, the allocation of capital has become more complex as investment
choices have widened with the opening up and liberalization of financial and real markets,
and as structural reforms, including price deregulation and increased competition, have
increased companies’ exposure to market forces risks. At the same time, the recent financial
crisis has reinforced how failures in corporate governance can ruin corporations and adversely
affect whole economies. These developments have made the monitoring of the use of capital
more complex in many ways, enhancing the need for good corporate governance.

This paper traces the many dimensions through which corporate governance works in firms
and countries. To do so, it reviews the extensive literature on the subject—and identifies areas
where more study is needed. A well-established body of research has over the last two
decades acknowledged the increased importance of legal foundations, including the quality of
the corporate governance framework, for economic development and well-being. Research
has addressed the links between law and economics, highlighting the role of legal foundations
and well-defined property rights for the functioning of market economies. This literature has
also addressed the importance and impact of corporate governance. 2 While this research has
expanded into emerging markets, much of it still refers to situations in developed countries, in
particular the United States, and less so to developing countries. Furthermore, this literature
does not always have a focus of the relationship between corporate governance and economic
development and well–being. The purpose of this paper is to fill these gaps.

The paper is structured as follows. It starts with a definition of corporate governance, as that
determines the scope of the issues, and reviews how corporate governance can and has been
defined. The paper next explores in which ways corporate governance may matter, and
especially how it affects corporations in emerging markets. It does so by providing extensive

2
The first broad survey of corporate governance was Shleifer and Vishny (1997). Several surveys have since
followed, including Becht et al. (2003), Claessens and Fan (2002), Denis and McConnell (2003), and Holmstrom
and Kaplan (2001).
2

Electronic copy available at: http://ssrn.com/abstract=1988880

background on countries’ economic, financial and institutional environments, including
ownership patterns, around the world that determine and affect the scope and nature of
corporate governance problems. This section highlights that corporate governance issues in
emerging markets vary from those in advanced countries due to still-limited development of
private financial markets and poor access to financing, concentrated ownership structures, and
low institutional ownership. It also shows some of the differences among emerging markets,
such as the variation in governance structures between East Asia and recent EU-member
Central and Eastern Europe countries. It also documents the differences in levels of market
pressures, political/government influence, capital cost controls, internalization of stakeholder
interests, governance spillovers through inward FDI, outward FDI and tapping of international
capital markets among emerging markets and between emerging markets and advanced
countries. These issues help set the stage of the remaining discussion in the paper.

After analyzing what the theoretical literature has to say about the various channels through
which corporate governance affects economic development and well–being, the paper reviews
the empirical facts about these relations. It explores recent research documenting how
(changes in) legal aspects can affect firm valuation, influence the degree of corporate
governance problems, and more broadly affect firm performance and financial structure. It
then reviews the evidence on how a number of (voluntary) corporate governance
mechanisms—ownership structures, boards, cross-listing, use of independent auditors—affect
firm performance and behavior. It also reviews research on the factors that play a role in
countries’ willingness to undertake corporate governance reforms. The paper concludes by
identifying some main policy and research issues that require further study.

2. What is Corporate Governance?

Definitions of corporate governance vary widely. They tend to fall into two categories. The
first set of definitions concerns itself with a set of behavioral patterns: that is, the actual
behavior of corporations, in terms of such measures as performance, efficiency, growth,
financial structure, and treatment of shareholders and other stakeholders. The second set
concerns itself with the normative framework: that is, the rules under which firms are
operating—with the rules coming from such sources as the legal system, the judicial system,
financial markets, and factor (labor) markets.

For studies of single countries or firms within a country, the first type of definition is the most
logical choice. It considers such matters as how boards of directors operate, the role of
executive compensation in determining firm performance, the relationship between labor
policies and firm performance, and the role of multiple shareholders. For comparative studies,
the second type of definition is the more logical one. It investigates how differences in the
normative framework affect the behavioral patterns of firms, investors, and others.

In a comparative review, the question arises how broadly to define the framework for
corporate governance. Under a narrow definition, the focus would be only on the rules in
capital markets governing equity investments in publicly listed firms. This would include
listing requirements, insider dealing arrangements, disclosure and accounting rules, and
protections of minority shareholder rights.

Under a definition more specific to the provision of finance, the focus would be on how
outside investors protect themselves against expropriation by the insiders. This would include
minority right protections and the strength of creditor rights, as reflected in collateral and
bankruptcy laws, and their enforcement. It could also include such issues as requirements on
3
the composition and the rights of the executive directors and the ability to pursue class-action
suits. This definition is close to the one advanced by Shleifer and Vishny in their seminal
1997 review: “Corporate governance deals with the ways in which suppliers of finance to
corporations assure themselves of getting a return on their investment” (1997, p. 737). This
definition can be expanded to define corporate governance as being concerned with the
resolution of collective action problems among dispersed investors and the reconciliation of
conflicts of interest between various corporate claimholders.

A somewhat broader definition would be to define corporate governance as a set of

mechanisms through which firms operate when ownership is separated from management.
This is close to the definition used by Sir Adrian Cadbury, head of the Committee on the
Financial Aspects of Corporate Governance in the United Kingdom: “Corporate governance
is the system by which companies are directed and controlled” (Cadbury Committee, 1992).

An even broader definition is to define a governance system as “the complex set of

constraints that shape the ex post bargaining over the quasi rents generated by the firm”
(Zingales, 1998, p. 499). This definition focuses on the division of claims and can be
somewhat expanded to define corporate governance as the complex set of constraints that
determine the quasi-rents (profits) generated by the firm in the course of relationships with
stakeholders and shape the ex post bargaining over them. This definition refers to both the
determination of value-added by firms and the allocation of it among stakeholders that have
relationships with the firm. It can be read to refer to a set of rules, as well as to institutions.

Corresponding to this broad definition, the objective of a good corporate governance

framework would be to maximize the contribution of firms to the overall economy—-that is,
including all stakeholders. Under this definition, corporate governance would include the
relationship between shareholders, creditors, and corporations; between financial markets,
institutions, and corporations; and between employees and corporations. Corporate
governance would also encompass the issue of corporate social responsibility, including such
aspects as the dealings of the firm with respect to culture and the environment.

When analyzing corporate governance in a cross-country perspective, the question arises

whether the framework extends to rules or institutions. Here, two views have been advanced.
One is the view that the framework is determined by rules, and related to that, to markets and
outsiders. This has been considered a view prevailing in or applying to Anglo-Saxon
countries. In much of the rest of the world, institutions—specifically banks and insiders—are
thought to determine the actual corporate governance framework.

In reality, both institutions and rules matter, and the distinction, while often used, can be
misleading. Moreover, both institutions and rules evolve over time. Institutions do not arise in
a vacuum and are affected by the rules in the country or the world. Similarly, laws and rules
are affected by the country’s institutional setup. In the end, both institutions and rules are
endogenous to other factors and conditions in the country. Among these, ownership structures
and the role of the state matter for the evolution of institutions and rules through the political
economy process. Shleifer and Vishny (1997, p. 738) take a dynamic perspective by stating:
“Corporate governance mechanisms are economic and legal institutions that can be altered
through political process.” This dynamic aspect is very relevant in a cross-country review,
but has received attention from researchers only lately.

When considering both institutions and rules, it is easy to become bewildered by the scope of
institutions and rules that can be thought to matter. An easier way to ask the question of what
4
corporate governance means is to take the functional approach. This approach recognizes that
financial services come in many forms, but that if the services are unbundled, most, if not all,
key elements are similar (Bodie and Merton, 1995). This line of analysis of the functions—
rather than the specific products provided by financial institutions, and markets—has
distinguished six types of functions: pooling resources and subdividing shares; transferring
resources across time and space; managing risk; generating and providing information;
dealing with incentive problems; and resolving competing claims on the wealth generated by
the corporation. One can operationalize the definition of corporate governance as the range of
institutions and policies that are involved in these functions as they relate to corporations.
Both markets and institutions will, for example, affect the way the corporate governance
function of generating and providing high-quality and transparent information is performed.

3. How do Countries Differ in Aspects Relevant to Corporate

Governance?
The nature of the corporate governance challenges is importantly determined in a general way
by the countries’ overall development and institutional environment, and specifically by
prevailing ownership structures. This section therefore provides for various countries –
advanced, emerging markets and transition economies – a number of salient statistics on both
countries’ economic and financial environment as well as key aspects of their institutional
environments, such as ease of contracting and the degree of legal and judicial efficiency.
Many of the measures and their relations with good corporate governance are discussed in
greater detail in the next sections. These comparisons highlight that emerging markets differ
in some key aspects from advanced countries, but they also show that there is much variation
in some of these features across emerging markets. Specific corporate governance issues and
the role of corporate governance for economic development and well-being are best
understood from the perspective of ownership structures and the related structures of business
groups. The section therefore next provides a review of the wide variety in ownership
concentration across countries and the variation in business group structures. The
comparisons thus naturally lead to subsequent discussions of the key corporate governance
issues in emerging markets and how they vary from those in advanced countries.

3.1 The diversity in economic and financial environments

Economic and financial conditions obviously differ greatly among countries. Table 1A
reports, for a sample of advanced countries, emerging markets and transition economies, key
aspects that are important influencing factors with respect to corporate governance. In the first
column, it reports economic development and prospects. In terms of GDP per capita,
emerging markets and transition economies rank still much below advanced countries. Some
emerging markets, though, such as Hong Kong and Singapore, exceed in terms of per capita
income many advanced countries, while others, such as Korea and Hungary, are ahead or not
far behind some of the advanced countries. As is well known, GDP growth has been much
higher recently in emerging markets and transition economies than in advanced countries
(column 2), almost double, as these countries are catching up quickly.

Important impetus for corporate governance over the past few years has been the
internationalization and globalization in trade and finance. The next column (3) shows that in
term of trade integration emerging markets and transition economies do not differ much
anymore from advanced countries, although again there are large differences among emerging
markets (e.g., East Asian countries are typically much more open). The flow of foreign direct

5
investment (FDI) as a percent of GDP (column 4) still differs much across countries. It shows
how emerging markets and transition economies rely, to date at least, much less on FDI, than
advanced countries do. There are differences though among emerging markets, with some
East Asian countries much more reliant on FDI.

Another important force for change has been pressures of financial markets. In terms of
financial market development, however, there remain relatively large differences between
advanced countries and emerging markets and transition economies, as shown by the ratio of
credit to GDP as a share of GDP (column 5). Advanced countries stand out as having much
deeper financial systems, with ratios more than double those of emerging markets and almost
three times as high as those of transition economies. But the variation among emerging
markets is very large as well. Many countries in East Asia, for example, have ratios of credit
to GDP close to or more than 100%, whereas many Latin American countries have ratios only
half those. Also, some transition economies like Poland and Romania score relatively low in
this respect, a reflection of episodes of high inflation which undermined financial
development.

These differences in credit market development are also reflected in stock market
development. Market capitalization as a share of GDP (column 6) is some 90% in advanced
countries, versus 67% in emerging markets and only 23% in transition economies. Again, the
differences among emerging markets are large. Besides many transition economies, Latin
American countries tend to have low stock market development. These differences are to
some degree also reflected in the frequency at which stocks are being traded, measured by the
turnover ratio (column 7). Here emerging markets are more similar to advanced countries than
they in the other dimensions, but transition economies still show much lower turnover ratios
than advanced countries do. Since the ratio is sometimes used as a measure of stock market
efficiency, the comparisons suggest that markets in transition economies are less efficient in
allocating resources, with consequences for corporate governance.

3.2 The diversity in institutional environments

Institutional aspects and consequent differences between countries span many dimensions.
Table 1B presents some salient institutional dimensions that matter for corporate governance.
Crucial for corporate governance and financial markets development in general, are properly
functioning legal and judicial systems. This involves a number of dimensions: the general
definition and protection in laws of property rights; the formal definition and protection of
creditor and shareholder rights specifically; the enforcement of legal rights in the judicial
system; the lack of corruption in general; and the overall disclosure regime and the
transparency of matters specifically related to corporate governance. Many of these aspects
are of a qualitative nature and consequently not as easily captured and codified. The
comparisons nevertheless show some clear differences between countries.

The starting point for describing the legal system is often its origin (column 1): Common Law
(British) or Civil Law, with the latter French or German in origin. A smaller category is the
Scandinavian. In terms of the overall strength of (formal) property rights protection, the
Common Law system is generally considered to be better. On this score, reflecting past
colonization, emerging markets do not differ much from advanced countries. Transition
economies do differ clearly in that they all have Civil Law origin.

The strength of countries’ formal legal rights has been captured using an index based on
various features of the countries’ legal system (column 2). This index shows little differences
6
between the averages for advanced countries versus transition economies, but emerging
markets tend to have less strongly defined rights. The formal definition of property rights is
particularly weak in some African, Latin America and Middle Eastern countries. It tends to be
better in those emerging markets that have a common law origin, like Hong Kong, Kenya,
Singapore and South Africa.

The specific property rights of creditors and shareholders (column 3 and 4) are on average
equally strongly defined in advanced countries as in emerging markets and transition
economies, except for the shareholders rights which are less strongly defined in transition
economies. Still, these averages hide large variations among countries. In many emerging
market countries, the formal rights of creditors are very weak. In Colombia, Egypt, and
Mexico, for example, the score for creditor rights is a zero. Also shareholders rights are often
very weak, especially in Latin America, with scores in Bolivia, Ecuador, and Venezuela less
than 10 on a scale of 100. Again, some of these differences reflect the legal origins of these
countries.

What matters at least as much as the formal definition of property rights is the degree of
enforcement of these rights. This aspect, while obviously hard to codify, is captured to some
degree in the efficiency of enforcement index (column 5) and the lack of corruption index
(column 6). These indexes show differences much larger than the formal rights between
advanced countries on one hand and emerging markets and transition economies on the other
hand. On average, the efficiency of enforcement is twice as high in advanced countries than it
is in emerging markets and transition economies. Also, there is much less lack of corruption
in both emerging markets and transition economies than in advanced countries. While only
two advanced countries do not score above 100 (Greece and Italy), with few exceptions
emerging markets and transition economies fall below that mark, and many actually score
below zero. Again, there is large variation, with “emerging markets” countries like Chile,
Hong Kong and Singapore scoring above many advanced countries, while others dramatically
failing to curb corruption, as is the case for Kenya and Nigeria, with score of -99 and -108
respectively.

Next is an index of the degrees to which corporations listed on local stock exchanges have to
disclose relevant financial and other information (column 7). Differences between advanced
countries and emerging markets are not large on average (these data do not cover the
transition economies). There is much more variation, though, among emerging markets. Some
emerging markets countries like Malaysia, Thailand and South Africa have disclosure
requirements on their stock exchanges that equal or exceed those of most advanced countries.
Others, such as Brazil, Ecuador, Uruguay and Venezuela, though have disclosure
requirements that are very weak. Last relevant comparison is a de-facto quality of corporate
governance index, based on actual corporations’ behavior (column 8). It reflects how
accounting statements are being provided, how earnings are being smoothed, and how stock
prices behave and reflect information about the firm. It shows the emerging markets and
transition economies to score below the advanced countries as a group, with again large
differences with the emerging markets group.

3.3 The diversity in ownership structures

The nature of the corporate governance problems importantly varies between countries and
over time depending on ownership structures. At the individual firm level, ownership
structure defines the nature of principal-agent issues. Here the difference between direct
ownership—also called cash-flow rights—and control rights—who has de facto control over
7
the running of the corporation, also called voting rights—is very important. In many
corporations, the controlling shareholder may have little direct equity stake, but through
various constructions she may still exercise de facto full control. Another factor is group-
affiliation, which is especially important in emerging markets, where business groups can
dominate economic activity. Of course, ownership and group-affiliation structures vary over
time and can be endogenous to country circumstances, including economic and financial
conditions and the legal and other foundations (see Shleifer and Vishny 1997). As such,
ownership and group-affiliation structures both affect the legal and regulatory infrastructure
necessary for corporate governance and are affected by the legal and regulatory infrastructure.

Much of the early corporate governance literature focused on conflicts between managers and
owners. But around the world, except for the United States and to some degree the United
Kingdom, insider-controlled or closely-held firms are the norm (La Porta et al. 1998). These
can be family-owned firms or firms controlled by financial institutions. Families like the
Peugeots in France, the Quandts in Germany, and the Agnellis in Italy hold large blocks of
shares in even the largest firms and effectively control them (Barca and Becht, 2001; Faccio
and Lang, 2002). In other countries, such as Japan and to some extent Germany, financial
institutions control large parts of the corporate sector (La Porta et al. 1998; Claessens et al.
2000; Faccio and Lang, 2002). Even in the United States, family-owned firms are not
uncommon (Holderness, 2009). This control is frequently reinforced through pyramids and
webs of shareholdings that allow families or financial institutions to use ownership of one
firm to control many more with little direct investment.

Most studies on emerging markets document the existence of a large shareholder which holds
a controlling direct interest in the equity capital of listed companies. Table 2 (see the
Appendix) summarizes analyses of these ownership patterns in emerging markets. For East
Asian countries, such as Hong Kong, Indonesia, and Malaysia, the largest direct
shareholdings are generally about 50%, with the largest shareholders often families and also
involved with management. On average, studies indicate that direct equity ownership of a
typical firm is slightly more than 50% in India and Singapore, and less so in S. Korea (~20%),
Taiwan (~30%), and Thailand (~40%). Financial institutions also have sizeable ownership
stakes in Bangladesh, Malaysia, India and Thailand. Some corporations in India, Indonesia,
Malaysia and Korea are foreign owned. Also some state ownership is reported, albeit by
studies from the 1990s, in India, Malaysia, and Thailand. Evidence of a large divergence
between cash flow and voting rights of controlling owners is reported for many East Asian
corporations, with this divergence mostly maintained by pyramid structures.

In Latin America, the typical largest shareholder has an interest of more than 50%. Direct
shareholdings even exceed 60% in Argentina and Brazil. Similar to East Asia, most of the
largest shareholders are wealthy families. In Chile, Colombia, Mexico and Peru, financial and
non-financial companies are also direct owners. In contrast to East Asia, where control is
maintained mostly through pyramids and cross-shareholdings, non-voting stock and dual-
class shares are more prevalent in Latin America. Divergence of cash flow rights from voting
rights is consequently more common in Latin America.

Studies from some other individual countries, such as Israel, Kenya, Turkey, Tunisia and
Zimbabwe, also point towards concentrated ownership and a large divergence of cash flow
rights from control rights. As such, a pattern of concentrated ownership with large divergence
between cash flow and voting rights seems to be the norm around the world.

8
There is limited research on changes in ownership structures, but most studies report that
ownership structures are fairly stable over time, except for transition countries. Foley and
Greenwood (2010) study the evolution of ownership in 34 countries, includes companies from
emerging markets such as Brazil, Chile, Egypt, Hong Kong, India, Korea, Malaysia, Mexico,
Singapore, Taiwan and Thailand. In almost every country, firms tend to have concentrated
ownership immediately following initial public offering (IPO). In countries with strong
protections for minority investors and liquid stock markets, the typical firm becomes widely
held within five to seven years. In the United States, for example, block ownership of the
median firm drops from 50 percent to 21 percent within five years.

Nearly everywhere else, however, firms remain closely held even ten years after going public.
In Brazil, for example, block holders still own half of the median firm five years after IPO.
Carney and Child (forthcoming) analyze changes in ownership patterns in East Asia from
1996 to 2008 and report that family control remains the most common form of ownership,
though there are clear differences between Northeast and Southeast Asia, with Northeast
Asian firms exhibiting a stronger orientation towards widely-held ownership while Southeast
Asian firms exhibit varying levels of reliance on family and state-dominated ownership.

These corporations’ ownership structures affect the nature of the agency problems between
managers and outside shareholders, and among shareholders. When ownership is diffuse, as is
typical for U.S. and UK corporations, agency problems stem from the conflicts of interests
between outside shareholders and managers who own an insignificant amount of equity in the
firm (Jensen and Meckling, 1976). On the other hand, when ownership is concentrated to a
degree that one owner (or a few owners acting in concert) has effective control of the firm, the
nature of the agency problem shifts away from manager-shareholder conflicts. The controlling
owner is often also the manager or can otherwise be assumed to be able and willing to closely
monitor and discipline management. Information asymmetries can consequently be assumed
to be less, as a controlling owner can invest the resources necessary to acquire information.

Correspondingly, the principal-agent problems in most countries around the world will be less
management-versus-owner and more minority-versus-controlling shareholder. Countries in
which insider-held firms dominate will therefore have different requirements in terms of
corporate governance framework than those where widely held firms dominate. In such
countries, the protection of minority rights is more often key than controlling management'
actions.

3.4 The diversity in group affiliation

An aspect related to ownership structures is that many countries have large financial and
industrial conglomerates and groups. In some groups, a bank or another financial institution
typically lies at the apex. These can be insurance companies, as in Japan (Morck and
Nakamura, 2007), or banks, as in Germany (Fohlin, 2005). In other countries, and most often
in emerging markets, a financial institution lies at the center within the group. Table 2 reports
that many emerging market corporations are indeed part of business groups. For example,
around 20% of all Korean listed companies are members of one of the 30 largest chaebols in
this country. The fraction is even higher in India and Turkey.

Being part of such groups can benefit the firm, such as by using internal factor markets, which
can be valuable in case of missing or incomplete external (financial) markets. Particularly in
emerging markets, group-affiliation can thus be valuable. Groups or conglomerates can also
have costs, however, especially for investors. They often come with worse transparency and
9
less clear management structures. This opens up the possibility of worse corporate
governance, including expropriation of minority rights (Khanna and Yafeh, 2007 offer a
review of these issues; Masulis et al., 2011 present more recent evidence from 45 countries).
Indeed much evidence suggest that in the presence of large divergence between cash-flow
rights and voting rights, group-affiliation has detrimental effects on stock valuation
(Claessens et al. 2002; Joh 2003; Lefort 2005; Bae et al. forthcoming; Bae et al. 2008) and
also on operating performance (Bertrand et al. 2002).

The existence of such problems and related corporate governance issues depends importantly
on the regulatory framework, but also on the overall competitive structure of the economy and
the role of the state. In more developed, more market-based economies that are also more
competitive, group affiliation is less common. Again, as with ownership structures, the line of
causality is unclear. The prevalence of groups can undermine the drive to develop external
(financial) markets. Alternatively, poorly developed external markets increase the benefits of
internal markets. And sometimes, the state itself is behind the formation of groups, as was the
case in Italy and Korea, raising public governance issue.

Another aspect is the role of institutional investors, which to date, is much less in most
emerging markets compared to in advanced countries. Studies exist on the role of institutional
investors in corporate governance, but largely for the US (see Black, 1998; Gillan and Starks,
2003 and 2007 for literature reviews). Existing studies focusing nearly exclusively on voting
by mutual funds, which is affected by conflict of interests (Davis and Kim, 2007 and Ashraf
et al. 2012) and the corporate governance of the funds themselves (Cremers et al. 2009).

As noted, ownership by institutional investors is generally small in emerging markets. The

typical presence of a dominant shareholder alters their corporate governance role as they have
little direct influence through voting, board representation or otherwise. They might also be
more concerned about protecting themselves against expropriation, rather than with
disciplining management. Only a handful of recent studies examine institutional investor
activism in markets with concentrated ownership and business groups. Giannetti and Laeven
(2009) study Sweden and find some evidence of differences of voting between pension funds
affiliated with business and financial groups and other pension funds. McCahery et al. (2010)
find large differences in preferences for activism between institutional investors in the US and
the Netherlands, countries which differ considerably in terms of ownership structures. Yafeh
and Hamdani (2011) study the voting behavior of institutional investors in Israel and report
that they tend to be active primarily when legally required to do so and that they often fail to
use the legal power granted to minority shareholders. But other studies of the role of
institutional investors in emerging markets specifically are largely absent to date.

10
4. How and Through What Channels Does Corporate Governance
Matter?
We organize the literature according to how and through what channels it has identified
corporate governance to impact corporations and countries:

• The first is the increased access to external financing by firms. This in turn can lead to
greater investment, higher growth, and greater employment creation.
• The second channel is a lowering of the cost of capital and associated higher firm
valuation. This makes more investments attractive to investors, also leading to growth and
more employment.
• The third channel is better operational performance through better allocation of resources
and better management. This creates wealth more generally.
• Fourth, good corporate governance can be associated with a reduced risk of financial
crises. This is particularly important, as highlighted recently again, given that financial
crises can have large economic and social costs.
• Fifth, good corporate governance can mean generally better relationships with all
stakeholders. This helps improve social and labor relationships and aspects such as
environmental protection, and can help further reduce poverty and inequality.

All these channels matter for growth, employment, poverty, and well-being more generally.
Empirical evidence using various techniques has documented these relationships at the level
of the country, the sector, and the individual firm and from the investor perspectives. 3

4.1 Increased access to financing

The role of legal foundations for financial and general development is well understood and
documented (see Levine 2005, Rioja and Valev, 2004, Ang, 2008 and Rathinam and Raja,
2010. Legal foundations matter crucially for a variety of factors that lead to higher growth,
including financial market development, external financing, and the quality of investment. A
good legal and judicial system is also important for assuring the benefits of economic
development are shared by many. Legal foundations include property rights that are clearly
defined and enforced and other key rules (disclosure, accounting, regulation and supervision).

Comparative corporate governance research documenting these patterns took off following
the works of La Porta et al. (LLSV, 1997 and 1998). These two pivotal papers emphasized the
importance of law and legal enforcement on the governance of firms, the development of
markets, and economic growth. Following these papers, numerous studies have documented
institutional differences relevant for financial markets and other aspects. 4 Many other papers

3
Some of these studies suffer from endogeneity issues: that is, firms, markets, or countries may adopt better
corporate governance and perform better. However, the relationship is not from better corporate governance to
improved performance; rather it is either the other way around or because some other factors drive both better
corporate governance and better performance. For discussions of the econometric problems raised by
endogeneity see Himmelberg et al. (1999), Coles et al. (2012), Adams and Ferreira (2008) and Roberts and
Whited (2011).
4
All these applications are important, although not novel. Coase (1937, 1960), Alchian (1965), Demsetz (1964),
Cheung (1970, 1983), North (1981, 1990), and subsequent institutional economic literature have long stressed
the interaction between property rights and institutional arrangements shaping economic behavior. The work of
LLSV (1997, 1998), however, provided the tools to compare institutional frameworks across countries and study
the effects in a number of dimensions, including how a country’s legal framework affects firms’ external
financing and investment.
11
have since shown the link between legal institutions and financial sector development (see
Beck and Levine, 2005 for a review).

These studies have established that the development of a country’s financial markets relates to
these institutional characteristics and furthermore that institutional characteristics can have
direct effects on growth. Beck et al. (2000), for example, document how the quality of a
country’s legal system not only influences its financial sector development but also has a
separate, additional effect on economic growth. In a cross-country study at a sectoral level,
Claessens and Laeven (2003) report that in weaker legal environments, firms not only obtain
less financing but also invest less than optimal in intangible assets. The less-than-optimal
financing and investment patterns in turn both affect the economic growth of a sector.
Acemoglu and Johnson (2005) find that private contracting institutions play a significant role
in explaining stock market capitalization.

While seminal in its approach, LLSV’s work and their initial indices of legal development
and enforcement have been subject to a range of critical responses both on conceptual
(Coffee, 1999 and 2001; Pagano and Volpin, 2005) and measurement grounds (Spamann,
2010; Lele and Siems, 2007). Partly in response to these criticisms, (Djankov et al., 2008)
present a new measure of legal protection of minority shareholders against expropriation by
corporate insiders: the anti-self-dealing index. Using this new measure they report that a high
anti-self-dealing index is associated with higher valued stock markets, more domestic firms,
more initial public offerings, and lower benefits of control. As such, the general finding that
better legal protection helps with capital market development is confirmed. Nevertheless,
there remain some disagreements on legal aspects as important drivers of financial sector
development (see, Armour et al. 2009)

This law and finance literature has shown that better creditor rights and shareholder rights are
associated with deeper and more developed banking and capital markets. Figure 1 depicts the
relationship between an index of creditor rights and the depth of the financial system (as
measured by the ratio of private credit to GDP). The figure shows that the better creditor
rights are defined, the more willing lenders are to extend financing. This relationship holds
across countries and over time, in that countries that improved their creditor rights saw an
increase in financial development (Djankov et al. 2008).

A similar relationship exists between the quality of shareholder protection and the
development of countries’ capital markets. Figure 2 depicts the relationship between the index
of shareholder rights (Djankov et al. 2008) and the size of the stock markets (as a ratio of
GDP). The figure shows a strong relationship, with the market capitalization doubling from
the three lowest quartiles to the highest quartile country. Most studies find that these results
are robust to including a wide variety of control variables in the analysis. Of course, it is not
just the legal rules that count, but importantly their enforcement. In this context a well staffed
and independent securities regulator becomes key (Jackson and Roe, 2009).

In countries with better property rights, firms thus have a greater supply of financing
available. As a consequence, firms can be expected to invest more and grow faster (Rajan and
Zingales, 1998). The effects of better property rights leading to greater access to financing on
growth can be large. For example, the evidence of financial sector development and economic
growth suggests that countries in the third quartile of financial development enjoy between 1
and 1.5 extra percentage points of GDP growth per year, compared with countries in the first
quartile. There is also evidence that under conditions of poor corporate governance (and
underdeveloped financial and legal systems and higher corruption), the growth rate of the
12
smallest firms is the most adversely affected, and fewer new firms start up—particularly small
firms (Beck et al., 2005).

Figure 1. The Relationship between Creditor Rights and the Size of the Banking Sector

Source: Own calculations using data from WDI-GDF (2011) and Djankov et al. (2008).
Countries with stronger protection of creditor rights have more developed banking sectors.

Figure 2. The Relationship between Shareholder Rights and the Size of the Stock Markets

Source: Own calculations using data from WDI-GDF (2011) and Djankov et al. (2008).
Countries with stronger protection of shareholder rights have larger stock markets.

There is also evidence on the importance of the cost of capital channel, both for equity and
debt financing. Chen et al. (2011) find that U.S. firms with better corporate governance have a
lower cost of equity capital after controlling for risk and other factors, with effects stronger
for firms that have more severe agency problems and face greater threats from hostile
13
takeovers. Ashbaugh-Skaife et al. (2004) report that firms with a higher degree of accounting
transparency, more independent audit committees and more institutional ownership have a
lower cost of capital, whereas firms with more blockholders have a higher cost. Hail and Luez
(2006) show how legal institutions affect the cost of equity.

Attig et al. (2008) report for eight East Asian emerging markets that the cost of equity capital
decreases in the presence of large shareholders different than the controlling owner,
suggesting that second large shareholders help curb the private benefits of the controlling
shareholder and reduce information asymmetries. Chen et al. (2009 and 2011) find that firm-
level corporate governance has a significantly negative effect on the cost of equity capital in
17 emerging markets. This effect is more pronounced in countries that provide relatively poor
legal protection. Thus, in emerging markets, firm-level corporate governance and country-
level shareholder protection seem to be substitutes for each other in reducing the cost of
equity. Byun et al. (2008) show that in Korea better corporate governance practices relate
negatively to estimates of implied cost of equity capital, with better shareholder rights
protection having the most significant effect, followed by independent board of directors and
disclosure policy.

Sound corporate governance has been shown to lower the cost of debt for US firms (Anderson
et al., 2004). Lin et al. (2011) find that the cost of debt financing is significantly higher for
companies with a higher divergence between the largest ultimate owner’s control rights and
cash-flow rights. They show that potential tunneling and other moral hazard activities by large
shareholders are facilitated by their excess control rights. These activities increase the
monitoring costs and the credit risk faced by banks and, in turn, raise the cost of debt.

Laeven and Majnoni (2005) find that improvements in judicial efficiency and enforcement of
debt contracts are critical to lowering financial intermediation costs for a large cross-section
of countries. Qian and Strahan (2007) find that stronger creditor rights result in loans with
longer maturities and lower spreads. Bae and Goyal (2009) show that it is enforceability, not
merely creditor rights, that matters to the cost and efficiency of loan contracting. Miller and
Reisel (2011) report that bond contracts are more likely to include covenants when creditor
protection laws are weak. Further, the use of restrictive covenants in weak creditor protection
countries is associated with a lower cost of debt.

4.2 Higher firm valuation and better operational performance

The quality of the corporate governance framework affects not only the access to and amount
of external financing, but also the cost of capital and firm valuation. Outsiders are less willing
to provide financing and are more likely to charge higher rates if they are less assured that
they will get an adequate rate of return. Conflicts between small and large controlling
shareholders — arising from a divergence between cash-flow and voting rights — are greater
in weaker corporate governance settings, implying that smaller investors are receiving too
little of the returns the firm makes. Better corporate governance can also add value by
improving firm performance, through more efficient management, better asset allocation,
better labor policies, and other efficiency improvements.

There is convincing empirical evidence for these effects. Table 3 gives an overview of
empirical analyses of the relationship between ownership structures and company valuations
and operational performance. Firm value, typically measured by Tobin's q, the ratio of market
to book value of assets, is higher when the largest owner’s equity stake is larger, but lower
when the wedge between the largest owner’s control and equity stake is larger (Claessens et
14
al. 2002; Mitton 2002; Lins, 2003). Large non-management control rights, blockholdings, are
also positively related to firm value. These effects are more pronounced in countries with low
legal shareholder protection. Much evidence from individual countries such as Korea (Bae et
al., forthcoming), Hong Kong (Lei and Song, 2008), Brazil, Chile, Colombia, Peru and
Venezuela (Cueto, 2008) confirms that less deviation between cash flow and voting rights is
positively associated with relative firm valuation. The magnitude of this effect is substantial: a
one standard deviation decrease in the degree of divergence is associated with an increase in
Tobin’s q of 28% (an increase in stock price of 58%) in Chile. Effects of a similar order are
reported for Korea (Black et al., 2006a) and Turkey (Yurtoglu, 2000 and 2003).

The country and firm level studies suggest that better corporate governance improves market
valuations. Two forces are at work here. First, better governance practices can be expected to
improve the efficiency of firms’ investment decisions, thus improve the companies’ future
cash flows which can be distributed to shareholders. The second channel works through a
reduction of the cost of capital which is used to discount the expected cash flows. Better
corporate governance reduces agency risk and the likelihood of minority shareholders’
expropriation and possibly leads to higher dividends, making minority rights shareholders
more willing to provide external financing.

While fewer studies analyze operating performance than valuation, the ones that do, report in
general positive effects when agency issues are less. Wurgler (2000) shows the general
beneficial role well developed financial markets play in the allocation of capital. In a cross-
country empirical study, Claessens et al. (2011) show that the responses of investment to
changes in Tobin's q are faster in countries with better corporate governance and information
systems. A positive impact of foreign corporate ownership on operating performance is
documented by Douma et al. (2006) for India. Pant and Pattanayak (2007) find that inside
owners in India improve operating performance when ownership is smaller than 20% and
greater than 49%, suggesting entrenchment effects at intermediate levels.
For Taiwan, insider ownership is negatively and institutional ownership positively related to
total factor productivity. Similarly, for Taiwan, Yeh et al. (2001) find adverse effects of
entrenched owners. Filatotchev et al. (2005) document a positive impact of institutional
investors and foreign financial institutions ownership on performance. Orbay and Yurtoglu
(2006) report a negative influence of the ownership-control disparity on the investment
performance in Turkey. Wiwattanakantang (2001) reports that controlling shareholders’
involvement in management negatively affects performance in Thailand. Carvalhal da Silva
and Leal (2006) for Brazil and Gutiérrez and Pombo (2007) for Colombia report higher
operating performance where owners have more cash flow rights and there is no ownership
disparity.

Besides financial and capital markets, other factor markets need to function well to prevent
corporate governance problems. These real factor markets include all output and input
markets, including labor, raw materials, intermediate products, energy, and distribution
services. Firms subject to more discipline in the real factor markets are more likely to adjust
their operations and management to maximize value added. Corporate governance problems
are therefore less severe when competition is already high in real factor markets.

The importance of competition for good corporate governance is true in financial markets as
well. The ability of insiders, for example, to mistreat minority shareholders consistently can
depend on the degree of both the degree of competition and protection. If small shareholders
have little alternative but to invest in low-earning assets, for example, controlling
15
shareholders may be more able to provide a below-market return on minority equity. 5 Open
financial markets can thus help improve with corporate governance, one of the so-called
collateral benefits of financial globalization (Kose et al, 2010).

Surprisingly, while well accepted and generally acknowledged (see Khemani and Leechor,
2001), there is less empirical evidence on the role of competition in relationship to corporate
governance. Guadalupe and Perez-Gonzalez (2010) show that within-country increases in the
intensity of competition lead to a reduction in the level and dispersion of private benefits of
control. Their results are more pronounced in weak-rule-of-law countries. In a paper on
Poland, Grosfeld and Tressel (2002) find that competition has a positive effect on firms with
good corporate governance, but no significant effects on firms with bad corporate governance.
Li and Niu (2007) find that moderate concentrated ownership and product market competition
are complementary in enhancing the performance of Chinese listed firms. They also report
that competitive pressures can substitute for weak board governance. Bhaumik and Piesse
(2004) observe patterns of change in technical efficiency from 1995 to 2001 for Indian banks
consistent with the notion that competitive forces are more important than ownership effects.
Estrin (2002) documents that weak competitive pressures played a pivotal role in the poor
evolution of corporate governance in transition countries. Conversely, Estrin and Angelucci
(2003) find evidence that post-transition competitive pressures encouraged better managerial
actions, including deep restructuring and investment.

4.3 Less volatile stock prices

The quality of corporate governance can also affect firms’ behavior in times of economic
shocks and actually contribute to the occurrence of financial distress, with economy-wide
impacts. During the East Asian financial crisis, cumulative stock returns of firms in which
managers had high levels of control rights, but little direct ownership, were 10 to 20
percentage points lower than those of other firms (Lemmon and Lins, 2003). This shows that
corporate governance can play an important role in determining individual firms’ behavior, in
particular the incentives of insiders to expropriate minority shareholders during times of
distress. Similarly, a study of the stock performance of listed companies from Indonesia,
Korea, Malaysia, the Philippines, and Thailand found that performance is better in firms with
higher accounting disclosure quality (proxied by the use of Big Six auditors) and higher
outside ownership concentration (Mitton, 2002). This provides firm-level evidence consistent
with the view that corporate governance helps explain firm performance during a financial
crisis.

Related work shows that hedging by firms is less common in countries with weak corporate
governance frameworks (Lel, 2012), and to the extent that it happens, it adds very little value
(Alayannis, Lel, and Miller, 2009). The latter evidence suggests that in these environments,
hedging is not necessarily for the benefit of outsiders, but more for the insiders. There is also
evidence that stock returns in emerging markets tend to be more positively skewed than in
5
The role of competition in financial sector development and stability is, however, still being debated (see the
views of Thorsten Beck versus those of Franklin Allen in one of The Economist debates in June 2011).
Theoretically, less competition can be preferable in a second-best world if banks expand lending under stronger
monopoly rights and thereby enhance overall output (Hellmann et al., 2000). Less competition may also lead to
more financial stability as financial institutions have greater franchise value and act therefore more conservative.
On the other hand, competition leads to more pressures to reduce inefficiencies and lower costs, and can
stimulate innovation. Besides the beneficial effects of reducing inefficiencies or weeding out corrupt lending
practices often associated with protected financial systems, greater competition may also reduce excessive risk
taking (Boyd and De Nicolo, 2005) and promote (implicit) investment coordination among firms (Abiad et al.,
2008).
16
industrial countries (Bae et al., 2006). This can be attributed to managers having more
discretion in emerging markets to release information, disclosing good news immediately,
while releasing bad news slowly, or that firms share risks in these markets among each other,
rather than through financial markets.

There is also country-level evidence that weak legal institutions for corporate governance
were key factors in exacerbating the stock market declines during the 1997 East Asian
financial crisis (Johnson et al, 2000). In countries with weaker investor protection, net capital
inflows were more sensitive to negative events that adversely affect investors’ confidence. In
such countries, the risk of expropriation increases during bad times, as the expected return of
investment is lower, and the country is therefore more likely to witness collapses in currency
and stock prices.

The view that poor corporate governance of individual firms can have economy-wide effects
is not limited to developing countries. In the early 2000s, the argument was made that in
developed countries corporate collapses (like Enron), undue profit boosting (by Worldcom),
managerial corporate looting (by Tyco), audit fraud (by Arthur Andersen), and inflated
reports of stock performance (by supposedly independent investment analysts) led to crises of
confidence among investors, leading to the declines in stock market valuation and other
economy-wide effects, including some slowdowns in economic growth.

Evidence from financial crises suggests as well that weaknesses in corporate governance of
financial and non-financial institutions can affect stock return distributions. Consistently, Bae
et al. (forthcoming) find that during the 1997 Asian financial crisis, firms with weaker
corporate governance experience a larger drop in their share values, but during the post-crisis
recovery period, such firms experience a larger rebound in their share values. And during the
recent financial crisis, firms that had better internal corporate governance tend to have higher
rates of return (Cornett et al., 2009). Importantly, in the recent financial crisis, corporate
governance failures at major financial institutions, such as Lehman and AIG, contributed to
the global financial turmoil and subsequent recessions. While this is more anecdotal evidence,
it is clear that corporate governance deficiencies can carry a discount, either specific to
particular firms or for markets as whole, in developed as well as developing countries, and
even lead to financial crises. As such, poor corporate governance practices can pose a
negative externality on the economy as a whole.

4.4 Better functioning financial markets and greater cross-border investments

More generally, poor corporate governance can affect the functioning of a country’s financial
markets and the volume of cross-border financing. One channel is that poor corporate
governance can increase financial volatility. When information is poorly protected—due to a
lack of transparency and insiders having an edge on firms’ doing and prospects—investors
and analysts may have neither the ability to analyze firms (because it is very costly to collect
information) nor the incentive (because insiders benefit regardless). In such a weak property
rights environment, inside investors with private information, including analysts, may, for
example, trade on information before it is disclosed to the public.

There is evidence that the worse transparency associated with weaker corporate governance
leads to more synchronous stock price movements, limiting the price discovery role of the
stock markets (Morck et al., 2000). A study of stock prices within a common trading
mechanism and currency (the Hong Kong stock exchange) found that stocks from
environments with less investor protection (China-based) trade at higher bid-ask spreads and
17
exhibit thinner depths than more protected stocks (Hong Kong-based) (Brockman and Chung,
2003). Evidence for Canada suggests that ownership structures indicating potential corporate
governance problems also affect the size of the bid-ask spreads (Attig et al., 2006). This
behavior imparts a degree of positive skewness to stock returns, making stock markets in
well-governed countries better processors of economic information than are stock markets in
poorly governed countries.

Another area where corporate governance affects firms and their valuation is mergers and
acquisitions (M&A). Indeed, during the last two decades, the volume of M&A activity and
the premium paid were significantly larger in countries with better investor protection (Rossi
and Volpin, 2004). This indicates that an active market for mergers and acquisitions—an
important component of a corporate governance regime—arises only in countries with better
investor protection. Also, in cross-border deals, the acquirers are typically from countries with
better investor protection than the targets, suggesting cross-border transactions play a
governance role by improving the degree of investor protection within target firms and aiding
in the convergence of corporate governance systems.

A recent study by Bhagat et al. (2011) reports that emerging country acquirers experience a
significantly positive market response of 1.09% on the announcement day. These abnormal
returns are positively correlated with (better) corporate governance measures in the target
country. Starks and Wei (2004) and Bris and Cabolis (2008) also report a higher takeover
premium when investor protection in the acquirer’s country is stronger than in the target’s
country. And Ferreira et al (2010) show that foreign institutional ownership significantly
increases the probability that a local firm will be targeted by a foreign bidder, with effects
economically significant: a 10 percentage point increase in foreign ownership doubles the
fraction of cross-border M&As (relative to the total number of M&As in a country). It also
suggests that foreign portfolio investments and cross-border M&As are complementary
mechanisms in promoting corporate governance worldwide.

4.5 Better relations with other stakeholders

Besides the principal owner and management, public and private corporations must deal with
many other stakeholders, including banks, bondholders, labor, and local and national
governments. Each of these monitor, discipline, motivate, and affect the management and the
firm in various ways. They do so in exchange for some control and cash flow rights, which
relate to each stakeholders’ own comparative advantage, legal forms of influence, and form of
contracts. Commercial banks, for example, have a greater amount of inside knowledge, as
they typically have a continued relationship with the firm. Formal influence of commercial
banks may derive from the covenants banks impose on the firm: for example, in terms of
dividend policies, or requirements for approval of large investments, mergers and
acquisitions, and other large undertakings. Bondholders may also have such covenants or
even specific collateral. Furthermore, lenders have legal rights of a state-contingent nature. In
case of financial distress, they acquire control rights and even ownership rights in case of
bankruptcy, as defined by the country’s laws. 6 Debt and debt structure can be important
disciplining factors, as they can limit free cash flow and thereby reduce private benefits.

6
Note the large differences between countries in this respect. In the United States, for example, banks are limited
in intervening in corporations operations, as they can be deemed to be acting in the role of a shareholder, and
therefore assume the position of a junior claimholder in case of a bankruptcy (the doctrine of equitable
subordination). This greatly limits the incentives of banks in the United States to get involved in corporate
governance issues as it may lead to their claim being lowered in credit standing. Other countries allow banks a
greater role in corporate governance.
18
Trade finance can have a special role, as it will be a short-maturity claim, with perhaps some
specific collateral. Suppliers can have particular insights into the operation of the firm, as they
are more aware of the economic and financial prospects of the industry.

Labor has a number of rights and claims as well. As with other input factors, there is an
outside market for employees, thus putting pressure on firms to provide not only financially
attractive opportunities, but also socially attractive ones. Labor laws define many of the
relationships between corporations and labor, which may have some corporate governance
aspects. Rights of employees in firm affairs can be formally defined, as is the case in
Germany, France, and the Netherlands where in larger companies it is mandatory for labor to
have some seats on the board (the co-determination model). 7 Employees of course voice their
opinion on firm management more generally. And then there is a market for senior
management, where poorly performing CEOs and other senior managers get fired or good
performing managers leave weakly performing corporations, that exerts some discipline on
poor performance.

It is hard to give a definitive answer as to whether and which forms of stakeholders’

involvement are good for a corporation as a whole, let alone whether they are socially and
economically optimal. There are many aspects of stakeholders’ involvement, with various
consequences – for firm performance, value added, risk taking, environmental performance,
etc. – and the overall net benefits are often unclear given current state of research. While, like
for other aspects of corporate governance, some many studies increasingly often can clearly
imply causality (as they use specific econometric techniques or study some event that
exogenously changes the institutional environment), some papers report only associations.
What can be distinguished are two forms of behavior related to other stakeholders’ role in
corporate governance issues: stakeholder management and social issue participation.

Stakeholder management. For the first category, the firm has no choice but to behave
“responsibly” to stakeholders: they are input factors without which the firm cannot operate;
and these stakeholders face alternative opportunities if the firm does not treat them well
(typically, for example, labor can work elsewhere). Better employment protection can then
improve the incentive structure and relative bargaining power of employees, and lead to more
output. Acting responsibly toward each of these stakeholders is thus necessary. Acting
responsibly is also most likely to be beneficial to the firm, financially and otherwise.

Acting responsibly towards other stakeholders might in turn also be beneficial for the firm’s
shareholders and other financial claimants. A firm with a good relationship with its workers,
for example, will probably find it easier to attract external financing. Bae et al. (2011) report
that U.S. firms that treat their employees more fairly maintain lower debt ratios, i.e., are less
risky financed, in part since employees want to preserve their job. This suggests that inside
stakeholders can affect a firm’s financial policies. Collectively, a high degree of corporate
responsibility can ensure good relationships with all the firm’s stakeholders and thereby
improve the firm’s overall performance. Of course, the effects depend importantly on
information and reputation because knowing which firms are more responsible to stakeholders

7
Employee ownership is of course the most direct form in which labor can have a stake in a firm. The empirical
evidence on the effects of employee ownership for U.S. firms is summarized by Kruse and Blasi (1995). They
find that “while few studies individually find clear links between employee ownership and firm performance,
meta-analyses favor an overall positive association with performance for ESOPs and for several cooperative
features”. A more recent study by Faleye et al. (2009) finds that labor-controlled publicly-traded firms “deviate
more from value maximization, invest less in long-term assets, take fewer risks, grow more slowly, create fewer
new jobs, and exhibit lower labor and total factor productivity”.
19
will not always be easy. Ratings at a country level, such as a ranking of the “best firms to
work for,” can help in this respect.

Social issue participation. Recent years have witnessed a growing interest in corporate social
responsibility (CSR) both from academia (McWilliams and Siegel, 2001; Margolis and
Walsh, 2003; Orlitzky et al., 2003) and from businesses (see Accenture, 2010). This greater
emphasis placed by firms on CSR activities can be interpreted as a shift in the interaction
between firms, their institutional environment, and important stakeholders, such as
communities, employees, suppliers, national governments and broader societal issues
(Ioannou and Serafeim, 2010).

In spite of this greater involvement, whether participation in social issues is also related to
good firm performance is less clear. Involvement in some social issues carries costs. These
can be direct, as when expenditures for charitable donations or environmental protection
increase, and so lower profits. Costs can also be indirect, as when the firm becomes less
flexible and operates at lower efficiency. As such, socially responsible behavior could be
considered “bad” corporate governance, as it negatively affects performance. (Of course, it
can also be the case that government regulations require certain behavior, such as
safeguarding the environment, such that the firm has no choice—although the country does.
These are not considered here.)

The general argument has been that many of these forms of social corporate responsibility can
still pay: that is, they can be good business for all and go hand in hand with good corporate
governance. So while there may be less direct business reasons to respect the environment or
donate to social charity, such actions can still create positive externalities in the form of better
relationships with other stakeholders, signaling the value of products to buyers, or being seen
as good citizens. The willingness, for example, of many firms to adopt high international
standards, such as ISO 9000, that clearly go beyond the narrow interest of production and
sales, suggests that there is empirical support for positive effects at the firm level.

The general empirical findings are of mixed evidence or no relationship between corporate
social responsibility and financial performance. As with many other corporate governance
studies, the problem is in part the endogeneity of the relationships. At the firm level, does
good corporate performance beget better social corporate responsibility, as the firm can afford
it? Or does better social corporate responsibility lead to better performance? The firms that
adopt ISO standards, for example, might well be the better performing firms even if they had
not adopted such standards. At the country level, a higher level of development may well
allow and create pressures for better social responsibility, while at the same time improving
corporate governance.

So far, there have been few formal empirical studies at the firm level to document these
effects. Empirically, it is extremely difficult to find satisfactory proxies of corporate social
performance (CSP). Consequently, existing indicators show a great deal of variation and tend
to capture either a single specific dimension or very broad measures of CSP. A recent study
(Ioannou and Serafeim, 2010) uses a unique dataset from ASSET4 (Thompson Reuters),
which covers 2,248 publicly listed firms in 42 countries for the period 2002 to 2008 and ranks
firms along three dimensions: social, environmental and corporate governance performance. It
reports a significant variation in CSP across countries and a negative association between
insider ownership and social and environmental performance at the firm level. This suggests
that better corporate governance is associated with better CSP, even though the direction and
causal nature of the link is not established.
20
At the country level, clearly, more developed countries tend to have both better corporate
governance and rules requiring more socially responsible behavior of corporations. These
stronger rules can pay off in terms of firm performance if they induce stakeholders to
contribute more to the firm. There is some evidence for this. Claessens and Ueda (2011) find
that greater employment protection in U.S. states promotes knowledge-intensive industries as
it induces workers to make firm-specific human capital investments and thereby boosts
overall output.

There is some evidence, however, that government-forced forms of stakeholdership may be

less advantageous financially. In the case of Germany, one study found that workers’ co-
determination reduced market-to-book values and return on equity (Gordon and Schmidt
2000). And Kim and Ouimet (2008), investigating the effects of employee ownership plans in
the U.S., find that small employment share ownership increases firm value, but not when
larger than 5% of outstanding shares. And there is ample evidence that too strong labor
regulations hinder economic growth. In a cross-country analysis, Botero et al. (2004) show
that heavier labor regulation is associated with lower labor force participation and higher
unemployment. Other cross-country regressions also generally find such negative effects
(e.g., Cingano et al., 2009).

Overall, the effect of country institutions on corporate social responsibility appears to be

larger than the effect of factors at the industry and firm level. Political institutions (the
absence of corruption) in a country and the prominence of a leftist ideology, are the most
important determinants of social and environmental performance. Legal institutions, such as
laws that promote business competition, and labor market institutions, such as labor union
density and availability of skilled capital are also important determinants. Capital market
institutions do not seem to play an important role (Chapple and Moon, 2005; Ioannou and
Serafeim, 2010).

5. Corporate Governance Reform

The analysis so far suggests that better corporate governance generally pays for firms,
markets, and countries. The question then arises why firms, markets, and countries do not
adjust and adopt voluntarily better corporate governance measures. The answer is that firms,
markets, and countries do adjust to some extent, but that these steps fail to provide the full
impact, work only imperfectly, and involve considerable costs. And there is often little
progress and sometimes it takes a major crisis to get reforms going. The main reasons for lack
of sufficient reforms are entrenched owners and managers at the level of firms and political
economy factors at the level of markets and countries. We start by documenting examples of
important corporate governance reforms and their effects. We then examine the various
voluntary mechanisms of governance adopted by firms. We end with a review of the political
economy factors for lack of sufficient reform.

5.1 Recent country level reforms and their impact

In the last decade, many emerging markets have reformed parts of their corporate governance
systems. Many of these changes have occurred in the aftermath and as a response to crises
(Black et al., 2001). While some reforms have been major and introduced fundamental
changes in capital market laws and regulations (e.g., Korea), others were more partial and
changed only a few specific aspects (e.g., Turkey). Many countries, for example, have
21
adopted corporate governance codes to which firms voluntary can adhere. Nevertheless, these
reforms can be useful ways to identify the importance of corporate governance. Indeed
researchers have analyzed the specific features of these reforms and other actions to quantify
their impact on firm level performance measures (see Table 4 for an overview of studies).

5.1.1 Legal reforms

Korea has been much studied as it has undertaken dramatic reforms in the aftermath of the
crisis. Non-transparent management and excessive expansion of Korean firms were important
reasons for the crisis (World Bank, 2000) and the government consequently adopted a series
of major reforms targeting internal and external control mechanisms (World Bank, 2006).
First, the role of the board of directors was strengthened by introducing a mandatory quota for
outsiders, with starting in 1999, at least one-quarter of the board members for listed
companies required to be independent outsiders. Since outside directors were uncommon
prior to 1997, post-crisis Korea presents a natural laboratory for testing the effect of board
independence enforced by authorities. Other policies aimed to weaken the ties among group-
affiliated firms through the elimination of cross-debt guarantees, restrictions on intra-group
transactions, elimination of restrictions on foreign ownership, and removal of restrictions on
exercising voting rights by institutional shareholders

These reforms triggered restructuring activities of Korean firms (Park and Kim, 2008).
Researchers document important effects on valuation and operating performance (Choi et al.,
2007). Black and Kim (2012) report a positive share price impact of boards with 50% or
greater outside directors, and some evidence of a positive impact from the creation of an audit
committee. For board composition, values increases exist for firms which are either required
by law to have 50% outside directors or voluntarily adopt this practice. Similar analyses exist
for other countries. Black and Khanna (2007) analyze a major governance reform in India in
2000, Clause 49, which resembles the U.S. Sarbanes Oxley Act. It requires, among other
things, audit committees, a minimum number of independent directors, and CEO/CFO
certification of financial statements and internal controls. The reforms applied initially only to
larger firms, and reached smaller public firms after a several-year lag. They document that
this reform benefited firms that need external equity capital and cross-listed firms more,
suggesting that local regulation can complement, rather than substitute for firm-level
governance practices.

A similar positive impact from improvements in the regulatory regime is documented by

Beltratti and Bortolotti (2007) and Li et al. (2011) in China. Non tradable shares (NTS) were
long recognized by investors as one of the major hurdle to corporate governance. During
2005-2006, Chinese regulators eliminated, through a decentralized process, NTS in the capital
of listed firms. The market responded very positive to this. After more than doubling in value
over the period, the market rose another 40% in the first four months of 2007, immediately
after the completion of the reform. Another reform in China was the introduction of
mandatory cumulative voting in director elections in January 2002. Qian and Zhao (2011)
show that firms with cumulative voting experienced less expropriation and improved
investment efficiency and performance relative to other firms.

Another example is the change in the Bulgarian Securities Law in 2002 which provided
protection against dilutive offerings and freeze-outs. Atanasov et al. (2006) document that
following the change, share prices jumped for firms at high risk of tunneling, relative to a
low-risk control group. Minority shareholders participated equally in secondary equity offers,
whereas before they suffered severe dilution, and freeze-out offer prices quadrupled. For
22
Israel, Yafeh and Hamdani (2011) find that legal intervention can play an important role in
inducing institutional investor activism.

5.1.2 Corporate governance codes and convergence

In recent years, a large number of countries have issued corporate governance codes to which
corporations can adhere voluntarily (Nestor and Thompson, 2000; Guillen, 2000).
Globalization and the worldwide integration of financial markets, combined with limited local
legal reforms, are acting as main drivers of this process (Khanna et al., 2006). Indeed,
Aguilera and Cuervo-Cazurra (2004) show that corporate governance codes more likely
emerge in more liberalized countries with a strong presence of foreign institutional investors
as well as in countries with weak legal protections and that civil law countries less often
revise and update their codes.

As part of a worldwide convergence of corporate governance standards, an important question

is whether these codes, and the integration of product and financial markets more generally,
help with convergence in actual corporate governance practices or just lead to formal
convergence. 8 The evidence to date suggests more the latter. Several authors argue that strong
path dependence will prevent the convergence of corporate governance systems (Bebchuk and
Roe, 1999; Coffee, 1999; Gilson, 2001; Bebchuk and Hamdani, 2009). 9 In a survey article,
Yoshikawa and Rasheed (2009) show that there is only limited evidence of convergence of
systems to date, with convergence more observed in form than in substance. They also
suggest that convergence, where it occurs, is often contingent on other factors, such as the
country’s institutional and political environment. Using a sample of corporations from various
countries, Khanna et al. (2006) similarly report evidence of formal convergence at the country
level, but find actual corporate governance practices to remain heterogeneous. This brings us
to the role of firm-level corporate governance practices.

5.1.3 The role of firm-level voluntary corporate governance actions

Evidence shows that firms can and do adapt to weaker environments by adopting voluntary
corporate governance measures. A firm may adjust its ownership structure, for example, by
having more secondary, large blockholders, which can serve as effective monitors of the
primary controlling shareholders. This may convince minority shareholders of the firm’s
willingness to respect their rights. Or a firm may adjust its dividend behavior to convince
shareholders that it will reinvest properly and for their benefit. Voluntary mechanisms can
also include hiring more reputable auditors. Since auditors have some reputation at stake as
well, they may agree to conduct an audit only if the firm itself is making sufficient efforts to

8
Gilson (2001) differentiates between three kinds of convergence: functional convergence, when existing
institutions are flexible enough to respond to the demands of changed circumstances without altering the
institutions’ formal characteristics; formal convergence, when an effective response requires legislative action to
alter the basic structure of existing institutions; and contractual convergence, where the response takes the form
of contract because existing institutions lack the flexibility to respond without formal change, and political
barriers restrict the capacity for formal institutional change.
9
Bebchuk and Roe (1999) identify two causes for this path dependence: structure-driven and rule-driven path
dependence. Structure-driven path dependence can arise either because an organization has adapted to a
particular ownership structure and thus would sacrifice efficiency by changing, or because certain stakeholders –
like the managers or the dominant shareholder – would lose from a shift to a more efficient structure, and thus
resist such a change. Rule-driven path dependence can arise for similar reasons. A country may adopt laws and
regulations that are designed to make companies with the existing ownership structures most efficient, and/or
influential managers and shareholders may be able to induce the political system to maintain a set of rules,
which, although inefficient, is to their advantage.
23
enhance its own corporate governance. The more reputable the auditor, the more the firm
needs to adjust its own corporate governance. A firm can also issue capital abroad or list
abroad, thereby subjecting itself to higher level of corporate governance and disclosure.
Empirical evidence shows that these mechanisms can add value and are appreciated by
investors in a variety of countries. At the same time, the country’s legal and enforcement
environment can still reduce their effectiveness. We review each of these mechanisms.

Voluntary adoption of corporate governance practices In the last decade, many researchers
have linked actual corporate governance practices of firms to their market valuation and
performance. Typically, such studies score firms on their corporate governance practices
using indices based on shareholder rights, board structure, board procedures, disclosure, and
ownership parity. Early studies were mostly for advanced countries and within a single
country, not allowing for studying differences in legal and enforcement regimes. An
influential study of a sample of U.S. firms found that the more firms adopt voluntary
corporate governance mechanisms, the higher their valuation and the lower their cost of
capital (Gompers et al., 2003). Similar evidence exists for the top 300 European firms (Bauer
et al., 2003). 10 Other studies (see Table 5 for a summary of key studies) generally showed as
well that improved firm corporate governance practices increase firm share prices, hence,
better-governed firms appear to enjoy a lower cost of capital.

The improvement in valuation derives from several channels. Evidence for the United States
(Gompers et al., 2003), Korea (Joh, 2003), and elsewhere strongly suggests that at the firm
level, better corporate governance leads not only to improved rates of return on equity and
higher valuation, but also to higher profits and sales growth, and lower their capital
expenditures and acquisitions to levels that are presumably more efficient. This evidence is
maintained when controlling for the fact that “better” firms may adopt better corporate
governance and perform better due to other reasons. Across countries, there is also evidence
that operational performance is higher in better corporate governance countries, although the
evidence is less strong.

The magnitude of the effects can be quite substantial. For example, Black et al. (2006a) report
that a worst-to-best change in their corporate governance index for Korean firms predicts a
0.47 increase in their Tobin’s q, which corresponds to an almost 160% increase in the share
price. Black et al., (2012) report similar results for Brazil. Comparing effects in India, Korea,
and Russia, they find that different practices are important in different countries for different
types of companies. Country characteristics thus influence which aspects affect market value
for which firms.

There is some evidence that voluntary practices matter more in weak environments. Two
studies (Klapper and Love, 2004; Durnev and Kim, 2005) find that firm-level practices
matters more to firm value in countries with weaker investor protection. Other studies suggest
that legal regimes can also be too strict. Bruno and Claessens (2010a) find that adopting
specific practices improves firm valuation in both weak and strong legal protection countries.
The impact varies, however, by countries’ legal system, with practices impacting valuation
less in strong legal regimes, suggesting that strong legal regimes may not necessarily be
optimal. This again supports a flexible approach to governance, with room for firm choice,
rather than a top-down regulatory approach (see further Bruno and Claessens, 2010b).

10
For the top 300 European firms, it was found that a strategy of over-weighting companies with good corporate
governance and under-weighting those with bad corporate governance would have yielded an annual excess
return of 2.97 percent (Bauer, Guenster and Otten 2004).
24
Markets can adapt as well, partly in response to competition, for example as listing and
trading migrate to competing exchanges. While there can be races to the bottom, with firms
and markets seeking lower standards, markets can and will set their own, higher corporate
governance standards. One example is the Novo Mercado in Brazil, which has different levels
of corporate governance standards, all higher than the main stock exchange. Firms can choose
the level they want, and the system is backed by private arbitration measures to settle
corporate governance disputes. Efforts like these have been shown to corporations improve
corporate governance at low(er) costs as they can list locally (Carvalho and Pennacchi, 2011).
Other papers report how dual-class premium in combination with a mandatory bid rule and
the provision of tag-along rights can be private contracting forms to deal with corporate
governance deficiencies (da Silva and Subrahmanyam, 2007; Bennedsen et al., 2012).

There is evidence, however, that these alternative corporate governance mechanisms, apart
from being costly, have their limits. In a context of weak institutions and poor property rights,
firm measures cannot and do not fully compensate for deficiencies. The work of Klapper and
Love (2004), Durnev and Kim (2005) and Doidge et al. (2007) shows that voluntary corporate
governance adopted by firms only partially compensates for weak corporate governance
environments.

Boards. Boards constitute an important corporate governance mechanism. Several studies

find a strong connection between board composition and market valuations of emerging
market companies. Table 6 provides an overview of studies on this topic. While some studies
suffer from endogeneity problems, in that better firms are more likely to adopt more
independent boards, other can control for this problem, by looking at how reforms affected
firms differentially. Findings suggest that companies with boards comprised of a higher
fraction of outsider/independent directors usually have a higher valuation. Black et al. (2006a)
report that Korean firms with 50% outside directors have 0.13 higher Tobin's q (roughly 40%
higher share price). Some evidence also shows that stronger board structures reduce the
likelihood of fraud (Chen et al., 2006) and expropriation through related party transactions
(Lo et al., 2010).

The positive effects of board independence documented for Korea and India are in countries
where governance reforms mandate a substantial level of board independence. Boards appear
ineffective or even hurt minority shareholders in countries (e.g., Turkey), where some
arbitrarily low level of board independence is recommended by existing codes of governance
(Ararat et al., 2011). Overall, results suggest that board independence plays an important role
in developing countries and emerging markets as well, where other control mechanisms on
insiders’ self-dealing are weaker. There is also some evidence that board independence has to
reach a certain threshold and be mandated to be effective.

Cross-Listings Firms that have access to foreign capital markets are more likely to obtain
capital at more favorable terms, so that they have greater incentives to adopt good governance
(Stulz, 1999). Correspondingly, Doidge et al. (2007) argue that financial globalization should
reduce the importance of the country-specific determinants of governance and increase firm-
level incentives for good governance. Indeed, there is some evidence that globalization has
improved corporate governance (Stulz, 2005).

Cross-listing securities on foreign markets is a specific way to access international financial

markets and can relate and affect firms’ corporate governance practices. There are several
reasons why companies may decide to cross-list. One argument is that firms can get cheaper
25
external financing (Karolyi, 1998). More recent studies consider, however, various other
motives for cross-listings (see Table 7 for an overview and Gagnon and Karolyi (2010) for a
literature review). One corporate governance motive is that by cross-listing in a stronger
environment, firms commit to tough disclosure and corporate governance rules. This has been
called the “bonding” argument (Coffee, 1999 and 2001). This view, also in (Doidge et al.,
2004), has been analyzed by Doidge et al. (2009). They find support for this view since
controlling shareholders who consume more private benefits of control are more reluctant to
cross-list their firms on a U.S. exchange, despite the financial benefits of a cross-listing.
Silvers and Elgers (2011) also report that legal bonding plays a significant role in increasing
the value of non-U.S. firms. Gande and Miller (2011) provide evidence that enforcement
actions of U.S. securities regulators against foreign firms are quite frequent and economically
significant events which supports the bonding view since the enforcement of U.S. securities
laws is a necessary condition for the bonding hypothesis to hold.

Three country specific studies (Licht, 2001; Siegel, 2005 and Chung et al., 2011; for a review
see Licht, 2003) challenge the bonding argument, however, by showing that firms are more
likely to choose cross-listing destinations that are less strict on self-dealing or exhibit higher
block premiums relative to the origin country, with this tendency more pronounced after
Sarbanes-Oxley in 2002. Other studies also point out that the ability of corporations to borrow
the framework from other jurisdictions by listing or raising capital abroad, or even
incorporating, is limited to the extent that some local enforcement of rules is needed,
particularly concerning minority rights protection (see Siegel (2009) for the case of Mexico).
As such, there remains considerable debate on the corporate governance motivations for and
benefits of cross-listing.

Other mechanisms The decision to adopt IAS (International Accounting Standards) enables
firms in emerging and other markets to provide financial information in a more familiar and
more reliable form to foreign investors. This should reduce information asymmetries and help
with signaling to shareholders the willingness of the firm to adhere to sound corporate
governance practices, thus make the firms more attractive to invest in. Covrig et al. (2007)
analyze firm-level holdings of over 25,000 mutual funds from around the world and find that
average foreign mutual fund ownership is significantly higher among IAS adopters. IAS
adopters attract not only a significantly larger pool of investors by reducing foreign investors’
information processing and acquisition costs, but, as Chan et al. (2009) show, achieve a lower
the cost of capital as well.

In line with this mechanism, Fan and Wong (2005) show that hiring high-quality reputable
external independent auditors enhances the credibility of the dominant shareholders with
investors. They find that East Asian firms subject to greater agency problems, indicated by
high control concentration, are more likely to hire Big 5 auditors than firms less subject to
agency problems. This relation is especially evident among firms frequently raising equity
capital in secondary markets. Additionally, hiring Big 5 auditors mitigates the share price
discounts associated with their agency problems.

The reforms and the voluntary corporate governance practices have led to many de facto
changes in corporate governance. These actual changes and their effects are analyzed by De
Nicolo et al. (2008). Using actual outcome variables in the dimensions of accounting
disclosure, transparency, and stock price behavior, they construct a composite index of
corporate governance quality at the firm level, document its evolution for many corporations
around the world during the 1994-2003 period, and assess its impact on growth and
productivity of the economy and its corporate sector. They report three main findings. First,
26
actual corporate governance quality in most countries has overall improved, although in
varying degrees and with a few notable exceptions. Second, the data exhibit cross-country
convergence in corporate governance quality with countries that score poorly initially
catching up with countries with high corporate governance scores. Third, the impact of
improvements in corporate governance quality on traditional measures of real economic
activity—GDP growth, productivity growth, and the ratio of investment to GDP—is positive,
significant and quantitatively relevant, and the growth effect is particularly pronounced for
industries that are most dependent on external finance.

5.1.4 The role of political economy factors

Countries do not always reform their corporate governance frameworks to achieve the best
possible outcomes. In some sense, this is shown by the pervasive and continued importance of
the origin of the legal system in a particular country in many analyses and dimensions.
Whether a country started with or acquired as a result of colonization a certain legal system
some century or more ago still has systematic impact on the features of its legal system today,
the performance of its judicial system, the regulation of labor markets, entry by new firms, the
development of its financial sector, state ownership, and other important characteristics
(Djankov et al., 2008; Acemoglu et al., 2001). Evidently, countries do not adjust that easily
and move to some better standards to fit their own circumstances and meet their own needs.

Partly this is because reforms are multifaceted and require a mixture of legal, regulatory, and
market measures, making for difficult and slow progress. Efforts may have to be coordinated
among many constituents, including foreign parties. Legal and regulatory changes must take
into account enforcement capacity, often a binding constraint. While financial markets face
competition and can adapt themselves, they must operate within the limits given by a
country’s legal framework.

The Nova Mercado in Brazil is a notable exception where the local market has improved
corporate governance standards using voluntary mechanisms, with much success in terms of
new listing and increases in firm valuation (Carvalho and Pennacchi, 2011). But it needs to
rely on mechanisms such as arbitration to settle corporate governance disputes as an
alternative to the poorly functioning judicial system in Brazil. Other experiments with self-
regulation in corporate governance, as in the Netherlands, have often not been successful. 11
More generally, the move towards greater public oversight and tighter regulation in advanced
and other countries following the recent financial crisis is a reflection of the limits to the
effectiveness of the previous prevailing model of more self-regulation and supervision.

So why do countries not reform their institutional systems? Part of the reason lies in the
values and rents political and other insiders get from the status quo. Studies which try to
quantify the value of political connections show that the size of these rents can reach
substantial amounts (see Table 8 for an overview of this literature). For example, in Indonesia,
there were direct relationships between the government and the corporate sector. Fisman
(2001) estimates the value of political connections to the Suharto regime, using
announcements concerning Suharto’s health, to be over 20% of a firm’s value. Claessens et al.
(2008) show that Brazilian firms, which provided contributions to (elected) political
11
In the Netherlands, the corporate governance reform committee suggestions in 1997 stressed self-enforcement
through market forces to implement and enforce its recommendations. A review of progress in 2003 (Corporate
Governance Committee, 2003), however, showed that this model did not work and that more legal changes
would be needed to improve corporate governance. Earlier empirical works had anticipated this effect (De Jong
et al., 2005) as they documented little market response when the recommendations were announced.
27
candidates experienced higher stock returns than firms that don't around the 1998 and 2002
elections. These firms were also able to subsequently access bank finance more easily.

Faccio (2006) shows that political connections are more frequently found in countries with
higher levels of corruption, more barriers to foreign investment, and less transparent systems.
She also reports that the announcement of a new political connection results in a significant
increase in firm value and that connections are diminished when regulations set more limits
on official behavior. In a cross-country study, (Faccio et al., 2006) find that politically
connected firms are significantly more likely to be bailed out than similar non-connected
firms, with those connected firms bailed out exhibit significantly worse financial performance
than their non-connected peers at the time of the bailout and the next two years.

Other evidence also suggests that political connections can influence the allocation of capital
through financial assistance when connected companies confront economic distress. For
example, in many countries, politically-connected firms borrow more than their non-
connected peers (Charumilind et al., 2006; Chiu and Joh, 2004; La Porta et al., 2003).
Collectively, these studies show that “cronyism” can be an important driver of borrowing and
lending activities in many markets, with high costs. Khawaja and Mian (2005) show that
political connections, which increase financial access for selected Pakistani firms through
government-owned banks, imply economy-wide costs of at least 2% of GDP per year. 12

By identifying the impact of political relations on firm and country level performance
measures, this literature offers an explanation as to why countries with higher concentrations
of wealth show less progress in reforming their corporate governance regimes. Corporate
governance reforms involve changes in control and power structures, with associated losses in
wealth. As such, reforms can depend on ownership structures. The reluctance of insiders to
reform is largely due to the existing rents that they could lose after reforms (see also
Claessens and Perotti, 2007). In parts of East Asia, for instance, considerable corporate sector
wealth is held by a small number of families. This suggests that wealth structures need to
change in order to bring about significant corporate governance reform. This can happen
through legal changes (gradually over time, or, more typically, following financial crises or
other major events), and also as a result of direct interventions (such as privatizations and
nationalizations, as during financial crises). Reforms can also be impeded by a lack of
understanding. Partly this will be linked to political economy factors, perhaps directly related
to ownership structures, as when the media is tightly controlled.

These various relationships between institutional features and countries’ more permanent
characteristics, including culture, history, and physical endowments, remain an area of
research. Institutional characteristics (such as the risk of expropriation of private property) can
be long-lasting and relate to a country’s physical endowments (Acemoglu, et al., 2003). Both
the origin of its legal systems and a country’s initial endowments have been shown to be
important determinants of the degree of private property rights protection (Beck et al., 2003).
The role of culture and openness in finance, including in corporate governance, has also been
found to be important (Stulz and Williamson 2003). Cultural differences have also been
shown to affect the flows of foreign direct investment and international mergers (Siegel et al.,
2011), loan characteristics and the extent of risk sharing in international syndicated bank loan
contracts (Gianetti and Yafeh, 2011), dividend payout ratios (Bae et al., 2010), and financial
12
They identify connected firms as those with a board member who runs for political office, and find that
connected loans are 45% larger and carry average interest rates, although they have 50 percent higher default
probabilities. Such preferential treatment occurs exclusively in government banks-private banks provide no
political favors.
28
market linkages (Lucey and Zhang, 2010). More generally, financial globalization is thought
to be an important force for reform (Kose, et al., 2010; Stulz, 2005). The exact influence and
weight of each of these factors is still unknown, however.

More generally, the dynamic aspects of corporate governance reform are not yet well
understood. The underlying political economy factors that may drive changes in the legal
frameworks over time is the subject of a study by Rajan and Zingales (2003a). They highlight
the fact that many European countries had more developed capital markets in the early
twentieth century (in 1913) than for a long period after the Second World War. Importantly,
many of these countries’ capital markets in 1913 were more developed than the U.S. market at
that time. A review of ownership structures at the end of the nineteenth century in the United
Kingdom (Franks et al., 2003) shows that most UK firms had widely dispersed ownership
before they were floated on stock exchanges. And in 1940 in Italy, the ownership structures
were more diffused than in the 1980s (Aganin and Volpin, 2003). These three studies cast
doubt on the view that stock market development and ownership concentration are
monotonically related (positively and negatively, respectively) to investor protection.

These papers identify the issues but do not clarify the channels through which institutional
features alter financial markets and corporate governance over time, and how institutional
features change (see also Rajan and Zingales, 2003b). As such, these papers are part an
ongoing research agenda on the political economy of reform. Work has shown the large
political economy role in financial sector development (see Haber and Perotti, 2008 for a
review and Haber et al., 2007 for many cases studies), particularly regarding how political
economy determines property rights protection (e.g., Roe and Siegel, 2009). Roe (2003)
shows specifically the political determinants of corporate governance in the U.S. 13 The
general thrust of this literature is that, while governments play a central role in shaping the
operation of financial systems through macroeconomic stability and the operation of legal,
regulatory, and information systems, there are some deeper constraints that cannot so easily
be overcome. More general reviews of this literature (e.g., Djankov et al., 2008 and
Fergusson, 2006) highlight the many unknowns in this area (and question some of the current
findings).

13
See also Roe and Siegel (2009).
29
6. Conclusions and Areas for Future Research
At the level of the firm, the importance of corporate governance for access to financing, cost
of capital, valuation, and performance has been documented for many countries and using
various methodologies. Better corporate governance leads to higher returns on equity and
greater efficiency. Across countries, the important role of institutions aimed at contractual and
legal enforcement, including corporate governance, has been underscored by the law and
finance literature. At the country level, papers have documented differences in institutional
features. Across countries, relationships between institutional features and development of
financial markets, relative corporate sector valuations, efficiency of investment allocation, and
economic growth have been shown. Using firm-level data, relationships have been
documented between countries’ corporate governance frameworks on the one hand, and
performance, valuation, cost of capital, and access to external financing on the other.

While the general importance of corporate governance has been established, knowledge on
specific issues or channels is still weak. An important general caveat to the literature is that it
has some way to go to address causality. This also applies to the following three areas:
ownership structures and the relationship with performance and governance mechanisms;
corporate governance and stakeholders’ roles; and enforcement, both public and private, and
related changes in the corporate governance environment.

• Ownership structures and relationships with performance. Much research establishes that
large, more concentrated ownership can be beneficial, unless there is a disparity of control
and cash flow rights. Little is known, however, on ownership structures in complex
groups, the role of multiple shareholders and the dynamics of ownership structures. Finer
studies which analyze links between outside shareholders and their board representation
deserve further attention. The specific subtopics that fall under this heading include:

o Family-owned firms. Such firms predominate in many sectors and economies. They
raise a separate set of issues, related to liquidity, growth, and transition to a more
widely held corporation, but also related to internal management, such as intra-
familial disagreements, disputes about succession, and exploitation of family
members. Where family-owned firms dominate, as in many emerging markets, they
raise system-wide corporate governance issues.

o State-owned firms. These have specific corporate governance issues, with related
questions like: What is the role of commercialization in state-owned enterprises? How
do privatization and corporate governance frameworks interact? Are there specific
forms of privatization that are more attractive in weak corporate governance settings?
What are the dynamic relationships between corporate governance changes and
changes in degree of state-ownership of commercial enterprises? Are there special
corporate governance issues in cooperatively owned firms?

o The corporate governance of financial institutions. The crisis has shown that the
corporate governance of financial institutions has been an underhighlighted area, as
there were massive failures at major institutions in advanced countries. Corporate
governance at financial institutions has been identified to differ from that of
corporations, but in which ways is not yet clear—besides the important role of
prudential regulations, given the special nature of banks. In this area, more work is
needed for emerging markets as well, in part related to the role of banks in business
groups. While there is some research on state ownership, corporate governance of
30
 banks in emerging markets is little analyzed. Clarifying this will be key, as banks are
important providers of external financing, especially for SMEs.

o The role of institutional investors. Institutional investors are increasing throughout the
world, and their role in corporate governance of firms is consequently becoming more
important. But the role of institutional investors in corporate governance is not
obvious and surely not clearly understood in emerging markets. In many countries,
institutional investors have purposely been assigned little role in corporate
governance, as more activism was considered to risk the company’s fiduciary
obligations. In some countries, though, institutional investors are being encouraged to
take a more active role in corporate governance, and some do. What is the right
balance here? Under which conditions are institutional investors most productive?

o The governance of the institutional investors themselves. This is a topic that deserves
more attention. Institutional investors will not exercise good corporate governance
without being governed properly themselves. Moreover, the forms through which
more activism of institutional investors can be achieved are not clear. For example,
institutional investors typically hold small stakes in any individual firm. Some form of
coordination is thus necessary, on the one hand. On the other hand, too much
coordination can be harmful, as the financial institutions start to collude and political
economy factors start playing a role. And what means are best, e.g., voting or exit?

o Corporate governance mechanisms. More research focused on how corporate

governance actually takes place would be very useful, even though data are hard to
get. Most evidence shows that truly independent boards contribute to better firm
performance and higher valuations. Relatively little evidence exists on executive
compensation and managerial labor market mechanisms. Also the role of internal
markets in business groups, as to whether they help to support efficient allocation of
financial resources across member of the group, deserves more attention.

• Corporate governance and stakeholders’ roles. A similarly under-researched area is the

role of other stakeholders. The analysis of employee representation, interactions with
suppliers and civil society institutions and issues related to social corporate responsibility
are almost empty research fields in emerging market countries (and in many advanced
countries as well). Three specific subtopics that fall under this heading include:

o Best practice in relation to other stakeholders. Little empirical research has been
conducted on the relationships between corporate governance and other stakeholders
like creditors, and labor. To the extent available, research refers largely to firms in
developed countries.

o Corporate social responsibility and environmental performance. Under the general

heading of corporate governance and stakeholders, is the need for more research on
the role of corporate governance for social and environmental performance, including
green financing. While many firms have been expressing a keen interest in this, little
rigorous analysis has been conducted on how this relates to overall performance.

o The impact on poverty alleviation. There are few studies on the direct relationship
between better corporate governance and greater poverty alleviation and reducing
inequality. While the general importance of property rights for poverty alleviation has
been established (De Soto, 1989; North, 1990) and the role of financial sector
31
 development for poverty alleviation has been documented (World Bank, 2007;
Demirgüc-Kunt and Levine, 2009; Akhter and Daly, 2009, Mookerjee and Kalipioni,
2010), the specific channels through which improved corporate governance can help
the poor have so far not been documented. This is in part because much of the
corporate governance research has been directed to the listed firms. However, much of
the job creation in developing countries and emerging markets comes from small and
medium-size enterprises. Different corporate governance issues arise for these firms.
These require different approaches, which so far have not very much been researched.

• Enforcement, both private and public, and dynamic changes. Enforcement is key to
actually make corporate governance reforms work, but little is known on what drives
enforcement. There is some evidence that when a country’s overall corporate governance
and property rights system are weak, voluntary and market corporate governance
mechanisms have limited effectiveness. But only a few studies exist which analyze how to
enhance enforcement in such environments. More general, enforcement needs to be
studied more. Several subtopics exist under this heading.

o How can enforcement be improved in weak environments? How can a better

enforcement environment be engineered? The degree of public-private partnership in
enhancing enforcement is presumably important, but understudied both from a
theoretical and empirical perspective. What factors determine the degree to which the
private sector can solve enforcement problems on its own, and what determines the
need for public sector involvement in enforcement?

o What are the roles of voluntary mechanisms? There is more evidence needed on how
voluntary mechanisms (such as cross-listings, adopting codes of best practices or
international accounting standards) can be most valuable. The interaction of cross-
listings with domestic financial development is a further potentially useful research
area as well, since cross-listing could undermine domestic financial development.

o The corporate governance role of banks. In many countries banks have important
corporate governance roles, as they are direct investors themselves or act as agents for
other investors. And as creditors, banks can see their credit claim change into an
ownership stake, as when a firm runs into bankruptcy or financial distress. Enhancing
the corporate governance of banks may be effective in improving overall governance.

o What are the lessons from corporate governance research that can be applied to
regulatory corporate governance? Obviously, there were, and are continue to be,
many failures in the oversight and performance roles of regulatory and supervisory
agencies in advanced countries. This is not a new research topic, but much can be
learned from corporate governance research in general, and from emerging markets
specifically, also for advanced countries, on how to improve regulatory governance.

o The dynamic aspects of institutional change. Finally, little is known about the dynamic
aspects of institutional change, whether change occurs in a more evolutionary way
during normal times or more abruptly during times of financial or political crises. In
this context, it is important to realize that enhancing corporate governance will remain
very much a local effort. Country-specific circumstances and institutional features
mean that global findings do not necessarily apply directly. Local data are needed to
make a convincing case for change. Local capacity is needed to identify the relevant
issues and make use of political opportunities for legal and regulatory reform.
32
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43
 Table 1A. Macroeconomic Indicators

Foreign
Per Capita GDP Private Market Stocks
Country Trade Direct
GDP Growth Credit Capitalization Traded
Investment
2005 USD Annual % % of GDP % of GDP % of GDP % of GDP % of MC

Australia 32248 3.2 40.3 2.8 115.8 114.9 80.9

Austria 33475 1.7 100.7 6.1 128.1 28.9 39.7
Belgium 31866 1.5 154.0 21.7 112.4 68.1 42.6
Canada 34369 2.1 72.8 3.7 184.1 112.4 76.0
Denmark 32808 0.9 92.9 3.9 178.7 62.7 83.0
Finland 30274 2.1 78.2 3.1 74.9 117.8 116.0
France 29519 1.4 53.2 3.0 112.1 83.7 101.1
Germany 31727 0.8 75.4 2.4 136.0 47.8 139.4
Greece 24179 3.4 56.1 0.9 91.8 57.7 48.3
Iceland 33277 3.1 79.9 9.4 184.1 102.1 69.8
Ireland 36936 3.8 161.5 6.7 153.7 53.9 49.0
Italy 28055 0.5 52.8 1.3 112.0 43.2 123.6
Japan 29841 0.7 26.1 0.2 304.6 77.5 107.2
Luxembourg 67207 3.4 289.2 347.0 . 163.3 1.0
Netherlands 35322 1.6 131.7 6.8 175.1 99.5 147.7
New Zealand 24430 2.4 60.4 3.0 128.8 37.2 51.0
Norway 46475 2.0 72.8 1.7 75.9 53.7 115.1
Portugal 21425 0.9 67.3 3.0 152.2 41.1 68.5
Spain 26956 2.6 57.2 3.7 160.7 86.9 174.4
Sweden 31927 2.0 88.8 5.0 112.4 104.8 124.3
Switzerland 35946 1.7 90.8 4.8 176.9 245.7 100.5
United Kingdom 32068 1.7 56.7 4.6 166.7 132.3 139.2
United States 41584 1.8 26.0 1.5 219.2 127.1 196.1
Developed (Avg) 33561.5 2.0 86.3 19.4 148.0 89.7 95.4

Argentina 10922 3.6 38.3 2.3 38.0 42.8 10.4

Bolivia 3648 3.7 61.4 3.7 57.5 18.9 0.9
Brazil 8559 3.3 25.7 2.7 81.3 51.4 46.0
Chile 11900 3.7 71.9 6.5 88.6 104.2 14.3
China 4164 10.3 57.6 3.1 134.0 65.9 121.9
Colombia 7321 4.0 35.8 3.4 33.0 27.7 9.8
Ecuador 6537 4.5 65.2 1.6 20.5 7.7 6.4
Egypt, Arab Rep. 4423 4.9 54.2 3.8 92.3 54.8 35.6
El Salvador 5680 2.1 69.9 2.7 45.6 19.2 4.5
Ghana 1198 5.5 89.1 3.2 30.0 14.3 3.0
Hong Kong, China 34753 4.2 353.5 20.7 140.4 483.3 63.0
India 2284 7.2 37.9 1.6 59.9 61.9 138.9
Indonesia 3204 5.1 59.3 0.5 46.8 26.6 51.5
Israel 23645 3.6 77.8 4.1 79.6 79.7 58.5
Jamaica 6922 1.1 98.6 6.5 56.1 80.3 2.8
Jordan 4297 6.3 125.6 10.5 95.3 147.7 41.6

44
Kenya 1342 3.6 60.1 0.6 39.6 28.8 7.7
Korea, Rep. 22439 4.4 79.4 0.7 95.0 66.3 248.0
Malaysia 11567 4.8 200.5 2.9 130.3 135.5 33.1
Mexico 12516 1.9 57.0 2.9 35.5 26.2 28.4
Morocco 3493 4.8 69.0 2.2 80.3 50.9 21.0
Nigeria 1697 6.1 73.3 3.3 17.7 19.6 14.5
Pakistan 2136 4.6 32.2 1.8 44.0 24.1 289.4
Panama 9464 5.8 140.5 7.0 89.9 27.6 2.3
Peru 6436 5.1 41.6 3.3 19.9 42.4 7.8
Philippines 2897 4.6 93.9 1.5 54.8 45.8 18.7
Singapore 42358 5.6 406.5 14.2 76.9 182.2 66.4
South Africa 8533 3.6 59.0 1.9 175.2 202.4 47.4
Sri Lanka 3568 5.0 72.7 1.3 43.4 16.1 18.1
Taiwan . . . . . . .
Thailand 6563 4.1 134.0 3.6 127.7 55.7 88.8
Tunisia 6414 4.7 101.9 4.3 72.4 13.3 14.7
Turkey 10472 3.8 48.7 1.7 47.9 27.4 156.6
Uganda 914 7.2 42.0 4.1 9.4 0.9 2.1
Uruguay 9915 2.3 51.9 3.8 48.3 0.6 3.9
Venezuela, RB 9998 3.9 50.9 1.3 15.7 4.6 6.3
Zimbabwe . -5.9 82.8 0.7 78.3 148.1 13.2
Emerging Markets (Avg) 8919.4 4.2 89.4 3.9 66.7 66.8 47.2

Bulgaria 9563 4.7 115.4 13.8 39.4 16.5 19.2

Croatia 14940 3.3 89.6 5.8 60.9 36.4 6.2
Czech Republic 19981 3.4 138.0 6.0 49.6 26.0 63.8
Hungary 16178 2.7 142.7 14.5 63.6 24.7 76.4
Kazakhstan 8306 8.6 93.3 9.2 28.0 22.0 13.5
Latvia 12267 4.8 98.3 4.2 62.0 9.7 13.2
Lithuania 13506 4.8 115.0 3.6 38.8 19.3 11.8
Poland 13899 3.9 72.9 3.9 43.2 26.4 37.6
Romania 9196 4.5 74.6 5.2 25.3 14.6 14.9
Russian Federati 11574 5.5 56.9 2.4 25.9 56.3 54.0
Slovak Republic 16207 4.5 162.8 4.8 50.8 6.3 24.8
Ukraine 5290 4.7 104.0 4.3 45.1 21.9 6.0

Transition (Avg) 12575.6 4.6 105.3 6.5 44.4 23.3 28.5

Definitions of the indicators and their sources:

Indicator Definition Period Source

Per Capita GDP GDP per capita, PPP in constant 2005 international USD. 2000-2010 WDI
Annual percentage growth rate of GDP at market prices based on constant
GDP Growth local currency. 2000-2010 WDI
Sum of exports and imports of goods and services measured as a share of
Trade gross domestic product. 2000-2010 WDI
Foreign direct investment Foreign direct investment, net inflows as a share of gross domestic product. 2000-2010 WDI
Private Credit Domestic credit to private sector as a share of gross domestic product. 2000-2010 WDI
Market capitalization of listed companies as a share of gross domestic
Market Capitalization (MC) product. 2000-2010 WDI
Stocks Traded Total value of shares traded divided by the average market capitalization for 2000-2010 WDI
45
the period.

46
 Table 1B. Governance Indicators
Legal
Legal Corporate
Creditor protection of Case A Anti Disclosure
Country Legal Origin Rights Governance
rights minority Efficiency Corruption requirements
Strength Opacity
shareholders
Index Index Index Index Index Index Index
Australia British 9.0 3 79 87.8 196 75 21
Austria German 7.0 3 21 78.0 198 25 13
Belgium French 7.0 2 54 90.8 137 42 13
Canada British 6.0 1 65 93.2 205 92 20
Denmark Scandinavian 8.7 3 47 76.7 244 58 21
Finland Scandinavian 7.0 1 46 92.4 242 50 13
France French 5.8 0 38 54.1 137 75 10
Germany German 7.7 3 28 57.0 188 42 12
Greece French 3.0 1 23 53.8 38 33 7
Iceland Scandinavian 7.0 . 24 . 218 . 0
Ireland British 8.0 1 79 89.9 160 67 16
Italy French 3.0 2 39 45.3 33 67 10
Japan German 6.8 2 48 95.5 119 75 10
Luxembourg French 7.0 . 25 . 195 . 6
Netherlands French 6.0 3 21 94.9 215 50 18
New Zealand British 10.0 4 95 90.7 235 67 16
Norway Scandinavian 7.0 2 44 91.8 210 58 17
Portugal French 3.0 1 49 82.3 113 42 2
Spain French 6.0 2 37 82.0 119 50 6
Sweden Scandinavian 4.8 1 34 86.0 225 58 21
Switzerland German 8.0 1 27 60.4 212 67 14
United Kingdom British 9.0 4 93 92.3 190 83 14
United States British 8.0 1 65 85.8 152 100 21
Developed (Avg) 6.7 2.0 46.9 80.0 173.1 60.7 13.1
Argentina French 4.0 1 44 35.8 -40 50 8
Bolivia French 1.0 2 8 . -59 . .
Brazil French 3.0 1 29 13.4 -3 25 10
Chile French 4.0 2 63 40.9 142 58 13
China German 4.8 2 78 43.6 -47 . 5
Colombia French 5.0 0 58 64.8 -26 42 5
Ecuador French 3.0 0 8 19.4 -86 0 .
Egypt, Arab Rep. French 3.0 2 49 28.6 -46 50 4
El Salvador French 5.0 3 57 37.8 -46 . .
Ghana British 6.5 1 73 . -12 . .
Hong Kong, China British 10.0 4 96 88.3 179 92 .
India British 7.2 2 55 . -40 92 7
Indonesia French 3.0 2 68 25.1 -82 50 9
Israel British 9.0 3 71 66.2 99 67 16
Jamaica British 8.0 2 35 69.0 -41 . .
Jordan French 4.0 1 16 44.5 17 67 7
Kenya British 10.0 4 22 . -95 50 10
Korea, Rep. German 7.0 3 46 88.1 41 75 .

47
Malaysia British 10.0 3 95 48.4 28 92 9
Mexico French 5.0 0 18 72.6 -28 58 6
Morocco French 3.0 1 57 41.9 -14 . 6
Nigeria British 8.0 4 52 . -110 67 18
Pakistan British 6.0 1 41 . -94 58 14
Panama French 6.0 4 15 43.0 -31 . .
Peru French 5.7 0 41 41.8 -27 33 8
Philippines French 3.0 1 24 17.5 -56 83 9
Singapore British 10.0 3 100 96.1 226 100 9
South Africa British 9.0 3 81 39.8 40 83 16
Sri Lanka British 3.3 2 41 45.7 -24 75 7
Taiwan German . 2 56 93.8 67 75 0
Thailand British 4.0 2 85 54.9 -24 92 8
Tunisia French 3.0 0 17 56.6 1 . .
Turkey French 4.0 2 43 6.6 -18 50 11
Uganda British 7.0 2 41 . -82 . .
Uruguay French 5.0 3 17 28.6 96 0 .
Venezuela, RB French 2.0 3 9 13.1 -98 17 23
Zimbabwe British 6.0 4 44 . -116 50 .
Emerging Markets (Avg) 5.5 2.0 47.3 47.1 -11.0 58.9 9.5
Bulgaria German 8.0 2 66 46.0 -20 . 12
Croatia German 5.3 3 25 45.0 -7 . 3
Czech Republic German 6.7 3 34 40.7 37 . 18
Hungary German 7.0 1 20 46.7 55 . 2
Kazakhstan French 4.0 2 48 31.4 -100 . 11
Latvia German 9.0 3 35 49.3 4 . .
Lithuania French 5.0 2 38 58.7 14 . 10
Poland German 8.2 1 30 67.7 36 . 11
Romania French 7.5 1 41 11.0 -28 . 10
Russian Federati French 3.0 2 48 39.0 -92 . 11
Slovak Republic German 9.0 2 29 58.9 27 . 0
Ukraine French 8.3 2 11 17.5 -91 . 0
Transition (Avg) 6.8 2.0 35.4 42.7 -13.8 . 8.0

Definitions of the indicators and their sources:

Indicator Definition Period Source
Legal Origin Legal origin. 1999 Shleifer et al. (1999)
Legal Rights Strength Strength of legal rights index (0=weak, 10=strong) 2000-2010 WDI (World Development Indicators,
World Bank)
Creditor rights Creditor rights aggregate score (0=weak, 4=strong). 2007 Djankov et al. (2007)

Legal protection of minority Anti-self-dealing index in bp (0=weak, 100=strong). 2006 La Porta et al. (2006)
shareholders
Case A Efficiency Case A Efficiency (0=weak, 100=strong). 2006-2008 Djankov et al. (2006)

Anti Corruption Average corruption score (higher numbers mean "less 1996-2000 WGI (Worldwide Governance Indicators,
corrupt'). World Bank Institute)
Disclosure requirements Disclosure requirements index in bp (0=weak, 2006 La Porta et al. (2006)
100=strong).
Corporate Governance Corporate governance opacity in bp (higher numbers 2008 Laeven et al. (2008)
Opacity mean "less opacity").

48
 Appendix

Contents:

Table 2 Summary of Key Studies on Ownership Structures

Table 3 Overview of Selected Studies on the Relationship between Ownership Structures and
Corporate Performance

Table 4 Overview of Selected Studies on the Effects of Legal Changes

Table 5 Overview of Selected Studies on the Relationship between CG Indices and

Performance

Table 6 Summary of Key Empirical Studies on Board of Directors

Table 7 Overview of Selected Studies on Cross-listings

Table 8 Overview of Selected Studies on Political Connections

References

49
Table 2 Summary of Key Studies on Ownership Structures

Study Country Data Period N BG LS IO Man. Family NFC FC FOR State WH Cross CO-OWN
/Dual /
[CO/OWN]
Pyramid

Al Farooque, Zijl, Dunstan, and Bangladesh HC 1995–2002 ~100 38.8* 19.7 2.9 31
Karim (2007)

Cheung, Connelly, Limpaphayom, Hong Kong HC 2002 168 53b

and Zhou (2007)

Lei and Song (2008) Hong Kong HC 2000-2003 707 44.7 45.8

Jaggi and Leung (2007) Hong Kong HC 1999-2000 399 38.6

Baek, Kang and Park (2004) Korea KIS, KLCA 1997-1998 644 22.9 17.81 11.19 [3.85 all
firms,5.83e

Black, Jang and Kim (2006a) Korea KSE 2001 515 20 19.67 0.07

Black and Kim (2007) Korea TS-2000 1998-2004 583 20 20.67 8.27

Bae, Baek and Kang (2007) Korea KLCA 1996-1999 644 18.94 29.24 4.82 [3.85 in 1996

2.15 in 1997]

Choi, Park and Yoo (2007) Korea KLCA 1999 -2002 457 19 31 5 6

Joh and Ko (2007) Korea TS-2000 1995 -2005 590 (in 21 29 19 6

1995)

649 (in
2005)

Park and Kim (2008) Korea TS-2000 1993–2004 251 14.25 7.15

Bae, Cheon and Kang (2008) Korea KLCA 30 100 8.98

50
Zhuang, Edwards and Capulong Indonesia HC 1997 42 48.2 25.4
(2001)
67.5b

Bunkanwanicha, Gupta and Indonesia ECFIN 1997 180 78.3d 3.3d 11.1d 1
Rokhim (2008)

Haniffa and Hudaib (2006) Malaysia KLSE 1996,2000 347 61.58a 34.53

Fraser, Zhang, and Derashid Malaysia HC 1990-1999 257 62 11

(2006)

Tam and Tan (2007) Malaysia KLSE 2000 150 43 65.33d 15.33d 12.66d 6.66d

Chu (2007) Malaysia KLSE 1994-2000 256 35

Chau and Gray (2002) Singapore HC 1997 62 57.31

Mak and Kusnadi (2005) Singapore HC 1999-2000 271 58 21 5

Zhuang, Edwards and Capulong The HC 1997 43 33.5 5.5 71.1 20.7 2.6
(2001) Philippines
65.2a

Yeh and Woidtke (2005) Taiwan HC 1998 251 8.66

Sheu and Yang (2005) Taiwan HC 1996–2000 333 39.40

Chiang and Lin (2007) Taiwan HC 1999-2003 232 26.3 29.9

Kim, Kitsabunnarat and Nofsiger Thailand 1987-1993 133 38.56

(2004)

Kouwenberg (2006) Thailand Worldscope 2002-2005 320 56.46

Bunkanwanicha, Gupta and Thailand Thailand St.Ex. 1992-1998 320 69.06d 8.7d 19.68d 3
Rokhim (2008)

Mohanty (2003) India IBID, Vans and 2001-2002 2363 4.8

Prowess

Kali and Sarkar (2005) India PROWESS 2000-2001 32.24 ~48

Sarkar and Sarkar (2005b) India PROWESS 1996-2003 ~1200 56.36 47.74 4.53 6.27 31.87g

Sarkar and Sarkar (2008) India PROWESS 2003 500 77.6

51
Patibandla (2006) India RBI 1989-2000 148 16.96 21.39 22.40g

Douma, George and Kabir (2006) India Capitaline 2000 1999-2000 1005 17.28 28.47 7.13 3.62

Pant and Pattanayak (2007) India PROWESS 2000-2003 1833 50

Black and Khanna (2007) India PROWESS 1999 791 50.8 37 2.9

Gopalan, Nanda and Seru (2007) India PROWESS 1992-2001 824 32.28 36.7

Kumar (2008) India PROWESS 1994-2000 2478 17.29 26.12 1.7 10.84

Balasubramanian, Black and India Survey, HC 2006 370 53 49.11 8.38

Khanna (2008)

Marisetty, Marsden and India PROWESS 1997-2005 67 44.98 20.22 26.35g

Veeraraghavan (2008)

1993-1995

Cueto (2007) Brazil Economatica 2000-2006 170 53 [1.33]

Chile, Bloomberg

Colombia

Peru

Venezuela

Bebczuk (2005) Argentina BASE 2003-2004 54 63.14 0 / 89d / [1.125]

37n

Lefort (2005) Argentina Economatica, 20-F 2002 15 61 3.9m 93n

82a

Lefort (2005) Brazil Economatica, 20-F 2002 459 51 86.9m 89n

65a

Silva and Subrahmanyam (2007) Brazil Economatica 1994-2004 141 72.32 85m [2.66]

Silveira, Leal, Carvalhal-da-Silva, Brazil CVM 1998-2002 ~200 59.1 51.5 17.5 6.6 16.5
and Barros (2007)

Lefort (2005) Chile Economatica, 20-F 2002 260 55 7.2m 68n

52
 74a

Silva, Majluf and Paredes (2006) Chile HC 2000 177 [1.22]

Lefort and Walker (2007) Chile Economatica, SVS 1990/94/98/2002 200 70 49.1

58.4a

Santiago-Castro and Brown (2007) Chile 20-F, HC 2000-2002 28 96 48d 25d 23d 3d 7k

Martínez, Stöhr and Quiroga Chile HC 1995-2004 175 57.14d

(2007)

Lefort (2005) Colombia Economatica, 20-F 2002 74 44 7.1m 50n

65a

Gutiérrez, Pombo and Taborda Colombia SVAL, SSOC 1996-2002 140 40.87 56d 10d 8.9d 6.7d [1.06]
(2008)
68.9b

Babatz (1997) Mexico HC 1996 121 >50 65.6 60m

Santiago-Castro and Brown (2007) Mexico 20-F, HC 2000-2002 35 57 79d 13d 1d 0d 48k

Lefort (2005) Mexico Economatica, 20-F 2002 27 52 37.8m 72n

73a

Macias and Roman (2006) Mexico HC 2000-2004 107 54* 51

Cueto (2008) Peru Economatica 2000-2006 171 21.05d 50.8d 23.4d 4.7d

Bloomberg

Lefort (2005) Peru Economatica, 20-F 2002 175 57 61m 100n

78a

Cueto (2008) Venezuela Economatica 2000-2006 46 8.7d 56.5d 34.8d 0d

Bloomberg

Hauser and Lauterbach (2004) Israel Meitav Stock 1990-2000 84 >50 [1.08]

53
 Guide

Lauterbach and Tolkowsky (2007) Israel HC >50 3.47

Barako (2007) Kenya HC 1992-2001 43 72c 58.4 28.3

Abdel Shahid (2003) Egypt CASE 2000 90 15 20 7 35 20g

Mehdi (2007) Tunisia HC 2000-2005 24 47.85 26.30 18.56

Yurtoglu (2003) Turkey ISE, HC 2001 305 39.6 45.8 79.3d 8.5d 7.2d 3.9d [4.57]

63.6a

Mangena and Tauringana (2007) Zimbabwe HC 2002-2003 67 84.2c 40 11.1

Notes to Table 2:
N: # of firms in the sample, BG: Fraction of the sample part of business groups, LS: Largest shareholder, IO: Insider Ownership, Man.: Managerial shareholdings, NFC: Nonfinancial
corporations, FC: financial corporations, For: Foreign, WH: widely held, [CO-OWN]: control rights minus ownership rights, [CO/OWN]: control rights / ownership rights.

HC: hand-collected from annual reports

* Board ownership
Inside ownership (shares held by officers, directors, their immediate families, as well as shares held in trust and shares held by companies controlled by the same parties)
a: top 3 shareholders, b: top 5 shareholders, c:top 10 shareholders, d: fraction of the sample , e: fraction of group firms, f: External unrelated block holdings, g: dispersed shareholdings, h:
Cross, k: Fraction of firms with Dual class shares, m: Fraction of firms with non-voting shares, n: Fraction of firms controlled through pyramids

BASE: Buenos Aires Stock Exchange , BCS: Bolsa de Comercio de Santiago, CASE: Cairo & Alexandria Stock Exchanges, CVM: Brazilian Securities Exchange Commission, KSE: Korea Stock
Exchange, IALC: Investment Analysis for Listed Companies, ACH: Asian Company Handbook, NICE: National Information and Credit Evaluation database, KLCA: Korea Listed Companies
Association Listed Companies Database, FSS: Financial Supervisory Service (Korea), KSD: Korean Securities Depository, ISE: Istanbul Stock Exchange, SVS: Superintendencia de Valores y
Seguros, SHSE: Shanghai Stock Exchange, SZSE: Shenzen Stock Exchange, CSRC: Chinese Security Regulatory Commission, TASE: Tel-Aviv Stock Exchange, TSE: Tunisian Stock Exchange

54
Table 3 Overview of Selected Studies on the Relationship between Ownership Structures and Corporate Performance

Study Sample Key Results

Claessens, Djankov, Fan and 1,301 publicly traded corporations in eight East Asian Firm value is higher when the largest owner’s equity stake is larger, but lower when the wedge
Lang (2002) countries (Hong Kong, Indonesia, South Korea, between the largest owner’s control and equity stake is larger.
Malaysia, the Philippines, Singapore, Taiwan, and
Thailand)

1996

Mitton (2002) 398 firms from Indonesia, Korea, Malaysia, the Divergence of the cash flow/voting right has a negative impact on firm value.
Philippines, and Thailand during the Asian crisis
Large non-management blockholders improve firm value, especially during crisis.

Lins (2003) 1433 firms from 18 emerging markets Deviations of cash flow rights from voting rights by management shareholdings lower firm value.

1995-1997 Large non-management control rights blockholdings are positively related to firm value.

These two effects are significantly more pronounced in countries with low shareholder protection.

Lemmon and Lins (2003) Over 800 firms in eight Asian emerging markets Divergence of the cash flow/voting right has a negative impact on firm value and on share returns.

Haw, Hu, Hwang and Wu 9 East Asian countries Income management that is induced by the wedge between control rights and cash flow rights is
(2004) significantly limited in countries with high statutory protection of minority rights and effective
extra-legal institutions (the effectiveness of competition laws, diffusion of the press, and tax
compliance).

Lang, Lins and Miller 2,500 firms from 27 countries Analysts are less likely to follow firms with potential incentives to withhold or manipulate
(2004) information, such as when the Family/Management group is the largest control rights blockholder.

Increased analyst following is associated with higher valuations, particularly for firms likely to face
governance problems.

Black, Jang and Kim Korea Builds a Korean Corporate Governance Index (KCGI) based on a survey of corporate governance
(2006a) practices by the KSE.
515 listed firms (20 % chaebol-affiliated);
A worst-to-best change in the Governance index (KCGI) predicts a 0.47 increase in Tobin’s q
2001 (about a 160% increase in share price), IV estimates suggest larger effects.

Firms with 50% outside directors have 0.13 higher Tobin’s q (roughly 40% higher share price),
after controlling for the rest of KCGI.

55
Bae, Baek and Kang (2007) Korea Controlling shareholders’ expropriation incentives derives a link between corporate governance and
firm value.
1996-1999, 644 listed firms
During the 1997 crisis, firms with weak corporate governance experience a larger drop in the value
of their equity, but during the post-crisis recovery period, such firms experience a larger rebound in
their share values.

Almeida, Park, Korea Proposes new metrics of ownership structure.

Subrahmanyam, and
Wolfenzon (2007) 1085 firms and 47 business groups Central firms and firms in cross-shareholding loops have lower valuations than other public
Chaebol firms.

Firms owned through pyramids have lower profitability than similar firms placed at the top of the
group

Lei and Song (2008) Hong Kong Builds a corporate governance index covering the areas board structure, Ownership structure,
Compensation and transparency.
All firms listed on the main board of HK except the
mainland Chinese companies; Firms with better CG ratings have higher firm value.

2000-2003 Family based and small firms have poor internal CG mechanisms and they tend to pay themselves
slightly higher.

However, top ten family groups appear to strongly hold to CG fundamentals. It implies that Hong
Kong investors are willing to pay a substantial premium for better- governed companies.

Douma, George and Kabir India Foreign ownership both by institutions and corporations improve Tobin’s q.
(2006)
1,005 firms listed on the BSE Only foreign ownership by corporations improves ROA. While both types of foreign shareholdings
improve ROA only domestic corporations’ shareholdings improve q.
1999–2000
Group membership has a substantial negative impact on both ROA and q.

Pant and Pattanayak (2007) India Ownership by insiders/promoters exhibits an up/down/up pattern with a negative effect in the range
of 20 % - 49% using several performance measures (ROA/ROE/Tobin’s q)
1,833 firms listed on BSE;
Tobin’s q increases with foreign promoters’ stakes.
2000-01 to 2003-04

56
Chu (2007)
Haniffa and Hudaib (2006)
Javid and Iqbal. (2007)
Yeh, Lee and Woidtke
(2001)
Filatotchev, Lien and Piesse
(2005)
Chiang and Lin (2007)
Wiwattanakantang (2001)
Malaysia Managerial or director ownership has a U-shaped impact on changes on q, the minimum occurs in
the range of 46% -62%.
256 manufacturing firms listed on Bursa Malaysia
Large shareholders also have a U-shaped influence, the impact becoming positive at around 6% of
1994 to 2000 ownership by large shareholders.
Malaysia Concentrated ownership (by top five shareholders) are negatively (positively) significant in the q
(ROA) equation.
347 companies listed on the KLSE
Managerial shareholdings have a negative impact on ROA.
1996 and 2000
Pakistan Builds a Corporate Governance Index based on 22 governance indicators covering boards,
Ownership and transparency, disclosure and audit.
50 firms non-financial firms listed on the KSE (more
than 70% of market capitalization); There is a positive and (weakly) significant relationship between CGI and Tobin’s q.
2003, 2004 and 2005
Taiwan Family firms with low levels of control have lower relative performance (q and ROA) than both
other family firms and widely held firms
208 companies listed on Taiwan Stock Exchange;
Negative relation between performance and the fraction of seats held by the controlling family
1994-1995
Taiwan Family and corporate ownership have no impact on performance.
228 firms listed on the Taiwan Stock Exchange Share ownership by institutional investors and foreign financial institutions in particular, is
associated with better performance (measured by ROA and Return on invested capital).
Taiwan The productivity of conglomerate, high-tech and non-family-owned firms is higher than in their
counterparts.
232 companies listed on the Taiwan Stock Exchange
(TSE) which have issued prospectuses from 1999 to Insider ownership is negatively and institutional ownership is positively related to TFP (Total factor
2003 productivity).
Thailand The presence of controlling shareholders is associated with higher performance (ROA and the
sales–asset ratio).
270 companies listed on the TSE
The controlling shareholders’ involvement in the management, however, has a negative effect on
1996 the performance. The negative effect is more pronounced when the controlling shareholderand
manager’s ownership is at the 25–50%.
57

Chen, Firth and Xu (2008)
Hu and Zhou (2008)
Cueto (2008)
Carvalhal da Silva and Leal
(2006)
Silveira, Leal, Carvalhal-da-
Silva, and Barros (2007)
Foreign controlled firms as well as firms with more than one controlling shareholder also have
higher ROA, relative to firms with no controlling shareholder
China The following controlling shareholders in China’s listed companies are identified: state asset
management bureaus (SAMBs), SOEs affiliated to the central government (SOECGs), SOEs
6113 firm-year observations from listed companies, affiliated to the local government (SOELGs), and Private investors.
1999–2004 Private ownership of listed firms in China is not necessarily superior to certain types of state
ownership.
The operating efficiency of Chinese listed companies varies across the type of controlling
shareholder. SOECG controlled firms perform best and SAMB and Private controlled firms
perform worst. SOELG controlled firms are in the middle
China Firms with significant managerial ownership outperform firms whose managers do not own equity
shares.
83 firms with managerial ownership and a control group
of 148 size- and industry-matched firms The relation between firm performance and managerial ownership is nonlinear, and the inflection
point at which the relation turns negative occurs at ownership above 50%.
About 170 (mostly) listed companies from Brazil, Chile, Higher voting rights held by the dominant shareholder are associated with lower q.
Colombia, Peru and Venezuela.
Higher ratios of cash-flow rights to the voting rights held by the dominant shareholder are
2000-2006 significantly associated with higher q values.
The second effect is twice as large in the fixed effects regressions.
Brazil Firm valuation and ROA are positively related to cash flow concentration, and negatively related to
voting concentration and to the separation of voting from cash flow rights.
236 financial and non-financial companies listed on
Bovespa; Firms controlled by the government, foreign and institutional investors generally have significantly
higher valuation and performance when compared to family-owned firms.
1998, 2000 and 2002
Brazil Overall firm-level CG quality is slowly improving but is still poor.
about 200 firms from 1998 - 2004 Voluntary adoption leads to greater heterogeneity of corporate governance quality.
Voluntarily joining stricter listing requirements, either by cross-listing in the US or by joining
Bovespa’s New Market, is positively associated with firm-level CG quality.
58

Gutiérrez and Pombo (2007) Colombia
108 non-financial listed firms
1998 to 2002
Gutiérrez and Pombo (2008) Colombia
233 non-financial listed firms
1996-2004;
Lefort and Walker (2007) Chile
About 200 firms
1990-1994,-1998-2002
Macias and Roman (2006) Mexico
107 listed non-financial firms
2000-2004
Lauterbach and Tolkowsky Israel
(2007)
144 firms traded on the TASE
Control rights concentration and family ownership are associated to poorer practices while the
presence of large blockholders agreements are related to better practices.
Large blockholders exert a positive influence on q (and ROA) at lower levels.
The relationship has an inverted U shape, the squared term implying a negative impact at 58%
(57%-66% GLS or fixed effects estimation for ROA).
Higher contestability of the largest blockholder's control helps limit tunneling and private extraction
of rents.
Control contestability (a more equal distribution of control rights among the four largest
blockholders) is positively related to Tobin’s q.
The ratio of voting rights to equity insignificant.
Higher ownership concentration by the three largest shareholders is negatively associated with q.
U-shaped relationship with a minimum at 68% of ownership.
Lower levels of deviation of cash flow and voting rights is positively associated with q. A one
standard deviation increase in the degree of coincidence is associated with an increase in q of 28%
(an increase in stock price of 58%).
Pension funds as minority shareholders increase q.
Builds a Governance Score (GS). GS improves over the 2000-2004 period, however, firm
performance (ROA) is not related to GS. Tobin’s q is negatively related to GS.
Tobin's q is maximized when control group vote reaches 67%. This evidence is strong when
ownership structure is treated as exogenous and weak when it is considered endogenous.
Other ownership structure variables do not significantly affect firm valuation.
59
Abdel Shahid (2003) Egypt Significant effects of ownership characteristics on ROA and ROE but not on stock market
indicators P/E and P/BV ratios-
90 most actively listed companies on Cairo & Alexandria
Stock Exchanges (CASE) Ownership by holding companies has an economically and statistically positive effect on
accounting performance measures.

Mehdi (2007) Tunisia Higher CEO and directors shareholdings are positively associated with better investment
performance (measured by marginal q).
24 firms listed on the Tunisian Stock Exchange
Blockholder and institutional shareholdings have a negative impact.
2000 - 2005

Yurtoglu (2000) Turkey Ownership concentration and deviations of voting rights from control rights have a negative effect
on ROA, market-to-book ratio and dividend pay-out ratios.
257 companies listed on the Istanbul Stock Exchange
(ISE)

1997

60
Table 4 Overview of Selected Studies on the Effects of Legal Changes

Study Sample Legal Change Key Results

Park and Kim Korea Government policies to weaken the ties among group-affiliated firms: The effectiveness of governance factors on firms’ activities is bound to the
(2008) elimination of cross-debt guarantees, restrictions on intra-group institutional context created by government regulations.
251 firms transactions.
Institutional ownership and regulatory changes in CG had significantly
1993–2004 Elimination of restrictions on foreign ownership. influenced Korean firms’ restructuring. Regulatory changes have positively
moderated the relationship between business group affiliation and restructuring,
Removal of restrictions on exercising voting rights by institutional and between institutional ownership and restructuring.
shareholders.

Choi, Park and Yoo Korea Introduction of a mandatory quota for outsiders. Outside directors have a significant and positive effect on firm performance
(2007)
~450 firms Starting in 1999, at least one-quarter of the board members for listed
companies are required to be composed of independent outside
1999 - directors.
2002

Black and Kim Korea Requirement that large firms (with assets over 2 trillion won, around A positive share price impact of boards with 50% or greater outside directors,
(2007) $2 billion) to have 50% outside directors, an audit committee with an and weaker evidence of a positive impact from creation of an audit committee.
248 firms outside chair and at least 2/3 outside directors as members, and an
outside director nominating committee.
1998-2004

Black and Khanna India Clause 49 in 2000: Reforms benefited firms that need external equity capital and cross-listed firms
(2007) more, suggesting that local regulation can sometimes complement, rather than
Requirement of audit committees, a minimum number of independent substitute for firm-level governance practices
directors, and CEO/CFO certification of financial statements and
internal controls

Beltratti and China Nontradable Share Reform in 2005/2006:
Bortolotti (2007)
Elimination of non tradable shares (a special class of shares entitling
the holders to exactly the same rights assigned to the holders of
tradable shares but which cannot be publicly traded)
After more than doubling in value throughout the program, the market rose 40%
in the first four months of 2007, immediately after the completion of the NTS
reform for the entire stock market.

Qian and Zhao China Mandatory use of cumulative voting in director elections (Section 31 Firms that used cumulative voting experienced a significant decrease in
(2011) of the Code of Corporate Governance for Listed Companies issued in expropriation activities and an improvement in investment efficiency and firm
381 firms January 2002) performance relative to other firms.

61
Atanasov, Black, Bulgaria Securities law changes in 2002 Following the legal changes, share prices jump for firms at high risk of tunneling,
Ciccotello and relative to a low-risk control group; minority shareholders participate equally in
Gyoshev (2006) 800 firms Provides protection against dilutive offerings and freezeouts. secondary equity offers, where before they suffered severe dilution; and freezeout
offer prices quadruple.
1999-2002

Nenova (2005) Brazil Law 9457/1997 lifts disclosure of the prices of block sales and
mandatory offers for voting shares at control sale, and weakens
withdrawal rights, leaving ample room for expropriation by
controlling parties
Instruction 299 amends the Corporate Law and reinstates and
enhances the minority rights revoked by Law 9457/1997
Firm control values of Brazilian listed companies are directly affected by changes
in the legal protection for minority shareholders.
Control value increases more than twice in the second half of 1997 in response to
Law 9457/1997 which weakens minority shareholder protection.
Control values drop to pre-1997 levels in the beginning of 1999 in response to
CVM Instruction 299/1999, which reinstates some of the minority protection
rules scrapped by the previous legal change.

62
Table 5 Overview of Selected Studies on the Relationship between CG Indices and Performance
Study
Black, Carvalho, and Gorga (2011)
Cheung, Thomas Connelly,
Limpaphayom and Zhou (2007)
Lei and Song (2008)
Black, Jang and Kim (2006a)
Mohanty (2003)
Balasubramanian, Black and
Khanna (2010)
Javid and Iqbal (2007)
Kouwenberg (2006)
Sample CG Index Properties
Brazil (India, A broad Brazil Corporate Governance Index (BCGI) and its subindices.
Korea, and
Russia)
Hong Kong Rights of shareholders (15 %); equitable treatment of shareholders (20 %);
role of stakeholders (5 %); disclosure and transparency (30 %); and board
responsibilities and composition (30%).
CGI ranges from a low of 32 (out of 100) to a high of 77.
Hong Kong CGI using a principal component analysis which covers the areas board
structure, ownership structure, compensation and transparency.
Korea Korean Corporate Governance Index (KCGI) based on a survey of corporate
governance practices by the Korean Stock Exchange (KSE).
India An index based on 19 measures taking into account shareholders and
stakeholders’ interests:
India An overall India Corporate Governance Index (ICGI) based on the following
sub-indices: Board Structure, Disclosure, Related Party Transactions,
Shareholder Rights and Board Procedures.
Pakistan Corporate Governance Index based on 22 governance indicators based on
three main themes: Board (8 factors), Ownership (7 factors) and
transparency, disclosure and audit (7 factors).
Thailand Voluntary adoption of the corporate governance code introduced in 2002
63
Key Results
A positive and statistically significant association
between BCGI (measured at year-end 2004) and firm
market value (measured at year-ends 2005 and 2006).
Different subindices are important in different countries
(for different sets of companies).
Companies’ market valuation (but not their ROE) is
positively related to its overall CGI score.
Firms with better CG ratings have higher firm value.
Family based and small firms have poor internal CG
mechanisms and they tend to pay themselves slightly
higher. Top ten family groups appear to strongly hold to
CG fundamentals.
A worst-to-best change in KCGI predicts a 0.47 increase
in Tobin’s q which corresponds to an almost 160%
increase in the share price.
institutional investors own a higher percentage of the
shares of better-governed firms based on this index:
A positive relationship for the overall ICGI and for an
index covering shareholder rights and firm performance.
A positive but weakly significant relationship between
CGI and Tobin’s q.
A one standard deviation increase in a firm-level code
adoption index is related to a 10% increase in firm value
in the period 2003-2005.
Bebczuk (2005) Argentina A transparency and disclosure index (TDI) comprising a total of 32 binary TDI and its components are significantly positive in
items on boards, disclosure and shareholders. OLS equations explaining accounting performance and
Tobin’s q.

Leal and Carvalhal da Silva (2005) Brazil Governance Practices Index based on a set of 24 survey question. A worst-to-best improvement in the CGI in 2002 would
lead to a 0.38 increase in Tobin’s q (or a 95% rise in the
stock value).

Macias and Roman (2006) Mexico Governance Score (GS): GS is a composite measure of governance based on GS improves from 0.66 in 2000 to 0.82 in 2004,
55 items (with subsections on board structure, external auditing, transparency however, both accounting and market measures of firm
in financial reporting, and disclosure and shareholders’ rights) and it is scaled performance are not related to the GS.
to be in the range of 0 to 1 higher values indicating better governance.

Zheka (2007) Ukraine An overall index of corporate governance (UCGI) and sub-indices of A one-point-increase the UCGI index would result in
corporate governance including: shareholder rights, transparency/ around 0.4-1.9% increase in performance; and a worst
information disclosure, board independence and chairman independence. to best change in UCGI predicts about 40% increase in
company’s performance.

Kowalewski, Stetsyuk and Talavera Poland Transparency and Disclosure Index (TDI) An increase in the TDI or its sub-indices that represent
(2007) corporate governance practices brings about a
statistically significant increase in the dividend payout
ratio.

Guriev, Lazareva, Rachinsky and Russia A corporate governance index based on a survey including six questions No link to performance.
Tsouhlo (2003) (concerning accounting standards, shareholder relations and independent
directors) related to corporate governance using principal components
analysis.

Lazareva, Rachinsky and Stepanov Russia, A corporate governance index based on a survey including six questions Neither the need for outside finance nor the actual
(2008) Ukraine and (concerning accounting standards, shareholder relations and independent outside investment have any relationship to the
Kyrgyzstan directors) related to corporate governance using principal components corporate governance index.
analysis.

Black (2001a) and Black (2001b) Russia Corporate governance rankings of a small sample (16 and 21) of major A one-standard-deviation improvement in governance
Russian firms developed by the Brunswick Warburg investment bank ranking predicts an eightfold increase in firm value; a
worst (51 ranking) to best (7 ranking) governance
improvement predicts a 600-fold increase in firm value.

Black, Love and Rachinsky (2006) Russia Six corporate governance indices, from five different providers, on Russian A combined index is economically and statistically
companies. related to market valuations.

64
Table 6 Summary of Key Empirical Studies on Board of Directors
Study Country Sample Dependent variables Independent Estimation Main Results
Variable (mean) Method

Lefort and Urzua Chile 160 listed firms in 2000-2003 Tobin’s q Proportion of independent OLS, Fixed effects and OLS and fixed effects: not
(2008) directors (20%) 3SLS regression significant
3SLS: significantly positive
Peng (2004) China 49 – 405 listed firms in 1992- ROE, Sales growth (SGR) Proportion of affiliated (30%) OLS Positive significant
1996 and non-affiliated outside
directors (11%) (affiliated outside directors
Chen, Firth, Gao and China 169 enforcement actions in FRAUD: A dummy variable Proportion of outside (or non- Probit Negative significant
Rui (2006) 1999–2003 for firms subject to an executive) directors (13%)
enforcement action.

Lo, Wong and Firth China 266 listed companies in 2004 Gross profit ratio on related Proportion of independent OLS Negative significant
(2010) party transactions directors (34.5%)
Chen and Nowland Hong Kong, 185 listed firms in 1998-2004 ROA and Tobin’s q Proportion of independent Fixed effects Concave relationship with an
(2010) Malaysia, directors (23% family firms, 34% optimal level of board
Singapore and other firms) independence at 36%
Taiwan
Ramdani and Indonesia, 61 firms in Indonesia, 75 in ROA Proportion of outside directors OLS, robust regressions OLS: Not significant
Witteloostuijn (2010) Malaysia, South Malaysia, 111 in S. Korea and (69%) (RR) and quantile RR: Positive significant
Korea and 61 in Thailand over 2001-2002 regressions (QR) QR: Positive significant at the
Thailand median and 75th percentile

Black, Jang and Kim Korea 515 companies in 2001 Tobin’s q and profitability Dummy variable indicating OLS and 2SLS (using asset Positive significant
(2006) whether firms have 50% or more size dummy as an
outside directors instrument)

Choi, Park and Yoo Korea ~450 listed firms in 1999 -2002 Tobin’s q Proportion of outside directors OLS and 2SLS Not significant
(2007) (31.2%)
Proportion of independent
directors (21.3%) Positive significant
Black and Kim Korea 248 listed companies in 1998- Cumulative market-adjusted Board independence index based Event study, Differences in Positive significant
(2007) 2004 returns and Tobin’s q on the existence of 50% or more differences, 2SLS, 3SLS
outside directors and fixed effects

65
Mak and Kusnadi Malaysia and 230 firms listed on the SGX and Tobin’s q Proportion of independent OLS Not significant
(2005) Singapore 279 on the KLSE in 1999 or directors (34%)
2000
Ararat, Orbay and Turkey 108 firms listed on the Istanbul Tobin’s q, ROA, Related Proportion of independent OLS, fixed effects, 2SLS Not significant / significantly
Yurtoglu (2011) Stock Exchange party transactions directors (7.5%) negative

Dahya, Dimitrov and 22 countries 799 firms with dominant Tobin’s q Proportion of outside directors OLS, country random Positive significant
McConnell (2008) including 7 shareholders (69%) effects, 2SLS
emerging markets
in 2002

66
Table 7 Overview of Selected Studies on Cross-listings

Study Motive of Cross-Listing / Key Results

Saudagaran and Foreign listing locations are influenced by financial disclosure levels and the level of
Biddle (1995) exports to a given foreign country. Firms are reluctant to cross-list in destinations with
strict accounting and regulatory disclosure requirement which could affect the
management’s pursuit of private benefits.

Coffee (1999) Firms from poor investor protection regimes can effectively utilize or borrow better
investor protection mechanism by cross-listing in such exchanges, e.g., in the US. This
Stulz (1999) voluntary commitment serves as a ‘bonding’ mechanism through which firms can
persuade outside investors to provide capital by protecting minority shareholders from
management’s extraction of private benefits.

Miller (1999) Firms which announce ADR programs experience a positive change in shareholder
wealth. This effect is larger for firms from countries, where legal barriers to capital flows
are prevalent. Cross-listings can mitigate barriers to capital flows and result in a higher
share price and a lower cost of capital.

Bacidore and Increasing stock liquidity

Sofianos (2002)

Foerster and Karolyi Expansion of the potential investor base

(1999) and
Sarkissian and Schill
(2004)

Baker, Nofsinger Accessing foreign analysts’ expertise

and Weaver (2002)

Pagano, Röell and Visibility to customers in product markets

Zechner (2002)

Karolyi (2003) and To improve a firm’s ability to effect structural transactions abroad such as foreign
Tolmunen and mergers and acquisitions, stock swaps, and tender offers.
Torstila (2005)

Doidge, Karolyi and Commitment to tough disclosure and corporate governance rules.
Stulz (2004)

Bailey, Karolyi and Absolute return and volume reactions to earnings announcements typically increase
Salva (2006) significantly once a company cross-lists in the U.S. These increases are greatest for firms
from developed countries and for firms that pursue over-the-counter listings or private
placements, which do not have stringent disclosure requirements. Additional tests
support the hypothesis that it is changes in the individual firm’s disclosure environment,
rather than changes in its market liquidity, ownership, or trading venue, that explain
these findings.

Lins, Strickland and A U.S. listing enhances access to external capital markets by showing that the sensitivity
Zenner (2005) of investment to cash flow decreases significantly for firms from emerging capital
markets, whereas it does not change for developed markets firms following a U.S.
listing.

Lang, Lins and Firms that cross-list on U.S. exchanges have greater analyst coverage and increased
Miller (2003)
forecast accuracy relative to firms that are not cross listed.

67
Siegel (2005) Reputational bonding (rather than legal bonding)

In the Mexican case, listed ADRs did not always serve as an effective bonding
mechanism for deterring malpractices such as fraud, outright theft, embezzlement, and
legal asset taking.

Licht (2001) Evidence which contradicts the bonding hypothesis for Israel.

Most issuers were listed only in the U.S. without having previously listed on the Tel
Aviv Stock Exchange. Israeli U.S.-listed issuers resisted any increase in their corporate
governance-related disclosure beyond the sub-optimal level they are subject to in the
U.S.

Sami and Zhou Chinese cross-listed firms have lower information asymmetry risk, lower cost of capital
(2008) and higher firm value than their non-cross-listed counterparts.

Halling, Pagano, Cross-listings can affect the level of domestic trading volume. Domestic trading volume
Randl and Zechner declines for companies from countries with poor enforcement of insider trading
(2008) regulation.

Liu (2007) Foreign cross-listings in the U.S. enhance home-market stock pricing efficiency, net of
market-wide efficiency shifts in the concurrent period. The efficiency benefit applies
equally well regardless of home-market development status or cross-listing location.

Chung, Cho and Evidence which contradicts the bonding hypothesis.

Kim (2011)
Firms are more likely to choose cross-listing destinations that are less strict on regulating
self-dealing or exhibit higher block premiums relative to the origin country, and this
tendency is more pronounced after Sarbanes-Oxley in 2002.

68
Table 8 Overview of Selected Studies on Political Connections

Study Key Results

Fisman (2001) The value of political connections to the Suharto regime in Indonesia.

Using announcements concerning Suharto’s health, the study documents that over
20% of a politically connected firm’s value is derived from its political connections.

Ramalho (2003) Politically connected firms’ stock values drop around dates of an anti-corruption
campaign in Brazil.

La Porta, López-de- Related lending is prevalent in Mexico (20% of commercial loans) and takes place on
Silanes and Zamarripa better terms than arm's-length lending (annual interest rates are 4% points lower).
(2003) Related loans are 33% more likely to default and, when they do, have lower recovery
rates (30% less) than unrelated ones. Related lending is a manifestation of looting.

Khwaja and Mian Political connections increase financial access for Pakistani firms. Politically
(2005) connected firms (those with a board member who runs for political office) have loans
which are 45% larger and carry average interest rates, although they have 50 percent
higher default probabilities. Such preferential treatment occurs exclusively in
government banks-private banks provide no political favors. The economy-wide costs
of the rents afforded to politically connected firms through government-owned banks
is about 2 % of GDP per year.

Faccio (2006) Politically connected firms are more frequently found in countries with higher levels
of corruption, with barriers to foreign investment, and with more transparent systems.
The announcement of a new political connection results in a significant increase in
value.

Faccio, McConnell and Politically connected firms are significantly more likely to be bailed out than similar
Masulis (2006) non-connected firms. Among firms that are bailed out, those that are politically-
connected exhibit significantly worse financial performance than their non-connected
peers at the time of the bailout and over the following two years.

Charumilind, Kali and Thai firms firms with connections to banks and politicians before the Asian crisis of
Wiwattanakantang 1997 had greater access to long-term debt than firms without such ties. Connected
(2006) firms needed less collateral and obtained more long-term loans.

Claessens, Feijen and Brazilian firms that provided contributions to (elected) political candidates
Laeven (2008) experienced higher stock returns than firms that don't around the 1998 and 2002
elections. These firms are also able subsequently to access bank finance.

Qian, Pan and Yeung Expropriation by controlling shareholders in China through tunneling or self-dealing
(2011) is far more severe in politically connected firms than in nonpolitically connected
firms. This results more from the formers’ lower concern with capital market
punishment than from the possibility that such firms tend to establish political
connections for protection.

Du (2011) Chinese firms’ political connections are positively associated with debt offering
amounts and issuer credit ratings, but only in the subsample of firms with poor
information environments, such as non-publicly listed firms and non-Beijing
headquartered firms.

The role of political connections in providing preferential access to debt is relevant to

both state-owned enterprises and privately held firms. In

69
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