The Future of Domestic Capital Markets in Developing Countries

Chapter 11. Corporate Governance Issues and Returns in Emerging Markets

 Corporate Governance Issues and Returns in Emerging Markets 11 This paper shares my views on corporate governance in emerging markets , focusing on Asia, the region covered by my company. CLSA, a subsidiary of the French banking group Credit Lyonnais, has produced its fourth report on corporate governance. We issued our first report in 2000, just after the financial crisis hit Asia, in response to the belief of our clients—international fund mangers—that this was a key area of concern for emerging markets in Asia. We have since issued a report each year, scoring the companies we cover, as well as markets, for macro determinants on corporate governance.1 In this paper, I share some of our findings on the correlation between good corporate governance and share price outperformance. I then provide some views on why this correlation should hold. Then, I discuss the main issues regarding corporate governance in Asia and how they differ from those in developed markets. Finally, I offer some personal observations on why real progress on corporate governance in Asia and most other emerging markets has been slow and what needs to be done for there to be more significant advance in this area.   1. Gill (2000, 2001, 2002, 2003). Correlation between Corporate Governance and Stock Returns In our latest report, we find, once again, prima facie evidence that the stocks of companies with good corporate governance tend to outperform the market , particularly over the medium term, that is, three to five years. This is especially true in markets where corporate governance is a concern. The positive effect of good corporate governance is seen more clearly over three to five years than in the short term. Every year, we rank the companies we cover in each of the markets we cover according to a system for scoring corporate governance. This system scores companies on fifty-seven issues, covering seven key areas of corporate governance: discipline, responsibility , transparency, fairness, independence, accountability, and social responsibility. The analyst for each company scores it based on the best information available to him and on his interpretation of the company’s track record. After scoring and ranking the companies, we divide them into corporate governance quartiles. Returns in global equity markets have been dismal in recent years. Most of our markets in Asia have fallen, whether we look at performance in 2002 alone or in the five years leading up to end-2002. Nevertheless, in 2002, the companies in the top quartile of corporate governance in six of the ten Asian countries under CLSA coverage had stocks that outperformed within their market—most notably in China and the Philippines (see figure 11-1). And over three and five years, the top-quartile corporate governance stocks outperformed in six and seven of the ten markets surveyed, respectively (see figures 11-2 and 11-3). Over the three years to end-2002, on average the top-quartile corporate governance stocks outperformed the average of companies covered by CLSA in each market by 5 percentage points, while over the last five years these stocks outperformed by 35 percentage points. The bottom-quartile corporate governance stocks underperformed in only five of the ten markets under coverage for 2002—Singapore, Hong Kong, Malaysia, Thailand, and China—but the underperformance was large enough such that, on average, the bottom quartile underperformed the average of all the quartiles of the respective market by almost 4 percentage points on average. Over the previous three years, the bottom quartile underperformed in seven of the markets by almost 8 percentage points on average (the exceptions were Hong Kong, Korea, and Taiwan). And over the last five years, the bottom quartile underperformed the average   performance in the market by 25 percentage points (although not in Hong Kong, Korea, Singapore, and Taiwan). The calculation is based on the simple average performance of the stocks in the top quartile versus the average performance of all the quartiles. A simple average is used within each quartile rather than a market cap–weighted average, so that the performance of the quartile is not skewed by that of any large-cap company: the aim is to examine whether, on average, companies with better corporate governance have stocks that perform well irrespective of size. The comparison is made against the average of the four quartiles rather than against the main country index because the performance of the index is skewed toward the performance of the...