How Corporate Governance Affects Firm Value: Evidence on Channels from Korea

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Abstract
Prior work in emerging markets provides evidence of an association between corporate governance and firm market value (based on the trading prices of minority shares), more limited evidence of a causal relationship, but very little evidence on the channels through which governance may affect firm behavior and therefore market value, and whether governance affects only the value of minority shares or also affects overall firm value. We first confirm the association between governance and the market value of Korean public companies in a firm fixed effects framework, using panel data 1998-2004. Firms with higher scores on an overall Korean corporate governance index (KCGI) have higher Tobin's q; this result is driven by the board structure subindex of KCGI and, less strongly, by ownership parity and disclosure subindices. Shareholder rights and board procedure subindices are not significant. We then provide evidence supporting two broad channels: Reduced insider self-dealing, and hence wealth transfer from controllers to outside shareholders; and improved firm performance, and hence higher overall firm value. For self-dealing, we find that for better-governed firms, related party transactions are less adverse to firm value and firm profitability is more sensitive to shocks to industry profitability. For overall firm value; we find that for better-governed firms (i) capital expenditures and sales growth are lower, but investment is more sensitive to profitability; (ii) profitability is more sensitive to growth opportunities; (iii) dividends are higher, controlling for profits, and are more sensitive to profits. In addition, lagged board structure is associated with higher firm profitability. Board structure subindex is associated with all results except those for dividends. A 2SLS analysis (using 1999 legal rules which apply only to large firms to instrument for board structure) offers evidence that the link between board structure and these channels is likely to be causal.