Academic journal article Financial Management

Corporate Governance, Valuation, and Performance: Evidence from a Voluntary Market Reform in Brazil

Academic journal article Financial Management

Corporate Governance, Valuation, and Performance: Evidence from a Voluntary Market Reform in Brazil

Article excerpt

In December 2000, the Sao Paulo Stock Exchange launched a new premium market segment for companies that voluntarily commit to "good practices of corporate governance. " We construct a composite index (NM6) that combines six proxies for the main governance practices targeted by Bovespa's reform. We find that higher scores for our index are related to greater market value but not to better operating performance. An investment strategy that purchased stocks of firms with high NM6 and sold stocks of firms with low NM6 would have earned abnormal returns of 10.68% per year from 2001 to 2005.

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In response to increasing capital markets competition and demand for superior shareholder rights, the Sao Paulo Stock Exchange (Bovespa) launched a new premium segment, Novo Mercado, in December 2000 for companies that voluntarily subscribe to what the exchange calls "good practices of corporate governance." Companies listed on this premium segment are required to follow a "one share, one vote" policy, keep a minimum free float of 25% of the outstanding shares, grant minority shareholders the same rights given to controlling shareholders in the event of transfer of control, and have a board with at least five directors who are elected to serve concurrent terms of one or two years. In addition, companies in Novo Mercado have to commit to higher standards of information disclosure including the preparation of financial statements according to the International Financial Reporting Standards (IFRS) or the US generally accepted accounting principles (US GAAP). If a firm chooses to delist from Novo Mercado, the controlling shareholder is required to make a tender offer for all outstanding shares at a price determined by a renowned appraiser. This appraiser is chosen by the minority shareholders from a three-nominee list submitted by the company's board of directors.

Bovespa has also created two additional segments, Nivel (level) 2 and Nivel 1, for companies that do not commit to the "one share, one vote policy." The corporate law in Brazil allows companies that went public before 2001 to issue up to two-thirds of their capital as nonvoting shares. Companies that went public after 2001 are allowed to issue up to 50% of their capital as nonvoting shares. Since a shareholder can retain control of a Brazilian dual class firm by owning as little as 16.7% of its outstanding shares, the requirement that capital be solely constituted by voting shares makes Novo Mercado less attractive for controlling shareholders. Nivel 2 allows for nonvoting stock but requires compliance with all other Novo Mercado rules. Nivel 1 only requires compliance with the 25% minimum free float and with more stringent disclosure rules that are common to the three "good governance" levels.

In this study, we combine six corporate governance practices that proxy for Novo Mercado rules into an objective index (NM6) and examine whether the practices targeted by this voluntary reform are significantly related to firm value and operating performance in Brazil, an important emerging market. (1) This examination is important since anecdotal and scholarly evidence have suggested that stronger investor protection has a positive effect in the development of emerging markets, representing an important source of high returns and diversification. For example, in a series of surveys conducted from 1999 to 2000, McKinsey & Co. found that institutional investors are willing to pay as much as 28% more for better governed companies in developing markets. (2) In addition, the International Finance Corporation (IFC), the Organisation for Economic Co-operation and Development (OECD), and the US Agency for International Development (USAID) argue that lower standards of corporate governance have been a major factor in economic instability across the globe and provide an overview of the issues to be addressed by firms in order to improve shareholder rights. …

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