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Kee -Hong Bae , York University Jae- Seung Baek , Hankuk University of Foreign Studies

Do Controlling Shareholders’ Expropriation Incentives Imply a Link Between Corporate Governance and Firm Value? Theory and Evidence. Kee -Hong Bae , York University Jae- Seung Baek , Hankuk University of Foreign Studies Jun-Koo Kang, Nanyang Techonological University

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Kee -Hong Bae , York University Jae- Seung Baek , Hankuk University of Foreign Studies

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  1. Do Controlling Shareholders’ Expropriation Incentives Imply a Link Between Corporate Governance and Firm Value? Theory and Evidence Kee-Hong Bae, York University Jae-SeungBaek, Hankuk University of Foreign Studies Jun-Koo Kang, NanyangTechonological University Wei-Lin Liu, NanyangTechonologicalUniversity

  2. Corporate governance and firm value • Examine the relation between governance and firm value change during crisis period. • Johnson, Boone, Breach, and Friedman (2000), Mitton (2002), Lemmon and Lins (2003), Baek, Kang, and Park (2004) • Firms with poor corporate governance suffer more during economic crisis period in the Asian region.

  3. Why poor governance firms suffer more? • Expropriation hypothesis • Johnson, Boone, Breach, and Friedman (2000) • Information hypothesis • Rajan and Zingales (1998) • Risk hypothesis • Overreaction hypothesis

  4. Research question • Reevaluate the validity of expropriation hypothesis against other possibilities. • The novelty of our approach • The prediction of expropriation hypothesis during recovery period is exactly opposite to that during crisis period.

  5. A simple model of expropriation • The change in firm value during the crisis is negatively (positively) related to the manager’s expropriation power (his equity ownership in the firm). • The change in firm value during the recovery period is positively (negatively) related to the manager’s expropriation power (his equity ownership in the firm).

  6. During the crisis period, controlling shareholder allocates less capital to investments, resulting in a smaller amount of investable capital available when the recovery arrives. • The limited amount of initial investable capital produce, on a per dollar investment basis, a large increase in firm value.

  7. Expropriation vs. Information

  8. Data • Korean sample (for main analyses) • 608 non-financial firms listed on the Korean Stock Exchange (KSE) during 1996-1999. • Additional evidence using • Asian sample: 598 firms from seven Asian countries during Asian crisis • Latin sample: 302 firms from four Latin countries during 2001 Argentine crisis

  9. Method • OLS • Dependent variable • Firm performance (BHRs, accounting profits) • Independent variables • Governance variables • Firm risk • Contrarian effect • Firm characteristics

  10. Governance variables • Disparity between voting rights and cash flow rights by controlling shareholders (defined as owner-managers and their family members) • Log of (voting rights / cash flow rights) • Equity ownership by controlling shareholders

  11. Firm risk and contrarian effect • Market beta using two-year daily stock returns • Residual variance • Past holding period return (HPR)

  12. Control variables • Log of total assets and its square • Leverage • Business group (top 30) dummy • Foreign ownership and ADR dummy • Financial investment in affiliated firms • Tobin’s q • Cash flow • Industry dummy

  13. Robustness tests • Alternative governance measures • Sum of block ownership by all shareholders • Largest managerial block ownership • Largest nonmanagerial block ownership • Alternative performance measure • Accounting profitability • Alternative crisis and recovery period

  14. Does governance matter on net? • Governance variables are not related to holding period return over the entire cycle, down and up. • Controlling shareholders’ propping behavior? (Friedman, Johnson, and Mitton (2003) • Propping activities during recovery may improve firm value and lead to large rebounds in the stock prices.

  15. Endogeneity issue and event study • The effect of corporate governance on firm values during the recovery period is not free from the endogeneity problem. • We consider exogenous events during the 1997-1998 period and examine the relation between the change in firm value due to such events and a set of governance variables.

  16. Further tests • Sample of seven East Asian countries during 1997 Asian currency crisis. • Sample of four Latin American countries during 2001 Argentine crisis.

  17. Conclusion • The fundamental premise of law and finance literature is the importance of investor protection in preventing the expropriation of minority investors (LLSV, 2000). • Our evidence shows that investor expropriation is indeed the main channel through which corporate governance affects firm value.

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