Researchers studying the corporate governance of 168 of Hong Kong's largest listed companies have found a positive and significant correlation between corporate governance score and price-to-book ratio. We bring you their paper.

Yes, there is a Governance Premium
22 June 2005

A new study by academics provides evidence that the market value of Hong Kong listed companies is positively and significantly correlated with their corporate governance scores. Click here (you need the latest Acrobat Reader 7.0) to download the research paper. The authors are Professor Stephen Cheung Yan Leung, who kindly sent us this paper, and research student Lynda Zhou of City University of Hong Kong, and Dr J. Thomas Connelly and Dr Piman Limpaphayom of Chulalongkorn University, Thailand.

The survey was based on public information on 168 of the largest listed companies in 2002, covering about 90% of market capitalisation. It compared the market value to book ratio (MTBV) at each company's financial year-end with the corporate governance index (CGI) assessed on five categories of scoring, with a total of 86 questions in each scorecard and scores of 3, 2 or 1 in each question, and then the whole thing was boiled down to a score on a scale of 0-100. Actual scores ranged from 32.86 to 76.34, and when plotting MTBV against CGI, the researchers found a slope co-efficient of 0.0337, suggesting that a 10-point increase in CGI implies a 33.7% increase in MTBV. The study was adjusted to account for variations in financial performance, such as return on assets.

Of course, none of this will come as a surprise to many investors who understand that companies with bad governance are more likely to steal or destroy your money than average, and therefore you should pay less for the shares (if you hold them at all) to discount for that risk - but it's nice to have some independent confirmation of this.

The study was based on broad OECD principles rather than being specific to the HK market (see the questionnaire in Appendix II). It is also based very much on the situation at a specific point in time, rather than looking at the historic behaviour of the company's management towards public shareholders. We would guess that with better-designed scoring systems it would be possible to find an even stronger connection to firm value.

©, 2005

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