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Corporate governance and firm value during a financial crisis

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Abstract

The main purpose of this paper is to evaluate the effects of management ownership and other corporate governance variables on Hong Kong firms’ stock performance following the onset of the Asian Financial Crisis (1997–98). Our results show that Hong Kong firms with a more concentrated management (executive board) ownership displayed better capital market performance during the 13-month period of the Crisis. We also find that firms with more equity ownership by non-executive directors, and in which the positions of CEO and board chairperson were occupied by the same individual experienced a smaller stock price decline. Our findings are consistent with the notion that there is a greater alignment of insiders with outside owners, rather than the expropriation by insiders who have the opportunity to divert value, for firms with higher levels of management ownership during an unexpected capital market crisis.

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Notes

  1. Endogeneity is recognized and addressed in several studies of US firms during non-crisis periods. Wang (2006) and Brown and Caylor (2005), for example, conclude that the discovered relationships are not necessarily causal, but only reflect associations.

  2. Holmstrom and Kaplan (2003) have noted similar behavior in the U.S. “When a company is not doing well everyone pays close attention—lenders and investors as well as board members. But when a company appears to be doing well, as was the case for Enron and Tyco, investors and the board are likely to be less critical”. Jensen (1993) observes that “few boards in the past decades have done this job [monitoring] well in the absence of external crises”. Research has been conducted on board monitoring during an Enron-type of bankruptcy crisis, but not on board monitoring activities during a capital market financial meltdown, such as the Asian financial crisis, in markets with strong outside investor protection.

  3. The significant differences between the two economies are graphically highlighted in La Porta et al. (1997, 1998) where countries are ranked along two axes, investor protection and the relative size/efficiency of their external markets. South Korea is placed near the center at the bottom alongside Pakistan, whereas Hong Kong is located near the upper right-hand corner with the United States and the United Kingdom.

  4. About 7 years after the AFC, Hong Kong was completely convergent with IAS rules, a condition not yet met in either the United States or the United Kingdom.

  5. The World Bank/IFC ranks Hong Kong third highest among 155 capital markets in the category of Investor Protection (World Bank 2005). We assume that a similar ranking prevailed at the outset of the AFC.

  6. In their studies of Asian countries, Lemmon and Lins (2003) and Mitton (2002) define the crisis period as running from July 1, 1997, when the Thai baht was depreciated, to August 1, 1998. Our crisis period is based on the movement of the Hang Seng Index in Hong Kong.

  7. We also use raw returns as the dependent variable in the analysis, and the results are qualitatively the same.

  8. Tobin’s Q has been used as a dependent variable in regressions explaining governance structures in some studies, many of which rely on U.S. financial data during relatively stable market periods (e.g., Morck et al 1988; McConnell and Servaes 1990; Brown and Caylor 2005). However, in a rapidly declining market, such as occurred during the AFC, or in an unexpected boom (“irrational exuberance”), Tobin’s Q is not an appropriate performance measure because the values for tangible and intangible assets are rapidly and continually changing.

  9. Shareholdings of other officers are not included because the stock ownership of non-director officers is usually low, and because such information is not publicly available for Hong Kong listed firms. Furthermore, proposals for new strategies and rapid reaction to suddenly changed circumstances are evaluated only by officers on the board (executive directors).

  10. In 1997, about 67% of the sample firms classified their board members into executive and non-executive directors and did not clearly identify independent non-executive directors.

  11. Adjusted by the market returns for the same period based on the Hang Seng Index.

  12. Of the reviewed studies, Mitton and BKP consider industry, but not geographic, segments and LL does not consider either one. In measuring organizational complexity to determine its relation to stronger monitoring through governance mechanisms, Bushman et al. (2004) evaluate both types of segments.

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Acknowledgments

The authors gratefully acknowledge useful comments from participants at the 2005 Asia-Pacific Corporate Governance Conference, Hong Kong, the Accounting and Finance Association of Australia and New Zealand (AFAANZ) 2006 Annual Conference, Wellington and the AAA 2006 Annual Meeting, Washington DC. An earlier draft received the best paper award in corporate governance at the AFAANZ 2006 Conference. Partial financial support by the Faculty of Business, City University of Hong Kong is also gratefully acknowledged.

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Authors and Affiliations

  1. Department of Accountancy, City University of Hong Kong, Tat Chee Avenue, Kowloon, Hong Kong

    Sidney Leung

  2. School of Management, Binghamton University (SUNY), SUNY Binghamton, NY, USA

    Bertrand Horwitz

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  1. Sidney Leung
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Correspondence to Sidney Leung.

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Leung, S., Horwitz, B. Corporate governance and firm value during a financial crisis. Rev Quant Finan Acc 34, 459–481 (2010). https://doi.org/10.1007/s11156-009-0141-z

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