Synthesis Report

International Conference on Corporate Governance in Emerging Markets

Istanbul, Sabanci University 1 !1" #ovember $%%"

Melsa &rarat, Sti'n Claessens, an( )urcin *urtoglu

1+ )ackgroun(
The First International Conference on Corporate Governance in Emerging Markets is built on the work of an informal research network supported by the Global Corporate Governance Forum (GCGF ! The network was kicked off by the one"day workshop on the Future of #esearch on Corporate Governance in $eveloping and Emerging Markets at the %orld &ank in 'pril ())(! The network has evolved over the years with support from GCGF as it has financed the organi*ation of one global and five regional meetings!+ The network was reinvigoration in ()), with the preparations for the First International Conference! ' Call for -apers was issued with contribution from both senior scholars of the .etwork" focusing on research gaps and practitioners" focusing on priorities for practice! The conference was held in .ovember +/"+01 ()), with participation of more than +)) researchers from 2) countries! The ob3ective of the conference was to take stock of ongoing research on corporate governance in emerging markets and the e4panding research in developing countries! More than 5) academic papers were presented and discussed and 5 keynote speeches were delivered! It attracted researchers from all key emerging markets and brought them together with internationally acknowledged senior members of the network! 6ni7ue was the involvement of GCGF8s -rivate 9ector 'dvisory Group (-9'G members as reflective practitioners which facilitated a lively debate between scholars and practitioners!

$+ Conference summary
The conference addressed two sets of broad issues: the impact of corporate governance on various aspects;valuation1 performance1 access to finance1 etc;at both the country" and
+

Global in 'pril ())(< Chile in $ecember ())(< 9outh 'frica in =anuary ())2< >orea in May ())2< ?ungary in =uly ())21 India in $ecember ())21 and Turkey1 May ())5!

firm"level< and the impact and the drivers of corporate governance reforms1 what is their effects1 why do reforms (not occur@ %e first provide a short summary of the papers %e then discuss the lessons of the highlighting their contributions to what is already known! ' detailed account of each paper is provided in the individual sessions8 summaries! conference for the EMCG.!

a+ ,he impact of corporate governance

The impact of corporate governance can be measured at the country and firm level! &oth approaches were used in papers presented1 often with new data covering new countries1 and using new methodological approaches! Country-level Evidence on the Relationship between CG Quality and performance 9tarting with the country level studies1 one study found improvements in corporate governance 7uality in most countries1 with convergence in corporate governance 7uality and a positive impact of these improvements on traditional measures of real economic activity (.icola1 Aaeven and 6eda (()), ! 'nother study showed that measures of financial openness1 political risk1 local banking sector and stock market development1 and BpushB factors together with e7uity market openness e4plain almost half of the variation in the degree of segmentation of e7uity markets (&ekaert1 ?arvey1 Aundblad and 9iegel1 ())C ! This finding suggests that corporate governance reforms can help emerging markets integrate with global financial markets and thereby lowers their risk"ad3usted cost of capital! It relates to the theory paper of Davu* (()), that e4plains why the effects of investor protection on the cost of e7uity cannot be fully diversified even in integrated markets and why investor protection is different from other country"specific factors that affect the cost of e7uity! This paper not only 3ustifies many previous empirical findings but also provides a new prediction: the effect of minority investor protection on the cost of e7uity is stronger in countries with larger G$- and higher G$- growth volatility! The results of 9arkar (()), 1 however1 are somewhat at odds with this prediction! %hile he documents improvements in legal shareholder protection measures from +0,) to ())E in India1 he argues that these are not causally related to the degree of India8s financial development! Firm-level Evidence on the Relationship between CG Quality, Performance and Valuation %hile country level evidence is useful to document broad patterns1 such studies do not always identify the channels! Firm level studies can more directly find effects of corporate governance reform and enhanced corporate governance practices on valuation and operational (

performance1 sources and ease of financing1 and reduced level of e4propriation! 9uch studies have shown that the channels through which corporate governance adds value include: (i improved operating performance (productivity1 return on assets1 etc! 1 (ii lower cost of capital and higher valuations1 and (iii better access to e4ternal finance! Many such studies e4ist for developed countries1 but only recently has similar evidence been documented for emerging markets1 transition economies1 and other developing countries! 9everal of these studies were presented at the conference! For the 6kraine1 Fheka (()), constructs an overall inde4 of corporate governance and shows that it predicts firm level productivity in 6kraine! The results imply that a one"point"increase in the inde4 results in around )!5G"+!0G increase in performance< and a worst to best change predicts a 5)G increase in company8s performance! 6sing data on companies in many 'frican countries1 including Ghana1 9outh 'frica1 .igeria and >enya1 >yereboah"Coleman (()), (forthcoming shows that better governance practices are associated with higher valuations and better operating performance! &aker1 Godridge1 Gottesman and Morey (()), using a uni7ue dataset from 'lliance &ernstein1 an international asset management company1 with monthly firm"level and country"level governance ratings for (( emerging markets countries over a five year period1 report a significantly positive relation between firm"level (and country"level corporate governance ratings and market valuation1 suggesting lower cost of e7uity for better governed firms! Finally1 >owalewski1 9tetsyuk and Talavera (()), construct a Transparency and $isclosure Inde4 (T$I to measure the 7uality of the corporate governance for listed -olish firms and show that a higher T$I is associated with a higher level of dividend payouts! They also document that concentrated share ownership and deviations from the one"share"one"vote principle lead to lower dividend payout ratios! 9ince dividends affects firm value1 this evidence supports that better corporate governance practices are associated with higher valuations! 'nother related line of research studies how changes in the corporate governance framework and other reforms affect firms8 performance and valuation! Choi1 Aee and -ark (()), take advantage of a uni7ue e4periment arising from the first target announcement of the so"called >orean Corporate Governance Fund1 which has the e4plicitly stated goal of investing in companies whose stocks are undervalued due to governance problems and generating profits by actively addressing those problems! The authors find that companies whose governance structure empowers corporate insiders at the e4pense of outside shareholders e4perience a more positive stock price reaction to the Fund8s first target announcement! This provides

direct evidence that worse (better firm level governance is associated with lower (higher valuations! mportance of Easier !ccess to E"ternal Finance In addition to studies that address the first two channels (i!e!1 improved operating performance and lower cost of capital 1 some have focused on better access to finance as a third potential channel through which improved corporate governance translates into better economic performance! Hne such contributions is by Gugler and -eev (()), who analy*e the investment decisions of (E1))) firms in +E transition economies over the period +002"())2! They report that investment becomes less sensitive to the availability of internal funds over the transition years and that ownership changes induce further declines in this sensitivity! They also document hardening of the so"called soft budget constraints for state owned firms and more efficient investment by foreign companies1 a finding which highlights the differences in the identity of owner categories! The importance of e4ternal finance as a corporate governance channel is also documented for China by $u1 #ui and %ong (()), where the government"guided financial resource allocation favors large"scale state"owned enterprises (9HEs ! 9maller 9HEs and most non" state enterprises are at a disadvantage in securing e4ternal financing and thus have an incentive to ac7uire controlling stakes in listed companies1 which have more access to e4ternal financing! Consistent with this motive to seek sources of financing rather than operationally based value adding synergies1 the paper shows that the post"ac7uisition financing activities1 in general1 do not help to improve the operational performance of target companies and retard or even worsen the earnings performance! Corporate governance is also important for access to e7uity forms of finance! >im1 9ung and %ei (()), show that international investors display a strong aversion to high"ownership"control disparity firms in >orea1 highlighting a further channel through which bad governance practices hurt the availability of e4ternal finance! Evidence of E"propriation Corporate governance also matters for minority shareholders that otherwise can be e4posed to e4propriation by large shareholders! Three papers provide evidence of such e4propriation at the firm level! $eng1 Gan and ?e (()), using detailed data from ChinaIs share issue privati*ation1 report two e4propriation channels: one is through related"party transactions1 including assets sales1 transfer pricing of goods and services1 and e4tracting trade credits< the other is through dividend policies so that corporate resources are kept in the firm and under 5

their control! .ot surprisingly1 e4propriation significantly reduces firm valuation and performance! =oh and >o (()), e4amine how ownership and control structures affect share repurchases in >orea! Firms more likely adopt corporate payout programs and increase the magnitude of repurchases when insider8 ownership is high and control rights are weak1 while foreign ownership reduces the amount of share repurchases! 'dditionally1 the market responds negatively to share repurchase announcements by firms with low insider ownership and low control rights! These results suggest that incumbent insiders adopt repurchases to protect their control positions! 'nd &ae1 &aek and >ang (()), show that during the +00, >orean financial crisis1 firms with weak corporate governance e4perience a larger drop in e7uity price1 but a larger rebound during the post"crisis recovery period! Their results confirm earlier studies which suggest that controlling shareholdersI incentives to e4propriate minority shareholders go up (down during the crisis (boom period due to the fall (increase in e4pected return on investment and are consistent with the view that controlling shareholdersI e4propriation incentives create a relation between corporate governance and firm value!

b+ ,he (rivers of Corporate Governance Reforms

%hile the evidence that better corporate governance is associated with better outcomes from the perspective of countries and firms is mounting1 there is still a suspicion that this relationships is due to other factors and merely reflects that better countries and better firms have better performance and better corporate governance (practices 1 but there is no causal relationship from corporate governance to performance! 's such there is need for more evidence on how corporate governance reforms can lead to improvements in performance! 'nd1 most importantly1 as also highlighted by the practitioners at the conference1 there remain many pu**les on the lack of reforms by countries! 'nd it is also surprising that many corporations do not yet adopt better corporate governance practices! It remains hard to introduce the legal and institutional changes which would enhance good governance1 support efficient financial markets and protect minority shareholders! 'nd many corporations do not see the rewards1 in part because the domestic institutional environment and financial markets do not yet sufficiently support corporate governance! The reason that many emerging markets do not yet take steps to achieve the economic advantages should be sought in their political systems! mportance of Reforms %hile large scale reforms can be blocked in many countries by insiders (managers and owners of corporations1 a number of papers presented at the conference show that reforms E

had substantially positive effects! 'tanasov1 &lack1 Ciccotello and Gyoshev (())/ analy*es the impact of changes in &ulgarian securities law in ())( on two common forms of financial tunneling1 dilutive e7uity offerings and below"market free*e"outs! 'fter adoption of new laws in ())( restricting both forms of tunneling1 minority dilution via e7uity issuances virtually disappears1 and the mean price of free*e"outs (measured by priceJsales ratio 7uadruples! &lack and >hanna (()), analy*e IndiaIs adoption of ma3or governance reforms (Clause 50 re7uiring among other things1 audit committees1 a minimum number of independent directors1 and CEHJCFH certification of financial statements and internal controls! They document that reforms benefited more those firms that need e4ternal e7uity capital and cross"listed firms1 suggesting that local regulation can sometimes complement1 rather than substitute for firm"level governance practices! &eltratti and &ortolotti (()), document a similar positive impact from improvements in the regulatory regime in the conte4t of the .on"tradable 9hare #eform in China! Further evidence on the importance of the regulatory environment is provided by Faroo7 and 'hmed (()), in the conte4t of -akistan! #ar$et Pressures Changes are not 3ust due to (lack of reform! Much improvement in corporate governance has come about as a result of market pressures! &ut these can remain limited without some other legal or regulatory supports! 'n e4ample of such market induced changes is provided by $ewenter1 >im and Aim (()), who analy*e the outcome of regulatory competition in the conte4t of >orea8s two stock e4changes >9E and >H9$'K! They show that successive efforts to tighten the regulation of the delisting rules ended up with no clear winner! Hther e4amples of market induced changes include voluntary adoptions of higher corporate governance 7uality by &ra*ilian firms 3oining &ovespa8s .ew Market (9ilveira1 Aeal1 Carvalhal"da"9ilva and &arros (()), 1 the use of tag"along rights by &ra*ilian companies8 controlling owners to increase investor protection for non"controlling owners (&ennedsen1 .ielsen and .ielsen (()), 1 and decisions to cross"list in a better investor protection country (>e1 #ui and Du (()), ! %hile these changes added value1 they were also helped by legal and regulatory changes! More generally1 it is important to differentiate between firm"level and country"level corporate governance and to investigate whether there is substitutability or complementarity between rules and practices! Chhaochharia and Aaeven (()), find that many firms choose to adopt governance provisions beyond those adopted by all firms in the country1 and that these higher corporate governance practices are positively associated with firm valuation! These results /

indicate that the market rewards companies that are prepared to adopt governance attributes beyond those re7uired by laws and common corporate practices in the home country! 'ggarwal1 Erel1 9tul* and %illiamson (())/ also analy*e the links between country"level and firm"level governance mechanisms! They report that investment in firm"level governance is higher when a country becomes more economically and financially developed and better protects investor rights1 supporting the complementarity view! &runo and Claessens (()), 1 however1 find that for companies with poor corporate governance practices1 there is very little or no impact of better country"level investor protection and for companies with good corporate governance practices1 there is a discount from better investor protection1 as there are costs involved with (too high standards! There are other e4amples of problems and frictions in the regulatory environment! Tian and Megginson (()), focus on distortions imposed by the government in the Chinese initial public offering market ; in the form of pricing caps1 LI-H 7uotasM and lockup contracts ; lead to a severe I-H underpricing! Effectively1 their analysis suggests that the Chinese government pursues its political interests at the e4pense of its financial interests! 'nother paper (Cheung1 #au and 9touraitis (()), enterprise (9HEs shareholders! Hne common theme of the papers presented in the conference is the need for enforcement! 9ome contributions implicitly confirm the notion that under weak enforceability most of the governance mechanisms1 whether re7uired by rules of voluntary corporate governance practice1 will be ineffective! %hether this leads to the superiority of firm"level practices compared to publicly provided mechanisms depends on the degree of complementarities between these two factors! 's such enforcement can be important as a determinant of improved country" as well as firm level performance! shows that political motives are behind tunneling such as related party transactions between Chinese publicly listed firms and their state owned

-+ ,he lessons of the conference

&esides the substance lessons1 there are three lessons from the conference and the format that was followed! .etworking among academics is very valuable to e4change methodology1 data1 and research e4perience! The large number of papers with authors belonging to different institutions in different countries and the lively discussions after academic and practitioner presentations confirm the importance of networking!

-ractitioners can add value as they can introduce real life perspectives and help guide research! The open discussion forum on boards was a good e4ample of such an interaction! 'fter &ernard &lack8s academic presentation on the issue of a causal link between board structures and firm performance1 -aulina &eato gave e4amples from her professional life suggesting that the reason why most boards in emerging markets are not functioning well can be e4plained by the fact that they are not independent! This view is also supported by some of the participants of the forum1 leading to discussions that range from how econometric methods capture such effects1 to identifying the top priorities in corporate governance reform in emerging markets!

There is a large leverage of key agents and sponsors! For many young scholars from emerging markets1 the conference was a milestone in capturing the state of the art research and for 3oining the debate on corporate governance in emerging markets! The post"conference evaluations of the participants revealed that the conference was rated as Ne4cellent8 in terms of not only contributing to our understanding of CG in emerging markets1 but also in terms of encouraging collaboration between senior and 3unior researchers1 and opening new research perspectives! This was only possible thanks to the generous financial support provided by Global Corporate Governance Forum at IFC and 'sian Institute of Corporate Governance ('ICG of >orea1 as well as to the organi*ational efforts of the host< Corporate Governance Forum of Turkey (CGFT at 9abancO 6niversity!

'll in all1 we believe that these factors demonstrate how the conference has filled a gap that other academic conferences would not be able to fill both in terms of the mi4 of papers selected for presentation and the involvement of practitioners!

.ist of papers presente( at the conference/