The two IESE researchers based their analyses on a comprehensive sample of Southeast Asian public firms from 2012 to 2017. With the cooperation of institutions promoting good governance in Indonesia, Malaysia, the Philippines, Singapore, and Thailand (Vietnam was excluded because of lack of data on foreign ownership in its enterprises), they obtained propriety data on the scores assigned to the listed firms in each of the countries. Based on these data, they analyzed foreign investors’ (ex-post) reaction to the publication of the Top 50 List.* They found out that being included in the List is associated with significant increases in foreign institutional ownership: on average, foreign investors increase by 0.3 percentage points their ownership in the firms included in the list. Based on the average market capitalization of the firms in the sample ($3.3 billion), their estimated magnitudes translate into an average capital injection of $9 million for each firm that appears on the Top 50 List relative to firms outside this. Considering that foreign investment in these countries are relatively low (except for Singapore), this effect is meaningful. After performing placebo tests, they also found out that their models capture the effect of the Top 50 List on foreign institutional ownership.
It is also worth noting that when they broke down foreign investments by investor type, they discovered that the documented patterns are driven by mutual funds and pension funds, but not by hedge fund and private equity funds, the latter group being more notorious for their obsession with maximum profitability. The investors with longer investment horizons — mutual funds and pension funds — are the ones that expect corporate governance improvements made by the sample firms will have long-term consequences. When the authors analyzed the firms’ ex-ante reaction to the Top 50 List, they also found out that the possibility to be included in the list generates incentives for firms to change their corporate governance practices for the better in conformity with the guidelines upon which the ASEAN Corporate Governance Scorecard (ACGS) is based.
There is additional evidence that the improvements in corporate governance precipitated by the inclusion in the Top 50 List have to do with corporate policies that are least related to profit maximization goals. The documented changes in ACGS are concentrated along corporate governance dimensions related to the role of stakeholders, disclosure, and transparency and the responsibilities of the board of directors. In contrast, the sample firms do not increase shareholder rights and equitable treatment of shareholders (i.e., mechanisms to share the control of the firm with minority shareholders). This means that the governance changes preserve the majority shareholders’ control over the firm. Furthermore, the authors studied the variation in the potential benefits that firms could obtain from receiving additional funding from foreign investors. They found out that firms with higher growth opportunities and higher financial constraints exhibit greater improvements in ACGS when they are closer to the 50th position in the ranking. This implies that the Top 50 List provides firms with incentives to improve their governance practices, especially when the benefits of doing so outweigh the costs.
Another meaningful finding of the study showed that the increase in foreign investment driven by the inclusion in the Top 50 List is associated with increases in capital expenditures. In contrast, there is no such association with changes in dividend payments. This evidence suggests that the firms included in the list use the increase in funding from foreign investors to invest in profitable projects rather than distributing those additional funds to the shareholders. This can also be interpreted to mean that efforts to improve corporate governance by top management and the board of directors do not give the highest priority to the interest of the shareholders, especially the majority ones.
The authors compare their study to previous papers on the consequences of the inclusion in a stock index such as those who examine the effect of the JPX-Nikkei Index 400, a Japanese stock index based on return on equity. Similar to these papers, the ACGS-related study provides evidence that the incentives for inclusion (or to avoid exclusion) in a publicly observable list can lead to changes in firm behavior. The difference lies, however, in the fact that while the inclusion in an index mechanically affects the investment of the passive investors following the index, there is no such mechanical effect when the firm is included in the ASEAN’s Top 50 List.
On the local front, the Institute of Corporate Directors (ICD) that provided the data from the Philippines for the ASEAN-wide research project of the IESE professors reported above conducted a similar study to find out what are the financial benefits of good corporate governance. The results of the study were meant to inform board directors, compliance officers, and corporate secretaries of Philippine PLCs, as well as regulators, investors, and other stakeholders. The years covered were 2014 to 2016. The results of the study showed that for the group of PLCs included in the study, there is a positive and statistically significant relationship between 1.) corporate governance and market capitalization; 2.) corporate governance and market valuation as measured by Tobin’s Q ratio; and, 3.) corporate governance and profitability as measured by return on equity. This means that as the quality of corporate governance practices improves, it is likely that the firm market capitalization, market valuation, and profitability will increase as well.
The ICD study indicates that increasing the efforts and resources devoted to improving the quality of corporate governance practices of a PLC would create positive and significant effects on its market capitalization, market valuation, and profitability. PLCs are well advised to exert efforts to raise the quality of their corporate governance — covering the five areas of: 1.) rights of shareholders; 2.) equitable treatment of shareholders; 3.) role of stakeholders; 4.) disclosure and transparency; and, 5.) responsibilities of the board — in order to improve the ACGS score. On the whole, regulations that go beyond compliance can help raise the bar on corporate governance in the country. On the buy side of the market, institutional and other investors in the country must be afforded access to the results of the ACGS process so they can reward PLCs garnering high governance scores with appropriate premiums on their share price. From my own experiences as an independent director of some PLCs in the Philippines, a good number of issues faced by the board of directors concern improvements in corporate practices that are not directly related to maximizing company profits. A good number of them have to do with ethical business practices, greater transparency of company operations, respect for the environment and the practice of corporate social responsibility. The results of the ICD study as well as those of the research done by the IESE professors have highlighted the fact that by focusing on improving corporate governance practices in general also in the long run help a PLC attain profitability levels that can guarantee their continuing access to long-term capital, both from domestic and foreign sources.
Maximum profit at any cost is actually the road to financial ruin and bankruptcy as can be gleaned from the experiences of ENRON, Lehman Brothers, and, more recently, Wirecard and WeWork.
It is heartening to confirm that in recent years, there are enough external pressures from outside agencies and institutions that motivate PLCs to include among their top concerns certain goals that are not directly related to the maximization of financial profits. These pressures come from mutual funds and pension funds that are increasingly including in their investment criteria the impact on society of the companies in which they invest. They also come from private institutions like the ICD and the equivalent organizations in the other ASEAN countries that launched the “Corporate Governance Initiative” in 2011 in tandem with the ASEAN Capital Markets Forum and the Asian Development Bank. As reported in this article, there are also more foreign direct investors who are looking for social purpose (such as those included in the acronym ESG — Environmental, Social and Governance factors) in the businesses in which they invest in the ASEAN region. There is also the requirement of public regulators like the Securities and Exchange Commission (SEC) requiring the inclusion in the annual reports of PLCs an account of their contribution to sustainable development in what is called Sustainability Reporting. In a few exceptional cases, the pressure is coming from within the enterprise from members of the Board of Directors, especially the independent ones, who demand more social accountability from their respective organizations. Only when the majority of business organizations are gifted with enlightened boards of directors and senior management can we be sure that capitalism is finally rid of the obsession with profit maximization that characterized it for most of the second half of the last century and the first decades of this third millennium.
To be continued.
*The Top 50 List is a list of the top 50 public firms based on corporate governance practices released by the Corporate Governance Initiative which was launched by the ASEAN Capital Markets Forum and the Asian Development Bank in 2011.
Bernardo M. Villegas has a Ph.D. in Economics from Harvard, is Professor Emeritus at the University of Asia and the Pacific, and a Visiting Professor at the IESE Business School in Barcelona, Spain. He was a member of the 1986 Constitutional Commission.