DOES CORPORATE GOVERNANCE PREDICT FIRMS MARKET VALUES

We report strong OLS and instrumental variable evidence that an overall corporate governance index is an important and likely causal factor in explaining the market value of Korean public companies. We construct a corporate governance index (KCGI, 0~100) for 515 Korean companies based on a 2001 Korea Stock Exchange survey. In OLS, a worst-to-best change in KCGI predicts a 0.47 increase in Tobin's q (about a 160% increase in share price). This effect is statistically strong (t = 6.12) and robust to choice of market value variable (Tobin's q, market/book, and market/sales), specification of the governance index, and inclusion of extensive control variables. We rely on unique features of Korean legal rules to construct an instrument for KCGI. Good instruments are not available in other comparable studies. Two-stage and three-stage least squares coefficients are larger than OLS coefficients and are highly significant. Thus, this paper offers evidence consistent with a causal relationship between an overall governance index and higher share prices in emerging markets. We also find that Korean firms with 50% outside directors have 0.13 higher Tobin's q (roughly 40% higher share price), after controlling for the rest of KCGI. This effect, too, is likely causal. Thus, we report the first evidence consistent with greater board independence causally predicting higher share prices in emerging markets. † Earlier versions of this paper were presented at American Law and Economics Association, (Second) Asian Conference on Corporate Governance, European Financial Management Association, Haas School of Business at University of California, Berkeley, Harvard Law School, International Monetary Fund, Korea America Economic Association annual meeting, Korea Association of Industrial Organization, KDI School of Public Policy and Management, Korea Fair Trade Commission, Korean Financial Association, (8th) Mitsui Life Symposium on Global Financial Markets, National Bureau of Economic Research Conference on Corporate Governance, Seoul National University College of Business Administration, Stanford Graduate School of Business, Stanford Law School, University of Chicago Law School, University of Texas Law School, and World Bank. We thank Wenton Zheng for research assistance and Stephen Bainbridge, Lucian Bebchuk, Harold Demsetz, John Donohue, Jeffrey Gordon, Daniel Hamermesh, Miyajima Hideaki, Ji-Sang Jang, Simon Johnson, Louis Kaplow, E. Han Kim, Kate Litvak, Florencio Lopez-de-Silanes, Inessa Love, Stephen Magee, Jun Qian, Trond Randoy, Mark Roe, Hyun-Han Shin, Jeff Strnad, Michael Weisbach, and Bernard Yeung for comments on earlier drafts. * Updated affiliation: Chabraja Professor at Northwestern University, Law School and Kellogg School of Management. Tel. 312-503-2784, email: bblack@northwestern.edu ** Professor of Finance, Korea University Business School, Anam-Dong, Sungbuk-Ku, Seoul, Korea 136-701. Tel: (+82-2) 3290-1929, e-mail: jangya@chollian.net *** Updated affiliation: Professor of Finance, Korea University Business School, Anam-Dong, Sungbuk-Ku, Seoul, Korea 136-701. Tel: (+82-2) 3290-2816, e-mail: wckim@korea.ac. kr