Corporate Governance and Investment Performance: An International Comparison B. Burçin Yurtoglu University of Vienna Department of Economics 1
Joint Research with Klaus Gugler and Dennis Mueller http://homepage.univie.ac.at/besim.yurtoglu/unece/unece.htm The Impact of Corporate Governance on Investment Returns in Developed and Developing Countries, Economic Journal, 2003. Globalization and Corporate Governance, Oxford Review of Economic Policy, 2004. Corporate Governance and the Returns on Investment, Journal of Law and Economics, 2004. The Effects of Insider Ownership on Investment Performance: An International Comparison, WP, University of Vienna, 2004. 2
The agency problem Measures of investment performance The impact of institutions on performance 3
Agency problems To what extent do corporate governance institutions reduce agency problems and thereby align the interests of managers and shareholders. Weak corporate governance systems allow managers to pursue their own goals at the shareholders expense. Growth-oriented managers will over-invest and pay out less than the share-price-maximizing level of dividends. Accordingly, many tests for the effectiveness of corporate governance in aligning managers and shareholders interests have compared measures of performance like dividend payouts and Tobin s q that are related to investment decisions. 4
The agency problem Return on investment (r), cost of capital (i) r H r L i I L CF I H Investment Cash Flow 5
Measures of investment performance: Dividends, Tobin s q, Marginal q The optimal dividend payout depends upon both the cash flows of a firm and its investment opportunities. Tobin s q is a measure of average performance. It thus confounds inframarginal and marginal returns. Tobin s q might be high, e.g., because a firm has considerable market power, which in turn could provide its managers the free cash flow to pursue their own goals. An ideal measure of investment performance for testing hypotheses about agency problems should identify marginal returns. 6
Methodology PV t = CF ( + i ) t j= 1 1 t+ j j PV t It rt = = it q mt I t M = M + M + µ t t 1 PV t δ t t 1 t M M = I M + µ t t 1 q mt t δ t t 1 t M M I µ = δ + q + M M M t t 1 t t m t 1 t 1 t 1 7
Example Consider that a firm with market value of 1000 in a given year invests 100 at a rate of return, r=10%, which exceeds its cost of capital, i=5%. Assuming no depreciation and no prediction errors by the market, its market value will increase by 200. M t M t 1 = qm It 1200 1000 = qm 100 8
Corporate Governance Institutions Legal systems Ownership structure Ownership Concentration Identity of Owners Financial Institutions and other Blockholders as outsiders Other Institutions Accounting Standards Creditor Rights Contract Enforcement 9
The Impact of Legal Systems Legal system qm Firms English Origin 1.02 13,557 Scandinavian Origin 0.78 439 German Origin 0.74 3,094 French Origin 0.59 1,818 Transition Countries 0.64 85 African Countries 0.77 17 10
English Origin Countries Country qm Firms Australia 0.94 346 Bermuda 0.91 215 Canada 1.16 1478 Cayman Islands 0.58 42 Great Britain 0.85 1,331 Hong Kong 0.78 127 India 0.80 246 Ireland 1.10 63 Israel 1.27 56 Malaysia 0.86 381 New Zealand 0.86 66 Pakistan 0.40 46 Singapore 0.97 208 South Africa 1.07 118 Thailand 0.64 243 USA 1.05 8,591 11
Scandinavian and German Origin Scandinavian Origin Countries qm Firms Denmark 0.65 101 Finland 0.96 79 Norway 1.04 103 Sweden 0.65 156 German Origin Countries qm Firms Austria 0.71 82 Germany 0.57 425 Japan 0.86 2,219 South Korea 0.70 82 Switzerland 0.64 160 Taiwan 1.26 126 12
French Origin French Origin Countries qm Firms qm Firms Argentina 0.78 24 Mexico 0.5 81 Belgium 0.51 79 Netherlands 0.69 174 Brazil 0.25 133 Netherlands Antilles 1.19 19 Chile 1.24 73 Panama 1.25 4 Colombia 0.43 15 Peru 0.11 20 France 0.57 495 Philippines 1.00 83 Greece 0.54 49 Portugal 0.46 49 Indonesia 0.84 132 Spain 0.54 117 Italy 0.64 150 Turkey 0.52 29 Luxembourg 0.70 12 Venezuela 0.58 10 13
The Effects of Ownership on the Returns on Investment by Legal System English Scandinavian European-German Asian-German French Origin Origin Origin Origin Origin Family 1.082 > 1.019 Financial 1.002 < 1.061 0.692 > 0.579 Non-Financial Dispersed 1.145 > 0.683 1.358 > 0.601 State 0.374 < 0.634 0.952 > 0.588 14
Implications These results show that differences in investment performance related to a country s legal system dominate differences related to ownership structure Nevertheless, ownership structures have important consequences on investment performance 15
Pyramiding, Cross-Shareholdings and Shareholder Voting Rights in Europe Pyramidal Structures: -0.09 Cross-Shareholdings: -0.25 Deviation of control and cash flow rights of the dominant shareholder: -0.12 (Business Groups in Japan: -0.11) 16
Insider Ownership in the USA and its Impact on Investment Performance 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 10 20 30 40 50 60 70 80 90 100 qa qm 17
Family Ownership in the English-origin non-us sample and its Impact on Investment Performance 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 10 20 30 40 50 60 70 80 90 100 qa qm 18
Family Ownership in Europe and its Impact on Investment performance 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 10 20 30 40 50 60 70 80 90 100 qa qm 19
Additional Findings Ownership by financial institutions in the USA improves companies investment performance. Ownership by banks, insurance companies and other financial companies in Continental Europe is associated with worse investment performance. 20
The Impact of Accounting Standards strong accounting standards strengthen the hand of shareholders resulting in higher returns on both reinvested cash flows and new equity issues, and this holds more or less regardless of a country s legal origin the improvement in performance for equity holders comes to a degree at the expense of debt holders. 21
The Effects of Creditors Rights Strong creditor rights tend to benefit debt holders and harm purchasers of new equity in all four countrygroups. The Impact of Strong Contract Enforcement No developed, English-origin country has weak contract enforcement. No developing, civil-law country has strong contract enforcement. Economically and statistically significant improvement in investment performance in countries with strong enforcement. 22
Conclusions Agency problems exist in all countries and can have significant impacts on the investment performance of companies. Agency problems can be mitigated by the institutional structures of a country. Legal institutions that strengthen shareholder rights do bring about superior investment performance. 23
Managers who wish to undertake low return investments in countries with strong corporate governance systems prefer to rely on internal cash flows to finance these investments Managers making similar investments in countries with weak corporate governance systems are freer to use the equity market as a source of finance. 24