Strong Investor Protection Research Articles

Media coverage of corporate social irresponsibility and audit fees: International evidence

This study uses a large sample of firms from 35 countries to examine how media coverage of corporate social irresponsibility (CSI) affects audit fees. We document a positive and significant relationship between media coverage of CSI and audit fees. Further evidence indicates that this positive relationship is less pronounced for firms with a higher level of commitment to corporate social responsibility (CSR) performance but is more pronounced for firms domiciled in countries with stronger investor protections, higher regulatory quality and higher CSR disclosure requirements. Taken together, these findings support the conjecture that CSI media coverage increases auditors' risk and thereby increases audit fees. Moreover, our findings suggest that the effect of media coverage of CSI on audit fees varies with country‐level institutional characteristics and the degree of firms' substantive commitment to CSR performance.

Societal trust and corporate underinvestment

We extend prior literature by showing that societal trust is a significant determinant of corporate investment policy. Firms in countries with a higher level of societal trust are less prone to underinvestment. We posit that the association between trust and underinvestment relates to a reduction of financial constraints. However, when we split our sample using different proxies for the level of financial constraints, we document that trust has an additional effect on underinvestment beyond enhanced access to capital. Consistent with the view that trust and conventional forms of governance are substitutes, we demonstrate that the effect of trust on underinvestment is reduced for firms in countries with strong investor protection.

Tax Avoidance and Firm Value: International Evidence*

Desai and Dharmapala (2006, 2009a, b) and Desai et al. (2007) propose that corporate governance plays a crucial mediating role in the relationship between tax avoidance and firm value (the D&D theory). This theory has received considerable attention in the tax accounting literature, but evidence remains mixed. We extend the D&D theory to an international setting and argue that country-level characteristics moderate the relationship between tax avoidance and firm value. Using a sample of firms from 45 countries, we find that the relationship between tax avoidance and firm value is positive when transparency or stock market development is high but negative when investor protection is strong. Our findings suggest that a key determinant of the positive effect of tax avoidance on firm value is a transparent and developed stock market environment. Under low transparency, shareholders in countries with strong investor protection regard tax avoidance as a negative signal of managerial diversion due to a lack of understanding of tax avoidance. Our research contributes to the debate on the link between tax avoidance and firm value according to the D&D theory by providing additional insights on the mediating roles of country characteristics.

Board directors' foreign experience and firm dividend payouts

We find that Chinese-listed firms are more likely to pay dividends and implement larger payout ratios when their directors have foreign experience. This finding remains after using various methods to address potential endogeneity concerns. The positive association is stronger for low-growth firms, non-state-owned firms, and when directors obtain foreign experience in countries with stronger investor protection. The effect of directors' foreign experience on dividend payouts is also more pronounced for independent directors than for executive directors. Directors with foreign experience appear to overcome the weak investor protection environment as the effects are more pronounced among poorly governed firms and before the regulatory dividend reforms in 2013. Overall, our findings identify a mechanism through which better governance practices are propagated.

The impact of globalization and the legal system on stock market quality

ABSTRACT This study examines how globalization affects stock market quality, whether investor protection serves as a channel in this relationship, and how the channel effect varies depending on the legal system. Our empirical analysis confirms that there is a positive causal relationship between globalization and market quality. Also, since we find that globalization induces stronger investor protection, we disentangle the component of investor protection predicted by globalization. Our analysis shows that the globalization-induced component of investor protection has a significantly positive effect on market quality, which demonstrates the role of investor protection as a channel. Finally, we show that these relationships among globalization, investor protection, and market quality are present in civil law countries but not in common law countries. This illustrates that globalization enhances financial market quality via a stronger ability to effect institutional change and investor protection in civil law countries.

Do foreign investors deter corporate fraud? Evidence from China

This paper investigates the effect of foreign investment on corporate fraud in China. Using a sample of 2,838 firms over the period of 2004–2016, we find that foreign investment helps reduce the risk of corporate fraud. Specifically, foreign investment decreases the likelihood of committing fraud, the frequency of fraud, and its severity. Further evidence suggests that the effect is largely driven by foreign block investment and investment from countries with strong investor protections. Also, the effect of the phenomenon is more pronounced in state-owned enterprises than in non-state-owned enterprises. Our findings suggest that foreign investors play an active monitoring role in emerging markets.

Corporate tax avoidance, economic policy uncertainty, and the value of excess cash: International evidence

This paper presents new evidence on the links between corporate tax avoidance, economic policy uncertainty, and the value of excess cash. Based on an international sample of 41,535 firm-year observations from 2005 to 2018, the results show that tax avoidance negatively affects the value of excess cash. This negative effect is only prevalent for firms operating in countries with strong investor protection. This study also explores the role of economic policy uncertainty and shows that tax avoidance lowers the discount on the value of excess cash in uncertain times because investors may underestimate any negative reputational and risky practices. These findings have important implications for investors, policymakers and the welfare of the overall economy.

Corporate Governance Reforms and Cross‐Listings: International Evidence*

ABSTRACTIn this study, we examine whether a country's implementation of major corporate governance reforms affects firms' cross‐listing activities. Cross‐listing is important in overcoming international investment barriers and thus it is worth investigating whether enhanced corporate governance at the country level contributes to the integration of international capital markets. Using a difference‐in‐differences research design, we predict and find that following the implementation of corporate governance reforms in their home countries, firms are more likely to engage in cross‐listing activities and tend to cross‐list in host countries with stronger investor protection and more developed markets than those in countries with no reforms in the same period. The results from country‐level cross‐sectional tests indicate that this effect is greater for firms in home countries with weaker investor protection and less developed stock markets in the prereform period. The reforms also have a stronger effect on firms subject to less analyst following and greater external finance dependence. Finally, we find a stronger association between cross‐listing activities and institutional ownership after the reforms. Taken together, this study increases understanding of the trade‐off between cross‐border capital supply and demand. Our finding suggests that country‐level corporate governance plays an important role in facilitating the supply of cross‐border capital, which in turn incentivizes firms to cross‐list. Our study also offers policy implications for national stock exchanges and securities regulators by suggesting that countries without well‐developed capital markets should strengthen their corporate governance to improve firms' ability to raise external financing and attract cross‐border capital flows.

Does investor protection affect corporate dividend policy? Evidence from Asian markets

AbstractThis study investigates the nexus between investor protection and dividend policy for 517 listed nonfinancial firms operating in Asian countries between the period 2008 and 2017. The dynamic panel data model (System‐GMM) reveals that stronger investor protection is associated with higher dividend payouts, and firms increase dividends, specifically in response to the rise of the extent of disclosure and director liability and also ease of shareholder suits. Besides, results highlight that firms pay out fewer dividends in cases of growth opportunity particularly in environments with stronger investor protection, a more developed financial market, and a common‐law system. Results are robust when alternative specifications are implemented.

The Real Effects of Private Equity Buyouts: A Meta-Analysis

Using a meta-analytical approach, this study reviews the fragmented and contradictory empirical literature on the real effects of private equity (PE) on their portfolio companies, focusing on post-buyout operating performance and employment. Based upon 330 samples including 403,820 firms, we find a positive PE effect on operating performance in the medium-to-long term, but no effect on employment. Interestingly, performance gains are stronger in private-to-private buyouts compared to public-to-private buyouts. Countries with strong investor protection laws or with individualistic cultures facilitate larger operating performance gains, while employees are better off in countries with more stringent employee protection laws or with collectivistic cultures.

Is short-term debt a substitute for or complementary to good governance?

Short-term debt can reduce potential agency conflicts between managers and shareholders by exposing managers to more frequent monitoring by the credit market. Using an international dataset, we examine whether internal monitoring can substitute for external monitoring through the use of short-term debt. We find that the relationship between debt maturity and governance depends on the institutional environment in a given country. In common-law countries and in countries with stronger investor protection rights, governance and short-term debt act as substitutes. The extent of creditor rights, state-level governance quality, cultural characteristics, and economic development levels of countries also play a role in explaining the relationship between governance and debt maturity.

Country-level corporate governance and lines of credit

Agency problems related to country-level investor protection are important determinants of corporate liquidity management. This paper extends the work of Dittmar, Mahrt-Smith, and Servaes (2003) on country-level governance effects on corporate liquidity but with a focus on line of credit. Since both line of credit and cash constitute integral elements of a company's liquidity policy, a complete understanding of how country-level governance affects liquidity management requires that we also examine its impact on firm-level utilization of line of credit. Using a large sample of international firms from 44 countries, we find that in economies where investor protection is strong, the likelihood and the magnitude of line of credit obtained is higher. We also show that the substitutability of the line of credit and cash holding is stronger in these countries. Our study implies that minority owners in countries with strong investor protection can force corporate managers to disgorge cash and increase their reliance on monitored liquidity through line of credit.

CSR and investment efficiency in Western European countries

AbstractThe aim of this study is to examine: (i) whether investment efficiency is associated with CSR performance and (ii) whether this relationship varies with the strength of investor protection. Using firm level data from Western European countries, we document a positive association between CSR score and investment efficiency. We further find that the effect of CSR on investment efficiency is driven by the areas Human Ressources, Business Behavior, Corporate Governance, and Human Rights. Finally, we find that the documented association is statistically and economically more significant in countries with stronger investor protection.

Investor protection and resource allocation: International evidence

We use a multi-period equation system to examine how international manufacturing firms allocate internally generated operating cash flow to different uses. With one dollar increase in operating cash flow, firms use about half to reduce external financing and about a quarter to increase cash balances. Another quarter or so is spent on investment and only a tiny portion is paid out as dividends. Furthermore, firms in countries with strong investor protection save less out of operating cash flow and retire more external financing, especially the equity. Additional analysis reveals that the cost of equity capital is lower in firms retiring more external funds and/or saving less. Our study provides a new perspective to evaluate the fund allocation decisions of international firms.

Equity ownership and corporate transparency: International evidence

This paper investigates the effect of insider ownership on stock price synchronicity. Specifically, for countries with poor investor protection, the managerial entrenchment effect dominates. When ownership increases, synchronicity increases at an increasing rate. However, for countries with strong investor protections, managerial entrenchment effect only dominates the incentive alignment effect when controlling ownership increases initially. As controlling ownership continues to increase, the incentive alignment effect becomes stronger and the net effect is reversed, leading to a more transparent firm. Additional tests reveal that financial reporting framework and insider trading law enforcement are crucial external governance channels affecting stock price synchronicity.

The Importance of Director External Social Networks to Stock Price Crash Risk*

ABSTRACTPrior research documents that information transmitted via director networks affects firms' policies and real economic activities. Given a manager's potential monopoly over firm information, it is important to analyze whether information transmission through director social networks undermines the manager's control. Specifically, we explore whether information flow through director networks influences managers' ability to hoard bad news. We predict and find that the extent of external connections of the board of directors is negatively associated with future stock price crash risk. Additional analysis implies that this evidence is driven by firms with more powerful executives, with weaker auditor monitoring, or subject to strong investor protection, and by directors with greater monitoring incentives or responsibilities and directors with less firm‐specific knowledge. Collectively, our research lends empirical support for the monitoring view under which better‐informed directors narrow the scope for bad news hoarding evident in stock price crash risk. In another series of tests, we fail to find evidence consistent with the information leakage view under which directors pass sensitive firm‐specific information to connections that trade on the information before its public release. Other analysis helps dispel the concern that the endogenous match between directors and companies is spuriously responsible for our core results. Our empirical findings have important implications on how social networks affect the proper functioning of capital markets.

The speed of adjustment in net operating working capital: an international study

ABSTRACT This paper analyses whether there are differences in the speed of adjustment in net operating working capital (NWC) across countries. Unlike prior research, which reported that the adjustment speed of any current item is always rapid, we find that the speed of adjustment to NWC targets depends on a country’s investor protection and financial development. Specifically, using a sample of firms from 30 countries, we show that NWC adjustment speeds vary across countries, and they are faster for companies that operate in countries with stronger investor protection and greater financial development.

The Price of Corporate Social Irresponsibility at Seasoned Equity Offerings: International Evidence

We examine the effect of corporate social responsibility engagements signaled through negative environmental and social (E&S) incidents on equity financing via seasoned equity offerings (SEOs) across 25 countries. The results show that negative E&S incidents significantly aggravate SEO underpricing, increasing cost of equity capital. We assess potential explanations from the perspective of corporate reputation risk and regulatory risk. We find support for both channels. Social reputation acts as a buffer against reputation risk arising from the E&S risk events while strong country-level E&S policies inflict regulatory risk to violating firms following E&S incidents leading to adverse E&S effects at SEOs. Further analysis reveals that the adverse pricing effects of firm E&S risk are driven by the social awareness of institutional and retail investors. We also find that the impact is negligible with the presence of larger blockholders. Managers appear to pre-empt the adverse effects by reducing the likelihood of equity financing in wake of negative incidents. Finally, there are rich cross-country variations in the pricing effects of E&S risk whereby common law countries and those with strong investor protection and individualistic but low power distance cultures suffer most from the adverse E&S incidents around SEOs.

Trade Policy Uncertainty and Global Stock Returns: Evidence from the 2016 US Presidential Election

Pastor and Veronesi (2012) develop a general equilibrium model to examine the relation between policy uncertainty and asset prices. Extending to their study, we develop a novel measure of firms’ uncertainty about the change in bilateral trade flows between each country and the US. We investigate the effect of trade policy uncertainty on the stock returns of firms in 52 countries around the 2016 US presidential election. Our findings show that firms with greater uncertainty about trade policy experience more negative stock returns during the election. Our results further show that this effect is more prominent for riskier firms or firms with more firm-specific information in their stock prices. Additionally, this effect becomes stronger in countries with closer social, economic, and political integration with the US or with stronger investor protection.

Reasons behind the worldwide diversity in identity and issuance of good governance codes

This study examines the impact of socio-economic factors on the number of good governance codes and issuers of the first codes at the macro-country level. By covering 3200 observations for 160 countries over 1995–2014, this study reports that countries with Anglo-Saxon culture and strong investor protection laws have developed a large number of good governance codes to meet the efficiency needs of legal, political, and cultural values. Moreover, this paper shows that countries with English common law origin alongside civil or religious law have developed a large number of good governance codes. Furthermore, this study indicates that countries with high regulatory quality index have issued a large number of governance codes as a response to the external forces that emerge from coercive associations. However, this study found a positive and significant association between the control of corruption index and the number of governance codes issued by governments to mitigate corruption risk. Additionally, this study reports that countries that issued a large number of good governance codes have gained substantial foreign direct investments inflows and financial aid. This study, therefore, provides meaningful implications for governments and policymakers in countries with weak regulations to issue new governance codes for protecting investors’ rights, thus gain more financial resources.