How Corporate Governance Affects Firm Value: Evidence on Channels from Korea

How Corporate Governance Affects Firm Value: Evidence on Channels from Korea
Black, Bernard S.Kim, Woochan
Korea; corporate governance; corporate governance index; law and finance; firm valuation; emerging markets
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Series/Report no.
KDI Working Paper Series;08-19
If firm level corporate governance affects firm market value (the price of minority shares) or overall firm value, what are the channels through which it does so? Prior work in emerging markets provides evidence of an association between corporate governance and firm market value, more limited evidence of a causal relationship, but very little evidence on the channels through which governance may affect value, and whether the effect is only on share price, or on overall firm value. We first confirm the association between governance and value using panel data on Korean public companies over 1998-2004. Firms with higher scores on an overall Korean corporate governance index (KCGI) have higher Tobin's q; this result is driven by the board structure component of KCGI and, less strongly, by ownership parity and disclosure components. Shareholder rights and board procedure subindices are not significant. We then provide evidence on several possible channels. For firms with higher KCGI scores: (i) related party transactions are less adverse to firm value; (ii) firm profitability is more sensitive to shocks to industry profitability; (iii) capital expenditures are lower, but investment is more sensitive to profitability and growth opportunities; (iv) sales growth is lower; (v) profitability is more sensitive to growth opportunities; (vi) lagged board structure is associated with higher firm profitability; and (vii) dividends are higher, controlling for profits, and are more sensitive to profits. Board structure is associated with the first six channels; parity with the third, fourth, and sixth, and disclosure with the fifth. A 2SLS analysis (using 1999 legal rules which apply to large firms to instrument for board structure) offers evidence that the link between board structure and firm value, and between board structure and these channels, is likely to be causal. The first two channels are consistent with governance reducing wealth transfers to insiders; the remainder are consistent with governance affecting overall firm value.
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