La recherche en économie au GREDEG Groupe de Recherche en

2013 Summer School
« Knowledge dynamics, industry evolution, economic development »
Corporate Governance and
International comparisons
and the issue of innovation
Jackie Krafft
Groupe de Recherche en Economie, Droit Economique et Gestion
GREDEG, UMR n°7321
Université de Nice – Sophia Antipolis et CNRS
• Since the 1980s, the literature on corporate governance has
developped in two directions:
- the promotion at a theoretical level of a model of corporate
governance, essentially agency-based
- the elaboration of metrics and scores of good governance
These directions are closely related:
From the 1980s till today, agency-based models have served as the
key reference to the elaboration of metrics
Dominant theory today
• At a theoretical level, ‘good governance’ increases firm value and
performance as it involves :
better monitoring, greater transparency and public disclosure
between the principal (the investor) and the agent (the manager)
increase in investor trust and, conversely, decrease in manager
discretion and rent expropriation
Less risk, more efficient operations, reduced audit and monitoring
costs for well-governed firms
=> These elements tend to alleviate the cost of capital and generate
higher expected cash flow stream, which in turn create higher firm
valuation and higher performances
Dominant practice today
• At a practical level, international investors now generally regard
corporate governance as an important criterion when making
investment decisions
• According to Mc Kinsey (2002), 15% of institutional investors
consider corporate governance to be more important than firms’
financial issues, such as profit performance or growth potential
• More and more countries started to tighten up rules and regulations
in the governance field by adopting new standards largely inspired
by US codes of best practice to establish guidelines for publicly
listed companies in an attempt to improve the overall governance of
• OECD acknowledges that an effective corporate governance system
will lower the cost of capital and encourage firms to use resources
more efficiently, thereby, underpinning growth
• All this implicitely and explicitely support the following belief:
« better governance will result in higher firm value and more
profitable firm performances »
=> true there, true everywhere
=> true for any kind of investments, including innovative ones
• But, do we really have robust evidence on that?
• And what if considering innovation performances of firms, and not
only financial performances ?
• What are the challenges ahead?
1. Results so far
2. Data and empirical strategy
2.1. International comparisons
2.2. Innovation
Where do we go?
1. Results so far
True everywhere?
• The issue of international comparisons!
• US corporate governance as a best practice and its diffusion
• Some commentators persistently advocate the importance of the
institutional context in which the governance system operates, and
tend to support the idea that there is a lack of convergence towards
the US model, and even a reluctance to adopt it, leading to a coexistence of distinct national models of corporate governance
True everywhere?
• Until the mid 1990s, most of the work on corporate governance has
been in the context of US firms
• Over the last decade, international comparisons started to develop,
stimulated by the work of La Porta, Lopez de Silvanes, Shleifer and
Vishny (1997, 1998, 2000a, 2000b, 2002)
• Much of this work has focused on differences between countries’
legal systems, and has studied how such differences relate to
differences in how economies and capital markets perform
• A substantial body of research about US firms showed that cross
firm differences in governance have substantial effect on firm value
and performance (Gompers et al., 2003; Bebchuk et al., 2008; Core
et al., 2006)
• However, much less documented is how non US firms are
performing when they adopt the US best practice
Inputs from theory
• Agency theory, transaction costs economics, new property rights
theory are based on different assumptions
• However, they converge to say that good governance is needed to i)
realign the incentives of the manager in the interests of the
shareholder, ii) guarantee high cash flow and low cost of capital, iii)
use resources more efficiently and stimulate growth
• They also converge on key attributes of good governance: board of
directors, proxy fights, hostile takeovers, corporate financial
• As the US model of corporate governance was elaborated to come
up with these issues then, from these theories, it should spread over
the world both in US and non US firms
• Issue of convergence of corporate systems and regulations:
convergence here being understood as the domination of a system
of corporate governance identified as ‘superior’ … and not as a
gradual interpenetration of rules and practices leading to a mix of
different co-existing systems
Inputs from theory
• Alternative theories (stakeholder perspective, varieties of capitalism,
economics of innovation) suggest that the adoption of the US model
in firms is not leading to the best results, as country-level or firmlevel differences are at work
• At the theoretical level, the issue is still unsolved:
- some critical debates on the emergence of a US best practice on
which all the other systems (and firms composing these systems)
should converge
- there is no overall ‘best’ system
True for any kind of investments?
• The issue of innovation!
• Today, innovation is only considered in the impact that corporate
governance may have on firms innovation performances (thus not
only stock market, firm value, or operational performances)
• Innovation performances of firms can be measured by input
measures (R&D), or output measures (patent)
• However, most of the studies focus only on the impact of corporate
governance on R&D, leaving the link between corporate governance
and patenting completely unexplored
• The general conclusion is that there is no general conclusion: further
investigations are needed to better understand innovation in the field
of corporate governance
Inputs from theory
• Debate:
(1) Because good governance involves better monitoring, greater
transparency and public disclosure, increase in investor trust, decrease
in manager discretion and rent expropriation, less risk, more efficient
operations, etc.
 it should be beneficial to all investments, especially innovative ones
(2) Because good governance puts a large emphasis on the interests of
the shareholders as a primary goal
 it should equally be detrimental to innovative investments as
i) shareholders and investors are mostly interested by dividends and
returns on investments, not about R&D strategy,
ii) it introduces a short-term perspective while innovation is long-term
2. Data and empirical strategy
2.1. International comparisons
IRRC data
• The Investor Responsibility Research Center (IRRC) publishes
detailed listings of corporate governance criteria for individual firms
• Data are derived from a variety of public sources (corporate bylaws
and charters, proxy statements, annual reports, 10K, and 10Q
• All sample firms are drawn from the Standard & Poor’s 500 and the
annual lists of Fortune, Forbes, and Business Week
• The reports cover about 1500 US firms, and are published in 1990,
1993, 1995, and 1998
IRRC data
• Gompers, Ishii and Metrick (2003, Quarterly Journal of Economics)
construct a firm-level governance index (G-Index) based on the
prevalence of 24 governance criteria
• They add one point for every attribute that reduces shareholder
• Firms with higher G-index values are reflecting less shareholder
rights, e.g. poor governance
• The authors test the impact of a change in G-index on firms stock
market performance (stock price, dividend yield) and firms value
(Tobin’s Q)
• They find that firms with poor governance have significantly lower
valuation than firms with lower index values
• They find, however, that badly governed firms do not necessarily
have lower operating performance (Net profit margin, Return on
IRRC data
• Bebchuk, Cohen and Ferell (2008, Review of Financial Studies) find
similar results with a slightly different governance index (called the
E-index for ‘entrenchment’ index), and consisting of a smaller set of
provisions (6 criteria of governance)
• Core, Guay and Rusticus (2006, The Journal of Finance) show that
firms with weak shareholder rights exhibit systematically significant
operating underperformance
Critics on IRRC data
• IRRC data can only examine the effects of the external mechanisms
of corporate governance, because the scores of corporate
governance are indeed very close to a takeover defense index
• IRRC data does not provide a measurement of overall corporate
governance, especially of internal mechanisms at work
• IRRC data is based on the largest US firms
• The way in which corporate governance develops outside the US is
not within the scope of IRRC data
• IRRC data is not published each year
• Important changes in governance occurring in the year where the
report is not published may be ignored
CLSA data
• Credit Lyonnais Securities Asia (CLSA) provides rankings in
corporate governance, drawn from a questionnaire circulated among
495 companies
• The sample is selected based on two criteria: firm size and investor
• The CLSA corporate governance questionnaire covers 7 broad
categories in 25 countries (US and non US)
• The questionnaire is then completed by Credit Lyonnais analysts
• The analysts add one point to each answer in favor of the best
practice and then the percent of positive response to questions in
each category is reported
CLSA data
• Klapper and Love (2004, Journal of Corporate Finance) use CLSA
firm-level data of 374 firms from 14 emerging countries
• They report that better corporate governance is highly correlated
with better operating performance and higher market valuation
• This gives some support that non US firms increasingly adopt US
firms’ practices in terms of corporate governance
Critics on CLSA data
• However this index is highly based on analysts’ subjective views
• About 70% of the questions are based on objective facts and the
remaining questions represent analysts’ opinion, which could be
biased by knowledge of stock returns
• Additionally, since CLSA has conducted only one study, the data
generated from this study is quite static
• Obvious limits in the generalization of results in terms of
convergence in systems of corporate governance
Single-market data
• Single-market survey-based governance index
• These firm-specific corporate governance indexes are constructed
by following broad surveys among listed companies in a single
• Black, Jang and Kim (2006, The Journal of Law, Economics and
Organization) construct a Korean Corporate Governance Index
(KCGI) for 515 Korean companies
• The study is based on a survey of corporate governance practices
by the Korea Stock Exchange in 2001, sent out to all listed firms on
the Korea Stock Market
• The authors extract 38 variables from the survey questions, which
are classified into 4 sub-indices, and then they combine sub-indices
into the overall index-KCGI
• They report an increase in KCGI predicts a 0.47 increase in Tobin’s
Single-market data
• Drobetz, Schillhofer and Zimmermann (2004, European Financial
Management) document a positive relationship between governance
practices and firm valuation for German public firms by constructing
broad corporate governance rating related to the German Corporate
Governance code
• To construct their sample, they sent out questionnaires to 253
German firms in different market segments and received answers
from about 36% of these firms
• Data are limited to one observation, March 2002
• Results exhibit a positive, significant relation
Single-market data
• Beiner, Drobetz, Schmid, Zimmermann (2006, European Financial
Management) sent out a questionnaire based on the suggestions
and recommendations of the Swiss Code of Best Practice to all
Swiss firms quoted at the Swiss Stock Exchange in 2003
• The index consists of 38 governance attributes divided into 5
• They report that an increase in the corporate governance index by
one point causes an increase of the market capitalization by roughly
Critics on single market data
• These contributions are all in line with an increasing convergence in
systems of corporate governance
• However there are several limitations with these studies
- most of the studies are based on one single year, or work under the
assumption of constant historical ratings
- and a longer period of study should be required to draw general
- a country case study raises the question of generalization to other
- empirical studies should be based on data that explicitly considers
several countries
• More systematic results should be expected on the following
• From academic to investors data…
Investors data: TCL
• The Corporate Library was founded in 1999 with the goal to provide
to its clients corporate governance, executive and director
compensation information and analysis
• In 2003, it launched its Board Effectiveness Ratings, now known as
The Corporate Library (TCL) Ratings
• These ratings cover four key components: board structure (50%),
CEO compensation (30%), takeover defenses (10%), and
accounting (i.e., screens for earnings management 10%).
• They cover five categories (higher to lower): A, B, C, D, and F
• TCL also provides the following eight sub-ratings: Board
Composition, Shareholder Responsiveness, Litigation and
Regulatory Problems, Strategic Decision-making, CEO
Compensation, Takeover Defenses, Accounting, and Analyst
• These sub-ratings also range from A to F
Investors data: GMI
• Governance Metrics International (GMI) was founded in 2000 to
provide tools to its clients to monitor firms’ corporate governance
• GMI considers various aspects of governance such as, board
accountability, financial disclosure and internal controls,
shareholder rights, executive compensation, market for control and
ownership base, and corporate behavior
• Companies are scored on a scale of 1.0 (lowest) to 10.0 (highest).
• GMI global ratings measure the strength of corporate governance
relative to all other companies in the GMI universe
Investors data: ISS/Risk Metrics
• Founded in 1985, Institutional Shareholder Services (ISS) provides
research and proxy advisory services to institutional investors
• In 2002, ISS introduced its Corporate Governance Quotient which
aims to ‘measure the strengths, deficiencies and overall quality of a
company's corporate governance practices and board of directors’
• ISS considers the following factors: Board of directors, audit
committees, their independence and the presence of a financial
expert, charter and bylaw provisions, anti-takeover provisions,
executive and director compensation, qualitative factors such as
board performance reviews, meetings of outside directors, CEO
succession plan, director and executive ownership, and director
• CGQs range from 0 to 100 and measure the quality of governance
relative to other firms in the company’s primary stock market index.
• To date this is the most exhaustive data, covering about 8000 firms
in 25 countries and 25 sectors
Data available
Board structure
/ Remuneration
Rights / Charter
Audit practices /
Board composition
Pay for
One share one
External auditors
Composition of
Non performance
based pay
Takeover defenses
Audit and
Board practices
Use of equity
Voting issues
Other audit issues
Board policies
Equity risk
Voting formalities
Related party
Non executive pay
Other shareholder
rights issues
and disclosure
Reliability of data?
• There are increasing (academic) criticisms against investors data:
- metrics is not based on the most recent analytical developments
and, consequently provide partial and even wrong evaluation
leading to over or under estimations of what firms really do in terms
of corporate governance
- difficulty to synthetise the complex reality of corporate governance
into one score
- objectivity of the measure and of the evaluators
- companies with good/bad scores are not systematically the ones
that perform the best/worst (exemple: Enron/Google)
- Indicators are often short term oriented, and depreciate some
sectors over others
- no account of the variation of scores due to country and or industry
Review: empirics (firm level)
• US data:
- Gompers et al. (2003), Bebchuk et al. (2008), Core et al. (2006):
firms with better governance (higher shareholder rights) have higher
performance in the US
• International comparisons:
- Klapper and Love (2004): better governance is highly correlated
with better operating performance and higher market valuation (14
emerging countries, 1 year study)
- Black et al. (2006): better governance involves an increase in
Tobin’s Q (1 country, Korea)
- Drobetz et al. (2004): positive relationship between governance
practices and firm valuation (1 country, Germany)
=> Convergence operates: non US firms increasingly adopt US firms’
best practice in terms of corporate governance
Krafft, Qu, Quatraro, Ravix (2013)
Industrial and Corporate Change
• At the theoretical level, the issue of convergence has to take country
level and firm level differences on board if some progresses are to
be made
• Maybe one way to overcome this theoretical dead-end is to develop
some further empirical results
• But empirical studies should be based on data that explicitly
- non US firms in several countries
- a long period of study
• We aim at providing an empirical contribution on the adoption of the
US best practice by non US firms (24 countries, more than 2500
firms), over the period 2003-2008
• H1: Better governed firms should have higher stock market
performances, measured on the basis of Stock Return or Dividend
• H2: Better governed firms should have higher value, measured by
the Tobin’s Q
• H3: Better governed firms should have higher operating
performance, measured by Return on Assets or Net Profit Margin
Data and variable
• Data:
- ISS Risk Metrics, largest corporate governance data provider
• Variables:
- Corporate Governance variable:
CGQ, as score metrics developped by the data provider, based on
55 governance factors which span over 8 attributes of corporate
- Performance variables:
Stock return, Dividend yield, Tobin’s Q, ROA, NPM
- Control variables:
Size, R&D/sales, Sales growth, Market capitalisation, Market to
book value
• Governance and stock market performance:
 Impact of CGQ on Stock return and Dividend yield
 Endogeneity: CGQ is exogenous for Dividend yield, CGQ is
endogenous for Stock return
 Stock return and CGQ is estimated by using the instrumental
variables technique
• Governance and firm value:
 Impact of CGQ on Tobin’s Q
 Endogeneity: CGQ is exogenous for Tobin’s Q
• Governance and operating performances:
=> Impact of CGQ on Return on asset and Net profit margin
 Endogeneity: CGQ is exogenous for NPM, CGQ is endogenous for
 ROA and CGQ is estimated by using the instrumental variables
• Governance and stock market performance:
- Positive relationship between CGQ and Stock Return, significant at
1% (2SLS)
- Positive relationship between CGQ and Dividend Yield, significant at
1% (OLS)
• Governance and firm value:
- Positive relationship between CGQ and Tobin’s Q, significant at 1%
(OLS), significant at 5% (FE)
• Governance and operating performance:
- Positive relationship between CGQ and ROA, significant at 1%
- Positive relationship between CGQ and NPM, significant at 10%
(OLS), significant at 5% (FE)
Results CG /
Gompers et al.
( 2003)
Bebchuk et al.
Core et al.
Klapper and
Love (2004)
Black et al.
Drobetz et al.
Beiner et al.
Krafft et al.
Non US
2.2. Innovation
Driver and Guedes (2012)
Research Policy
• Agency theory: Good governance increases R&D because investors
are assured that managers are not shirking
=> H1: Greater levels of governance induce more R&D spending
• Innovation theory: There is a possibility of perverse effect of
“good governance” on uncertain, long term investments
=> H2: Greater levels of governance induce less R&D spending
• Data:
- Investor base, single market (UK): Manifest global proxy governance
and voting service database
- 91 UK manufacturing and service (excluding financial) firms, with the
highest averaged R&D expenditure in the period 2000–2005
• Results:
- The governance variable in levels is significantly negative in all
specifications (FE and GMM)
- This suggests that there is a long-run negative effect of governance
on R&D
• This is consistent with the views of the minority of those who have
argued that the adoption of the best practice can have contradictory
or perverse effects, when innovation is taken into account
Lhuillery (2011)
Industrial and Corporate Change
Investor base, single market (F): Vigéo
5528 firms belonging to 110 large French listed business groups
Results (FE and GMM):
Support of agency theory set of hypotheses, i.e. adoption of the best
practice increases firms’ performances
- Support of the ‘additivity’ hypothesis, i.e. any additional provision
further amplifies firms’ performances
• However:
- In France, no significant influence of good governance on R&D
- Possible doubts regarding the “Anglo-Americanization” of (some)
European firms
Becker-Blease (2011)
J. of Corporate Finance
• Data:
IRRC, Financial accounting standards, NBER patent
database,1984-1997, 600 US firms
Focus on antitakeover provisions on firm innovation
H1: Managerial myopia (Stein, 1988): threat of hostile acquisition
can lead managers to avoid undertaking long term, risky
investments because such projects can lead to a wide divergence
between market and intrinsic values.
Takeover provisions may shield managers from concerns related to
short term performance and permit more long term, valuemaximizing investment strategy that encourages greater innovation
H2: Quiet life (Bertrand and Mullainathan, 2003): if the presence of
takeover protection reduces the effectiveness of the external
disciplinary market, then the manager may exploit the opportunity to
avoind difficult and risky investments, especially if these could
reveal managers to be lower quality
• Results:
• Higher levels of 23 takeover provisions are associated with
innovation efforts (R&D expenditures, awarded patents, quality of
patents, number of patents awarded per $ of R&D)
=> Innovation is positively correlated with antitakeover
• Some provisions are more important than others in this positive
correlation (power hypothesis)
• Firm-level provisions are significant in this positive correlation, while
state-level provisions are not significant (visibility hypothesis)
O’Connor and Rafferty (2012),
J. of Financial and Quantitative Analysis
• Data:
- IRRC and Compustat, 1719 firms (1990-2005)
- Effect of antitakeover provisions on long term investments
• Hypotheses:
- H1: Managerial myopia (Stein, 1988): positive relation
- H2: Quiet life (Bertrand and Mullainathan, 2003): negative relation
• Models:
- Static models (OLS): negative relationship between corporate
governance index and R&D activity, but not robust
- Dynamic models (GMM): no relation, or only slightly positive
Krafft and Ravix (2008)
Louvain Economic Review
• Data:
Risk Metrics / International Shareholder Services
2500 firms from 25 Industries, 24 Countries (non US)
Oct 2003 to Dec. 2008
Coefficient on LnCGQ
*** Significant at 1%
• FE model
• LnSPi,t = α + β1 LnCGQi,t +
β2LnMVi,t + β3LnDYi,t + υi,t
• Positive and significant
relationship in Agro-Food and
• The impact of a variation in
CGQ on performance is much
more important in ICT
compared to Agro-food
… and the CGQ itself is more instable in ICT industries
than in Agro-Food
• Innovative versus non-innovative sectors have an impact
- Good governance principles have a stronger impact on stock
market performance in innovative industries compared to more
traditional ones
- Increasing volatility may be the outcome, especially in a context
where variations of CGQ are much more important in innovative
industries than in more traditional ones
• Suggests that the adoption of the best practice is amplifying the ups
and downs of industrial development, especially of innovative
Results CG on
Driver and
Not significant
and Rafferty
No relation: slightly
positive with GMM,
negative but not
robust with OLS
Non US
Positive, potentially
amplifying ups and
Krafft and
Where do we go?
International comparisons
• Convergence of non US firms towards the US best practice in terms
of corporate governance operates and generates more
• … But this does not put an endpoint to the discussion on corporate
- Investigate firm level differences with more scrutiny: compare the
governance of non US firms to the governance of comparable US
- Investigate whether the adoption of the US best practice in non US
firms involves a greater sensitivity and potentially increased volatility
of value and performances over time
• Emerging literature on the way in which innovation interacts with
corporate governance
• Creating new perspectives:
- At a theoretical level: possible link between economics of innovation
and economics of governance, and not only between agency theory
and the economics of governance
- At the empirical level: negative impact of ‘good governance’ on firms
performance in terms of innovation
• … But also further challenges:
- the data and metrics used are still highly influenced by agency
theory, and much less by innovation theory
- Significant efforts should be made in that direction
- firm-level international comparisons are needed here as well!