A common approach to testing whether established good governance is reflected in the firm’s performance and market valuation is to regress Tobin’s Q (and later ROA) on corporate governance scorecard controlling for those factors affecting firm value. The following models are for part two analysis.
The three setups namely pooled, SIC effects and firm effects are studied for all the equations as did in part one. SCORE2 is added to control for nonlinearity if any.
We also use return on total assets (ROA) as an alternative measure of firm performance, which is calculated as Net Income/Total Assets. The model structures are the same as in equations (4) to (9).
Table 4 reports the estimated coefficients with Q as dependent variable. The first three columns report results from Equation (4). Equation (5) with SCORE2 term does not change the ownership pattern, whose estimates are shown in Columns four to six. Columns seven to twelve are for regressors of firm characteristics as given in Equation (6) and (7). Finally, the last six columns present results from Equation (8) and (9).
The prominent finding of performance analysis is that SCORE has the predicted sign and is significant only after controlling for firm fixed effects. Under pooled settings, results are mixed for corporate governance scorecard with different set of regressors. Based on the combined model, it is at best positive but insignificant. We interpret this inconsistency as information content difference in cross-section and time-series disclosure.
As our findings suggest that firms improving their corporate governance over time perform better, changes in governance are of more importance than level of governance in determining market valuation. This conclusion has intuitive appeal to investors because they may find that information obtained from longitude corporate governance disclosure in annual report matters more than information gained from cross-sectional absolute governance ranking in performance evaluation.
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