1 Do Investors Really Value Corporate Governance? Evidence from the Hong Kong Market Prof. Stephen Y. L. Cheung City University of Hong Kong

2 1. Background Corporate governance (CG) reform in Asian market Various efforts from both regional (PECC, 2001) and international (OECD, 2004) In Hong Kong (Code of Best Practice, 1999, Hong Kong Code on Corporate Governance, 2004) Family-controlled firms and Anglo-Saxon legal system in Hong Kong market

3 2. Research Question Do CG practices pay in Hong Kong market? What are the determining factors for good CG practices in Hong Kong? CG performance of China-related companies listed in Hong Kong

4 3. Literature Testing results of whether CG leads to better performance are mixed (e.g. Weiss and Nikitin, (1998), Klein (1998)) Limited studies on the association between overall corporate governance practice and firm value (e.g. Gillan et al.(2003)) Board responsibilities and composition are the focus of CG studies (e.g. Fama and Jensen(1983), Black et al.(2003))

5 4.1 Methodologies - Data 168 largest companies are covered Constituent stocks of four main indices in HK market –Hang Seng Index (HSI) –Hang Seng Hong Kong Composite Index (HSHKCI) –Hang Seng China-Affiliated Corporations Index (HSCCI), Red-chip –Hang Seng China Enterprises Index (HSCEI), H- share

6 4.1 Methodologies – Data (Cont ’ ) H-share: incorporated in Mainland China Red-chip: incorporated in Hong Kong but controlled by organizations in Mainland China Based on publicly available information (e.g. annual reports, AGM minutes, articles of association), 2002.

7 4.2 Methodologies – Survey Design Based on Revised OECD Principles (OECD, 2004) and Code of Best Practices (HKEx, 1999) Including five categories and 86 criteria Overall CG index ranges from 0~100 Transparency index and non-transparency index are constructed

8 Scorecard Followed The Five OECD Corporate Governance Principles OECD principle Number of questions & sub-questions A.Rights of shareholders 16 B.Equitable treatment of shareholders 10 C.Role of stakeholders 4 D.Disclosure and transparency 30 E.Board responsibilities 26 Total86 OECD is internationally recognized HKEx guidelines comprehensively covered 168 public companies surveyed

9 4.2 Methodologies – Survey Design (cont ’ ) Companies were ranked as good, fair and poor for each criterion Each company was rated by two different members The overall results were cross-checked by academics Avoids selection bias Measure the CG Index quantitatively, give credit to the “ amount ” of information for each of the criteria under study

Results – Descriptive Statistics CG overall Index ranges from to 76.34, average is Perform well in Section B and D, poor in Section A relatively Highest scores for HSI stocks, lowest for H-share stocks Finance and utilities sectors are on the top, property sector is on the bottom

11 Corporate Governance Performance by Categories Weak Strong A: Rights of Shareholders B: Equitable Treatment of Shareholders C: Role of Stakeholders in Corporate Governance D: Disclosure and Transparency E: Board Responsibilities

12 Corporate Governance Performance by Indices Weak Strong HSI (Hang Seng Index ) HSHKCI (Hang Seng Hong Kong Composite Index ) HSCCI (Hang Seng China-Affiliated Corporations Index ) HSCEI (Hang Seng China Enterprises Index )

13 Corporate Governance Performance by Industries Weak Strong

Correlation Matrix of All Variables

Results – Regression Results(1) Market-to-book ratio (MTBV) was used as proxy for company’s market value Positive and significant relationship between MTBV and CG Index was found Number of executive directors has negative impact The top 5 shareholders ’ holding has negative impact The inclusion in the MSCI has positive impact

16 Positive Correlation between Good Corporate Governance and Company Valuation MTBV

OLS Results for CGI with Control Variables MTBV (1)(2)(3)(4)(5) CGI0.0330**0.0428**0.0475***0.0356**0.0337** ROA2.5282**3.0430***3.0431***2.2866** Ln(TA) *** ** ** *** Current D/E BOUT BEXC *** ** Top *** *** Dummy CEO & Chairman Dummy Audit committee Dummy Compensation Dummy ADR Dummy MSCI1.4939*** Dummy H Share & Red Chips0.3374

Results – Regression Results(2) Transparency index does matter Non-transparency index become insignificant when the number of executive director and top 5 shareholder ’ s share holding add into the model ROA has positive effect on MTBV Large firms tend to be undervalued

OLS Results for Transparency Index with Control Variables MTBV (1)(2)(3)(4) TINDEX0.0371**0.0414**0.0373**0.0388*** NONTINDEX0.0179*0.0202** ROA2.3482**2.8850***2.8973***2.1137** Ln(TA) *** *** ** *** Current D/E BOUT BEXC *** ** Top *** *** Dummy CEO & Chairman Dummy Audit committee Dummy Compensation Dummy ADR Dummy MSCI1.4847*** Dummy H Share & Red Chips0.2346

Results – Regression Results(3) For China-related firms, MTBV is positively related to CG Index For local firms, the relationship is not significant Investors have different criteria to value China-related firms and local firms

21 Comparison of OLS Results between Mainland-related Firms and Local Firms MTBV China-related FirmsLocal Firms CGI0.0572** ROA *** Ln(TA) Current D/E *** BOUT BEXC ** Top Dummy CEO & Chairman Dummy Audit committee * Dummy Compensation Dummy ADR

Results – Robustness Test Why we use 86 questions? Endogeneity Performance measurement (ROE)

23 Spearman Ranking Correlation Test Spearman correlation coefficients between new and original rankings. All of the correlation coefficients below are significant at 1% level (P-value <0.0001)

24 Endogeneity Use H-shares dummy as instrumental variable Durbin-Wu-Hausman Test (Two-stage- least- squares) for endogeneity No existence of endogeneity was found

25 Performance Measurement Use Return on Equity (ROE) to measure operating performance Replace MTBV by ROE in OLS regressions Similar results were found Confirm the robustness of the OLS results

26 6. Conclusion Construct a CG measure for HK listed firms 10 points increase in CG Index implies a 33.7% increase in MTBV. Worst-to-best change in CG Index implies 147% increase in MTBV Investors care more about CG performance of China-related firms Similar results were found in Thailand market ( McKinsey & Company, Thailand IOD, 2002 ) Comparison among different markets Policy Implication - encourage adoption of best practice of corporate governance in Hong Kong

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