Do Investors Really Value Corporate Governance Evidence from

Do Investors Really Value Corporate Governance? Evidence from the Hong Kong Market Prof. Stephen Y. L. Cheung City University of Hong Kong 1

1. Background • Corporate governance (CG) reform in Asian market • Various efforts from both regional (PECC, 2001) and international (OECD, 2004) • In Hong Kong (Code of Best Practice, 1999, Hong Kong Code on Corporate Governance, 2004) • Family-controlled firms and Anglo-Saxon legal system in Hong Kong market 2

2. Research Question • Do CG practices pay in Hong Kong market? • What are the determining factors for good CG practices in Hong Kong? • Do investors reward improving corporate governance practices or penalize firms with deteriorating corporate governance practices in the same manner? 3

3. Literature • Testing results of whether CG leads to better performance are mixed (e. g. Weiss and Nikitin, (1998), Klein (1998)) • Limited studies on the association between overall corporate governance practice and firm value (e. g. Gillan et al. (2003)) • Board responsibilities and composition are the focus of CG studies (e. g. Fama and Jensen(1983), Black et al. (2003)) 4

4. 1 Methodologies - Data • More than 160 largest companies are covered in each sample year • Constituent stocks of four main indices in HK market – Hang Seng Index (HSI) – Hang Seng Hong Kong Composite Index (HSHKCI) – Hang Seng China-Affiliated Corporations Index (HSCCI), Red-chip – Hang Seng China Enterprises Index (HSCEI), Hshare 5

4. 1 Methodologies – Data (Cont’) • H-share: incorporated in Mainland China • Red-chip: incorporated in Hong Kong but controlled by organizations in Mainland China • Based on publicly available information (e. g. annual reports, AGM minutes, articles of association), year 2002, 2004, and 2005. 6

4. 2 Methodologies – Survey Design • Based on Revised OECD Principles (OECD, 2004) and Code of Best Practices (HKEx, 1999) • Including five categories and 86 criteria • Overall CG index ranges from 0~100 • Transparency index and non-transparency index are constructed 7

Scorecard Followed The Five OECD Corporate Governance Principles OECD principle Number of questions & sub-questions A. Rights of shareholders 16 B. Equitable treatment of shareholders 10 C. Role of stakeholders 4 D. Disclosure and transparency 30 E. Board responsibilities 26 Total 86 • OECD is internationally recognized • HKEx guidelines comprehensively covered • 168 public companies surveyed 8

4. 2 Methodologies – Survey Design (cont’) • Companies were ranked as good, fair and poor for each criterion • Each company was rated by two different members • The overall results were cross-checked by academics • Avoids selection bias • Measure the CG Index quantitatively, give credit to the “amount” of information for each of the criteria under study 9

5. 1 Results – Descriptive Statistics • The average of CG overall Index is 61. 702. • Perform well in Section B and D, poor in Section E and C relatively • Highest scores for HSI stocks, lowest for H -share stocks • Finance and utilities sectors are on the top, property sector is on the bottom 10

Corporate Governance Performance by Indices in year 2002 Strong Weak • • HSI (Hang Seng Index ) HSHKCI (Hang Seng Hong Kong Composite Index ) HSCCI (Hang Seng China-Affiliated Corporations Index ) HSCEI (Hang Seng China Enterprises Index ) 11

Corporate Governance Performance by Industries in year 2002 Strong Weak 12

Positive Correlation between Good Corporate Governance and One-year Buy and Hold Return 13

5. 3 Results – Regression Results in year 2002 • Market-to-book ratio (MTBV) was used as proxy for company’s market value • Positive and significant relationship between MTBV and CG Index was found • Number of executive directors has negative impact • The top 5 shareholders’ holding has negative impact • The inclusion in the MSCI has positive impact 14

5. 4 Results – Robustness Test • Why we use 86 questions? • Performance measurement (ROE or MTBV) 15

Performance Measurement • Use Return on Equity (ROE) to measure operating performance • Replace MTBV by ROE in OLS regressions • Similar results were found • Confirm the robustness of the OLS results 16

Fixed Effects Regression Results for CGI and Stock Returns Model 1 Model 2 Model 3 Constant -1. 4636 -1. 2487 -0. 9747 CGI 0. 0445*** LN(TA) -0. 0144 -0. 0119 -0. 0109 D/E -0. 0017 -0. 0019 -0. 0017 ROA 1. 0914 1. 2714 1. 4494 BEXC -0. 0042 -0. 0031 DUMMY_BOARD -0. 6507 -0. 6863 DUMMY_AUDIT -0. 0872 DUMMY_COMP 0. 0303 17 DUMMY_DUAL -0. 3199

Fixed Effects Regression Results for Changes in CGI and Stock Returns Model 1 Model 2 Model 3 Model 4 Constant 1. 1063*** 2. 0429*** 2. 2263*** 2. 6291*** CGI 1. 6904*** 1. 3506*** 1. 4278*** 1. 4345*** LN(TA) -0. 0672 -0. 0619 -0. 0604 D/E 0. 0014 0. 0015 0. 0019 ROA 1. 2130 1. 4355 1. 6056 BEXC -0. 0045 -0. 0017 DUMMY_BOAR D -0. 7003 -0. 7530 DUMMY_AUDIT -0. 2366 DUMMY_COMP 0. 0590 DUMMY_DUAL -0. 3387 18

The Asymmetric Response of CGI Changes to Stock Returns Model 1 Model 2 Model 3 Model 4 1. 2599*** 2. 0060*** 1. 5650*** 1. 9877*** CGI×Positive 0. 7564* 0. 9483** 0. 9728** 0. 9219* CGI×Negative -5. 9015*** -3. 3976** -3. 2270* -3. 6369** LN(TA) -0. 0586 0. 05071 -0. 0476 D/E 0. 0011 -0. 0009 ROA 0. 9335 0. 8717 0. 9462 BEXC 0. 0219 0. 0306 DUMMY_BOARD 0. 0321 0. 0383 Constant DUMMY_AUDIT -0. 3665 DUMMY_COMP 0. 0635 DUMMY_DUAL -0. 3254 19

Positive Correlation between Corporate Governance and Company Value 20

6. Conclusion • We find that a positive relation between CGI scores and one-year buy-and-hold returns. • An asymmetric response to changes in the quality of corporate governance practices. • Specifically, the magnitudes of the decline in stock returns when firms show deteriorating CGI scores are much larger than the magnitudes of return increases when firms show improving CGI scores 21

6. Conclusion • Comparison among different markets • Policy Implication - encourage adoption of best practice of corporate governance in Hong Kong 22

7. Further Research • Survey conducted in 2006 and in China • Impact of voluntary and non-voluntary disclosure on corporate valuation • Investment implications. 23

Thank you 24