Weak Investor Protection Research Articles

Does high cash compensation compromise the independence of outside directors? Evidence from directors' dissenting votes in China

Using data on directors' voting behaviour in board meetings in China, we examine whether high cash compensation compromises outside directors' independence in markets with weak investor protection. The results show that highly paid outside directors are more likely to vote against proposals sponsored by executives, particularly in firms with weaker monitoring of executives. Highly paid outside directors are also positively associated with cash dividends and future firm performance. Overall, the evidence suggests that high cash compensation reflects the market value of reputable outside directors and reputation concerns motivate outside directors to maintain their independence and challenge executives in board meetings.

Legal origins of corporate governance: Choice of law in Egypt, 1887–1914

AbstractThis paper revisits the classic question of legal origins: whether laws originating from common or civil law traditions are more effective in promoting governance rules with stronger shareholder and investor protection. But corporate governance cannot be easily disentangled from other sources that can influence firm outcomes. This paper disentangles these effects by assembling a new dataset of corporations in Egypt between 1887 and 1914. Egypt had an unusual system of incorporation. The main legal system was a close French transplant but entrepreneurs – Europeans and Egyptians alike – had the option of incorporating under any European law. This practice allowed extraordinary legal flexibility in choice of law, governance provisions, and board composition. The new findings show that companies incorporated under British law provided weaker shareholder protection than companies incorporated under French laws, especially in giving weaker voting rights to minority shareholders, preventing oversight over directors' borrowing powers, and limiting director rotation. These rules mattered for firm performance. Corporations with weaker investor protection had higher failure risk, were less profitable, and had lower firm value.

ESG performance and corporate risk-taking: Evidence from China

Corporate environmental, social and governance (ESG) is vital for sustainable growth, while the motivation of corporate ESG engagement could decide whether ESG participation is green or greenwashing behavior. This paper attempts to understand the motivation of corporate ESG engagement from the firm's risk-taking perspective. Using Chinese publicly listed firm data from 2010 to 2020, we find that ESG rating significantly reduces corporate risk-taking. This finding still holds after a series of robustness tests to address potential endogeneity concerns and alternative risk-taking proxies. Furthermore, the marginal inhibitory impact of ESG on corporate risk-taking is more pronounced in firms with lower information transparency, weaker corporate governance and less external monitoring pressure. Our results shed essential insight on the trade-off between sustainable growth and corporate risk-taking behavior in a relatively weak investor protection institutional environment.

Regulatory Protection and Opportunistic Bankruptcy*

ABSTRACTWe document controlling shareholder (insider) opportunism in an insolvency regime that uses an accounting rule to determine bankruptcy eligibility. Our study sheds light on managerial incentives induced by weak investor protection laws. Using unique data on bankrupt firms from an emerging market, consistent with our prediction, we show insiders intentionally manage earnings downward to understate firm net worth so as to be able to file for bankruptcy. Downward pre‐bankruptcy earnings management is associated with more payments to insiders and weaker performance, post‐filing. A battery of tests suggests our results cannot be fully explained as an artifact of financial distress. Rather, they are consistent with insiders exploiting weak investor protection to extract private benefits at the expense of lenders and outside shareholders. Our study serves as a cautionary tale for all insolvency regimes that use a balance sheet test in an environment with weak creditor protection.

Risk-preparedness mechanism and audit quality: Evidence from mandatory increase of professional indemnity insurance and professional risk fund

We examine the risk-preparing benefits of Chinese audit firms’ professional indemnity insurance (PII) and professional risk fund (PRF) by using the Notice on Adjusting the Application Requirement of Audit Firms for Securities Qualifications as an exogenous shock. This policy requires audit firms to raise the sum of the cumulative compensation limit of their PII and PRF from 6 million to 80 million yuan. It is found, first, that the capital market regards this policy revision as a signal to strengthen investor protection and responds positively; client firms with high audit risks have a stronger response. Second, auditors’ governance of financial information has strengthened, resulting in the significant improvement of their clients’ financial reporting quality, with a stronger effect on firms with higher earnings management risk. There is no evidence that audit firms pass the costs on to their clients. Finally, the mismatch between auditors and new client firms is alleviated. We show that in an emerging market with weak investor protection, establishing a sound risk-preparedness mechanism for audit firms and strengthening the capacity for civil compensation ex post greatly improve the adaptive degree between international auditing standards and the legal environment of China, thereby enhancing the overall service quality of the audit market.

Impact of Corporate Hedging and ESG on Stock Price Crash Risk: Evidence from Indonesian Energy Firms

Corporate hedging and environmental, social and governance (ESG) affect the transparency of a firm’s information environment because they can reduce information asymmetry and volatility of cash flow. Focus of this research investigates the impact of corporate hedging, as a risk management strategy, and ESG on stock price crash risk in Indonesian energy firms. This study finds that both hedging and ESG do not affect stock crash risk. This may be caused by a natural hedge conducted by the company. Another explanation is, most energy companies in Indonesia that use hedging do not report the proportion of the amount of hedging on the company’s financial statements. Further, this study fails to find the effect of ESG on stock crash risk. This finding corroborates Silva (2022) , who states that the benefit of ESG is less effective in developing countries like Indonesia, which are characterised by weak investor protection and regulation enforcement.

Earnings Quality and Trading Volume Reactions Around Earnings Announcements: International Evidence

Using a cross-country setting, we document differences in the relation between earnings quality and the two components of trading volume around earnings announcements, one related to differential interpretation of the earnings signal and the other related to pre-event differential information precision. We find that in countries with stronger investor protection, less corrupt governments, and more liquid stock markets, a noisier earnings signal increases differential interpretation of the earnings signal but decreases investors’ incentive for information acquisition before earnings announcements, leading to lower pre-event differential information precision. However, these trading patterns flip in countries with weaker investor protection, more corrupt governments, and less liquid stock markets. We also find that institutional investors in countries with stronger institutions are likely to benefit more from their superior information processing skills, leading to more information acquisition both at and before earnings announcements. Overall, our study adds to the literature by documenting significant cross-country variations in investors’ trading volume reactions to earnings quality.

Directors and officers liability insurance and maturity mismatch: evidence from China

ABSTRACT We investigate the impact of the purchase of Directors’ and Officers’ liability insurance (D&O insurance) on a firm’s risk-taking behaviour in China, measured by the firm’s maturity mismatch ratio. Using a unique manually collected dataset, we find a significant positive relationship between a firm’s purchase of D&O insurance and the firm’s maturity mismatch ratio, which supports the moral hazard theory. The mechanisms of our main finding are corresponding internal and external monitoring, in which the main finding is only significant for firms under weak monitoring. Our result remains significant after employing several approaches to alleviate potential endogeneity concerns, including an alternative sample and the sensitivity test model. Our paper sheds some extra light on the issue related to D&O insurance in a country with inadequate internal supervision and weak investor protection and the determinant of a firm’s maturity mismatch ratio.

Domestic liquidity of cross-listed stocks: Evidence from the ADR market

This paper examines the impact of cross-listing in the US on domestic liquidity of the cross-listed stocks. We use a sample of firms from 31 developed and emerging economies that cross-listed their shares on major US stock exchanges through an American Depository Receipt (ADR) program between 1998 and 2020. The study finds that domestic liquidity increases significantly following a US cross-listing for both developed and emerging market firms. Our results suggest that for firms in developed markets, domestic trading activity decreases before and during the cross-listing year. However, it increases significantly in the long-term, suggesting evidence of the ‘flow back’ effect. For firms in emerging economies, the anticipatory, impact, intermediate and long-term effects on domestic liquidity are all significantly positive. We also find evidence for the ‘bonding hypothesis’ suggesting that the improvements in domestic liquidity are greater for cross-listed firms from countries with low rule of law, weak investor protection and bad quality of accounting information long-term.

Mind the sovereign ceiling on corporate performance

We find direct evidence that sovereign default risk has a negative impact on corporate performance via a rating spillover pooling mechanism. Our results show that this adverse effect is concentrated in firms that are more likely to experience limited access to external finance following a rating downgrade. Difference-in-differences tests exploiting the heterogeneity in corporate credit ratings following sovereign rating downgrades reveal that firm performance deteriorates predominantly for sovereign bound firms with higher information asymmetry, limited financial flexibility, and those operating in countries with less developed banking systems and weaker investor protection.

Acquiring firms’ transparency and their returns around M&A announcements: Evidence from China

This study empirically examines the effects of the information transparency of acquiring firms on their stock returns around merger and acquisition (M&A) announcements in China. We find that acquiring firms’ information transparency is positively associated with their returns within M&A announcement windows. Our cross-sectional analyses show that such associations are more significant for acquiring firms from regions with an underdeveloped market institution, with lower institutional investor shareholdings, and that are state-owned, suggesting that acquiring firms’ information transparency is a critical determinant of perceived M&A benefits in environments with severe agency problems. We expect our results to be relevant to other emerging markets with institutional characteristics similar to those of China, such as significant agency problems and weak investor protection.

Country-level determinants, takeover locations, and the gains to target firms

This study enhances the understanding of imperfect factor markets by examining the impact of country-level factors on takeover location decisions and the gains to target firms. The focus of this study is on eight East and Southeast Asian countries, where there have been significant changes regarding corporate governance structures and practices following the 1997-1998 Asian financial crisis. The results suggest that the likelihood that a completed deal is a cross-border acquisition rather than a domestic acquisition is higher for target countries with lower government quality, weaker investor protection, stronger restrictions on capital mobility, lower corporate tax rates, and more depreciated currencies. Further, the study documents that target firm shareholders experience positive and significant abnormal returns in both cross-border and domestic acquisitions around the announcement date; but cross-border target firms gain significantly higher returns than domestic target firms.

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.

Investor protection, hedge fund leverage and valuation

Weak investor protection inevitably causes concentrated insider equity ownership, economic decision distortion and resource misallocation (Shleifer and Vishny, 1993). Our paper focuses on theoretical hedge fund valuation and dynamic leverage choice by incorporating the consideration of weak investor protection. The weak investor protection effect on dynamic leverage choice is ambiguous, as it depends on the managers’ moneyness ratio, which will certainly have a negative effect on the hedge fund investors’ payoff. Thus, managers should take more ownership and engage in short volatility strategies in weak investor protection to secure their total payoff.Weak investor protection also significantly increases the hedge fund founding break-even alpha.

Earnings management during financial crisis: The case of Greece

Research Question: Did Greek listed firms engage in earnings management practices during the initial phase of the 2010's economic crisis? Motivation: Impact of structural attributes of a country along with firms' characteristics on economic entities' accounting policy decisions. Idea: Firms' accounting policy decisions are conditioned upon their characteristics and the conditions prevailing in the broader economic and business environment. We investigate whether these factors affect firms' propensity to engage in earnings management within a context of financial distress. Data: The sample consists of all Greek listed firms which were active for the period 2009-2014. Tools: We employ the Kothari et al (2005) model to estimate discretional accruals of Greek listed firms. Findings: The family-controlled Greek firms that are audited by Big-4 Auditing firms are likely to use discretionary accruals in order to affect accounting figures. This finding may be attributable to the family control of the firms, along with the weak legal enforcement and investor protection that prevail in Greece. In addition, discretionary accruals show a positive relation with firm’s ability to cover its current liabilities using current assets while they are negatively associated with cash-flow from operations. Contribution: This study contributes to the existing literature on earnings management. Our research has been conducted in the initial phase of financial crisis and within an economic environment which is characterized by family-controlled firms, dependency on debt financing and low investor and creditor protection.

Earnings management and stock price crashes post U.S. cross-delistings

We examine whether cross-delisted firms from the major U.S. stock exchanges experience an increase in crash risk associated with earnings management. Consistent with our prediction, we find that earnings management has a greater positive impact on stock price crash risk post cross-delisting when compared to a control group of firms that remain cross-listed. More importantly, we find that this effect is more pronounced for cross-delisted firms from countries with weaker investor protection, poorer quality of their information environment and less conservative accounting practices. Our findings are robust to the potential endogenous nature of the cross-delisting decision, alternative measures of stock price crash risk and information asymmetry. We interpret our results as evidence of a “reverse bonding effect” following cross-delistings from U.S. stock exchanges.

Soft activism and corporate dividend policy: Evidence from institutional investors site visits

We study the governance effect of institutional site visits and focus on corporate payout. Due to the weak investor protection and poor information quality in China, institutional investors resort to site visits as a form of soft activism. We show that site visits lead to an increase of corporate cash dividend, through the mechanism of disciplining management with exit threats. Such effect is more pronounced for visits by state-owned institutions. We further confirm the causal link with both difference-in-difference analysis and instrumental variable regression. The paper contributes to the research on soft activism and governance device of institutional investors in weak institutional environments.

Board of directors and target price performance: evidence from Tunisia

PurposeThis article examines the link between the structure of the board of directors and target price accuracy using a sample of 51 listed firms on the Tunisian Stock Exchange over the period of 2011–2017.Design/methodology/approachIn this study, the authors used the generalised method of moments (GMM) model to control the endogeneity problem.FindingsAs a result, that model can serve as a signal in the forecasting process. The authors' results suggest that target price accuracy is negatively related to board independence, and dual Chief Executive officer (CEO). In addition, CEO compensation tends to exert a negative impact on target price error.Practical implicationsThe authors' findings are valuable for common investors because the findings can be useful in enhancing their capital allocation decisions by assigning higher weights to forecasts issued by firms with strong corporate governance systems. The authors' study also has practical implications for managers and policymakers. Specifically, the evidence provided herein suggests that firms with strong corporate governance mechanisms enhance the accuracy of market expectations, alleviate information asymmetry, and limit market surprises, especially in a context characterised by weak investor protection. The authors' results highlight the advantages of strong corporate governance in improving a firm's information environment and, therefore, are useful for the cost–benefit analysis of improving internal governance mechanisms. Additionally, the authors' results may prove useful to investors who can rely on the information provided by analysts for well-governed companies.Social implicationsThe authors' study contributes to the literature in both corporate governance and analysts' forecasts fields. The study provides additional evidence of the benefit of board quality attributes on target price accuracy in an emerging market characterised by high information asymmetry and weak investor protection. The authors' findings exhibit the effectiveness of board attributes in producing better financial information quality in Tunisia. This is useful for investors who may improve their capital allocation decisions by assigning greater weights to target price forecasts of companies with good governance quality, suggesting that good corporate governance is a credible signal of better financial information quality. These results have important implications for capital market regulators and corporate management in encouraging the implementation of good governance practices.Originality/valueThe authors attempted to assess whether corporate governance of listed firms are priced in the Tunisian context characterised by weak governance control and to highlight which mechanism is highly considered by independent financial analysts to build their forecasts.

Multinational enterprises’ internationalization and adoption of sustainable development goals

PurposeUsing a sample of 1,517 multinational enterprises (MNEs) from 25 countries, this study aims to examine whether firm’s level of internationalization has a deterministic role for their engagement with sustainable development goals (SDGs). Additionally, this study aims to investigate the country- and industry-specific moderation effects on the relationship.Design/methodology/approachThis study employs negative binomial regression model along with the fixed effects for industry and time in the empirical estimation.FindingsThis study shows that MNEs’ internationalization is associated with their higher engagement in SDGs. This is owing to the pressures MNEs face from diverse stakeholders coupled with the need to build local legitimacy to overcome the liability of foreignness. The country-level results of this study suggest that this positive relation is stronger in countries with weak legal environment, countries with weak investor protection and in countries with higher SDG index scores. However, the industry-level results of this study indicate that the positive relation between MNEs internationalization and their SDG engagement are weaker in industries facing more competition and industries exposed to negative externalities. The results survive to controls for factors specific to firm and industry.Originality/valueThis study is one of the early studies which empirically examine the role of MNE internationalization and SDG engagement. Also, the findings of this study improve the understanding on country-specific and industry-specific challenges in implementing SDGs.

Debt maturity structure and firm investment in the financially constrained environment

PurposeThe financial policies of the modern world corporations and their investment decisions are generally considered as interrelated because the agency problems, associated with the debt level and its maturity structure, give rise to incentives for overinvestment or underinvestment. The present study empirically investigates the linkage between debt maturity structure and firm investment in a financially constrained environment, using Pakistan as a case study, to determine how the institutional environment in which firms operate affect these decisions and their linkage.Design/methodology/approachThe empirical analysis is carried in a panel data setting using panel regression models as the baseline methods. Moreover, generalized methods of moments (GMM) estimators are used, coupled with the instrumental variables approach, for robustness and improving the efficiency and consistency of estimates.FindingsResults suggest that firms rely more on short financing in Pakistan. Thus, given the capital structure which is characterized by higher proportion of short-term financing, the higher level of leverage is less likely to cause underinvestment problem. However, the underinvestment problem do persists in the firms that have higher portion of long-term debt. These findings imply that the debt-overhang problem may persist even in the financially constrained environments where attractive investment opportunities are limited, and long-term financing is difficult to acquire.Originality/valueThis study contributes to the literature by revealing how corporate investment and financing decisions and their linkage is influenced by the institutional environment of the less developed countries which is characterized by underdeveloped financial markets, inefficient legal system and weak investor protection system.