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...57(2), 2741-2771) provide empirical evidence regarding expropriation arising the separation of cash flow from voting rights in Asian firms. Their analysis suggests a high degree of expropriation in Hong Kong, Indonesia, Malaysia, and Thailand. We re-examine the problem of expropriation in Asian firms reported by earlier research. We explore firm-level governance-control structure interactions, and control-legal environment interaction for a set of Asian firms for which we are able to obtain relevant data for all the required variables. The major contribution of this paper is that it jointly examines ownership-control structure, firm-level governance and country-level legal protection available to external suppliers of capital. Using post-crisis data, we find a strong country effect in governance. In general, high control firms in countries with weak legal protection have lower firm-level governance scores in general. On the other hand, high control firms, in countries which have a stronger legal protection environment, signal their intention to not expropriate minority shareholders' wealth by voluntarily adopting measures to strengthen their discipline and responsibility scores. Contrary to earlier findings, we do not find a relationship between control-ownership wedge and firm value. Furthermore, we do not find any relation between firm-level governance and firm value as measured by Tobin's Q.
JEL Classification Numbers: G15, G32, G34
Key words: corporate governance, expropriation, ownership structure
1. Introduction
A rapidly evolving body of literature shows that cross-country differences in legal protection available to minority shareholders and other suppliers of external capital have significant impact on ownership structure, dividend payment, access to external finance, cost of capital and market valuation. (1)
While recognizing the importance of legal and regulatory environment, an evolving strand of research has focussed on the impact of firm level governance on valuation. For instance, Klapper and Love (2002) show evidence indicating that firm-level corporate governance provisions matter more in countries with weak legal environments. Durnev and Kim (2002), use international data to study the relation between firm-level corporate governance and valuation. Not surprisingly, they find a stronger relation in countries with weaker regulatory protection for minority investors.
Johnson et al. (2000) present convincing evidence that weak legal institutions had an important role to play in exacerbating the currency depreciations and stock market declines in the recent Asian financial crisis. They reason that an adverse shock to investor confidence will lead to increased expropriation by insiders. A policy implication of their findings is to mandate significant improvements in the quality of legal protection available to minority shareholders and other suppliers of external capital.
For expropriation to occur, insiders must have both the ability and incentive to divert funds for their private advantage. The Asian financial crisis represents an exogenous event that provides incentives to insiders who hold substantial control rights of the firm. The cost of expropriation should increase directly with ownership. Thus controlling shareholders who have a large wedge between their control rights and cash flow rights (ownership) have the maximum incentive to expropriate. Claessens et al. (2000) show that corporate control is substantially enhanced by using pyramid structures and cross-holdings by firms in nine East Asian countries. The separation of ownership and control is most pronounced among family-controlled firms and small firms especially in Indonesia, Thailand and Taiwan. Lemmon and Lins (2001) find that Tobin's Q ratios of Asian firms in which minority shareholders are most subject to expropriation decline 12% more than other firms. Claessens et al. (1999, 2002) lend further credence to the expropriation possibilities arising from the separation of cash flow from voting rights in Asia. Their analysis suggests a high degree of expropriation in Hong Kong, Indonesia, Malaysia and Thailand. They however, do not find empirical support regarding expropriation for firms in South Korea, Philippines, Singapore and Taiwan.
There exist certain gaps in our understanding of how ownership (control versus cash flow) interacts with governance variables. The finding by Claessens et al. that a wedge between control and cash flow rights does not necessarily result in expropriation is worthy of further closer examination. In particular, we would like to know if these high control-low ownership firms compensate by adopting voluntarily high standards of corporate governance. Furthermore, controlling insiders of firms, operating in countries with legal environment that explicitly offers protection to minority investors, are precluded from expropriation. Thus country differences should matter. We explore these firm-level governance-control structures, and control structure-legal environment interactions for a set of Asian firms for which we are able to obtain relevant data for all the required variables.
Our empirical evidence using post-crisis data show that there is a strong country effect in firm level governance scores. High control firms in countries with weak legal protection for minority shareholders do not voluntarily enhance their governance environment to improve their standing with suppliers of external capital. On the other hand, high control firms in countries with better legal protection environments, such as Hong Kong and Singapore, explicitly incorporate measures to improve their governance. Furthermore, contrary to some of the earlier research on expropriation in Asian firms we do not detect any evidence that indicates expropriation in our sample.
The rest of the paper is organized as follows. In Section 2, we describe in detail the legal environment pertaining to corporate governance in the following eight Asian countries: Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand. In Section 3, we empirically examine the linkages between control-cash flow wedge, firm-level governance and firm valuation. The final Section contains an interpretation of our findings and our conclusions.
2. Corporate governance and ownership structure in Asia
As far as the legal environment for corporate governance (CG) is concerned, Asian countries present a mixed bag. We portray the legal environment in Asia in Table I. The data is reproduced from La Porta et al. (1998). According to La Porta et al. (1998), countries with English Law (common law) tradition have the strongest legal protection for minority investors while French law provides the weakest protection. German law countries fall in the middle in terms of protection to shareholders. Anti-director rights measure how strongly the legal system favours minority shareholders against managers and dominant shareholders. (2) La Porta et al. (1998) believe that a strong legal enforcement system could substitute for weak rules since an effective judiciary can step in and save minority shareholders from exploitation by the management. Law enforcement is measured by Judicial Efficiency and Rule of Law, while Corruption, Contract Repudiation, and Expropriation Risk signify government's attitude towards business. In addition, accounting standards play an important role in corporate governance. Strong accounting standards render reliability of financial disclosures by companies. Also, accounting standards are crucial for setting up financial contracts.
The recently concluded Asian Financial Crisis has been attributed by some researchers [especially Johnson et al. (2000)] to the weaknesses of legal institutions that are supposed to preclude the expropriation of minority shareholders. Johnson et al. (2000) relate exchange rate depreciation and stock market declines during the Asian crisis to country-level governance variables which reflect the status of legal protection available to minority shareholders. Lemmon and Lins (2001) study the joint impact of firm-level ownership structure and the legal environment for protection of minority shareholders using firm level data during the Asian Financial Crisis. They argue that firms with high control rights relative to their ownership have the ability to expropriate. Incentives are provided for expropriation in legal environments with inadequate protection to minority shareholders. They do not consider firm-level governance in their study. Claessens et al. (1999) present the most comprehensive study to date regarding the expropriation of minority shareholders in Asia. Using detailed ownership structure data, they show expropriation is indicated in companies where block holders control significantly large proportion of shares compared to their ownership. When they define ultimate control using a 10% cut-off in control rights of the largest shareholder, it is seen that most Asian firms have a controlling shareholder (close to 98% of all firms). Using a 20% cut-off the proportion of "controlled" firms reduces--but is still high. Japan, which is shown for comparative purposes, has only 20% of its firms controlled by a large shareholder. Korea only has 57% of its firms controlled by a large share-holder.
We show the ownership and control variables across Asian countries of our sample in Table II. The data for this table is assembled from two sources: La Porta et al. (1998) and Claessens et al. (1999). Ultimate control is indicated by the presence of a controlling shareholder who holds 20% of the voting rights. Our definition follows the one used in Claessens et al.
Firm level governance variables are represented in Table III. According to CLSA (2001) there are three key levels in the process of setting up and maintaining an excellent corporate governance system:
1. Recognition that CG is an issue that needs to be tackled.
2. Making the rules for ensuring better CG standards.
3. Implementing the rules.
We highlight important qualitative factors pertaining to each of the countries below:
2.1. HONG KONG
Hong Kong follows the English Law tradition pertaining to corporate governance regulations. Hong Kong scores relatively high in terms of the following legal environment (LE) variables: Anti-director, Judicial Efficiency, Rule of Law, Corruption, Risk of Expropriation, and Risk of Contract Repudiation....
NOTE: All illustrations and photos
have been removed from this article.
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