Shareholder Protection and Corporate Value

Empirical analyses, such as that of Brockman and Chung (2003), Caprio et al., (2007), Claessens and Fan (2002), Johnson et al. (2000a) and La Porta et al. (2002) suggest that the legal protection of shareholders’ rights influences the valuation of firms. This is important for this thesis as the size of financial markets which is one of the key measures for the financial development indicators here and remains mainly a result of corporate valuation.

Based on their empirical analysis of 27 wealthy countries, using Tobin’s measurement, LLSV (2002) find that countries with better protection of minority shareholders experience higher valuation. Johnson et al. (2000a) also conclude that the lack of minority shareholders protection is a significant factor in the extent of stock market decline during the Asian financial crisis. Claessens and Fan (2002) suggest that the lack of protection for minority shareholder rights in Asia has been the major corporate governance issue, pricing itself into the firm’s cost of capital.  This evidence indirectly supports the negative effects of expropriating minority shareholders by controlling shareholders in many countries and for the role of the law in limiting such expropriation.

Caprio et al. (2007) find that stronger investor protection laws measured by higher values of the shareholder rights indicator, using LLSV (2002) data on shareholder rights, tend to enhance bank valuations. In the comparison carried out between two types of Hong Kong stock exchange listed companies by Brockman and Chung (2003), findings showed that blue chip firms,[1] having its high level of investor protection, enjoy a higher firm liquidity (measured by trading spread and volume) than other China-based red chips and H-shares characterised with low level of investor protection due to its exposure to the Chinese legal environment. Thus, it can be assumed such liquidity cost is ultimately reflected in stock valuation.

This empirical evidence show positive association between shareholder protection and stock market valuation. However, these studies, using the LLSV Anti-Director Index, are subject to the same criticisms highlighted earlier in Section 3.3.1. To explore more fully the nature of this relation, as will be discussed in the following section, a considerable number of recent studies used event-study methodology to analyse the link between investor shareholder protection and a firm’s value via its impact on the share price.

Event studies with its long history – perhaps the first published study is by Dolley (1933) –  have been commonly used as econometric tools in corporate law and corporate governance policy analysis (Bhagat and Romano, 2002a, 2002b). From a policy analysis view point, the benchmark for evaluating the benefit of investor protection regulations is whether they improve investor protection and thus increase the firms’ share prices. In principle, this can be established by measuring whether the stock prices have positively reacted to the event or not. If the stock prices react positively, then it could be attributed to the market’s assessment that minority shareholder protection level has improved, thus reducing expected future expropriation of them.

The Sarbanes-Oxley Act (SOX) passed in the U.S. as a result of the financial scandals and bankruptcies that unfolded at the turn of the century, is one of the most studied legal protection changes using event studies. A number of studies assess investor reaction to the adoption of the SOX with mixed results.

Rezaee and Jain (2006), using S&P 500 firms, examine the market reaction to all Congressional 12 event periods relative to the Act and find that the induced benefits of the Act significantly outweigh its imposed compliance costs. The results indicate that a positive abnormal return at the time of several legislative events increased the likelihood of the passage of the Act. Similar results provided by Chhaochharia and Grinstein (2007), found that the positive effect is greater for firms with poor governance.

However, Zhang (2007) proposes a problem with the event dates and windows used by Rezaee and Jain (2006). She uses concurrent stock returns of non-U.S.-traded foreign firms as a valid parameter to estimate normal U.S. returns. The results suggest that U.S firms experienced a statistically significant negative cumulative abnormal return around key SOX events.

Unfortunately for Zhang (2007), Li et al. (2008) uses the same kind of argument to criticise her use of the SOX legislative events, arguing that Zhang (2007) includes a set of event dates which do not clearly link to the SOX dates, and thus, significantly affects her results. Li et al. (2008) uses a market and sample portfolio data of over 252 trading days in the 2002 and revealed that significantly positive abnormal stock returns are associated with SOX events. The findings also indicate considerable evidence of a positive relationship between SOX event stock returns and the extent of earnings management.

A number of other studies from emerging markets also revise the effects of particular legal shareholder protection reforms on the firms and equity market value using event studies. Black and Khanna (2007) find that India’s security regulator’s adoption of major investor protection reforms [2] (Clause 49) is accompanied by a 4 per cent increase in the price of large firms over a two-day event window (the announcement date plus the next trading day), relative to smaller public firms; the difference grows to 7 per cent over a five-day event window. Mid-sized firms had an intermediate reaction.

In China, Berkman et al. (2010) use standard event-study methodology to examine the wealth effects of three regulatory changes designed to improve minority shareholder protection in the Chinese stock markets. They show that minority shareholders in firms with higher total values of related-party transactions experienced significantly larger abnormal returns than minority shareholders in firms with lower or zero total value of related-party transactions.

Recently, Muravyev (2009) used the treatment and control groups to investigate the effect of introducing a mandatory rule that improved the empowerment of preferred (non-voting) shareholders to veto unfavourable changes in their class rights. The study finds a statistically and economically significant effect of improved protection of preferred shareholders on the value of their shares.

Although, there are different methodological cautions – particularly related to defining event windows and confounding events –  the results of empirical event studies suggest that the question of whether and how legal protection of shareholder matters for financial market variables can be explored further in a particular country regulation reform (more details will be presented in Section 7.2.3 of Chapter 7). This is why this thesis is enhanced by event-study methodology to examine the market reactions to three legal protection reforms that occurred in Tunisia and Saudi Arabia during 2008 and 2009. Having highlighted in the previous two sections the shareholder protection association with concentrating on ownership and corporate valuation, the following section will presents major studies that examine the association with dividend payouts.

[1] A red chip is a stock of a company member of the Hang Seng China-Affiliated Corporations Index, while a blue chip is a stock of a company member of the Hang Seng Index.

[2] The reforms require among other things, public companies to have audit committees, a minimum number of independent directors, and CEO/CFO certification of financial statements and internal controls.


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