Reducing Risk Through Governance: Impact of Compensation, Defense, and Accounting Practices

Reducing Risk Through Governance: Impact of Compensation, Defense, and Accounting Practices

I-Jan Yeh (Shih Hsin University, Taiwan), Ching-Liang Chang (Yuan Ze University, Taiwan), Joe Ueng (University of St. Thomas, USA) and Vinita Ramaswamy (University of St. Thomas, USA)
DOI: 10.4018/978-1-5225-3909-4.ch082
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The main purpose of this study is to investigate the determinants of formal governance policy. Many firms have a formal governance policy. Others, however, have no such a policy. This study examines what kind of firm's characteristics that encourage companies to adopt a formal governance policy. Data were collected from Corporate Library. A sample of 3,068 firms from the database of 2010 Corporate Library was analyzed. Results show that when firms have a better financial performance and better corporate governance practice, they are more likely to have a formal governance policy. Specifically, when firms have a better board rating, compensation policy, takeover defense strategy, and accounting practice, firms are more likely to have a formal governance policy.
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Literature Review

Prior studies, in general, have documented that the adoption of a formal corporate governance policy has a positive impact on the firm’s value. Having a formal corporate governance also enhances shareholders’ value. Ashbaugh-Skaife et al. (2006) investigated whether firms with strong corporate governance will result in higher credit ratings relative to firms with weaker governance. They documented that credit ratings are negatively related to the quality of corporate governance, proxied by the number of block holders and CEO power, and positively related to takeover defenses, accrual quality, earnings timeliness, board independence, board stock ownership, and board expertise.

Bai et al. (2004) investigated the relationship between governance mechanisms and the market valuation of publicly listed firms in China. They examine the effect of corporate governance variables on market valuation after controlling for factors commonly used in market-valuation analysis. Their results indicated that both high concentration of non-controlling shareholding and issuing shares to foreign investors have positive impact on the firm’s market valuation, while a large holding by the largest shareholder, the CEO being the chairman or vice chairman of the board of directors, and the largest shareholder being the government have negative effects.

Black et al. (2006) provide evidence that an overall corporate governance index is an important and likely causal factor in explaining the market value of Korean public companies. Evidence from his study differs from what Bai documented in their study.

Gompers et al. (2003) used the incidence of 24 governance rules and constructed a “Governance Index” to proxy for the level of shareholder rights at about 1,500 large firms during the 1990s. They find that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions. Their study suggests a positive relationship between the power of shareholders and the firm’s financial performance.

Bauer et al. (2003) analyzed whether good corporate governance leads to higher common stock returns and improves firm value in Europe. Surprisingly, and contrary to Gompers, et al., Ishii and Metrick (2003), they find a negative relationship between governance standards and these earnings based performance ratios.

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