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Corporate Governance Score Card Project

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					  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), H-
    share

                                                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
                           Number of
OECD principle             questions &     • OECD is
                           sub-questions
A.      Rights of          16
                                             internationally
        shareholders                         recognized
B.      Equitable
        treatment of
                           10
                                           • HKEx guidelines
        shareholders                         comprehensively
C.      Role of            4                 covered
        stakeholders
D.      Disclosure and     30              • 168 public
        transparency                         companies
E.      Board              26
        responsibilities
                                             surveyed
Total                      86                                  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            110
                                                                         Range
                     100
                                                                         Mean
                     90
                                      B
                     80               82.78
                                                          D
                                                  C       74.88
                     70
            Scores




                                                  69.54
                                                                  E
                     60                                           60.7
                     50
                            A
                     40     42.96

                     30
                     20
   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
                    80
    Strong                                                             Range
                    75

                    70                                                 Mean
                    65

                    60
           Scores




                    55
                                   HSI
                    50                   HSHKCI      HSCCI
                         All
                    45                                         HSCEI
                    40

                    35

                    30



    Weak
•     HSI (Hang Seng Index )
•     HSHKCI (Hang Seng Hong Kong Composite Index )
•     HSCCI (Hang Seng China-Affiliated Corporations Index )
                                                                               12
•     HSCEI (Hang Seng China Enterprises Index )
                    Corporate Governance
                   Performance by Industries
Strong            80
                                                                                            Range
                  75

                  70                                                                        Mean
                  65

                  60
         Scores




                  55

                  50

                  45

                  40

                  35

                  30
                       All   Industrial Properties Finance Utilities Consolidated Hotel &
                                                                     Enterprises  Misc
Weak




                                                                                                    13
                  5.2 Correlation Matrix of All
                           Variables
  This table provides correlation coefficients between dependent variables, independent variables and control variables
  Statistically significant correlations (at 5% level or better) are shown in bold.

                         1        2        3       4        5        6        7        8       9      10      11          12   13   14        15
 1 Total CGI         1.000
 2 mtbv              0.131    1.000
 3 ln(TA)            0.196   -0.282 1.000
 4 roa               0.084    0.305 -0.056 1.000
 5 current          -0.062    0.131 -0.386 0.139 1.000
 6 bexc             -0.151   -0.248 0.258 0.020 -0.180 1.000
 7 bout              0.355    0.043 0.460 0.027 -0.067 -0.190 1.000
 8 top_5            -0.116   -0.093 0.097 0.005 -0.154 0.067 -0.190 1.000
 9 dummya            0.370    0.040 0.025 -0.056 0.082 -0.004 0.147 -0.118 1.000
10 dummyc            0.556    0.135 0.203 0.138 -0.091 -0.203 0.186 -0.096 0.272 1.000
11 dummycc          -0.037    0.079 -0.048 0.016 -0.025 -0.130 -0.102 -0.016 -0.052 0.040 1.000
12 dummymsc          0.227    0.169 0.392 0.088 -0.088 -0.072 0.402 -0.321 0.010 0.134 0.062 1.000
13 dummyADR          0.107   -0.096 0.436 0.045 -0.130 0.025 0.314 0.002 -0.017 0.126 0.068 0.247 1.000
14 dummyhr          -0.179   -0.127 0.078 0.073 -0.043 0.255 -0.205 0.291 -0.164 -0.033 -0.089 -0.379 0.040 1.000
15 D/E               0.085    0.302 0.245 -0.037 -0.025 -0.030 0.212 0.078 0.014 0.142 -0.150 0.066 -0.026 -0.049 1.000

                                                                                                                                         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
Positive Correlation between Good
   Corporate Governance and
        Company Valuation
       10

            9

            8

            7
Tobin's Q




            6
 MTBV




            5

            4

            3

            2

            1

            0
             30   35   40   45   50   55   60   65   70   75   80
                                  Scores

                                                                    16
         OLS Results for CGI with Control
                   Variables
                                                    MTBV
                              (1)         (2)           (3)          (4)          (5)
CGI                         0.0330**   0.0428**      0.0475***    0.0356**     0.0337**
ROA                                    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
Top5                                                 -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
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
• Large firms tend to be undervalued



                                          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
Top5                                     -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
   Top5                            -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-stage-
  least- 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
• 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
                                                26
~ END ~




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