Relationship between Corporate Governance and Market Value of Singapore Listed Companies

Relationship between Corporate Governance and Market Value of Singapore Listed Companies.
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Abstract
This study aims at elaborating Corporate Governance (CG) together with investigation of trends in development of CG and its operation in Singapore. I have extracted a model from (SMU, 2009) to measure the quality of corporate governance practices of listed companies in Singapore. Corporate governance is a vital component in explaining the market value of companies listed in Singapore. This research has a basis on findings of the Revised OECD Principles of Corporate Governance (OECD, 2004) and the Best Practices Singapore code of corporate governance (SCCG, 2005). Information was used to construct an overall quality of Singapore corporate governance index (SCGI) for 400 listed companies during the year of 2007. These evidences exemplify that the companies’ market value (market-to-book ratio, MTBV) and corporate performance (return on equity, ROE) reflect a positive and significantly associated with their SCGI. The outcome turns to be robust after controlling for firm characteristics, ownership structure and other corporate governance features. In this research, it is evident that the market value growth really exists, taking into account of financial fundamentals and market dynamics. In summary, this study implies strong evidence that companies with better corporate governance are associated with higher market value in Singapore.
Contents
 TOC \o "1-3" \h \z \u  HYPERLINK \l "_Toc295569798"
1.0 Introduction  PAGEREF _Toc295569798 \h
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Objectives  PAGEREF _Toc295569799 \h
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2.0. Background (Overview)  PAGEREF _Toc295569800 \h
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2.1. Corporate Governance (CG) reform in Asian market  PAGEREF _Toc295569801 \h
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3.0 Literature Review  PAGEREF _Toc295569802 \h
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3.1 The Interaction of Different Governance Mechanisms  PAGEREF _Toc295569803 \h
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3.2 The Relationship between Governance Mechanism and Firm Performance  PAGEREF _Toc295569804 \h
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3.3. Endogeneity of Corporate Governance Mechanisms in Firm Valuation  PAGEREF _Toc295569805 \h
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3.4 Corporate Governance Scorecard in Examining Stock return, Firm value and Performance  PAGEREF _Toc295569806 \h
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4.0 Methodology and Data  PAGEREF _Toc295569807 \h
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5.0 Results  PAGEREF _Toc295569808 \h
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5.1 Descriptive statistics  PAGEREF _Toc295569809 \h
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5.2 Regression results ….19
5.3 Analysis of variables............................................................................................................19
5.4 Robustness………………………………………………………………………………...22
6.0 Conclusion…………………………………………………………………………………...24

1.0 Introduction
Corporate governance is the process and structure by which the business and affairs of the company are directed and managed so as to enhance long term value of the shareholder through strengthening corporate performance and accountability, while taking into consideration the interests of other stakeholders. Corporate governance created dilemma during the financial crisis of year 1997 which led to changes in listing and financial accounts requirements. With this dilemma caused, it was the catalyst for the region’s initial round of restructuring corporate governance. It contributed to renewal economic growth and capital market confidence through bank reform and business debt reformation. The effect in increasing level playing field for investors enhanced public governance, a centre attention on auditor independence, and the internal governance of listed companies. There have been numerous corporate governance reform initiatives including regional Pacific Economic Cooperation Council (PECC, 2001) and international (OECD, 2004) efforts. The objective is to capitalize on corporate value and induce corporate managers to enhance the quality of corporate governance practices. The issue is whether good corporate governance practice matters in Asia. The empirical evidence on the relationship between corporate governance practices and corporate performance is questionable and most prior researches has mainly focused on US and Europe markets. This study attempts to concentrate on the question in one of the important Asian market that is in Singapore. In Singapore, this is the initial independent corporate governance government index which seeks to generate and promote high quality investigation, produce scholarly commentary, and promote discussion between the academic and business organization on the best practices in corporate governance. The algorithm for measuring corporate governance practice in this study is derived from the Revised of OECD Principles of Corporate Governance (OECD, 2004).
Over the decades, the growing interest in corporate governance around the world is based on the belief that good governance generates investor goodwill and confidence. Corporate governance has succeeded in attracting a great deal of public interest because of its noticeable importance for the economic health of corporations and society in the general. Its framework has created a long-term trust between companies and its stakeholders. Based on CLSA watch (2010), it was clear that Singapore has performed well in the corporate governance and was awarded an overall CG score of 57.8% ranking above average among the Asian countries.
Objectives
In this research, there are 3 main aims that will be focused on:
Assess the effect of corporate governance reform of Singapore listed companies using a global benchmark (such as the OECD principles) since in Singapore’s equity market has been developed for several decades.
The second aim is to further examine the empirical relation between corporate governance practices and market valuation of Singapore listed companies in order to allow assessment of whether the benefits of good corporate governance are visible in the Singapore market.
Finally, to compare the corporate governance practices of companies incorporate outside Singapore with those incorporate locally using the same benchmark, so as to determine the strong correlation of corporate governance and market value.
2.0. Background (Overview)
2.1. Corporate Governance (CG) reform in Asian market
The financial crisis of 1997 played an important role in effecting reforms of CG in Asian countries. Immediately after the crisis, Asian governments acknowledged that bad corporate governance could have led to the crisis. In 1997, the Singapore government took decisive actions to help improve corporate governance among companies and to promote trust and transparency.
To create a good environment for regulation and promotion of the financial services industry, the Monetary Authority of Singapore (MAS) adopted various reform measures which had been recommended IN 1997, by the Financial Sector Review Group (FSRG) which was under the leadership of then Deputy Prime Minister Lee Hsien Loong. Among the measures, which were put into operation, were, introduction of the best practice guide for Audit Committee and security dealing and raising bank disclosure standards such as disclosing off-balance sheet items and significant exposures in the notes to accounts.
In addition to this, the Singapore institute of Directors was started in 1998 to represent directors and raise the standards of corporate governance by offering education and training to the directors. In 1999, Singapore declare plan to build itself as an International Financial Hub. More emphasis was put on the revision of the corporate regulatory framework, corporate governance and disclosure standards in Singapore. The Monetary Authority of Singapore, the Attorney General’s chambers and the private sector led committees set up by the Ministry of Finance recommended that all companies must comply with the SGX Listing manual. Since 2003, companies have to reveal their corporate governance practices and provide explanations for any operations outside the code.
In 2001, the Corporate Governance Code was issued. It outlined 15 principles as guidelines for corporate behaviour. In 2002, Singapore formed the Council for Corporate Disclosure and Governance (CCDG). This was to review accounting standards, disclosure issues and corporate governance. The new Code of Corporate Governance was issued in 2005. This came under the purview of MAS and SGX taking effect fro the beginning of September 2007.
3.0 Literature Review
Corporate Governance has drawn much interest over several years. This has led to recommendation of various codes of operation, empirical studies and conceptual models. An increased number of empirical studies conducted in Europe and America has shown that sound Corporate Governance leads to a better protection of investors. There are numerous studies relating to the measurement of corporate governances and firm market value, normally proxied by Tobin’s q. The studies include Gompers et al. (2003) for the US., Drobetx et al. (2004) for Germany, Bernard S. Black et al (2005) for Korea, Rob Bauer et al. (2004) for Japan, N. Balasubramanian, Bernard S. Black and Khanna (2008) for India, Cheung, Connelly, Limpaphayom and Zhou (2005) for Hong Kong, Klapper and Love (2004) for fourteen emerging markets, Durnev and Kim (2002) for twenty seven countries, Bauer et al. (2003) for the EMU and the U.K.. These studies determine a positive relationship between corporate governance standards associated with a higher firm value.
According to La Porta, Lopze-de-silanes, Shleifer, and Vishny, (2002) it is clear that investors pay more to attain improved legal protection which in turn will lead to more companies’ profits which would return to them as interests or dividends as divergent to being expropriated by the entrepreneur who manages the company. They also claim that by using firm-level data from twenty-seven developed countries, the result is the evidence of higher valuation of firms in countries with improved protection of minority shareholders. Klapper and Love (2003) have used firm-level data from fourteen emerging stock markets and reported that better corporate governance is highly correlated with better operating performance and higher market valuation. They added further that firm-level corporate governance provisions matters to those countries with weak legal environments. Chhaochharia and Laeven (2009) used data from Risk Metrics (formerly Institutional Shareholder Service (ISS) to evaluate the firm-level corporate governance provisions on the valuation and found a positive effect on their firm value.
Bebchuk, Cohen, and Ferrell (2005) constructed an enhancement index based on the six provisions of the 24 governance provisions developed by the Investor Responsibility Research Center (IRRC). They found Tobin’s q determined a negative relation between the index values and firm valuation, for U.S firms in the period between 1990 and2003.
Chen, Chen, and Wei (2003) and Drobetz, Schillhofer, and Zimmermann (2003) examined the effect of governance index on equity capital cost for nine markets in Asia and Germany respectively. There findings show that sound corporate governance reduces such costs.
3.1 The Interaction of Different Governance Mechanisms
Based on the U.K. code, corporate governance comprises of many categories; directors, remuneration of directors, shareholders roles, accountability and audit. Some of categories supplement each other while others substitute others. The relationship between outside directors and board members especially when the CEO is participating in their nomination is convex Peasnell et al. (2001). This is both in the UK and US. Whenever “best practice” standards are implemented, managerial entrenchment is reduced or the non-executive directors are increased.
3.2 The Relationship between Governance Mechanism and Firm Performance
There are several studies on the governance mechanisms; some explain the impact of one set of mechanism like Himmelberg et al. (1999) while others cover the different sets of governance mechanisms. Himmelberg et al used panel data to show that key variables in the contracting environment explain managerial ownership. Below, we will briefly review some of previous studies on the governance-performance relationship.
Board Composition
There are some researchers who have come up with varying results on the relationship between non-executive directors abd performance. While most appreciate the positive impact of their presence in the board to reduce agency costs and higher market value Kee et al. (2003) and Hutchinson and Gul (2003), others find a negative impact between the firm’s investment opportunities and performance Coles et al. (2001), and Weir et al. (2002).
Leadership Structure
In the UK, the different roles the CEO and Chairman play are good for governance but in the US the costs that are involved in the separation of their roles are large Brickley et al. (1997).
(3) Board Ownership
In different countries the management have different alignment levels to the ownership. In the United Kingdom, they are more entrenched to ownership than their counterparts in the United States (e.g. Faccio et al., 1999; Short and Keasey, 1999).
(4) Institutional Holdings
Empirical evidence is not in support to the institutional roles in governance; De Jong et al. (2002) found that there is a negative influence from the outside and industrial shareholders to the firm’s value.
(5) Committee Composition
Those firms in the UK which have remuneration committees pay their directors less because there has been a slow adaptation of nominating committees Conyon & Mallin (1997).
(6) Managers’ Remuneration
This has been found from empirical work to have a limited role in coordinating managers’ and investors’ interests. While Hutchinson and Gul (2003) find a positive impact Coles et al. (2001) do not.
3.3. Endogeneity of Corporate Governance Mechanisms in Firm Valuation
There has not been found any evidence to link improvement of a firm’s performance in profitability with the presence of independent directors. This is despite the several meetings they may hold whenever share prices decline Vafeas (1999). Others studies on the area of ownership do not support governance-performance relationship Demsetz and Villalonga (2001). According to Cho (1998), investment affects corporate value which affects ownership but not the other way round.
There are seven mechanisms that are used to control agency problems between managers and shareholders Agrawal and Knoeber (1996):
shareholdings of insiders,
institutions
large block holders;
use of outside directors;
debt policy;
the managerial labor market; and
The market for corporate control.
An outside director as a mechanism is not that optimal and so there is an equation that investigates the influence on the corporate governance score card on the firm’s performance. The results have shown that managerial ownership, board composition and Tobin’s Q are determined at the same time. Vafeas and Theodorou (1998) found that there is an insignificant relationship between the board structure and performance of the firm.
3.4 Corporate Governance Scorecard in Examining Stock return, Firm value and Performance
In recent studies corporate governance scorecard has been used to control the corporate world worldwide. It has been taken as one of the measures used to examine the agency problem and it has the advantage of implicitly incorporating into one study the substitutive or complementary effect of a variety of governance practices. Within a country the mechanism is usually used to analyze either inter-country difference or inter-firms variation. La Porta et al (2002) has investigated these differences in the standards of governance in 27 countries worldwide.
The resulting evidence has it that countries with better governance standards have higher valuations. This means that there is a positive relationship between governance standards and firm value; this relationship is stronger in countries that have les developed standards. There are many examples of inter-firm investigations among them are:
Drobetz et al. (2003) within one country
Gompers et al. (2003) for Germany
Marry and Stangeland (2003) for the U.S.,
Klapper and Love (2004) for fourteen emerging markets,
Durnev and Kim (2002) for twenty seven countries,
Bauer et al. (2003) for the EMU and the U.K.,
Black et al. (2002) for Korea,
Black (2001) for Russia, and
Callahan et al. (2003) for Fortune 1000 firms.
Klapper and Love (2004) and Durnev and Kim (2002) are the only two research that have investigated the determinants of corporate governance scorecard. Klapper and Love (2004) found that firm-level governance is directly related to the firm size, sales growth and assets composition. They have also reported that good governance is positively correlated with market valuation and operating performance of the investigated firms. Durnev and Kim (2002) reported higher disclosure levels and thereafter higher market valuations for firms that had greater growth opportunities, greater needs for external financing, and more concentrated cash flow rights. Luo Lei studies have differed with both the above studies in three ways; the use of time-varying governance scorecard for controlling the unobserved firm heterogeneity with fixed impacts or effects, broadening of the governance scorecards and the shareholding variables also. The third way is that Luo Lei addressed the endogeneity problem with a simultaneous equation in which the governance mechanism was put into.
Among the inter-firm studies only Bauer et al. (2003) detected a negative relationship the governance standards had on the firms’ performance which were approximated by the profitability ratios. The other studies; Gompers et al. (2003), Marry and Stangeland (2003), Klapper and Love (2004), published a positive relationship between the governance scorecard and performance. Setting up a zero investment portfolio will see investors earning abnormal returns when they buy firms from higher corporate levels governing groups and short-selling them to those of a lower level in the governance group (Gompers et al., 2003; Drobetz et al., 2003; Bauer et al., 2003).
In Germany and nine Asian markets, Drobetz et al. (2003) and Chen et al. (2003) investigated what the influence of governance scorecard would have on cost of equity. There concluding results showed that good corporate governance helped reduce such costs. According to Creamers et al. (2003), the external and internal governance mechanisms strongly complimented each other together with long term abnormal gains and profitability measures of accounting. When the a company has high takeover vulnerability and ownership of high public funds, its Qs increase while those that had only two governance mechanisms high had even higher Qs.
4.0 Methodology and Data
The data was collected from all SGX listed companies with the exception of exchange-traded funds, structured products, real estate investment trusts, secondary listings and OTC for international securities listed abroad. I have obtained stock price and accounting information from Global Vantage and got the ownership data from the yearly rep...