Do Investors Really Value Corporate Governance? Evidence from the Hong Kong Market

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

2. 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

3. 2. ResearchQuestion • 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

4. 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))

5. 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), H-share

6. 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.

7. 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

8. Scorecard Followed The Five OECD Corporate Governance Principles • OECD is internationally recognized • HKEx guidelines comprehensively covered • 168 public companies surveyed

9. 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

10. 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

11. Strong Weak Corporate GovernancePerformance by Categories A: Rights of Shareholders B: Equitable Treatment of Shareholders C: Role of Stakeholders in Corporate Governance D: Disclosure and Transparency E: Board Responsibilities

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

13. Strong Weak Corporate Governance Performance by Industries

14. 5.2 CorrelationMatrix of All Variables

15. 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

16. Positive Correlation between Good Corporate Governance and Company Valuation MTBV

17. OLS Results for CGI with Control Variables

18. 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

19. OLS Results for Transparency Index with Control Variables

20. 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

21. Comparisonof OLS Results between Mainland-related Firms and LocalFirms

22. 5.4 Results – Robustness Test • Why we use 86 questions? • Endogeneity • Performance measurement (ROE)

23. 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)

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

25. 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

26. 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 (McKinsey & Company, Thailand IOD, 2002) • Comparison among different markets • Policy Implication - encourage adoption of best practice of corporate governance in Hong Kong

27. 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)

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