Corporate Governance, and the Returns on Investment Klaus Gugler, - - PowerPoint PPT Presentation

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CBR Summit: Innovation and Governance 29-30 March 2006

Corporate Governance, and the Returns on Investment Klaus Gugler, Dennis C. Mueller and

• B. Burcin Yurtoglu

University of Vienna, Department of Economics BWZ, Bruennerstr. 72, A-1210, Vienna

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CBR Summit: Innovation and Governance 29-30 March 2006

Considerable interest recently in differences in corporate governance systems. Ten years ago -- German and Japanese systems were thought to be better. Today, many think US & UK (Anglo-Saxon systems better.

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CBR Summit: Innovation and Governance 29-30 March 2006

Focal point of literature has been on the extent to which corporate governance institutions align the interests of managers and shareholders. Weak corporate governance systems allow managers to pursue their own goals. Much of the literature has emphasized the importance of growth or empire building as a managerial goal.

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CBR Summit: Innovation and Governance 29-30 March 2006

In our empirical work we measure a firm’s average return on investment (r ) as a ratio to its cost of capital (i ) a ratio that we define as qm, qm = r / i . Since the average return on capital should be greater or equal to the marginal return on capital, we predict for a firm, which maximizes shareholder wealth, qm ≥ 1 .

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CBR Summit: Innovation and Governance 29-30 March 2006

Main Hypotheses (1) Legal Institutions and Returns on Investment A strong corporate governance system aligns managerial and shareholder interests. Managerial and shareholder interests are more likely to be aligned in countries in which it is easy for shareholders to monitor managers, and initiate proxy fights or hostile takeovers.

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CBR Summit: Innovation and Governance 29-30 March 2006

(2) Legal Institutions, Ownership Structures and Returns on Investment We define five ownership categories:

• Family-controlled
• Firm-controlled,
• Finance-controlled
• State-controlled
• Dispersed ownership

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Legal Origin

10.90 0.77 African Countries 4.30 0.64 Transition Countries 29.23 0.59 French Origin 35.51 0.74 German Origin 13.67 0.78 Scandinavian Origin 111.34 1.02 English Origin t-value Legal System

n = 112, 590, Adj.R2 = 0.25

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country

0.21 0.04 0.01 0.00 0.02 0.00 0.27 0.20 (qm≠1) 63 1.10 Ireland 246 0.80 India 127 0.78 Hong Kong 1331 0.85 Great Britain 42 0.58 Cayman Islands 1478 1.16 Canada 215 0.91 Bermuda 346 0.94 Australia Firms Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country 8591 0.00 1.05 USA 243 0.00 0.64 Thailand 118 0.72 1.07 South Africa 208 0.75 0.97 Singapore 46 0.00 0.40 Pakistan 66 0.05 0.86 New Zealand 381 0.00 0.86 Malaysia 56 0.18 1.27 Israel Firms (qm≠1) Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country Scandinavian Origin

156 0.00 0.65 Sweden 103 0.63 1.04 Norway 79 0.69 0.96 Finland 101 0.00 0.65 Denmark Firms (qm≠1) Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country German Origin

126 0.01 1.26 Taiwan 160 0.00 0.64 Switzerland 82 0.00 0.70 South Korea 2219 0.00 0.86 Japan 425 0.00 0.57 Germany 82 0.02 0.71 Austria Firms (qm≠1) Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country French Origin

495 0.00 0.57 France 49 0.00 0.54 Greece 15 0.00 0.43 Columbia 73 0.29 1.24 Chile 133 0.00 0.25 Brazil 79 0.00 0.51 Belgium 24 0.16 0.78 Argentina Firms (qm≠1) Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country

4 0.23 1.25 Panama 19 0.17 1.19

• Netherl. Antil.

174 0.00 0.69 Netherlands 81 0.00 0.50 Mexico 12 0.52 0.70 Luxembourg 150 0.00 0.64 Italy 132 0.06 0.84 Indonesia Firms (qm≠1) Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Estimated qms by Country

70 0.00 0.45 China 10 0.04 0.58 Venezuela 29 0.00 0.52 Turkey 117 0.00 0.54 Spain 49 0.00 0.46 Portugal 83 0.98 1.00 Philippines 20 0.00 0.11 Peru Firms (qm≠1) Country

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CBR Summit: Innovation and Governance 29-30 March 2006

Scandinavian Origin 0.796 ≈ 0.743 1.014 ≈ 1.045 State 1.145 > 0.683 1.001 ≈ 1.050 Dispersed 0.718 ≈ 0.761 1.058 ≈ 1.041 Non-Financial 0.561 ≈ 0.812 1.002 < 1.061 Financial 0.773 ≈ 0.739 1.082 > 1.019 Family English Origin

• B. The Effects of Ownership Structures

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CBR Summit: Innovation and Governance 29-30 March 2006

0.374 < 0.634 1.358 > 0.601 0.626 ≈ 0.628 0.561 ≈ 0.640 0.599 ≈ 0.636 European-German Origin 1.322 ≈ 0.880 State 0.829 ≈ 0.906 Dispersed 0.896 ≈ 0.863 Non-Financial 0.869 ≈ 0.882 Financial 0.987 ≈ 0.872 Family Asian-German Origin

• B. The Effects of Ownership Structures

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CBR Summit: Innovation and Governance 29-30 March 2006

0.952 > 0.588 0.543 ≈ 0.605 0.565 ≈ 0.644 0.692 > 0.579 0.569 ≈ 0.605 French Origin State Dispersed Non-Financial Financial Family

• B. The Effects of Ownership Structures

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CBR Summit: Innovation and Governance 29-30 March 2006

2,683 10,684 0.00 32.84 0.77 Developing 0.23 16,327 101,875 0.00 114.84 0.97 Developed 5,457 30,096 0.00 47.51 0.68 Civil Law 0.23 13,553 82,463 0.03 111.32 1.02 English Origin R2 Firms Obs. (qmI 1) t-value qmI Category

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CBR Summit: Innovation and Governance 29-30 March 2006

The Impact of Strong Accounting Standards

• All developed English-origin countries have strong

accounting standards.

• In 28/30 comparisons the coefficient for a strong-accounting-

system country is larger than the corresponding coefficient for a weak-system country, 13 of the 28 differences are significant (5 percent level, one-tailed test). Only the coefficient on cash flow for all developed countries with strong accounting standards is significantly lower than the corresponding coefficient for a weak-system countries.

• There is also some indication that the improvement in investment

performance that strong accounting standards cause comes in part at the cost of debt holders.

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CBR Summit: Innovation and Governance 29-30 March 2006

The Impact of Strong Contract Enforcement

• No developed, English-origin country has weak contract
• enforcement. No developing, civil-law country has strong

contract enforcement.

• For 21 of the possible 24 comparisons of coefficients on

cash flow and new equity, the coefficient is higher where contract enforcement is strong, 13 of these 21 differences are significant.

• There is no evidence suggesting that the improved returns
• n investments financed out of cash flows and new equity

issues come at the expense of debt holders.