Emerging Markets Corporate Governance Research Network Newsletter, February 2014
In our 14th issue we feature an interview with Prof. Alex Edmans from Wharton and LBS. Prof. Edmans tells us about his recent work on how blockholders can exert influence through the threat of exit, and he highlights the implications of his research for emerging markets. Closely related to governance through “wall street walk” are topics of reporting quality, diversion, accountability and fraud. So, we feature articles on income diversion in Russia, CEO accountability in China, governance disclosures in Egypt, ownership dynamics in Chile and the influence of governance in Turkey. As always, we present interesting reports, news and events.
CG Insights Series - Is There More Than One Way for Shareholders to Exert Influence Over the Firm’s Corporate Governance Environment?
Dr. Alex Edmans is Professor of Finance at the London Business School, on leave from the University of Pennsylvania’s Wharton School. His research explores the connection between corporate governance and company performance and the broader connection to market valuation. This is an abbreviated version, read the full interview here.
The most interesting piece on corporate governance I read recently was...
...A paper in the Journal of Finance studying the effect of corporate governance on firm value. The authors use a technique called “regression discontinuity” to analyze shareholder voting patterns on governance proposals. They compare votes that pass by a narrow margin with those that fail by a narrow margin. The close passage or the close failure of a proposal can be viewed as a random shock to governance, and this allows us to identify causality. The results show that approving and enacting a governance-related proposal does indeed improve stock returns and firm value.
Right now, I am working on...
...Continued exploration of the link between corporate governance and asset pricing, which has not been the focus of much research in the past. In a recent paper, I looked at the ways in which large shareholders—blockholders—can influence the corporate governance environment of the firm. The first way is ‘voice’: you can tell management what you’d like to see happen. The risk here is that the threat of such intervention can undermine managerial initiative. It also increases the potential that the blockholders are exerting influence for the purpose of extracting private benefits, rather than adding value to the company. The second way shareholders can influence this is by exiting—selling their shares. When blockholders sell off their shares, this pushes down the stock price, which hurts the manager because his pay depends on the stock price. The bottom line is that voting with your feet can be an effective motivator for management, in addition to the threat of intervention.
I think the most relevant CG research topic for emerging markets now is...
...Understanding more about this link between governance and financial markets, and how it gives minority shareholders more power than they might think they have. Emerging market countries can help drive improved corporate governance by increasing the liquidity of their stock markets. Reducing regulatory barriers for buying and selling—like taxation—and liberalizing financial markets would encourage more active buying and selling, which can be tremendously beneficial. It gives shareholders—and particularly minority holders—another tool to influence firm governance. This can be a powerful motivator for change.
Income Diversion, Corporate Governance and Firm Value Juan-Pedro Gómez and Maxim Mironov Gómez and Mironov investigate the efficacy of corporate governance in reducing income diversion. They use a unique set of banking transaction data pertaining to large public Russian corporations. Direct income diversion turns out to be sizeable, amounting to, on average, 1.8% of company revenues or 1.7% of assets per year. Publicly traded companies (and especially those cross-listed in the USA) divert less income than private companies. Furthermore, auditing by internationally reputed accounting firms or board size and composition are largely unrelated to income diversion. Firm value and income diversion are positively related, even after controlling for corporate governance variables. This constitutes evidence of better performing firms (higher market to book values and higher profit margins) more actively engaging in income diversion.
CEO Accountability for Corporate Fraud: The Role of Controlling Shareholders and Institutional Reform in China Jiandong Chen, Douglas Cumming, Wenxuan Hou, and Edward Lee The authors use a unique natural experiment that enables an exogenous test of the influence of controlling shareholders on managerial accountability for corporate fraud. In China, prior to the Split Share Structure Reform (SSSR), state shareholders held restricted shares that could not be traded. This restriction mitigated state-owned enterprise controlling shareholders’ incentives to monitor managers. They show the SSSR strengthens incentives of state-owned enterprise controlling shareholders to replace fraudulent management. Their findings support the view that economic incentives are important to promote corporate governance and deter fraud.
Can Chinese State Owned Enterprises Fulfill Both Social and Corporate Objectives? Quan Cheng and Alex Ng How state governance impacts the performance of Chinese firms is well studied, but how it impacts various aspects of firm employment is neglected. Cheng and Ng propose that state governance will have mutual effects on performance and employment, and they use a large and recent sample of 27,896 Chinese publicly listed firms during 2001-2011 to test their hypothesis. They find that privately governed and highly state governed firms have lower performance than mixed governed firms and state governance positively affects employment stability and employment numbers in Chinese firms.
Ownership Concentration, IFRS Adoption and Earnings Quality: Evidence from an Emerging Market Mine Aksu, Yaz Gulnur Muradoglu, and Ayse Tansel Cetin The authors investigate impacts of governance and IFRS adoption on earnings quality in Borsa Istanbul. Using a hand-collected dataset, they find strong first time evidence for low persistence of earnings and high earnings management. Furthermore, they find that ownership concentration impedes earnings quality while foreign ownership enhances it. Mandatory IFRS adoption has a strong positive effect on earnings persistence and a weaker effect on earnings management. The impact of IFRS in reducing the negative impact of only family type ownership concentration is noteworthy.
Opinion and Commentary
China Innovation The Economist features a very interesting ongoing debate on China’s innovative power, and this debate includes arguments on how state-owned enterprises and privately held corporations impact differently the innovation in China.
Emerging Trends in Environmental, Social, and Governance Data and Disclosure: Opportunities and Challenges Steve Lydenberg In this report Lydenberg explains how social factors that have driven increased voluntary environmental, social, and governance (ESG) disclosure over the past three decades are sufficiently compelling to lead to mandated disclosure worldwide. Whether ESG data will then be fully integrated into corporate management and investment practices ultimately depends on the willingness of governments, stock exchanges, and the accounting profession—along with corporations, investors, consumers, and other members of society—to acknowledge the essential role these data can play in bringing about the alignment of market forces with society’s interests.
Family Firm Research – a Review Qiang Cheng Cheng reviews family firm studies in the finance and accounting literature. Given the distinguishing features of family ownership and control, family firms around the world face unique agency conflicts. Cheng discusses the agency problems in family firms and review the findings of recent family firm studies. Part 3 of this article investigates China in particular.
Diversification in Emerging Markets: The Case of Chilean Firms Mauricio Jara-Bertin, Christian Espinosa, and Félix J. López-Iturriaga The authors investigate the ownership dynamics of 83 nonfinancial Chilean companies between 2005 and 2009, and they find evidence of a discount for participating in ownership of other companies. Namely, there is a discount for ownership diversification. However, this discount turns into a premium when participation in the ownership of another company results in control, especially in related sectors.
International Corporate Governance Network's Academic Meeting will be held on June 15, 2014 in Amsterdam, The Netherlands. The organizers invite papers on the following topics: Cross-border voting, Governance research / proxy advisors, Function and responsibilities of institutional shareholders in corporate governance, and block ownership.
We encourage all of our members to notify us regarding their ongoing research or the events or conferences they want to share with the Network. We also welcome other relevant information and your feedback. Please contact Mehmet Canayaz at Mehmet.Canayaz@sbs.ox.ac.uk
The Emerging Markets Corporate Governance Research Network is supported by IFC's Global Corporate Governance Forum. The Forum is part of the knowledge management activities of IFC Corporate Governance Group, providing capacity building tools and best practice guidance to support corporate governance good practices and reform efforts in emerging markets and developing countries. Our work is currently supported by Austria, Luxembourg, and Switzerland. For more information about the EMCGN's activities, go to http://www.gcgf.org/research or contact firstname.lastname@example.org.