Investors Value Firms that Disclose More
Firms with three key attributes---good investment opportunities, greater reliance on external financing and higher ownership concentration---have better corporate governance and disclosure practices than companies without those characteristics, report two researchers from the University of Michigan Business School. Their findings confirm that companies with higher governance and transparency ratings also invest more and are more highly valued than their counterparts.
Moreover, the researchers dispel the stereotype that all firms in weak legal regimes suffer from poor corporate governance and all firms in strong legal regimes practice uniformly high-quality corporate governance. Rather, they conclude that the relations between firm attributes, governance practices and valuations are actually stronger in countries with weak legal environments and less investor-friendly regulatory oversight.
E. Han Kim, the Fred M. Taylor Professor of Business Administration, and Art Durnev, a doctoral student in finance at the Business School, studied the corporate governance and transparency practices of 859 firms in 27 countries. In their study, “To Steal Or Not to Steal: Firm Attributes, Legal Environment and Valuation,” they examine what motivates firms to practice better corporate governance, defined as the degree to which non-controlling, outside shareholders get their fair share of return on investment.
First, the researchers say, profitable investment opportunities provide the controlling shareholder with an incentive to make sound investment decisions rather than to divert corporate resources for personal gain. “Profitable firms tend to stress financial incentives and discipline for managers, enforcement and managerial accountability, and minority shareholder protection in their governance structure,” said Kim, professor of finance and international business and director of the Mistui Life Financial Research Center.
Second, firms relying more heavily on external financing come under greater pressure to convince investors that they will be protected through good corporate governance and to dispel fears of possible malfeasance. “These firms appear to gravitate toward governance structures stressing transparency, board independence, enforcement and managerial accountability, and minority investor protection---important concerns to new investors,” Kim said.
Third, ownership concentration makes it less likely that the controlling shareholder will divert funds away from the company when he or she has the most to lose by doing so, and the cost is relatively high, the researchers say.
Surprisingly, although social awareness attracts a great deal of public attention, firms do not become more socially responsible when they become more profitable or more reliant on external financing, they add. Nor do socially responsible firms necessarily enjoy higher valuation.
Kim and Durnev find that firms in weak legal regimes often structure their own governance in order to take better advantage of profitable investment opportunities, to overcome the negative effects of poor legal protection on their ability to raise external capital and to resolve conflicts between controlling and outside shareholders. Their results imply that economic policies do affect corporate governance, particularly in developing areas and countries with weak legal systems.
“To the extent that pro-growth policies generate more profitable investment opportunities for corporations, the controlling shareholders will have greater incentives to improve governance practices,” Kim said.
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