Current Draft : August , 2002 First Draft : April , 2002 Comments welcome To Steal or Not to Steal : Firm Attributes , Legal Environment , and Valuation Art Durnev

A simple model is presented in which the controlling shareholder chooses the quality of corporate governance under different legal regimes. The model identifies three firm-specific attributes that affect governance: investment opportunities, reliance on external financing, and ownership structure. Using firm-level corporate governance and transparency data on 859 firms in 27 countries, which reveal a wide variation in corporate governance and disclosure practices across firms within countries, we find results that are consistent with the hypotheses derived from the model. Firms with profitable investment opportunities, more reliance on external financing, and more concentrated ownership have higher-quality governance and disclose more. And firms with higher governance and transparency ratings are valued higher and invest more. Moreover, these relations are stronger in countries that are less investor-friendly, demonstrating that individual firms do adapt to poor lega l environments to achieve efficient governance practices. These results are obtained while controlling for legal regime and industry differences. In his warning to lawmakers against too much regulation following the collapse of Enron Corp., Federal Reserve Chairman Alan Greenspan stated, “We have to be careful . not to look to a significant expansion of regulation as the solution to the current problems, especially as price/earnings ratios increasingly reflect the market’s perception of the quality of accounting. ” (Wall Street Journal, March 27, 2002). Accounting quality is but one attribute that constitutes a firm’s corporate governance structure, and stock prices should reflect the overall quality of corporate governance. Any finding to the contrary would be surprising because it would imply a failure by the stock market to process information concerning corporate governance. Several studies have investigated the relation between corporate governance and performance using U.S. data (e.g., Bhagat and Brickley (1984), Bhagat and Jefferis (1991), Denis et al. (1997), Karpoff (1998), Demsetz and Lehn (1998), Denis (2001), Gompers et al. (2002)). Most of these studies show mixed results with the exception of Gompers et al., who find that corporate governance provisions related to takeover defenses are significantly related to firm valuation. The results are more definitive on the international front. Based on country-level data, previous authors have shown that better legal protection for investors is associated with higher value of stock market (La Porta et al. (1997)), higher valuation of listed firms relative to their assets or changes in investments (Claessens et al. (2002), La Porta et al. (2002), Wurgler (2000)), and larger listed firms in terms of their sales and assets (Kumar et al. (1999)). Rajan and Zingales (1998) and Demirgüç-Kunt and Maksimovic (1998) also find that industries and firms in better legal regimes rely more on external financing to fund their growth. Although these studies provide valuable insights into the effects of regulatory environment on stock markets, valuation, and corporate financing, they do not address firm-level issues such as what drives different governance structure across firms within a country and how corporate governance affects individual firm valuation. Previous and current studies attempting to address these issues include Black (2001) and Black et al. (2002), who demonstrate a strong relation between corporate governance and firm valuation in Russia and Korea, and Doidge et al. (2001), who show foreign