cg1. a cross-firm analysis of the impact of cg

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Journal of Financial Economics 64 (2002) 215241

A cross-firm analysis of the impact of corporate

governance on the East Asian financial crisis$

Todd Mitton

Marriott School, Brigham Young University, Provo, UT 84602, USA

Received 12 October 2000; accepted 16 May 2001

Abstract

In a sample of 398 firms from Indonesia, Korea, Malaysia, the Philippines, and Thailand,

firm-level differences in variables related to corporate governance had a strong impact on firm

performance during the East Asian financial crisis of 19971998. Significantly better stock

price performance is associated with firms that had indicators of higher disclosure quality

(ADRs and auditors from Big Six accounting firms), with firms that had higher outsideownership concentration, and with firms that were focused rather than diversified. The results

suggest that individual firms have some power to preclude expropriation of minority

shareholders if legal protection is inadequate.r 2002 Elsevier Science B.V. All rights reserved.

JEL classification: G15; G32; G34

Keywords: Financial crises; Corporate governance; Disclosure; Ownership structure; Diversification

1. Introduction

Weak corporate governance has frequently been cited as one of the causes of the

East Asian financial crisis of 1997 to 1998.1 While weak corporate governance may

$I am grateful to Simon Johnson, Sendhil Mullainathan, David Scharfstein, and Jeremy Stein for

advice and encouragement, and to Simeon Djankov, Kristin Forbes, Ken French, Kathy Kahle, S.P.

Kothari, Grant McQueen, Andrei Shleifer, Keith Vorkink, Marc Zenner, an anonymous referee, and

seminar participants at Brigham Young University, MIT, Texas A&M University, the University of

Illinois at Urbana-Champaign, and the University of Pittsburgh for helpful comments. I thank Simeon

Djankov for making data available that is used in Panel C of Table 3. This paper is a revised version of achapter of my MIT Ph.D. thesis. All errors are mine.

E-mail address: [email protected] (T. Mitton).1Stiglitz (1998), Harvey and Roper (1999), and Greenspan (1999) provide examples of this theory.

0304-405X/02/$ - see front matter r 2002 Elsevier Science B.V. All rights reserved.

PII: S 0 3 0 4 - 4 0 5 X ( 0 2 ) 0 0 0 7 6 - 4


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not have triggered the East Asian crisis, the corporate governance practices in East

Asia could have made countries more vulnerable to a financial crisis and could have

exacerbated the crisis once it began. Recent research highlights the importance of

corporate governance in emerging markets. La Porta, Lopez-de-Silanes, Shleifer,and Vishny (LLSV) (1997, 1998, 1999b, 2000) demonstrate that, across countries,

corporate governance is an important factor in financial market development and

firm value. Regarding the East Asian crisis, Johnson, Boone, Breach, and Friedman

(JBBF) 2000a, show that country-specific measures of corporate governance perform

better than standard macroeconomic variables at explaining the extent of currency

depreciation and stock market decline of emerging markets during the crisis.

If corporate governance was a significant factor in the crisis, then corporate

governance should explain not just cross-country differences in performance during

the crisis, but also cross-firm differences in performance within countries. This paper

uses firm-level data from the five East Asian crisis economies of Indonesia, Korea,

Malaysia, the Philippines, and Thailand to study the impact of corporate governance

on firm performance during the crisis. Because the measures of legal protection

emphasized in LLSV (1997, 1998, 1999b) and JBBF (2000a) are country-specific, I

examine other aspects of corporate governance that vary at the firm level. I show

that the three aspects I examine, disclosure quality, ownership structure, and

corporate diversification, all had a significant impact on the stock price performance

of firms during the crisis. Because the crisis was, by all accounts, an unexpected

event, it presents an interesting opportunity to study the proximate effect of

corporate governance on firm performance during a period of extreme distress.Corporate governance is the means by which minority shareholders are protected

from expropriation by managers or controlling shareholders. Corporate governance

could become more critical in a financial crisis for two reasons. First, expropriation

of minority shareholders could become more severe during a crisis. JBBF (2000a)

argue that a crisis can lead to greater expropriation because managers are led to

expropriate more as the expected return on investment falls. Second, a crisis could

force investors to recognize and take account of weaknesses in corporate governance

that existed all along. Rajan and Zingales (1998) argue that investors ignored

weaknesses of East Asian firms while the region was doing well economically, but

quickly pulled out once the crisis began because they believed the region lackedadequate institutional protection for their investments. For both of these reasons,

firms with weaker corporate governance could have lost relatively more value during

the crisis.

Anecdotal evidence from the East Asian crisis suggests that expropriation of

minority shareholders was prevalent. One example occurred in November 1997 when

United Engineers Malaysia (UEM) acquired 32.6% of its financially troubled

parent, Renong. UEM minority shareholders interpreted this as a bailout of Renong

at an inflated price, and UEMs stock price fell 38% the day the transaction was

announced (Straits Times 11/19/97, p. 62). Another example comes from Korea

where minority shareholders of Samsung Electronics protested that the firm hadbeen providing debt guarantees to less-successful Samsung group companies and

that these guarantees often were not disclosed (The Economist 3/27/99, p. 68). JBBF

T. Mitton / Journal of Financial Economics 64 (2002) 215241216


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(2000a) document other instances of expropriation of minority shareholders during

the crisis, and Johnson et al. (2000b) describe different forms that expropriation can

take. This paper considers whether the presence of firm-level characteristics related

to corporate governance can help prevent such instances of expropriation and, inturn, preserve firm value during a crisis.

The first firm-level characteristic presented here, disclosure quality, is an

important element of corporate governance. LLSV (1998) argue that accounting

standards play a critical role in corporate governance by informing investors and by

making contracts more verifiable. While LLSV (1998) and JBBF (2000a) employ

country-specific measures of accounting standards, I propose two firm-specific ways

in which disclosure quality can be measured. First, a firm may have higher disclosure

quality if it has a listed American depository receipt (ADR). This higher disclosure

quality can emerge formally, through mandated disclosure requirements of the

listing exchange (for level II and III ADRs), or informally, through a larger pool of

investors spurring increased demand for disclosure and increased scrutiny of the

firms reports (see Coffee, 1999). Reese and Weisbach (2001) argue that increased

protection of minority shareholders is a primary motivation for non-U.S. firms to

cross-list in the U.S. (see also Stulz, 1999).

Second, a firm may have higher disclosure quality if its auditor is one of the Big

Six international accounting firms.2 Previous research (e.g. Reed et al., 2000; Titman

and Trueman, 1986) has associated Big Six auditors (or Big Eight auditors, for

earlier years) with higher audit quality. The Big Six firms may be more likely to

ensure transparency and eliminate mistakes in a firms financial statements becausethey have a greater reputation to uphold (Michaely and Shaw, 1995), because they

may be more independent than local firms, or because they face greater legal liability

for making errors (Dye, 1993). Additionally, even in cases in which actual disclosure

quality is not higher, Big Six auditors may offer higher perceived disclosure quality

and allay investors fears because of their prominent, recognizable names (see

Rahman, 1998).

These proxies for higher disclosure quality are associated with significantly better

stock price performance during the crisis period (July 1997 to August 1998).

Regression analysis shows that having an ADR is associated with a higher return of

10.8% over the crisis period and having a Big Six auditor is associated with anadditional higher return of 8.1% over the crisis period (after controlling for size,

leverage, country, and industry). While alternative interpretations (discussed later)

are possible, this finding is consistent with the view that higher disclosure quality

benefits minority shareholders by increasing transparency and mitigating expropria-

tion during a period of distress.

The second aspect of corporate governance studied here is ownership structure. I

first consider levels of ownership concentration. Shleifer and Vishny (1997) argue

that ownership concentration is, along with legal protection, one of two key

determinants of corporate governance. Large shareholders can benefit minority

2Six major accounting firms remained at the outset of the crisis as the Price Waterhouse/Coopers &

Lybrand merger did not occur until late 1997.

T. Mitton / Journal of Financial Economics 64 (2002) 215241 217


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shareholders because they have the power and incentive to prevent expropriation.

On the other hand, large shareholders can themselves engage in expropriation. La

Porta et al. (1999a) find high degrees of ownership concentration in firms from

countries with relatively poor shareholder protection and argue that the conflictbetween large shareholders and minority shareholders is the primary corporate

governance problem in such countries. Morck et al. (2000) and Bebchuk et al. (2000)

discuss how controlling shareholders may pursue objectives that are at odds with

those of minority shareholders.

Consistent with the view that large shareholders can prevent expropriation, higher

ownership concentration is associated with significantly better stock price

performance during the crisis. Regressions show a higher return of 2.6%, on

average, for every increase of 10% in the ownership of the largest shareholder (after

controlling for size, leverage, country, and industry). This result suggests that the

crisis amplified the pre-crisis valuation premium for emerging market firms with

large blockholders reported by Lins (2000). Still, large shareholders could be more

likely to pursue objectives that are inconsistent with those of minority shareholders if

they are involved with management of the firm or if their voting rights exceed their

cash flow rights (Claessens et al., 2000). I find that the return premium associated

with higher ownership concentration is largely attributable to large blockholders

that are not involved with management. Also, firms in which the largest

shareholders voting rights exceed their cash flow rights and firms with pyramidal

ownership structures have significantly lower returns, although the significance

disappears after controlling for other factors.The third aspect, corporate diversification, is not a corporate governance

mechanism per se, but previous research has suggested that agency problems are

different within diversified firms. The lower transparency of diversified firms in

emerging markets results in a higher level of asymmetric information that may allow

managers or controlling shareholders to more easily take advantage of minority

shareholders (see Lins and Servaes, 2000; Lins, 2000). If expropriation of minority

shareholders increases during a crisis period, then the associated loss in firm value

could be particularly pronounced for diversified firms. While diversification can also

offer the benefit of improving capital allocation (Stein, 1997), particularly in

emerging markets (Khanna and Palepu, 2000), this benefit could virtually disappearin a time of crisis as investment opportunities diminish.

Corporate diversification is associated with significantly worse stock price

performance during the crisis. Regressions show that, on average, diversified firms

had lower returns of 7.6% over the crisis period (after controlling for size, leverage,

country, and industry). This result builds on the finding of a pre-crisis diversification

discount in Asian emerging markets by Lins and Servaes (2000) and by Claessens

et al. (1999a), who also find that this discount widened during the crisis. One way in

which diversified firms could dissipate value during the crisis is by inefficiently

supporting distressed industries with resources from relatively stable industries. That

is, inefficient transfer of resources across divisions (Scharfstein and Stein, 2000;Rajan et al., 2000) could become severe if some divisions are hit harder by the crisis

and are inefficiently propped up to survive. Consistent with this possibility, the loss



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in value for diversified firms is almost entirely attributable to diversified firms that

have a high variation in investment opportunities across divisions.

Taken together, my results reinforce the claim that corporate governance had a

significant effect on firm performance during the East Asian crisis. The results areimportant because they add to our understanding of the causes of the crisis and

demonstrate a link between corporate finance and macroeconomic events. But

perhaps more importantly, the results suggest that individual firms, and not just

countries, have some control over the level of protection offered to minority

shareholders. La Porta et al. (1999a) suggest that if a countrys legal environment

fails to prevent expropriation of minority shareholders, then firms may opt into legal

regimes that are more protective of minority shareholder rights. They cite ADR

issuance as an example of this phenomenon. The results in this paper support the

viability of opting for better protection of minority shareholders. Whether through

higher disclosure quality, improved transparency, a more focused corporate

organization, or more favorable ownership structure, minority shareholders can be

offered protection beyond their legal rights. To some degree, firms are not hostages

to the legal regime of their home country.

The next section describes data and methodology. Section 3 reports the main

results. Section 4 presents the results of robustness tests while Section 5 analyzes

alternative interpretations. Section 6 reports the evidence on firm performance

following the crisis. Section 7 concludes.

2. Data and methodology

The countries studied in this paper are Indonesia, Korea, Malaysia, the

Philippines, and Thailand, which are the five countries that were most involved in

the East Asian financial crisis. Although other East Asian countries (and other

emerging markets outside of Asia) were affected by the crisis, the five considered here

suffered disproportionately in terms of stock market decline and currency

depreciation (see Table 1).

All firms from these five countries are included in the sample provided that they

meet three criteria. First, each firm must have financial data reported in theWorldscope database, which is the primary data source used in this study. Second,

the primary business segment of each firm must not be in financial services, that is,

not in standard industrial classification (SIC) 60006999. Finally, each firm must be

identified in Worldscope as being included in the International Finance Corpor-

ations (IFC) global index. Firms are included if they are added to the IFC global

index on or before the IFCs 1997 review. Although this review occurs in October

1997, a firms inclusion is based on performance during the prior year, so firms added

in 1997 met the standards for inclusion prior to the beginning of the crisis. The IFC

includes firms in the global index only if they are among the largest and most liquid

firms in a given market. This criterion reduces the sample size, but it is imposed fortwo reasons. First, the quality of data available in Worldscope is higher among the

firms followed by the IFC. For example, non-IFC firms would be three to four times



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Table 1

Summary statistics and correlation coefficients

Panel A reports summary statistics for 398 East Asian firms. Panel B reports correlation coefficients of key variables

where noted. Financial statement data comes from Worldscope and is based on the latest financial statements prior tcalculated from International Finance Corporation data. The crisis period is defined as July 1997 through August 1998

capital. ADR means that the firm had a listed American depository receipt prior to the crisis. Largest blockholder con

holdings of the largest shareholder. Summed ownership concentration is defined as the sum of ownership of all sha

company. Management blockholder means that the blockholding belongs to an officer of the firm. Firms are classified a

are attributed to one two-digit SIC code, and diversified otherwise. The number of industries is the number of two-digi

Items marked with * are based on supplemental data supplied by Simeon Djankov.

Panel A. Summary statistics

All countries Indonesia Korea Ma

Crisis statistics

Crisis-period stock return of sample firms 68.7% 73.6% 67.1% 7(Median) 79.2% 84.5% 74.2% 8

Crisis period currency depreciation 78.0% 34.5% 3

Sample inclusion

Number of firms in Worldscope 1,309 155 318

Number of firms passing IFC screen 571 63 194

Number of firms after elimination of financial firms 398 44 144

Financial statistics

Total assets ($000) 1,817,299 1,212,521 3,135,169 1,11

(Median) 688,506 668,628 1,450,087 40

Debt ratio 48.1% 46.0% 62.7% 3Book/market ratio 0.89 0.74 1.40

Return on assets 7.0% 10.1% 4.3%

Disclosure quality proxies

Percentage of firms with ADR 10.3% 6.8% 9.0%

Percentage of firms with Big Six auditor 29.6% 4.5% 0.0% 7


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Ownership structure

Largest blockholder concentration 27.0% 47.7% 15.7% 2

Summed ownership concentration 43.1% 62.5% 24.7% 4

Percentage of firms with large management blockholder 20.3% 5.4% 38.0% 1

Size of large management blockholdings 14.9% 6.9% 15.0% 1

Largest nonmanagement blockholder 25.3% 47.7% 12.0% 2Cash flow rights/voting rights of largest blockholder* 84.8% 78.1% 85.4% 8

Percentage of pyramid-structured firms* 39.2% 67.5% 39.0% 3

Diversification

Percentage of diversified firms 59.6% 45.5% 56.3% 7

Number of industries 2.29 1.82 1.99

Panel B. Correlation coefficients

ADR Big Six auditor Diversified Largest nonmgt.

blockholder

Largest mgt.

blockholder

Cas

Big Six auditor 0.003 1.000

Diversified 0.042 0.095 1.000

Largest nonmgt. blockholder 0.031 0.213 0.028 1.000

Largest mgt. blockholder 0.119 0.151 0.084 0.374 1.000

Cash flow/voting rights 0.069 0.024 0.006 0.041 0.045

Pyramid 0.099 0.133 0.032 0.033 0.069

Firm size 0.346 0.207 0.037 0.019 0.058

Debt ratio 0.018 0.305 0.029 0.343 0.161


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as likely to be excluded from my regressions because of missing data points. Second,

in some cases the corporate governance decisions considered in this paper are more

relevant for larger firms. The clearest example is that the decision of whether to issue

an ADR is not as relevant for smaller firms because the cost of doing so is oftenprohibitive (La Porta et al., 1999a).

The sample selection process is outlined in Table 1. The final sample consists of 398

firms from the five crisis countries. In general, the sample is representative of larger

firms that trade on the major stock exchange of each country. Small listed firms and

other unlisted firms, including large multinationals with no local listing (which can

make significant contributions to GDP) are not represented in the sample. Table 1

shows that Korea has the most firms in the sample, with 144, and the Philippines has

the fewest, with 29. The median size of firms, in terms of total assets, also varies, with

Korea having the largest (a median size of over $1.45 billion) and the Philippines the

smallest (a median size of over $316 million). Table 1 presents other summary statistics

of firms by country and correlation coefficients of key variables.

Fig. 1 shows the movement of composite stock indexes for all five countries from

1995 through 1999. Lines on the chart delineate the crisis period as defined in this

0

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Fig. 1. East Asian stock market indexes. The figure shows local stock market indexes for five East Asian

crisis countries from 1995 through 1999. Vertical lines delineate the crisis period as defined in the paper.

Indexes are expressed in U.S. dollars, and January 1995 is set to 100 for comparative purposes. Data come

from the International Finance Corporations global index.



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paper. The beginning of the crisis period corresponds to the devaluation of the Thai

baht on July 2, 1997, a date generally considered to be the starting point of the crisis.

The July beginning point also corresponds to the date when all five indexes began

moving downward together. As Fig. 1 shows, some of the indexes had already beentrending downward (see Section 4 where I analyze an earlier starting point). The

ending point of the crisis period, August 1998, corresponds with the date on which

the indexes began a sustained upward trend.

2.1. Variable descriptions

To measure firm performance during the crisis I use stock returns over the crisis

period, from July 1997 through August 1998. The returns are dividend inclusive and

are expressed in local currencies adjusted for local price index changes. I do notcalculate abnormal returns using historical betas because data limitations prevent

the calculation of pre-crisis betas for many firms. As an alternative, I use measures of

leverage and size, industry dummies, and country dummies in the regressions to

control for factors that could affect expected returns. Pre-crisis betas can be

calculated for about 80% of the firms if a minimal requirement of 24 monthly pre-

crisis observations is imposed. In regressions using this subsample of 80% of the

firms, beta has no significant explanatory power for returns once size, leverage, and

industry are included as control variables. Table 1 shows the average return by

country for the crisis period.

To measure disclosure quality I use two variables. The first is a dummy variablethat is set to one if the firm had an ADR listed in the U.S. at the beginning of the

crisis and zero otherwise. Firms with ADRs are identified using a comprehensive

listing of ADRs from the Bank of New York. Firms with all types of ADRs are

included.3 The second variable is a dummy variable that is set to one if the firm is

audited by one of the Big Six international accounting firms and zero otherwise. I

identify the names of auditors using data from Worldscope. Because I hypothesize

that name recognition of Big Six auditors by investors is essential, I do not include

auditors that do not carry a Big Six name, even if the local firm has an affiliation

with a Big Six firm.4

To measure ownership concentration, I use data reported by Worldscope, whichidentifies all parties that own 5% or more of each firm. This data set has limitations

in that it does not incorporate indirect shareholdings, does not indicate divergence

between cash flow rights and voting rights, and does not indicate if a listed

shareholding is jointly owned by separate parties. I alleviate these problems by

matching my data set, where possible, with data compiled by Claessens et al. (2000),

3On average, crisis-period returns are even higher for firms with level II and III ADRs, but these types

of ADRs are rare in these countries (only five in this sample).4The names of the Big Six are Arthur Andersen, Coopers & Lybrand, Deloitte & Touche, Ernst &

Young, KPMG Peat Marwick, and Price Waterhouse. None of the Korean firms in my sample have Big

Six auditors (see Table 1). Clearly the Big Six have a presence in Korea, but the major Korean accounting

firms have Korean names, even if they have some affiliation with a Big Six firm. The results for the Big Six

variable are virtually unchanged if Korea is excluded from the regressions.



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which separately indicates cash flow rights and voting rights. The ownership data I

use are pre-crisis data, which means the last reported data from each firm prior to

July 1997. Data are missing for some firms in Worldscope, in which cases I

supplement the data with information from the Asian Company Handbook (19951999) and the Corporate Handbook: KLSE Main Board(1998) where possible. Given

the data limitations, I identify ownership concentration for 301 of the 398 firms in

the sample (75.6%). I consider two measures of ownership concentration. The first is

the ownership percentage (in terms of cash flow rights) of the largest shareholder in

the firm, which I refer to as largest blockholder concentration. The second is the

total holding of all shareholders that own 5% or more of the stock, which I refer to

as summed ownership concentration.

To determine which blockholdings are held by individuals involved with

management, I compare a list of officers and directors in each firm (compiled from

Worldscope and the above-mentioned handbooks) with the list of significant owners

in each company. If the full name of an officer matches the full name of an owner,

this ownership block is classified as managerial ownership. (Thus the term

managerial here implies that an individual is involved with decision making

within the firm, and not necessarily that the individual is hired as an outside

professional.) This name matching procedure is not exhaustive, but it identifies a

subset of managerial blockholdings that are the most transparent. In some cases the

true owner of a particular block could be obscured if the owner places the block

under the name of another individual or company. I also draw on the data compiled

by Claessens et al. (2000) to evaluate the impact of voting rights of the largestshareholder as compared to cash flow rights. I match their data set with mine, and

rely on their measures of cash flow rights and voting rights as well as a dummy

variable indicating whether firms are controlled through a pyramidal ownership

structure.

To measure corporate diversification, I determine the number of industries in

which each firm operates, with industries being defined at the two-digit SIC level.

The SIC codes are reported by Worldscope, generally from pre-crisis data, but using

later data if pre-crisis data are unavailable. I use product segment data from

Worldscope and other sources to determine what percentage of each firms sales

corresponds to each two-digit SIC code. The first diversification variable is amultiple-segment indicator that is set to zero if 90% or more of a firms sales come

from one two-digit SIC, and one otherwise. The second variable is the number of

industries in which the firm operates. Worldscope reports a maximum of five

industries per firm, so this variable could be truncated for some firms.

Because many firms from these countries are affiliated with corporate groups, the

question arises as to whether firms that are reported as diversified are stand-alone

firms with multiple business segments or group-affiliated firms with consolidated

balance sheets reflecting the activities of a number of different firms. A review of the

types of firms in the sample and their accounting practices suggests three reasons

why firms that are reported as diversified should generally be interpreted as beingdiversified and not just group affiliated. First, in this sample, diversified firms are no

more likely to be affiliated with groups (as defined by Claessens et al., 2000) than are



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single-segment firms.5 Second, while most firms in the sample do report consolidated

balance sheets (at least for significant subsidiaries), the percentage of firms with

consolidated balance sheets is almost as high among single-segment firms (76%) as

among diversified firms (81%). Third, as discussed in Section 4, despite some overlapbetween diversification and group affiliation, a diversification indicator has strong

explanatory power for firm performance during the crisis, whereas a group-

affiliation indicator has very little explanatory power.

I use other variables to control for factors that could affect firm performance. The

first is firm size, measured by the logarithm of total assets. Using total assets as a

measure of firm size could be problematic if different countries in the sample have

varying standards for reporting the cost basis of investments on their balance sheet.

Each country has some firms that use strictly historical cost basis and some firms

that use some type of market revaluation. The exception is Korea, where all sample

firms use historical cost. To address this potential bias, I also use net sales as an

alternative size measure.

An additional control variable is the firms debt ratio, measured as the book

value of total debt divided by the book value of total capital. These data are reported

by Worldscope. I include dummy variables for four of the five countries included

in the regressions to control for country fixed effects. I also include dummy

variables for ten of 11 industries, where industries are defined broadly, as in

Campbell (1996).

By including leverage as a control variable, I am potentially making it more

difficult to detect the effects of weak governance. Specifically, weak corporategovernance could have been correlated with higher debt levels prior to the crisis (see

Friedman and Johnson, 2000), so poor stock price performance attributed to

leverage could also be partially caused, indirectly, by weak corporate governance.

Still, leverage is included as a control variable because higher debt naturally leads to

lower stock returns in a downturn, although Forbes (2000) does not find strong

evidence of this during the crisis.

2.2. Econometric issues

A number of econometric issues in the regression analysis need to be addressed.Multicollinearity does not appear to be a problem in the model. With all key

variables included in the model, the average variance inflation factor is 2.6 (with a

maximum of 5.8), which is not unreasonably high. I correct for heteroskedasticity

using robust standard errors.

I test for omitted variables using two versions of the Ramsey test, one using

powers of the fitted values of the dependent variable and one using powers of the

independent variables. With all key variables included in the model, I fail to reject

the null hypothesis that the model has no omitted variables at the 95% confidence

level using both tests. Nevertheless, even though formal tests detect no omitted

5Using a different sample of firms, Claessens et al. (1999b) find a significantly larger fraction of

diversified firms among group firms in two of the five countries studied here.



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variables, visual inspection of residual plots suggests some remaining evidence

of omitted variables in the model. The remaining pattern in the residuals disappears

if returns are converted to logarithmic returns. When I repeat the regressions

using logarithmic returns (results not reported), the coefficients on all keyvariables increase in magnitude and retain their significance. This robustness check

suggests that my reported results are conservative and not driven by omitted

variables.

I also consider the potential influence of errors in variables. The variables for

which measurement reliability might be a concern would be the ownership variables,

the diversification variables, and the size and leverage variables. Sensitivity tests

evaluate how low the measurement reliability of these variables could fall before the

regression results on the full model would change materially. The results are not

particularly sensitive to measurement error. Any of the variables in question can fall

to measurement reliability of 0.85 (indicating a 15% measurement noise to total

variance ratio) before the results are materially affected (and some reliabilities can

fall much lower). The results hold even if all variables in question have reliability of

0.85 simultaneously.

Another issue is potential endogeneity of the regressors in the model. If the

corporate governance variables are not exogenous, then their estimated coefficients

are not consistent and inferences about the direction of causality of the variables are

not clear. The exogeneity of ownership variables, in particular, could be in question,

as others (e.g., Demsetz and Lehn, 1985) have shown that ownership and firm value

can be jointly determined. To some extent, the exogeneity of the disclosure qualityvariables could be in question as well. I address the issue of endogeneity in three

ways. First, concerns about endogeneity should be reduced because the East Asian

crisis was an unexpected event, and (with few exceptions) I measure all variables in

the model on a pre-crisis basis. Second, for the ownership variables, I check my

results with an instrumental variables approach. This approach is discussed in

Section 4. Third, lacking a suitable instrument for the disclosure quality variables, I

examine whether firms that opted for better disclosure prior to the crisis would have

expected more stable stock prices in the future (based on past experience). On

average, firms with Big Six auditors had higher betas than non-Big Six firms in the

two years preceding the crisis (among firms for which data availability permitscalculation of beta). Firms with ADRs had lower betas, but no lower than expected

for firms of comparable size. These results are not entirely conclusive, but they

suggest that firms did not elect to have ADRs or Big Six auditors based on

expectations of having more stable stock prices.

A final econometric issue is that errors across firms may not be independent

because returns are correlated in calendar time. As a diagnostic measure to address

this issue, I run simulated regressions of the actual return data on a wide variety of

randomly generated hypothetical variables. In 10,000 repetitions, the coefficients on

the hypothetical variables are significant at the 1% level 1.1% of the time, at the 5%

level 5.3% of the time, and at the 10% level 10.3% of the time. The lack ofspuriously significant coefficients suggests that correlation of errors is not a serious

problem in the data.



13/27

3. Results

To assess the impact of corporate governance variables on firm stock price

performance during the crisis, I estimate the following model:

Crisis Period Return a b1Corporate Governance Variables b2 Size

b3Leverage b4Country Dummies

b5Industry Dummies e; 1

in which the corporate governance variables included change according to the

specification, and the other variables are as defined previously.

3.1. Disclosure quality and firm performance

Table 2 presents the results of regressions of crisis-period stock returns on

measures of disclosure quality. The first two columns include the ADR indicator

(with and without controls for size and leverage), the second two columns include the

Big Six auditor indicator, and the final two columns include both variables. All

columns include country and industry fixed effects. The final column of Table 2

shows that the coefficient on ADR is 0.108 after all controls are included. The

magnitude of the coefficient indicates that firms with ADRs had, on average, a

higher return of 10.8% over the crisis period. The coefficient on ADR is significant at

the 5% level. The coefficient on Big Six auditor is 0.081 with all controls included.The magnitude of the coefficient indicates that firms with Big Six auditors had, on

average, an additional higher return of 8.1% over the crisis period. The coefficient on

Big Six auditor is also significant at the 5% level.

The results are economically significant as well. The higher returns attributed to

firms with higher disclosure quality seem even larger in light of the fact that firm

values declined, on average, almost 70% over the crisis period. For example, if a

non-ADR firm declined 70% over the period and an ADR firm declined 59.2%

(10.8% higher), then by the end of the crisis period, these firms would be valued at

30% and 40.8% of pre-crisis values respectively. This amounts to a 36% post-crisis

premium for ADR firms relative to non-ADR firms when compared to their pre-crisis valuations. In other words, retaining an additional 10.8% of pre-crisis value

amounts to retaining 36% of post-crisis value. This measurement is important

because it reflects the valuations of investors at the bottom of the stock market

decline. At this point, investors placed a very high premium on firms that had opted

for higher disclosure quality.

The disclosure quality results should be interpreted cautiously for two reasons.

First, firms with ADRs and Big Six auditors could have unmodeled characteristics

other than higher disclosure quality that affect their returns. These potential

alternative explanations are considered in Section 5. Second, the lack of a valid

instrument for these variables could leave some question about the direction ofcausality. Nevertheless, as noted previously, the crisis was an unanticipated event,

and firms opted for ADRs and Big Six auditors before (sometimes many years



14/27

Table 2

Crisis-period stock returns and disclosure qualityThe table reports coefficients of regressions of crisis-period stock returns on disclosure quality variables for 398 East A

over the crisis period (defined as July 1997 through August 1998) in local currency terms adjusted for local price cha

assets or debt ratios are excluded from regressions that include these variables. ADR means the firm had an Ameri

at the outset of the crisis. Big Six auditor means the firms auditor is one of the Big Six accounting firms. Firm size i

ratio is total debt over total capital. Country dummies are included for four of the five countries, and industry dumm

broadly defined as in Campbell (1996). Heteroskedasticity-consistent t-statistics are given in brackets and asterisnn 5%; and nnn 1%:

(i) (ii) (iii) (iv)

Constant 0.468nnn 0.550nn 0.481nnn 0.776nnn

[5.56] [2.15] [5.29] [3.20]

ADR 0.123nn 0.114nn

[2.56] [2.27]

Big Six auditor 0.098nn 0.087nn

[2.26] [2.09]

Firm size 0.025 0.050nn

[0.96] [2.09]

Debt ratio 0.0033nnn 0.0033nnn

[6.02] [6.04]

Country dummies Included Included Included Included

Industry dummies Included Included Included Included

Number of observations 398 384 398 384

R2

0.204 0.265 0.199 0.262


15/27

before) the crisis began. And when these choices were made it doesnt appear that

firms opting for higher disclosure quality would have expected to have more stable

stock prices (based on past data).

3.2. Ownership structure and firm performance


ownership structure variables. As noted in Section 2.1, these regressions are based on

a subsample of 301 firms because of data limitations. Panel A presents the results for

levels of ownership concentration (measured as cash flow rights). The first two

columns analyze the largest blockholder concentration. With all control variables

included, the coefficient on largest blockholder concentration is 0.261. This indicates

that each increase of 10% in ownership concentration is associated with a higher

return of 2.6% during the crisis. The coefficient on largest blockholder concentration

is significant at the 1% level. The second two columns of Panel A analyze summed

ownership concentration. With all control variables included, the coefficient on

summed ownership concentration is 0.174, indicating a higher return of 1.7% for

each increase of 10% in ownership concentration. This coefficient is significant at the

5% level. These results indicate that the presence of a strong blockholder was

beneficial during the crisis, consistent with the hypothesis that a strong blockholder

has the incentive and power to prevent expropriation of minority shareholders.

In Panel B of Table 3, I differentiate between ownership blocks held by individuals

involved with management and blocks held by others. The first two columns includeblockholdings of those involved with management (with and without controls for

size and leverage), the second two columns include nonmanagement blockholdings,

and the last two columns include both types of blockholdings. The coefficient on

management blockholdings is positive when all controls are included, but it is

insignificant in all specifications. The coefficient on nonmanagement blockholdings

is slightly higher than the coefficient on general blockholdings (in Panel A) and is

significant at the 1% level. The difference in coefficients for management and

nonmanagement holdings indicates that the value of a large blockholder is greater

during a crisis when that blockholder is not involved with management. This result is

consistent with the idea that if blockholders are involved with management theycould have more opportunity or incentive for expropriation of minority share-

holders.

In Panel C of Table 3, I differentiate between cash flow rights and voting rights of

the largest shareholders. As mentioned previously, I draw on data from Claessens

et al. (2000), which is available for 311 of my sample firms. The first two columns

show the difference in coefficients when large blockholdings are measured as cash

flow rights or voting rights. The coefficient is slightly higher when measured as

voting rights, but the two coefficients are very similar in magnitude and significance.

The second two columns analyze a dummy variable that is set to one if a firm has a

divergence between the cash flow rights and voting rights of the largest owner.Consistent with the idea that cash flow/voting rights divergence increases the

incentive for expropriation, the coefficient on this variable is negative. However, it is



16/27

Table 3

Crisis-period stock returns and ownership structure

The table reports coefficients of regressions of crisis-period stock returns on ownership structure variables for 398 Eas

ownership concentration measures. Panel B differentiates between managerial and nonmanagerial ownership. Panel C

voting rights. Stock returns are measured over the crisis period (defined as July 1997 through August 1998) in local c

changes. Firms with missing data on total assets or debt ratios are excluded from regressions that include these varia

assets. The debt ratio is total debt over total capital. Country dummies are included for four of the five countries, and in

11 industries broadly defined as in Campbell (1996). Heteroskedasticity-consistent t-statistics are given in brackets an 10%; nn 5%; and nnn 1%: Variables in Panel C are based on data supplied by Simeon Djankov.

Panel A. Ownership concentration(i) (ii)

Constant 0.649nnn 1.257nnn

[8.24] [5.52] [

Largest blockholder concentration 0.327nnn 0.261nnn

[4.36] [3.42]Summed ownership concentration

Firm size 0.083nnn

[3.42] Debt ratio 0.0027nnn

[4.64] Country dummies Included Included InIndustry dummies Included Included InNumber of observations 301 294 R2 0.218 0.307


17/27

Panel B. Management and nonmanagement ownership(i) (ii) (iii) (iv)

Constant 0.534nnn 1.247nnn 0.663nnn 1.232nnn

[7.08] [5.57] [8.37] [5.44] Largest management blockholder(%) 0.146 0.012

[0.89] [0.08] Largest nonmanagement blockholder(%) 0.356nnn 0.253nnn

[4.74] [3.53]

Firm size 0.093nnn 0.080nnn

[3.85] [3.33] Debt ratio 0.0030nnn 0.0027nnn

[5.06] [4.52]

Country dummies Included Included Included Included Industry dummies Included Included Included Included Number of observations 301 294 301 294 R2 0.180 0.283 0.225 0.305

Panel C. Cash flow rights and voting rights

(i) (ii) (iii) (iv)


[5.03] [4.96] [10.70] [4.71] Largest blockholder voting rights(%) 0.277nn

[2.41]

Largest blockholder cash flow rights(%) 0.254nn

[2.32]Cash flow/voting rights divergence 0.047n 0.004

[1.66] [0.14]Pyramidal ownership structure

Firm size 0.078nnn 0.076nnn 0.080nnn

[3.20] [3.10] [3.20] Debt ratio 0.0036nnn 0.0036nnn 0.0038nnn

[6.06] [6.05] [6.29]

Country dummies Included Included No Included Industry dummies Included Included Included Included Number of observations 305 305 311 305 R2 0.258 0.257 0.090 0.243


18/27

not significant once all control variables are included. Claessens et al. (1999b) find a

significant negative effect on firm value prior to the crisis associated with cash flow/

voting rights divergence. The lack of significance of this variable in my regressions

suggests that there was no incremental loss of value during the crisis for firms withthis divergence. The difference in explanatory power attributed to this variable could

also be due to sample differences or methodological differences. Claessens et al.

(1999b) cover nine countries and do not use country fixed effects; the third column of

Panel C shows that the variable is significant in my regressions if country fixed effects

are omitted. The final two columns of Panel C analyze a dummy variable that is set

to one if the firm has a pyramidal ownership structure. Consistent with the idea that

such structures increase the likelihood of expropriation of minority shareholders, the

coefficient on this variable is negative, but it is significant only when size and leverage

controls are not included.

3.3. Corporate diversification and firm performance


diversification variables.6 The first two columns include the diversified indicator

(with and without controls for size and leverage). With all controls included,

the coefficient on diversified is 0:076; which indicates that diversified firms, on

average, had a lower return of 7.6% over the crisis period. The coefficient

on diversified is significant at the 1% level. The second two columns include

diversification measured as the number of industries per firm. The coefficient on this

alternative diversification measure is also negative and significant at the 1% level.

These results are consistent with the hypothesis that the reduced transparency of

diversified firms offers greater opportunities for expropriation of minority share-

holders. Valuations declined much less for firms that had opted for a focused

structure prior to the crisis.

In the final two columns of Table 4, I distinguish between diversified firms that

have high and low degrees of variation in investment opportunities across operating

segments. I create a measure of the diversity of investment opportunities similar to

that used in Rajan et al. (2000). I use the market-to-book ratio of each firm as a

proxy for Tobins q to indicate the level of investment opportunity. I match each

segment of each diversified firm to the industry median market-to-book ratio for

single-segment firms in each industry in each country. Industries are defined at the

two-digit SIC level, but if no single-segment firms are available for a particular two-

digit SIC in a particular country, I use broader industry classifications as defined in

Campbell (1996). If no match is available at all, I use the countrywide median

market-to-book ratio as a fill-in. To measure variation in investment opportunities I

take the standard deviation of the matched market-to-book ratios for all segments in

6 I also calculate the diversification discount for firms in the sample using methodology similar to Berger

and Ofek (1995). Consistent with my regression results and with Claessens et al. (1999a), I find that the

diversification discount widened significantly during the crisis period. However, I do not report these

results because reliable estimates of the discount require a larger number of sample firms.



19/27

Table 4

Crisis-period stock returns and diversification

The table reports coefficients of regressions of crisis-period stock returns on diversification variables for 398 East Asian

the crisis period (defined as July 1997 through August 1998) in local currency terms adjusted for local price changes. Firdebt ratios are excluded from regressions that include these variables. Diversified is a dummy variable set to zero if 90

one two-digit SIC code and one otherwise. Number of industries if the number of two-digit SIC codes in which the firm

that firm has above (below) median variation in investment opportunities across segments. Firm size is the logarithm of

over total capital. Country dummies are included for four of the five countries, and industry dummies are included for te

Campbell (1996). Heteroskedasticity-consistent t-statistics are given in brackets and asterisks denote significance level

(i) (ii) (iii) (iv)


[4.71] [2.99] [4.20] [3.10]

Diversified 0.074nn 0.076nnn

[2.53] [2.61]

Number of industries 0.031nnn 0.031nnn

[2.70] [2.70]

Diversifiednhigh variation

Diversifiednlow variation

Firm size 0.052nn 0.058nn

[2.18] [2.39]

Debt ratio 0.0034nnn 0.0034nnn

[6.27] [6.18]


Industry dummies Included Included Included Included Number of observations 398 384 398 384

R2 0.202 0.269 0.201 0.267


20/27

the firm. Diversified firms with variations above (below) the median for all diversified

firms are designated as having high (low) variation in investment opportunities. In

Table 4, I then interact this measure with the diversification indicator. The final two

columns of Table 4 show that the negative coefficient on diversified firms is muchstronger among those firms that have high variation in investment opportunities.

This result is consistent with the idea that diversified firms lose value if segments that

are relatively stable are used to inefficiently support segments that are hit particularly

hard by the crisis.

4. Robustness checks

Table 5 presents the results from additional regressions to test the robustness of

the results presented in Section 3. I present each robustness check twice (except in

Panel D), without ownership variables and with ownership variables (which reduces

the sample size). All columns include both disclosure quality variables, diversifica-

tion interacted with variation in investment opportunities, and all control variables

used previously. In Panel A, I leave all variables unchanged from the previous tables

to assess whether results presented separately in previous tables are manifestations of

the same effect. Panel A shows little collinearity among the results, as the disclosure

quality, ownership, and diversification variables change very little in magnitude and

retain their significance when included together. The one exception is the coefficient

on Big Six auditor, which, while still significant in the full sample, is not significant inthe reduced sample. Although the coefficients should be interpreted cautiously

because of the relatively small number of firms per country, I also repeat the model

on each individual country and find that the coefficient on ADR ranges from 0.495

(Philippines) to 0:235 (Indonesia; this is the only instance where a coefficient is of

the unexpected sign, Malaysia is the next lowest at 0.042), Big Six Auditor ranges

from 0.590 (Indonesia) to 0.043 (Malaysia), Diversified*High Variation ranges from

0:283 (Thailand) to 0:012 (Korea), and Largest Nonmanagement Blockholdings

ranges from 0.468 (Indonesia) to 0.204 (Korea).

In Panel B of Table 5, I change the definition of the crisis period to begin on May

1996. The motivation for this robustness check can be seen in Fig. 1, which showsthat the stock markets of Thailand and Korea were declining steadily well before

July 2, 1997, a date usually considered to be the start of the crisis. Panel B shows that

the results are robust to measuring returns over this longer period. Although the

magnitude of some coefficients declines somewhat, all key variables retain

significance. In Panel C of Table 5, I measure returns in U.S. dollars. The results

are robust to this change as well. The magnitude of the coefficients declines, but

again all key variables retain significance.

In Panel D of Table 5, I address the potential endogeneity of ownership structure

with an instrumental variables approach. To create an instrument for the percentage

holdings of the largest nonmanagement blockholder, I use 1994 data on thepercentage holdings of the largest blockholders from Worldscope. I find the holdings

of the largest blockholder for only a subset of the firms in my sample, because



21/27

Table 5

Robustness checks

The table reports coefficients of regressions of crisis-period stock returns on corporate governance variables for 398 Eas

is defined as July 1997 through August 1998 except for Panel B where it is May 1996 through August 1998. Stock return

local currency terms adjusted for local price changes, except in Panel C where returns are in U.S. dollars. In Panel D, 19

as an instrument for pre-crisis largest nonmanagement blockholder percentages. Firms with missing data on own

excluded from regressions that include these variables. ADR means the firm had an American depository receipt listthe firms auditor is one of the Big Six accounting firms. Blockholder percentages are classified according to the hold

Diversified firms are classified based on having above- or below-median variation in investment opportunities. Countr

five countries, and industries are defined as in Campbell (1996). Heteroskedasticity-consistent t-statistics are in brackenn 5%; and nnn 1%:

Panel A Panel B PAll key variables combined Earlier crisis period start Returns i

(i) (ii) (i) (ii) (i)

Constant 0.567nn 1.107nnn 0.823nnn 1.137nnn 0.674nnn

[2.25] [4.61] [3.55] [4.24] [4.28]

ADR 0.116nn

0.104nn

0.093nn

0.082n

0.075nn

[2.46] [1.99] [2.05] [1.83] [2.56] Big Six auditor 0.073n 0.045 0.051n 0.023 0.039n

[1.85] [1.55] [1.67] [0.86] [1.65] Largest mgt. blockholder(%) 0.154 0.263

[0.92] [1.22] Largest nonmgt. blockholder(%) 0.260nnn 0.261nnn

[3.49] [3.87] Diversifiedn high variation 0.082nnn 0.069nnn 0.066nnn 0.065nnn 0.048nnn

[3.21] [2.77] [2.96] [2.70] [3.02] Diversifiedn low variation 0.027 0.024 0.024 0.023 0.016

[0.80] [0.83] [0.77] [0.80] [0.77] Firm size 0.026 0.061nn 0.017 0.040 0.01

[0.98] [2.31] [0.67] [1.38] [0.69] Debt ratio 0.0031nnn 0.0024nnn 0.0027nnn 0.0022nnn 0.0019nnn

[5.67] [4.14] [5.27] [3.51] [6.03] Country dummies Included Included Included Included Included Industry dummies Included Included Included Included Included Number of observations 384 294 384 294 384 R2 0.286 0.337 0.227 0.254 0.279


22/27

Worldscope coverage was not as extensive in 1994. Ownership percentages from

1994 are highly correlated with pre-crisis percentages. This approach assumes that

past values of the explanatory variables are uncorrelated with the error term in the

crisis-period regressions. Other examples of this approach include Schmukler andVesperoni (2000) and Lins (2000). Panel D shows that the results from the

instrumental variables regression are similar to the results from the ordinary least

squares regressions. The coefficient on largest nonmanagement blockholder

increases to 0.341, and is significant at the 5% level.

In other tests not reported, the results are robust to using alternative measures of

firm size, including the square and cube of total assets and the log values of those

measures. The results are also robust to measuring size as net sales, the square and

cube of net sales, and the log values of those measures. Similarly, the results are

robust to measuring the debt ratio as total debt over total sales and including a

market-to-sales ratio as an explanatory variable, although in this specification the

coefficient on Big Six decreases significantly in the reduced sample (with ownership

variables) and increases significantly in the full sample. In an analysis of outliers, the

results are robust to truncating the data at the first and 99th percentiles of the return,

size, leverage, and ownership variables. In a test of the robustness of the diversified

variable, the magnitude and significance of the coefficient on diversified remain the

same if I also include a dummy variable indicating group affiliation. This suggests

that the diversification of operating segments drives the results on diversified firms,

not their affiliation with corporate groups.

5. Alternative interpretations

One alternative interpretation of the results is that disclosure quality, ownership

structure, and diversification are proxies for other characteristics that affect firm

returns. Firm size, leverage, and industry are three possibilities that have been

controlled for in the regressions, but other possibilities remain. One firm

characteristic that my variables could potentially be proxies for is the degree to

which firms conduct business internationally. Firms with a higher proportion of sales

to foreign countries would be insulated from the crisis to the extent that sales are tocountries that did not experience relative currency depreciation. To test this

possibility I use a variable constructed as the percentage of a firms foreign

sales divided by total sales. I am able to test this variable only on a subset of firms,

because Worldscope reports this information for only 230 of the firms in my sample.

In regressions using this subsample (not reported), the percentage of foreign sales

has no explanatory power for returns during the crisis, whether the variable is used

alone or with control variables. The lack of significance of this variable indicates

that firms with a high percentage of international business are not driving the

results.

In addition, disclosure quality, ownership structure, and diversification could becorrelated with other variables that have been shown to be correlated with firm

returns. One possibility is a firms book-to-market ratio (Fama and French, 1992).



23/27

This variable is available for about 95% of the firms in my sample. The book-to-

market ratio is insignificant in all regressions, and is not reported. As discussed

previously, a firms beta also has no explanatory power for returns in the subset of

firms for which a pre-crisis beta can be calculated (once firm size, leverage, andindustry are included as control variables).

Another alternative interpretation of the results is that disclosure quality,

ownership structure, and diversification always affect stock returns in these

countries, and that their significance is not specific to the crisis period. If the

importance of these variables during the crisis is due to an increased risk (or

awareness) of expropriation of minority shareholders, then the variables should not

have as great an impact in pre-crisis periods. To address this issue, I repeat the

regressions of corporate governance variables on returns for two pre-crisis years. (I

do not look at earlier periods because limitations on Worldscopes historical data

begin to greatly reduce the available sample of firms prior to 1995.) Panel A of

Table 6 shows the results of regressions of returns from the pre-crisis period of July

1995June 1996. Panel B shows the results for the pre-crisis period of July 1996June

1997. The number of observations declines in each earlier year due to data

limitations. Very few strong patterns are evident in the coefficients in Panels A and

B. In some cases the sign of the coefficients is opposite of the sign during the crisis

period, but in other cases the sign is the same. None of the corporate governance

variables in the pre-crisis regressions is significant at standard levels. The results in

Panels A and B suggest that the impact of these variables during the crisis was not

the continuation of effects that existed prior to the crisis. Nor does the performanceof these variables during the crisis appear to be a reversal of abnormal returns prior

to the crisis.

A final important alternative interpretation to consider is that firms with ADRs

(or perhaps, those with Big Six auditors) perform better during the crisis because

these firms have better access to capital. Lins et al. (2000) argue that access to

external capital markets is an important benefit for non-U.S. firms listing their stock

in the U.S. One indicator of whether firms with ADRs benefited from better access to

capital is to look at how investment levels changed for firms during the crisis. As

would be expected, investment levels fell for most firms during the crisis. Between the

last pre-crisis year (fiscal year-ends before July 1997) and the mid-crisis year (fiscalyear-ends between July 1997 and June 1998) the median drop in capital expenditures

for all firms in the sample is 39.3%. The declines for firms with ADRs and without

ADRs were fairly similar. The median decline in capital expenditures for firms with

ADRs was 36.1%, and the median decline for firms without ADRs was 39.5%. The

difference is even smaller between Big Six and non-Big Six firms. The decline in

capital expenditures divided by sales was 18.0% for firms with ADRs and 20.0% for

firms without ADRs. The median decline for Big Six firms was greater than for non-

Big Six firms. The relatively small differences in investment declines between these

groups (none of which are statistically significant) suggest that differences in access

to capital were not a large factor in performance differences during the crisis.Nevertheless, greater access to capital is one alternative interpretation of the

disclosure quality results that cannot entirely be ruled out.



24/27

Table 6

Stock returns before and after the crisis period

The table reports coefficients of regressions of stock returns over the periods indicated on corporate governance var

Stock returns are measured in local currency terms adjusted for local price changes. Firms with missing data on ow

excluded from regressions that include these variables. ADR means the firm had an American depository receipt list

the firms auditor is one of the Big Six accounting firms. Blockholder percentages are classified according to the hold

Diversified firms are classified based on having above- or below-median variation in investment opportunities. Countrfive countries, and industries are defined as in Campbell (1996). Heteroskedasticity-consistent t-statistics are in bracknn 5%; and nnn 1%:

Panel A. Pre-Crisis 1 Panel B. Pre-Crisis 2

July 1995 to June 1996 July 1996 to June 1997

(i) (ii) (i) (ii)

Constant 1.883nnn 2.466nnn 0.077 0.073

[3.11] [3.16] [0.13] [0.10]

ADR 0.001 0.060 0.008 0.039

[0.01] [0.64] [0.11] [0.45]

Big Six auditor 0.094 0.113 0.022 0.066[0.96] [0.90] [0.39] [0.98]

Largest management blockholder(%) 0.195 0.113

[0.44] [0.25]

Largest nonmanagement blockholder(%) 0.192 0.161

[0.68] [0.73]

Diversificationn high variation 0.107 0.092 0.054 0.048

[1.44] [1.17] [0.98] [0.76]

Diversificationn low variation 0.040 0.018 0.040 0.019

[0.50] [0.24] [0.89] [0.41]

Firm size 0.218nnn 0.250nnn 0.025 0.007

[3.16] [3.05] [0.36] [0.09]

Debt ratio 0.001 0.001 0.000 0.001

[0.65] [0.36] [0.06] [0.74]


Industry dummies Included Included Included Included

Number of observations 328 273 356 289

R2 0.261 0.293 0.213 0.186


25/27

6. Firm performance following the crisis

Panels A and B of Table 6 show that variables related to corporate governance had

little explanatory power for firm returns prior to the crisis period. In Panel C of Table6, I examine whether the importance of corporate governance variables that is revealed

during the crisis period continues after the crisis. The dependent variable in Panel C is

firm stock returns during the post-crisis year of September 1998 through August 1999.

Panel C shows that the coefficients on the disclosure quality and diversification

variables have opposite signs as in the crisis-period regressions, although only the

coefficient on ADR is significant. The coefficients on the ownership variables have the

same sign as in the crisis-period regressions and are also not significant.

Although the variables do not have the same explanatory power following the

crisis, the reversal of sign of some coefficients is informative. Specifically, if firms

with relatively weak governance rebound following the crisis, then the hypothesis of

JBBF (2000a) that a crisis leads to increased expropriation seems to be supported.

That is, if improving investment opportunities following the crisis lead to a reduction

in expropriation, then we would expect firms with relatively weak governance to at

least partially reverse their poor crisis-period performance. On the other hand, if

firms with relatively weak governance performed poorly during the crisis because the

crisis exposed and made investors account for their weaknesses (as in Rajan and

Zingales, 1998), then we would not necessarily expect a reversal of poor crisis-period

performance. The information learned by investors would continue to be reflected in

valuations after the crisis. The mixed results on whether firms with relatively weakgovernance rebound after the crisis suggests that the hypotheses of JBBF (2000a)

and Rajan and Zingales (1998) could both have been at work during the crisis.

The actions of firms and institutions following the crisis have demonstrated at

least a recognition of the role of weak governance in the crisis and of the need to

change governance practices. For example, in Thailand, exchange-listed firms were

ordered to appoint audit subcommittees on their boards and to align disclosure

practices with international standards. In Korea, the government asked chaebols to

eliminate excessive diversification and concentrate on core businesses. In Indonesia,

rules were changed to encourage exchange-listed firms to offer new equity to new

outside shareholders (Asian Development Bank, 2000). Whether countrywidemandates will result in effective change at the firm level remains to be seen, but

investors have also taken steps to encourage improvements in governance. For

example, following the crisis the California Public Employees Retirement System

drew up a set of global governance principles and has since tried to ensure that the

billions of dollars it has committed to Asia are not invested in companies that lack

good governance practices (Brancato, 1999).

7. Conclusion

Legal protection of minority shareholders is clearly a key element of corporategovernance. But legal reforms come about slowly, and some countries may never

have strong and well-enforced minority shareholder rights. Are firms in such



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countries destined to remain vulnerable to devaluation and distress during a financial

crisis? To some extent yes, perhaps, but this paper suggests that at least some power

for improving minority shareholder protection lies at the firm level. Companies that

offered higher disclosure quality, greater transparency, a more favorable ownershipstructure, and a more focused organization appear to have provided greater

protection to their minority shareholders during the East Asian financial crisis.

Stronger corporate governance was especially important when it should have been

importantduring an unexpected period of extreme economic distress when the risk

of expropriation of minority shareholders was high.

The East Asian financial crisis was a devastating event that adversely affected

millions of people. For that reason alone, the crisis warrants the special attention it

has received from researchers. The findings of this paper contribute to our

understanding of the crisis and support the often-stated policy recommendation that

countries should build a strong institutional foundation before opening to foreign

capital flows. Whether the effects of corporate governance demonstrated in this

paper apply to other situations is an open question. Further research could

determine if firms that opt for stronger corporate governance experience benefits

during other crisis periods, or during stable periods on issues in which the

importance of legal protection of minority shareholders has been demonstrated.

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