Corporate Governance and the Market Value of Firms

ABSTRACT. Scholarly research reveals strong correlations between the importance of corporate governance measures in determining firm value during a crisis, the relation between overall firm governance and firms' market values or performance, the changing nature of the corporation, and the difficulties associated with identifying specific channels through which the corporate governance reforms affected firm value. The paper generates insights about determinants of firm value during the period of economic crisis, the underlying value of the corporation, the potential effects of conflicts of interest between controlling and outside shareholders on firm value and profitability, and the causal effect of corporate governance provisions on firms' market value and long-term performance.JEL Classification: G34, M14, L25Keywords: corporate governance practice, firms' market value1. IntroductionThere have been few comprehensive assessments of what research has learned about the importance of the importance of corporate governance in the development of financial markets, the link between corporate governance and corporate valuation, emerging markets in the process of attempting to improve their corporate governance practices, and the notion of the corporation as a mechanism for providing commitments to others. The theory that I shall seek to elaborate here puts considerable emphasis on the influence of product market competition on the valuation effect of corporate governance, the shareholder model of the corporation, the effect of corporate governance on firm valuation and performance, and the effect of changes in the firm's internal corporate governance structure on shareholder value and managers' behavior.2. Corporate Governance and Product Market CompetitionBlack et al. employ an in-depth study of Korea to offer both OLS and instrumental variable evidence, consistent with overall governance causally predicting higher share prices, using unique features of Korea' s corporate governance rules to construct a reasonably strong instrument for KCGI (corporate governance is an important factor in explaining the market value of Korean public companies). The overall effect of corporate governance on firm value or performance is unclear. Board independence may causally predict higher prices in an emerging market. Black et al. argue that investors value the same earnings or the same current dividends more highly for better-governed firms (better-governed firms enjoy a lower cost of capital). Korean accounting requires regular updating of the value of tangible assets to current market value. Korean firms with 50% outside directors are more highly valued outside directors may play an important role in emerging markets, where other controls on insider self-dealing are weaker). l Black et al. argue that broad measures of firm-level corporate governance2 predict higher share prices in emerging markets, analyzing whether firm-level variation in overall firm-level corporate governance practices predicts firms' market values, in both cross-section and time series. Black et al. study the connection between the firm-level governance of Russian firms and their market values over 1999-2004.3Giroud and Mueller posit that firms in noncompetitive industries benefit more from good governance4 than do firms in competitive industries. Absent competitive pressure from the product market, weak governance gives rise to agency costs. Weak governance firms have lower labor productivity and higher input costs than do good governance firms (weak governance firms have lower equity returns, worse operating performance, and lower firm value in noncompetitive industries).One thing that is clear is that the positive effects of good governance on stock market performance are relatively stronger in noncompetitive industries. Giroud and Mueller maintain that the relationship between governance and stock market performance is small and insignificant in competitive industries (policy efforts to improve governance might benefit from focusing primarily on firms operating in noncompetitive industries). …