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? • CG performance of China-related companies listed in Hong Kong 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 • 168 largest companies are covered • 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), 2002. 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 • CG overall Index ranges from 32. 86 to 76. 34, average is 48. 33. • Perform well in Section B and D, poor in Section A 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 Categories Strong Weak A: Rights of Shareholders B: Equitable Treatment of Shareholders C: Role of Stakeholders in Corporate Governance D: Disclosure and Transparency E: Board Responsibilities 11

Corporate Governance Performance by Indices 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 ) 12

Corporate Governance Performance by Industries Strong Weak 13

5. 2 Correlation Matrix of All Variables 14

5. 3 Results – Regression Results(1) • 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 15

MTBV Positive Correlation between Good Corporate Governance and Company Valuation 16

OLS Results for CGI with Control Variables MTBV (1) (2) (3) (4) (5) 0. 0330** 0. 0428** 0. 0475*** 0. 0356** 0. 0337** 2. 5282** 3. 0430*** 3. 0431*** 2. 2866** Ln(TA) -0. 3081*** -0. 2043** -0. 2209** -0. 3583*** Current -0. 042 -0. 0317 -0. 0209 0. 0098 D/E -0. 0441 -0. 0190 0. 0347 0. 1423 BOUT -0. 0249 -0. 0070 -0. 0193 BEXC -0. 1089*** -0. 0941** -0. 0622 Top 5 -0. 0128*** -0. 0126*** -0. 0011 Dummy CEO & Chairman 0. 1837 0. 1738 Dummy Audit committee 0. 1353 0. 2321 Dummy Compensation 0. 2794 0. 3000 CGI ROA Dummy ADR -0. 1421 Dummy MSCI 1. 4939*** Dummy H Share & Red Chips 0. 3374

5. 3 Results – Regression Results(2) • Transparency index does matter • Non-transparency index become insignificant when the number of executive director and top 5 shareholder’s share holding add into the model • ROA has positive effect on MTBV 18

OLS Results for Transparency Index with Control Variables MTBV (1) (2) (3) (4) TINDEX 0. 0371** 0. 0414** 0. 0373** 0. 0388*** NONTINDEX 0. 0179* 0. 0202** 0. 0136 0. 0108 ROA 2. 3482** 2. 8850*** 2. 8973*** 2. 1137** Ln(TA) -0. 3414*** -0. 2419*** -0. 2540** -0. 3850*** Current -0. 0575 -0. 0496 -0. 0416 -0. 0108 D/E -0. 0589 -0. 0319 0. 0164 0. 1205 BOUT -0. 0277 -0. 0106 -0. 0267 BEXC -0. 1046*** -0. 0902** -0. 0558 Top 5 -0. 0140*** -0. 0138*** -0. 0017 Dummy CEO & Chairman 0. 2084 0. 1935 Dummy Audit committee 0. 1642 0. 2637 Dummy Compensation 0. 1997 0. 2254 Dummy ADR -0. 1382 Dummy MSCI 1. 4847*** Dummy H Share & Red Chips 0. 2346

5. 3 Results – Regression Results(3) • For China-related firms, MTBV is positively related to CG Index • For local firms, the relationship is not significant • Investors have different criteria to value China-related firms and local firms 20

Comparison of OLS Results between Mainland-related Firms and Local Firms MTBV China-related Firms Local Firms CGI 0. 0572** 0. 0273 ROA 1. 1930 4. 5531*** Ln(TA) -0. 0318 0. 0662 Current 0. 0704 0. 1208 D/E 0. 1192 0. 1882*** BOUT -0. 0309 -0. 0601 BEXC -0. 1327** -0. 1401 Top 5 -0. 0051 -0. 0111 Dummy CEO & Chairman 0. 1984 0. 1391 Dummy Audit committee -0. 0322 0. 5584* Dummy Compensation 0. 0791 0. 3003 Dummy ADR -0. 1142 -0. 5526 21

5. 4 Results – Robustness Test • Why we use 86 questions? • Endogeneity • Performance measurement (ROE) 22

Spearman Ranking Correlation Test • Spearman correlation coefficients between new and original rankings. • All of the correlation coefficients below are significant at 1% level (P-value <0. 0001) 23

Endogeneity • Use H-shares dummy as instrumental variable • Durbin-Wu-Hausman Test (Two-stageleast- squares) for endogeneity • No existence of endogeneity was found 24

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 25

6. Conclusion (1) • Construct a CG measure for HK listed firms • 10 points increase in CG Index implies a 33. 7% increase in MTBV. Worst-to-best change in CG Index implies 147% increase in MTBV • Investors care more about CG performance of China-related firms • Similar results were found in Thailand market (Mc. Kinsey & Company, Thailand IOD, 2002) • Comparison among different markets • Policy Implication - encourage adoption of best practice of corporate governance in Hong Kong 26

7. Future Research • Regional Comparison (Macro) – Regulatory framework – Market perception • Regional Template (supported by the World Bank) • Individual economies (Micro) – Thailand (3 times), China, the Philippines, Indonesia (in progress) 27

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