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Do Investors Really Value Corporate Governance?

Evidence from the Hong Kong Market

Prof. Stephen Y. L. CheungCity University of Hong Kong

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1. Background

• Corporate governance (CG) reform in Asian market

• Various efforts from both regional (PECC, 2001) and international (OECD, 2004)

• In Hong Kong (Code of Best Practice, 1999, Hong Kong Code on Corporate Governance, 2004)

• Family-controlled firms and Anglo-Saxon legal system in Hong Kong market

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2. Research Question

• Do CG practices pay in Hong Kong market?

• What are the determining factors for good CG practices in Hong Kong?

• CG performance of China-related companies listed in Hong Kong

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3. Literature

• Testing results of whether CG leads to better performance are mixed (e.g. Weiss and Nikitin, (1998), Klein (1998))

• Limited studies on the association between overall corporate governance practice and firm value (e.g. Gillan et al.(2003))

• Board responsibilities and composition are the focus of CG studies (e.g. Fama and Jensen(1983), Black et al.(2003))

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4.1 Methodologies - Data• 168 largest companies are covered• Constituent stocks of four main indices in HK

market– Hang Seng Index (HSI)– Hang Seng Hong Kong Composite Index (HSHKCI)– Hang Seng China-Affiliated Corporations Index

(HSCCI), Red-chip– Hang Seng China Enterprises Index (HSCEI), H-

share

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4.1 Methodologies – Data (Cont’)

• H-share: incorporated in Mainland China• Red-chip: incorporated in Hong Kong but

controlled by organizations in Mainland China

• Based on publicly available information (e.g. annual reports, AGM minutes, articles of association), 2002.

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4.2 Methodologies – Survey Design

• Based on Revised OECD Principles (OECD, 2004) and Code of Best Practices (HKEx, 1999)

• Including five categories and 86 criteria • Overall CG index ranges from 0~100• Transparency index and non-transparency

index are constructed

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Scorecard Followed The Five OECD Corporate Governance Principles

OECD principleNumber of questions & sub-questions

A. Rights of shareholders

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B. Equitable treatment of shareholders

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C. Role of stakeholders

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D. Disclosure and transparency

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E. Board responsibilities

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Total 86

• OECD is internationally recognized

• HKEx guidelines comprehensively covered

• 168 public companies surveyed

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4.2 Methodologies – Survey Design (cont’)

• Companies were ranked as good, fair and poor for each criterion

• Each company was rated by two different members

• The overall results were cross-checked by academics

• Avoids selection bias• Measure the CG Index quantitatively, give credit to

the “amount” of information for each of the criteria under study

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5.1 Results – Descriptive Statistics

• CG overall Index ranges from 32.86 to 76.34, average is 48.33.

• Perform well in Section B and D, poor in Section A relatively

• Highest scores for HSI stocks, lowest for H-share stocks

• Finance and utilities sectors are on the top, property sector is on the bottom

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Corporate Governance Performance by Categories

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30

40

50

60

70

80

90

100

110

Scor

es

A42.96

B82.78

C69.54

D74.88

E60.7

Range

Mean

Weak

Strong

A: Rights of Shareholders B: Equitable Treatment of Shareholders C: Role of Stakeholders in Corporate GovernanceD: Disclosure and TransparencyE: Board Responsibilities

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Corporate Governance Performance by Indices

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35

40

45

50

55

60

65

70

75

80

Scor

es

AllHSI

HSHKCI HSCCI

HSCEI

Range

Mean

Weak

Strong

• HSI (Hang Seng Index ) • HSHKCI (Hang Seng Hong Kong Composite Index ) • HSCCI (Hang Seng China-Affiliated Corporations Index )• HSCEI (Hang Seng China Enterprises Index )

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Corporate Governance Performance by Industries

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35

40

45

50

55

60

65

70

75

80

Scor

es

Range

Mean

IndustrialAll Properties Finance Utilities ConsolidatedEnterprises

Hotel &Misc

Weak

Strong

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5.2 Correlation Matrix of All Variables

This table provides correlation coefficients between dependent variables, independent variables and control variablesStatistically significant correlations (at 5% level or better) are shown in bold.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 151 Total CGI 1.0002 mtbv 0.131 1.0003 ln(TA) 0.196 -0.282 1.0004 roa 0.084 0.305 -0.056 1.0005 current -0.062 0.131 -0.386 0.139 1.0006 bexc -0.151 -0.248 0.258 0.020 -0.180 1.0007 bout 0.355 0.043 0.460 0.027 -0.067 -0.190 1.0008 top_5 -0.116 -0.093 0.097 0.005 -0.154 0.067 -0.190 1.0009 dummya 0.370 0.040 0.025 -0.056 0.082 -0.004 0.147 -0.118 1.000

10 dummyc 0.556 0.135 0.203 0.138 -0.091 -0.203 0.186 -0.096 0.272 1.00011 dummycc -0.037 0.079 -0.048 0.016 -0.025 -0.130 -0.102 -0.016 -0.052 0.040 1.00012 dummymsc 0.227 0.169 0.392 0.088 -0.088 -0.072 0.402 -0.321 0.010 0.134 0.062 1.00013 dummyADR 0.107 -0.096 0.436 0.045 -0.130 0.025 0.314 0.002 -0.017 0.126 0.068 0.247 1.00014 dummyhr -0.179 -0.127 0.078 0.073 -0.043 0.255 -0.205 0.291 -0.164 -0.033 -0.089 -0.379 0.040 1.00015 D/E 0.085 0.302 0.245 -0.037 -0.025 -0.030 0.212 0.078 0.014 0.142 -0.150 0.066 -0.026 -0.049 1.000

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5.3 Results – Regression Results(1)

• Market-to-book ratio (MTBV) was used as proxy for company’s market value

• Positive and significant relationship between MTBV and CG Index was found

• Number of executive directors has negative impact

• The top 5 shareholders’ holding has negative impact

• The inclusion in the MSCI has positive impact

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Positive Correlation between Good Corporate Governance and

Company Valuation

30 35 40 45 50 55 60 65 70 75 800

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Scores

Tobi

n's

QM

TBV

OLS Results for CGI with Control Variables

    MTBV    

  (1) (2) (3) (4) (5)

CGI 0.0330** 0.0428** 0.0475*** 0.0356** 0.0337**

ROA 2.5282** 3.0430*** 3.0431*** 2.2866**

Ln(TA) -0.3081*** -0.2043** -0.2209** -0.3583***

Current -0.042 -0.0317 -0.0209 0.0098

D/E -0.0441 -0.0190 0.0347 0.1423

BOUT -0.0249 -0.0070 -0.0193

BEXC -0.1089*** -0.0941** -0.0622

Top5 -0.0128*** -0.0126*** -0.0011

Dummy CEO & Chairman 0.1837 0.1738

Dummy Audit committee 0.1353 0.2321

Dummy Compensation 0.2794 0.3000

Dummy ADR -0.1421

Dummy MSCI 1.4939***

Dummy H Share & Red Chips 0.3374

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5.3 Results – Regression Results(2)

• Transparency index does matter• Non-transparency index become insigni

ficant when the number of executive director and top 5 shareholder’s share holding add into the model

• ROA has positive effect on MTBV

OLS Results for Transparency Index with Control Variables

  MTBV    

  (1) (2) (3) (4)

TINDEX 0.0371** 0.0414** 0.0373** 0.0388***

NONTINDEX 0.0179* 0.0202** 0.0136 0.0108

ROA 2.3482** 2.8850*** 2.8973*** 2.1137**

Ln(TA) -0.3414*** -0.2419*** -0.2540** -0.3850***

Current -0.0575 -0.0496 -0.0416 -0.0108

D/E -0.0589 -0.0319 0.0164 0.1205

BOUT -0.0277 -0.0106 -0.0267

BEXC -0.1046*** -0.0902** -0.0558

Top5 -0.0140*** -0.0138*** -0.0017

Dummy CEO & Chairman 0.2084 0.1935

Dummy Audit committee 0.1642 0.2637

Dummy Compensation 0.1997 0.2254

Dummy ADR -0.1382

Dummy MSCI 1.4847***

Dummy H Share & Red Chips 0.2346

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5.3 Results – Regression Results(3)

• For China-related firms, MTBV is positively related to CG Index

• For local firms, the relationship is not significant

• Investors have different criteria to value China-related firms and local firms

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Comparison of OLS Results between Mainland-related Firms and Local Firms

MTBV 

  China-related Firms Local Firms

CGI 0.0572** 0.0273

ROA 1.1930 4.5531***

Ln(TA) -0.0318 0.0662

Current 0.0704 0.1208

D/E 0.1192 0.1882***

BOUT -0.0309 -0.0601

BEXC -0.1327** -0.1401

Top5 -0.0051 -0.0111

Dummy CEO & Chairman 0.1984 0.1391

Dummy Audit committee -0.0322 0.5584*

Dummy Compensation 0.0791 0.3003

Dummy ADR -0.1142 -0.5526

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5.4 Results – Robustness Test

• Why we use 86 questions?

• Endogeneity

• Performance measurement (ROE)

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Spearman Ranking Correlation Test

• Spearman correlation coefficients between new and original rankings.

• All of the correlation coefficients below are significant at 1% level (P-value <0.0001)

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Endogeneity

• Use H-shares dummy as instrumental variable

• Durbin-Wu-Hausman Test (Two-stage-least- squares) for endogeneity

• No existence of endogeneity was found

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Performance Measurement

• Use Return on Equity (ROE) to measure operating performance

• Replace MTBV by ROE in OLS regressions

• Similar results were found • Confirm the robustness of the OLS results

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6. Conclusion (1)

• Construct a CG measure for HK listed firms• 10 points increase in CG Index implies a 33.7%

increase in MTBV. Worst-to-best change in CG Index implies 147% increase in MTBV

• Investors care more about CG performance of China-related firms

• Similar results were found in Thailand market (McKinsey & Company, Thailand IOD, 2002)

• Comparison among different markets • Policy Implication - encourage adoption of best practi

ce of corporate governance in Hong Kong

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7. Future Research

• Regional Comparison (Macro)– Regulatory framework– Market perception

• Regional Template (supported by the World Bank)

• Individual economies (Micro)– Thailand (3 times), China, the Philippines,

Indonesia (in progress)

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