Corporate Governance at Play: Between Law and Its Perception

When firms go through an Initial Public Offering (IPO), their corporate governance changes by becoming more complex to reflect the requirements of a public firm. At the same time, there are many mechanisms at play due to the presence of different categories of owners: insiders vs. outsiders, founders vs. venture capital investors, etc. Therefore, the literature on corporate governance of IPO firms is abundant, but primarily it focuses on firm-level characteristics of IPO firms. 

A burgeoning stream of literature compares corporate governance across national contexts, but primarily is interested in how corporate governance of emerging markets’ firms adopts principles of governance of more developed countries where they list. The literature finds that firms can compensate for the bad perception of law in their countries, by adopting ‘better’ corporate governance practices. This figures in the literature as the bounding hypothesis (positive effect from listing abroad regardless of your practice), and is different from the firm-signalling effect, which does not necessarily relate to foreign IPO (e.g., Infosys adopted good governance practices in India to increase its market value in India). Conversely, for firms originating from countries where the law is positively perceived, adopting good corporate governance practices may not make such a difference. Rather, firms can be more selective in adopting corporate governance mechanisms, without necessarily suffering a negative impact on their valuation. Going even further, markets can punish firms for being “over-governed,” i.e., having too many corporate governance mechanisms in place that may reduce the leeway that managers have to adopt the optimal strategy in terms of investors’ risk appetite.

In our recent paper, we test the effect that firm-level corporate governance may have on IPO value depending on the perception of the country’s law. We specifically test the impact of firm’s corporate governance in countries where the law is negatively perceived (i.e., perception of law is below the sample average), relative to countries where it is positively perceived (i.e., perception is above the sample average). We test the hypotheses on key determinants of IPO firm’s corporate governance, such as board size, board independence, board gender diversity, board committees, and whether there are founders and VC/PE funds as owners of shares.

One of the novelties of our study is the focus on “legal signalling” which we model theoretically and test empirically. Rather than focusing on the quality of the positive (actual) law, we argue that what matters is the impact of the perception of law on IPO value. This is illustrated with a dataset across 66 countries, shown in Table 1. The perception is measured using the law on minority shareholders’ protection. There is roughly the same number of countries in each category (correctly perceived low-quality law, correctly perceived high-quality law, misperceived low-quality law, and misperceived high-quality law), which clearly shows that law is not always correctly perceived. Take India for instance, which is a democratic country with well-designed legislation. However, the general (investor) sentiment is that the laws may be difficult to enforce, bureaucracy is ripe, and corruption is omnipresent. Hence, the formally high levels of shareholder protection may not be as bullet-proof as is normally expected of a market-based financial system. Furthermore, this misperception may negatively impact the premium the investors are willing to pay for IPO shares.

Table 1. Perception of law in 66 countries. 

Correctly perceived low-quality lawCorrectly perceived high-quality lawMisperceived low-quality lawMisperceived high-quality law
Argentina*BelgiumAustraliaBulgaria*
Bangladesh*CanadaFinlandChile*
Brazil*DenmarkFranceIndia*
China*Hong KongGermanyPakistan*
CyprusIreland-RepLuxembourgSouth Korea
Egypt*IsraelNetherlandsSpain
GreeceJapanOman*Thailand*
Indonesia*Malaysia*Saudi Arabia*Turkey*
ItalyMaltaSri Lanka*
Jordan*New ZealandSwitzerland
Kenya*Norway
Kuwait*Singapore
Mexico*South Africa*
Nigeria*Sweden
Philippines*Taiwan
Poland*United Kingdom
Russian Fed*United States
Tunisia*
Vietnam*
35.2%31.5%18.5%14.8%
(19 of the 54 home countries)(17 of the 54 home countries)(10 of the 54 home countries)(8 of the 54 home countries)

Source: Schnyder et al. (2021)

We find that in negatively perceived countries (perception is below average), higher levels of corporate governance reduce the positive impact of legal perception of IPO value. In positively perceived countries, firm-level corporate governance mechanisms do not impact the positive relationship between perception and valuation. For such countries, the legal framework may be considered sufficient to guarantee a reasonable level of shareholder protection for investors and any additional firm-level corporate governance certification may be interpreted as “over-governance,” that constrains managers and imposes additional costs of compliance. This hints at the contextual nature of the firm-signalling effect, which depends not only on the level of actual legal shareholder protection, but also on its perception. This also supports the idea that firm signalling does not always have an impact on firm’s reputation. In other words, investors seem to be driven by contextual factors beyond firm-level, which we call “legal signals.” The study shows that research on Law and Finance can benefit from further re-conceptualization of the role of law, as we found that the perception of law matters more than the law itself. This finding hints at shortcomings of existing theorisation of the role of law in the economy in the extant literature.

Gerhard Schnyder is the Director of the Institute for International Management at Loughborough University London

Anna Grosman is a Senior Lecturer at the Institute for Innovation and Entrepreneurship at Loughborough University London

Kun Fu is the Entrepreneurship and Innovation Management Programme Director and Senior Lecturer at Loughborough University London

Mathias Siems is a Professor and Director of Graduate Studies at European University Institute

Ruth V. Aguilera is the Darla and Frederick Brodsky Trustee Professor in Global Business at the D’Amore-McKim School of Business at Northeastern University 

This post is adapted from their paper, “Legal Perception and Finance: The Case of IPO Firm Value”,  published at the British Journal of Management.

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