QUALITY OF GOVERNANCE AND FIRM PERFORMANCE: EVIDENCE FROM SPAIN

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QUALITY OF GOVERNANCE AND FIRM PERFORMANCE
EVIDENCE FROM SPAIN

• Eloisa Pérez de Toledo
• Universitat Autònoma de Barcelona

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WHY CORPORATE GOVERNANCE MATTERS?

• Increases firms access to external finance
• Reduces the information asymmetry
• Governs the way in which decisions will be taken
• events not contemplated in the established
  contracts

Increase in firms value
FCFt (1WACC)t
?
FIRMS WITH GOOD GOVERNANCE
Reduction in the Cost of Capital
Lower required IRR for the projects
Increase in firms competitiveness
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THEORETICAL FRAMEWORK

• Theory of the firm
• Coase (1937)
• Agency theory
• Jensen and Meckling (1976)

QUALITY OF GOVERNANCE
Principal
Agent
AGENCY PROBLEMS
Conflict of interests Information asymmetry
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THEORETICAL FRAMEWORK
Institutional theory (North,1990)
FIRMS WITH WEAK GOVERNANCE
FIRMS WITH GOOD GOVERNANCE
UNDER THE SAME LEGAL, INSTITUTIONAL AND
REGULATORY ENVIRONMENT DEGREE OF INVESTOR
PROTECTION
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RESEARCH QUESTIONS

• Which observable factors make companies adopt
  different levels of governance under the same
  contracting environment?
• Does corporate governance influence market value?
• The setting for exploring these questions
  Spanish public companies

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GOVERNANCE INDEX GOV-I

• Proxy to Quality of Governance
• Questionnaire with 25 binary objective questions
  obtained exclusively from secondary data
• Each positive answer adds one point to the index
• Four dimensions to be considered
• Access and content of the information
• Structure of the board
• Ownership structure and control
• Progressive practices

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METHODOLOGY

• Part 1 Determinants of the quality of corporate
  governance

Governance determinant Code
Future growth opportunities SALESGR
Composition of firms assets TANG
Firm size (SIZE) Log(SALES)
Issuance of ADRs ADR
Compliance to the Código Olivencia OLIV
Ownership structure (OWN) CON
Capital structure LEVER
Performance (PERF) Q / ROA / EBITDA
Dividend payout PAYOUT
Industry IND
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METHODOLOGY
Part 1 Determinants of the quality of governance
GOV-Ii a b1SALESGRi b2log(SALES)i b3TANGi
b4ADRi b5OLIVi b6OWNi b7PERFi b8PAYOUTi
??jIND ?i

• Method cross-sectional multiple regression
• The estimation of the model is expected to
  answer
• Firms with higher growth opportunities present
  better governance?
• Bigger firms present better governance?
• Composition of a firms assets have any relation
  with its quality of governance?
• Firms that issue ADRs present better governance?
• Firms that comply with the Código Olivencia
  present better governance?
• Ownership structure affect firms governance?

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METHODOLOGY
Part 2 Relationship between corporate governance
and market value

• PERFi ? ?1 GOVi ?2OWNi ?3LEVERi
  ?4log(SALES)i ?5ADRi ?6OLIVi ?7LIQi
  ?8TANGi ??jINDji ??lIDENTlli ?i

• GOV governance variables GOV-I (Governance
  Index), BSZ (Board Size), BIN (Board
  Independence), etc.
• PERF performance variables Tobins Q, ROA,
  EBITDA/ASSETS

• Method cross-sectional multiple regression
• The estimation of the model is expected to
  answer
• Does corporate governance influence corporate
  performance?

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GOVERNANCE PERFORMANCE THE PUZZLE
Quality of governance (G)
Firm performance (P)
causal
Possibility I
Spurious correlation observed
Quality of governance (G)
Quality of governance (G)
Firm performance (P)
Firm performance (P)
causal
causal
causal
Other factors (observable and unobservable)
Possibility II
Possibility III
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METHODOLOGY

• Theory is unclear on the exact direction of
  causality between governance and performance
• Plausible that causality may run both ways
• Two ways to solve this problem of reverse
  causality
• Simultaneous equations using exogenous
  instrumental variables
• Examine whether the change in G over time is
  correlated with the past or future change in P
• If change in G is correlated w/ past change in P
  (P?G)
• If change in G is correlated w/ future change in
  P (G?P)

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SAMPLE AND DATA COLLECTION

• Sample
• All non-financial listed companies in the Bolsa
  de Madrid
• Approximately 150 companies
• Data collection
• Spanish Securities Exchange Commission (CNMV)
• Bolsa de Madrid Spanish Securities Exchange
• governance related information
• COMPUSTAT
• financial and accounting information