A central issue in corporate governance literature is the extent to which ‘good’ governance practices are universal (one size mostly fits all) or instead depend on country and firm characteristics, including interdependencies between organizations and their surrounding institutional environments. For long since La Porta and others published their work (here and here), researchers have been arguing that there are systematic differences in corporate governance structures and practices across countries, which are related to law, political institutions, cultures and social norms, economic and financial development as well as other institutional factors. The voluminous studies on comparative corporate governance have also generated debates on which type of governance is ‘superior’ in protecting investor rights and maximizing firm value, and whether there is an ‘end of history’ for corporate law and corporate governance as argued by Hansmann and Kraakman.
There has also been a moving landscape of corporate governance practice globally: in the past few decades, corporate governance reforms have taken place around the world. These reforms are mostly towards the Anglo-American governance model, featured by high proportion of independent directors on the board, elimination of provisions empowering managers, active market for corporate control, equity- and option-based compensation structure, dispersed ownership structure, and strong role of external governance forces such as auditors, analysts and institutional investors. These developments have created an implicit quest for a single and universally ‘best’ set of corporate governance practices. Institutional Shareholder Services (ISS; formerly RiskMetrics) have issued guidance and metrics based on the renowned G-index, E-index, and the GOV index for institutional investors and companies worldwide to evaluate their corporate governance ‘quality’. However, Bebchuk and Hamdani argue that the quest for a universal set of global corporate governance standards is misleading, as the effectiveness of governance mechanisms crucially depend on companies’ ownership structures, which can vary immensely across countries. Even within the same company, different governance mechanisms can function in distinct ways under different circumstances.
To enhance our current debate, it is important to understand which aspects of corporate governance matter and when these aspects matter. In our rent paper, entitled Universal Corporate Governance, we try to empirically answer the following two questions. Are some sets of corporate governance practice universally effective across the world? If some governance practices are not unconditionally applicable, under what conditions are they effective?
To do so, we have assembled information from all major international corporate governance databases, including RiskMetrics (now ISS), Thomson Reuters, MSCI, and Factset, and test their link with firm value on a large sample of more than 20,000 firms across 47 countries. Empirically, to investigate the (non-)existence of a universal corporate governance model, we consider a few sets of ‘good governance’ from the perspectives of corporate rules, ownership structure, and investor legal protection. In particular, we primarily focus on corporate rules which are more implementable, and we self-constructed a ‘global entrenchment index’ (Global E-index) as our primary proxy for the (lack of) rule-based governance. We then compare it with the governance indices in existing studies (mostly based on US samples for firm-level governance) and the aggregate indices provided by major governance data providers (eg, ISS Governance and MSCI Governance Metrics).
We find the relation between rule-based governance practices and firm value indeed vary substantially across countries. In many subsamples that are well studied in the literature (eg, common law, French civil law, Western Europe, East Asia, developing counties, etc), we do not find a significant correlation between the Global E-index and firm valuation. This finding casts serious doubts on the existence of a universal corporate governance model, thus the universality of a standard set of corporate governance practices around the world. We further find that the effect of rule-based governance (ie, governance provisions in corporate charters and bylaws, as measured by our self-constructed Global E-index) on q (the market-to-book ratio of assets) is contingent on the ownership structure (eg, institutional ownership) and institutional environments (eg, legal protections and political systems). In particular, effect of rule-based governance becomes stronger in firms with greater independent institutional ownership, stronger investor protection and rule of law, and under left-wing and majoritarian political regimes. In contrast, we find that (independent) institutional ownership is conditionally associated with higher q across all subsamples, consistent with the recent advocates on the unique role of institutional investors’ activism in dealing with agency problems in their portfolio companies. This is further supported by our analysis on the voting outcomes of governance-related shareholder proposals during shareholder meetings under a regression discontinuity framework for global companies. We find that even within a small margin, the adoption of corporate governance proposals which are usually sponsored by institutional shareholders is associated with positive stock market reactions.
Overall, our results support the view that the functioning of firm-level rule-based governance crucially hinges on external governance mechanisms such as institutional shareholdings and institutional environments. They provide systematic evidence of how different governance mechanisms interact with each other. Regulators should take different and nuanced approaches of corporate governance (not merely legal rules versus comply-or-explain), instead of questing for global governance standards, as advocated by rating agencies and international institutions. We believe this will have vast implications for the ongoing corporate governance reforms around the world.
Mikael Homanen is a doctoral candidate at the Cass Business School, City University of London.
Hao Liang is an Assistant Professor of Finance at the Lee Kong Chian School of Business, Singapore Management University.