In this paper I outline the relationship between Corporate Governance (CG) and the valuation of a firm. Working through the huge body of empirical research I want to give a clear picture of the mechanisms and their relative importance in influencing the valuation. At first I clearly define what I am speaking about: What is Corporate Governance? What do I mean when I speak about “Corporate Valuation”? Once the terms are clear the main question is: Why are these two things connected? What are the theoretical arguments? To evaluate the empirical findings I shortly describe beforehand the statistical problems and pitfalls that arise within this research. With this stable fundament I describe, comprehend and evaluate the descriptive research that has been done until today. Throughout this part I also pay attention to the used methodology. The aim is to give the reader a comprehensive and clear answer to the question how does Corporate Governance influence the Corporate Valuation.
Table of Contents
1) Introduction
2) Definition of “Corporate Governance” and “Corporate Valuation”
3) Statistical Problems
4) Corporate Governance and Corporate Valuation
4.1) Internal control mechanisms
4.1.1) Board composition and size
4.1.2) Insider ownership
4.1.3) Equity ownership structure
4.2) External control mechanism
4.2.1) Market for corporate control
4.2.3) Legal and Regulatory System
4.3) CG-Index
5) Concluding remarks
Research Objectives and Core Themes
This paper aims to provide a comprehensive analysis of the relationship between Corporate Governance (CG) mechanisms and firm valuation. The research seeks to clarify how various internal and external control instruments influence the market value of a firm, while addressing the theoretical foundations and statistical challenges inherent in empirical valuation studies.
- Theoretical link between information asymmetry and corporate agency costs.
- Impact of internal mechanisms such as board composition, insider ownership, and equity structure.
- Role of external control mechanisms including the market for corporate control and regulatory frameworks.
- Methodological challenges, specifically endogeneity and reverse causality in valuation research.
- Synthesis of modern CG-index approaches and the search for an optimal corporate governance structure.
Excerpt from the Book
3) Statistical Problems
Endogeneity is the biggest challenge in research on effects of CG: “[…] endogeneity […] presents both a curse and an important set of challenges to researchers in empirical corporate governance.” Endogeneity means that there is more interaction between the firm valuation (explained variable) and the explaining CG mechanisms (regressors). Econometrically speaking: The regressors are correlated with the error terms. The CG mechanisms influence firm valuation not only direct, but also via other attributes of firm valuation - like firm size - that are included in the error term, i.e. an interaction term influencing both variables. The other problem of endogeneity is reverse causality – when both variables are determined inside the model, the direction of causality remains unclear. In both cases the regressor is not exogenously given and as a result a standard OLS-Regression gives an inconsistent estimation.
Many papers are mainly concerned about the endogeneity between ownership structure and value (Table 2). The theoretical argument is that firms will adopt the ownership structure that is most appropriate - given the characteristics of the firm.
There are different ways how to deal with endogeneity: One is to find exogenous variables, which are highly correlated with the endogenous regressor (Instrumental Variables, two-stage least square estimation). Another possibility is to develop a system of equations, in which each variable is once explained and in the other equations a regressor. A last possibility is to look at the reaction of firms during a truly exogenous event. Lemmon and Lins (2003) look at the relationship between ownership structure and valuation during the exogenous shock of the Asian Crisis. Bris and Cabolis (2004) look at firms that are bought in a cross-border merger – also an exogenous event - and have to adapt to the new regulatory CG environment.
Summary of Chapters
1) Introduction: Defines the core concepts of Corporate Governance and Corporate Valuation and establishes the research question regarding their empirical relationship.
2) Definition of “Corporate Governance” and “Corporate Valuation”: Explores the theory of the firm, agency costs, and the role of information asymmetry in valuation.
3) Statistical Problems: Identifies endogeneity and reverse causality as primary methodological obstacles in measuring the impact of governance on firm value.
4) Corporate Governance and Corporate Valuation: Examines specific internal and external mechanisms and the current trend toward using comprehensive CG-indices.
5) Concluding remarks: Synthesizes the findings and suggests future research directions, focusing on practical advice for companies and regulators.
Keywords
Corporate Governance, Corporate Valuation, Tobin’s Q, Agency Costs, Information Asymmetry, Endogeneity, Ownership Structure, Shareholder Protection, Board Composition, Insider Ownership, Market for Corporate Control, Legal Framework, CG-Index, External Control Mechanisms, Firm Performance.
Frequently Asked Questions
What is the primary focus of this paper?
The paper examines the empirical relationship between various corporate governance mechanisms and the valuation of firms, specifically exploring how these mechanisms impact shareholder value.
What is the central research question?
The research addresses how Corporate Governance influences Corporate Valuation and why these two concepts are theoretically linked through the reduction of agency costs.
Which mechanisms are categorized as internal?
Internal mechanisms discussed include board composition and size, insider ownership levels, and equity ownership structure.
What external control mechanisms does the author analyze?
The author analyzes the market for corporate control, product market competition, and the influence of the legal and regulatory system.
What methodological challenge is emphasized?
The paper highlights endogeneity, particularly reverse causality, as the most significant hurdle when using standard OLS-Regression models to estimate CG effects on valuation.
What is the significance of the "LLSV" index?
The LLSV index, quantifying shareholder protection, is identified as a groundbreaking measurement that enabled extensive cross-country research in the field.
How does insider ownership affect valuation?
The impact is non-linear: low ownership can align management incentives with shareholders, while excessive or specific concentrations can lead to expropriation of minority shareholders.
Why are financial firms typically excluded from these studies?
They are excluded because of their highly specific regulatory environments, which differ significantly from standard industrial firms.
Does a "stronger" governance model always lead to higher value?
Not necessarily; the author notes that recent studies suggest the possibility of overregulation, implying that an optimal form of corporate governance is not always the strongest one.
- Arbeit zitieren
- Dennis Eggert (Autor:in), 2007, Corporate Governance und Unternehmenswert, München, GRIN Verlag, https://www.hausarbeiten.de/document/76531
