cheung et al - 2007 - do investors really value corporate governance - evidence from the hong kong market [hcgi]

It is common to find that the chairman ofthe board is also the chief executive officer in Hong Kong listedcompanies.1A report of the Corporate Governance Working Group ofthe Hong Kong Socie

Do Investors Really Value Corporate

Governance? Evidence from the

Hong Kong Market

The authors are indebted to Herbert Hui, Peter Wong, and the Hong Kong Institute of Directors for financial support, and Charnchai Charuvastr of the Thai Institute of Directors Association for providing technical assistance This project was substantially supported by a grant from City University of Hong Kong (Project no 7001912) We also thank Cindy Chen, Sam Lam, Simon Lam, Justin Liang, Sarah Wan, and Sam Yang for their research support.

be due in part to the legacy of an Anglo-Saxon legal system thatinfluences corporate governance and regulatory practices Hong Kongalso has a well-developed financial market infrastructure, known forclose and careful regulatory supervision In addition, local accountingstandards are being harmonized with international standards, allowingfirms to cross-list in other markets.

On the other hand, the Hong Kong market has many characteristicsmore commonly observed in developing economies, especially in Asia.Unlike the more diffuse ownership structures frequently found in devel-oped economies, Hong Kong firms normally have a closely intertwinedmanagement and ownership structure, with firms quite often beingfamily owned and managed It is common to find that the chairman ofthe board is also the chief executive officer in Hong Kong listedcompanies.1A report of the Corporate Governance Working Group ofthe Hong Kong Society of Accountants in December 1995 remarked

‘‘almost 90 per cent of listed companies have a major shareholder who byhimself or with family members owns 25 per cent or more of the sharecapital.’’ Ownership structures have changed little following the financialcrisis A corporate governance report published by Standard & Poor’s in

2002 echoes the previous statement, noting ‘‘the main weaknesses in theHong Kong governance environment are less at the legal and regulatorylevels than at the individual firm level Standard & Poor’s recognized thatfamily domination of companies’ ownership structure and the limited(though growing) shareholder activism culture present particular chal-lenges.’’

This highly concentrated, family dominated ownership structuremeans that the classic agency problem stemming from the separation

of ownership (shareholders) and control (managers) is rarely observed inHong Kong However, this type of ownership structure often results in

an opaque rather than transparent shareholding structure, potentiallyleading to a unique agency conflict between owners who are alsomanagers (insiders) and minority shareholders (outsiders) This alsomeans that market-disciplining mechanisms such as hostile takeoverscannot function properly in Hong Kong.2

In sum, Hong Kong is an international financial center that combinescharacteristics of both developed and developing economies: concen-trated ownership of listed companies, family owned and managed firms,

an Anglo-Saxon legal and corporate governance system, strong tory oversight, and a weak market for corporate control Thus, HongKong is a good testing ground to examine whether corporate governanceinfluences firm valuation in a market where family ownership andconcentrated shareholdings predominate

regula-The objective of this study is to investigate whether there is a relationbetween corporate governance practices and firm valuation in HongKong Are investors concerned with the good corporate governancepractices of Hong Kong firms? Do better-governed firms perform betterthan firms that are more poorly governed? A positive relation betweencorporate governance practices and firm value will provide supportingevidence to the potential benefit of good corporate governance Usingpublicly available information from publicly traded companies in 2002,

we rate the corporate governance practices of the 168 largest firmsconstituting the four major Hong Kong stock indices While this sample

is only 15 per cent of the total number of listed companies, the firmschosen account for almost 90 per cent of total market capitalization andalmost 80 per cent of the total market turnover

Previous efforts to measure corporate governance practices usedsurveys with a binary scale to note the presence or absence of a practice.This ‘‘box-ticking’’ approach has been criticized for not measuring thequality of corporate governance practices The present study uses a newly

designed survey to measure corporate governance practices This uniquemeasurement tool permits assessment of both the quality and quantity ofcorporate governance practices The quality of corporate governancepractices is captured using information provided in source documents.The addition of qualitative measures leads to a richer understanding ofthe relation between corporate governance practices and firm perfor-mance Survey questions are derived from the Revised OECD Principles

of Corporate Governance (OECD, 2004) and the Code of Best Practices(HKEx, 1999a) The survey is comprised of 86 questions addressing thefive categories of the OECD Principles of Corporate Governance: rights

of shareholders; equitable treatment of shareholders; role of holders; disclosure and transparency; and board responsibilities andcomposition The survey responses and qualitative values are combined

stake-to create a corporate governance index (CGI) score for each surveyedfirm

The findings show that listed Hong Kong firms exhibit a widedisparity in the quality of their corporate governance practices OverallCGIscores range from a low of 32 (out of 100) to a high of 77 for firmswith good practices The empirical findings offer compelling evidencethat good corporate governance practices do matter in Hong Kong

A positive and statistically significant relation is found between theperformance measures and the CGI, even after the inclusion of firmcharacteristics as control variables The results are robust whethermarket-to-book ratio (MTBV) or return on equity (ROE) is used asthe performance indicator The results are also robust to the number ofsurvey questions used in the index, up to a random reduction of 10 of the

86 questions

Of the five categories of the OECD Principles of Corporate ance, we find that disclosure and transparency are highly correlated withmarket valuation To further examine the effect of corporate disclosureand transparency on firm value, we construct sub-indices for transpar-ency and non-transparency and find a positive and statistically significantrelation between the transparency index and market valuation Thefindings provide empirical support for the notion that, for Hong Konglisted companies, good corporate governance practices are consistentwith value maximization

Govern-The remainder of this paper is organized as follows: Section 2 framesthe study through a literature review; the data sources and studymethodology are described in Section 3; Section 4 presents the results;and Section 5 concludes the paper

2 Literature Review

Numerous studies have examined the relation between corporate ance practices and firm performance, primarily in developed countries.These prior studies often concentrate on a narrow aspect of governancesuch as ownership structure, board composition, executive compensa-tion, or disclosure and transparency These studies, taken together, oftenshow conflicting results, indicating that the link between good corporategovernance practices and superior firm performance is not clear Differ-ent aspects of corporate governance have complex interrelations and may

govern-be complementary Therefore, the lack of a particular aspect may govern-beoffset by the presence of other aspects

Looking first at the relation between ownership characteristics andfirm performance, Morck et al (1988) and McConnell and Servaes (1990)document a non-linear relation between insider ownership and firmvalue These authors argue that ownership by firm insiders aligns theinterests of insiders with the interests of outside shareholders, increasingfirm value However, as inside ownership increases, the entrenchmenteffects of inside ownership dominate and higher inside ownershipbecomes associated with a lower firm value In contrast, Himmelberg

et al (1999) suggest that managerial ownership and firm performance aredetermined by a common set of characteristics and question the causalrelation between ownership and firm performance implied by Morck

et al (1988) A series of studies finds that concentrated ownership maylead to more active monitoring, resulting in better corporate governance(Hill and Snell, 1988; Weiss and Nikitin, 2004).3 Bhagat et al (2004),however, do not find evidence supporting a positive association betweenownership concentration and firm performance In East Asia, theconcentration of insider ownership is higher than in other regions ofthe world, making ownership concentration a critical factor (Claessens

et al., 2000)

Another major topic in the corporate governance literature is boardcomposition, especially the impact of outside directors, that is, indepen-dent non-executive directors (INEDs) In 2002, at the time of this study,the board of each listed company in Hong Kong is required to have atleast two INEDs Beginning in 2005, the number of INEDs requiredincreased to a minimum of three per company Agency theory suggeststhat outsiders are important monitors of management and providers ofrelevant expertise central to the effective resolution of agency problemsbetween managers and shareholders (Fama, 1980; Fama and Jensen,

1983) Independent directors play major roles in US and UK publiccompanies Bhagat and Black (2002) report that most large US publiccompanies have independent directors making up a high proportion

of the board Faccio and Lasfer (1999) report that on average,non-executive directors make up 43 per cent of boards in the UnitedKingdom

In contrast, several researchers have raised concerns that outsidedirectors lack the necessary time, expertise, and incentives and thusmay not be able to make a meaningful contribution to shareholderwealth creation (Mace, 1986; Patton and Baker, 1987) Agrawal andKnoeber (1996) find a negative relation between the proportion ofoutside directors and firm performance among US firms They positthat a political process within firms influences the selection of outsidedirectors, and the directors may be less effective as they are beholdenthrough the selection process Bhagat and Black (2002) investigate USfirms and find no significant relation between board independence andlong-term firm performance Klein (1998) finds no association between afirm’s committee structure and firm value Neither activism of institu-tional investors (Carleton et al., 1998) nor ownership by outsideblockholders (Bhagat et al., 2004) is found to have an important effect

on firm value

Disclosure and transparency practices can also influence the extentand quality of a firm’s corporate governance practices Recently, mucheffort has been focused on increasing the quality of corporate disclosureand transparency in the Asia-Pacific region Bushman et al (2004) definecorporate transparency as the availability of firm-specific information tooutside investors and stakeholders This information is needed to makeinvestment and resource allocation decisions The levels of corporatetransparency depend on firms’ willingness to disclose relevant informa-tion to the public Disclosure and transparency can help protect share-holders’ rights, helping them to feel confident that the firm is beingmanaged with their interests in mind

The divergence of findings in these studies may be due to differentproxies being used to measure corporate governance.4 The lack ofconsistency may also be attributed to the narrow focus of previousstudies Typically, studies consider one or at most a few componentsconstituting corporate governance instead of a composite measure.Studies on the association between overall corporate governancepractice and firm market value are limited, but work by Gompers

et al (2003), Black (2001), Bebchuk et al (2004), and Brown and

Caylor (2006) examine this connection for US firms while Black (2001),Drobetz et al (2003), and Black et al (2006) do the same for non-USfirms.

Gompers et al (2003) construct a governance index to proxy the level

of shareholder rights with respect to takeovers Their data are derivedfrom Investor Responsibility Research Center (IRRC) publications thattrack 22 measures such as company charter provisions, bylaw provisions,and other firm-level rules, plus coverage under takeover laws of six states.Gompers et al (2003) identify 24 unique provisions and build an index.They find evidence that firms with stronger shareholder rights have ahigher firm value, higher profits, and lower capital expenditures How-ever, they only consider takeover defense provisions and other provisionsrelated to shareholder rights Although their study makes an importantcontribution to the literature on takeover defenses in the United States, it

is of limited relevance to Asian markets where hostile takeovers seldomoccur Bebchuk et al (2004) construct an entrenchment index based onsix provisions: staggered boards, limits to shareholder bylaw amend-ments, supermajority requirements for mergers, supermajority require-ments for charter amendments, poison pills, and golden parachutearrangements The first four provisions measure the rights and participa-tion of shareholders and the last two provisions cover hostile takeovers.These measures are selected from a total of 24 governance provisionsdeveloped by the IRRC They find that increases in the level of theentrenchment index are monotonically associated with significant reduc-tions in firm valuation These authors also find higher firm valuation, asmeasured by Tobin’s Q, at firms with stronger shareholders’ rights.Brown and Caylor (2006) create a CGI based on 51 corporate governanceprovisions propounded by Institutional Shareholder Services They findthat better-governed firms are associated with both higher returns onequity and higher returns on assets

Compared with US market studies, recent research on emergingmarkets generates results that generally support a link between corporategovernance practices and firm valuation For Russian firms, Black (2001)finds a positive relation between corporate governance behavior andmarket performance; however, his result is based on a small sample of 21firms Drobetz et al (2003) follow the approach of Gompers et al (2003),developing a governance index and linking it to the performance ofGerman firms As with the original study, the conclusions from thistakeover defense study for German firms throw limited light on Asianmarkets Ho and Wong (2001) compare the effectiveness of different

corporate disclosure practices in Hong Kong and identify ways toenhance communication between corporations and investors Leungand Horwitz (2004) find that: (1) concentrated board ownership iscorrelated with low voluntary disclosure, and this negative relation isstronger when firm performance is very poor; (2) non-executive directorsenhance voluntary disclosure for firms with low director ownership butnot for firms with concentrated ownership Black et al (2006) create agovernance score using a survey conducted by the Korean StockExchange and find that firms with higher scores have a higher marketvalue However, their survey relies on companies’ responses that couldgenerate a selection bias in the data.

There are other studies examining the relation between corporategovernance and firm performance for Asian markets Durnev and Kim(2005) use the Credit Lyonnais Securities Asia (CLSA, 2002) governanceindex and the S&P disclosure score (Standard and Poor’s, 2002) tomeasure corporate governance practices for a sample of 859 large firms in

27 countries In their theoretical model, they identify three firm attributes(investment opportunities, external financing, and ownership structure)that relate to corporate governance and conclude that firms with higherscores carry higher stock market valuations Klapper and Love (2003)use the CLSA governance index and find a positive correlation betweenmarket value and corporate governance for 374 firms in 14 countries.They also document a positive relation between governance and operat-ing performance as measured by return on assets (ROA) Mitton (2004)also uses the CLSA governance index to show that firms (365 firms from

19 countries) with stronger corporate governance have higher dividendpayouts However, despite its frequent use, the CLSA index has afundamental limitation The index is based on the judgment of securityanalysts, who would naturally be subjective, potentially creating bias inthe data

From the literature review, measuring the quality of corporategovernance practices is clearly an important issue Previous studiesonly identify the presence of certain practices without considering thevariation among those practices Previous studies also narrowly definecorporate governance and are thus applicable only to some parts of theworld Our study seeks to resolve these issues by creating a measurementscale that can detect variation in corporate governance quality Themeasurement scale is also comprehensive, incorporating aspects ofcorporate governance practices accepted and recognized by internationalorganizations

3 Data and Methods

Our sample consists of the 168 largest companies5constituting the fourmajor Hong Kong Exchange and Clearing Limited (HKEx) indices:Hang Seng Index (HSI), Hang Seng Hong Kong Composite Index(HSHKCI), Hang Seng China-Affiliated Corporate Index (HSCCI),and Hang Seng China Enterprise Index (HSCEI) The HSI is the mostwidely quoted performance indicator of the Hong Kong stock market Itcurrently has 33 constituent stocks, which cover about 70 per cent of themarket capitalization of all eligible stocks listed on the Main Board ofthe HKEx Constituents of the HSHKCI include the HSI constituentstocks plus the largest Hong Kong companies The HSCCI and HSCEIconstituent stocks are China-related companies; the HSCCI is for red-chip companies, while the HSCEI is for H-share companies.6 BothH-share and red-chip companies are listed in Hong Kong H-sharecompanies are incorporated in mainland China while red-chip companiesare incorporated in Hong Kong but are controlled (at least 35 per centowned) by state, provincial, or municipal-owned organizations in China.The constituents of these four indexes are representative of all HongKong shares Although the firms in the four indices account for 15 percent of all listed companies, they account for almost 80 per cent of theHong Kong market turnover and almost 90 per cent of the total marketcapitalization

Based on the Revised OECD Principles (OECD, 2004) and the Code

of Best Practices (HKEx, 1999a), we develop a survey composed of 86questions.7 The question classification scheme matches the five OECDPrinciples: rights of shareholders; equitable treatment of shareholders;role of stakeholders; disclosure and transparency; and board responsi-bilities and composition From the five OECD Principles, the questionsare modified to be consistent with the Code of Best Practices (HKEx,1999a) and make the questionnaire more applicable to Hong Kong firms.8The corporate governance practices of listed companies are examinedfrom an outside shareholder’s perspective, using publicly availableinformation an investor would use to make an investment decision.Our data sources include annual reports, articles of association, memor-andums of association, notices to call shareholders’ meetings, annualgeneral meeting minutes, company websites, analyst reports, and othersources After gathering the data, we rate each company on the 86 surveyquestions To construct a CGI, each question within a specific surveycategory is weighted, as is each category: rights of shareholders (15 per

cent); equitable treatment of shareholders (20 per cent); role of holders (5 per cent); disclosure and transparency (30 per cent); and boardresponsibilities and composition (30 per cent).9 Major questions undereach category are equally weighted, and sub-questions under each majorquestion are equally weighted as well.10 We combine question scoreswithin the five category sub-indices, which are then combined into anoverall score A total CGI value, ranging from 0 to 100, is then calculatedfor each company.

stake-The majority of questions (87 per cent) have a binary (yes, no)response For the remaining questions, clear standards are used toevaluate the quality of corporate governance practices There are threequality levels based on practices observed: good, matching internationalstandards or best practice for Hong Kong firms; fair, that the practicemeets but does not exceed the required standard; or poor, that thepractice is below standard or missing This feature of the questionnairerepresents a major improvement in measuring the quality of corporategovernance practices because it can capture variation in degrees ofcorporate governance practices In addition, each company is assessed

by two different raters to ensure consistency The final results are checked and audited by the research team

cross-Once individual firm scores are complete, we examine the relationbetween the overall CGI scores and firm performance A series ofregression analyses are performed using both accounting performanceand market performance as dependent variables The regression model isgiven by

MTBV¼ a þ b1CGIþ b2ROAþ b3LnðTAÞ þ b4Currentþ b5D=E

þ b6BOUTþ b7BEXCþ b8Top5þ b9DummyCEO & Chairman

þ b10DummyAuditþ b11DummyCompensationþ b12DummyADR

þ b13DummyMSCIþ b14DummyHshares & redchipsþ e ð1ÞThe dependent variable is a proxy of market valuation, the MTBV.This ratio provides an estimate of the total value of a firm (includingintangible assets such as monopoly power, goodwill, high-quality man-agers, and growth opportunities) and reflects firm performance (Tobinand Brainard, 1968) MTBV is considered a better measure of firmperformance than accounting measures (e.g., ROE or ROA) because it isbased on market value, not just accounting earnings and is not affected

by earnings management or accounting manipulations The explanatoryvariable of interest is the CGI The control variables used include

financial measures such as profitability (ROA) and firm size (total assets

or TA), and risk factors as described by the current ratio (Current) anddebt to equity ratio (D/E) Other explanatory variables include boardcharacteristics such as the number of outside (BOUT) and executivedirectors (BEXC) on the board.11Ownership concentration is captured

by the variable TOP5, the percentage of shares owned by the top fiveshareholders Lastly, a series of corporate governance dummy variablesare included as indicators of whether the CEO is also the Chairman,whether the firm has audit or compensation committees, whether thecompany has American depositary receipts (ADRs) trading outside ofHong Kong, whether the company is a constituent of a Morgan StanleyCapital International Index (MSCI) index, and whether the company is

an H-share or Red Chip firm To check for robustness of the results, themodel is re-run replacing MTBV with firm profitability as measured byROE The descriptions of variables are presented in Table 1

Endogeneity is always a concern for studies dealing with the relationbetween firm value and corporate governance attributes (Black, 2001).Even though a firm that practices good corporate governance may bemore likely to make a high profit, investors may value the high profitrather than the corporate governance characteristics To avoid misinter-preting investor behavior, we tackle this problem using two approaches.First, we include a comprehensive set of control variables to mitigate theomitted-variable bias and the possibility that our results are affected byendogeneity Second, we include an instrumental variable to minimizeendogeneity Each of these approaches will be discussed in the followingsections describing the robustness tests Furthermore, we examine therelation between each of the five sub-indices of the CGI and marketvaluation to test whether any one of these sub-components is moresignificantly driving the relation To perform the analyses, the overallCGIscores are replaced in the regression models with the scores from thefive survey sub-indices

In their study on the association between overall corporate ance practice and firm market value for US firms, Bebchuk et al (2004)construct an entrenchment index based on six governance provisionsout of a larger set of 24 The six chosen provisions are negativelycorrelated with firm value during the 1990–2003 sample period andbetter explain the relation with firm value than the remaining 18provisions In a similar vein, we propose to split the CGI into twocomponents, a transparency index and a non-transparency index, inorder to test whether transparency characteristics (firms with greater

govern-disclosure) better explain the relation to firm value than do the remainingfour sub-components of the CGI To construct these two indices, weseparate the survey questions listed in Appendix A into two groups:questions related to disclosure, which are used to compile the transpar-ency index, the remaining questions constituting the non-transparencyindex We then examine the impact of corporate disclosure and trans-parency on market valuation.

Accounting information and market-related data are obtained fromDatastream and Bloomberg Accounting data are based on the firms’fiscal year ends Firm market values and other performance data are

Table 1 Variable Definitions

questions in the survey

related questions in the survey

stock We drop two firms with negative book value of common stock

non-executive directors, non-executive directors, and honorable directors)

States; 0 otherwise

otherwise

This table provides brief descriptions of the variables used in the regression analyses Accounting data and firm performance information are for 2002, drawn from Datastream and Bloomberg The firm performance variables are geometric averages of monthly data based

on firms’ fiscal years Accounting variables are annual values based on firms’ fiscal years.

based on monthly data for 2002 We then use geometric averaging tocalculate annual values.

4 Results

4.1 Descriptive Statistics

A major contribution of this study is the creation of a CGI for the largest

168 listed companies in Hong Kong Panel A in Table 2 containsdescriptive statistics of the CGI and its five sub-indices On a scale of 0–

100, the CGI ranges from a low of 32.86 to a high of 76.34; the averagescore is 48.33 The results of the sub-indices indicate that companies do best

in Section B (equitable treatment of shareholders) and Section D closure and transparency), with mean scores of 82.78 and 74.88, respec-tively The results for Section C (role of stakeholders; mean score of 69.54)and Section E (board responsibilities and composition; mean score of60.70) show that, on average, companies perform well in these areas Themean score for Section A (rights of shareholders) was the lowest at 42.96.Panel B of Table 2 presents CGI values for each of the four stockmarket indices The results show that H-share companies (HSCEI) havethe lowest CGI scores, with a mean score of 44.54 The HSI constituentstocks (HSI) show the highest mean CGI score of 52.26 The CGI scoresgrouped by industry sector are summarized in Panel C of Table 2 Acrossindustry classifications, there does not seem to be much difference in themean scores Companies in the finance and utilities sectors have thehighest average scores at 52.86 and 51.68, respectively, while companies

(dis-in the property sector have the lowest average score at 45.12

Table 3 shows the descriptive statistics of companies included in oursample Statistics for each stock market index grouping are shown aswell For the full sample, covering only 2002, the average firm size isHK$20,396 million; the ROA is 4 per cent; the current ratio is 2.05; andthe debt-equity ratio is 1.39 There are some obvious differences acrossthe four stock index groupings HSI firms are larger, judging from totalassets; are more profitable, judging from ROA; and have much largermarket values than the other three groupings Other financial measures,such as the debt/equity ratio and the current ratio, differ widely acrossindex groupings as well Table 3 also includes descriptive statistics forboard composition Across the whole sample, the mean number ofoutside directors is just under five (4.97), while the mean number ofexecutive (inside) directors is just under six (5.95)

Turning next to a measure of ownership concentration, we see that onaverage, the top five shareholders control more than 50 per cent ofcompany shares, although the ownership concentration varies across the

Table 2 Descriptive Statistics for the Corporate Governance Index (CGI)Panel A: Descriptive statistics of CGI and sub-indices

Total

CGI

Section A Section B Section C Section D Section E

Rights of shareholders

Equitable treatment of shareholders

Role of stakeholders

Disclosure and transparency

Board responsibilities and composition

Panel B: CGI by listing category

Hotel and others

of the CGI by industry.

HSI, Hang Seng Index; 33 best-known Hong Kong companies; HSHKCI, Hang Seng Hong Kong Composite Index; the largest Hong Kong companies, including HSI; HSCCI, Hang Seng China Affiliated Corporate Index; ‘‘red chip’’ companies; HSCEI, Hang Seng China Enterprise Index; H-share companies.

stock index groupings Some additional statistics, shown at the bottom ofTable 3, help further characterize the sample Among the 168 firms in thesample, 56 firms (33 per cent) have the same person serving as both CEOand board chairman A majority of firms (134 companies; 80 per cent)have an audit committee, but only 38 firms (23 per cent) have compensa-tion committees More than 90 companies have ADRs currently trading

in the United States, with the largest portion from the HSI (28 out of 33firms) and HSHKCI (63 out of 110 companies) groupings A largeportion of the HSI and HSHKCI sample companies are included in theMSCI Lastly, of the sample of 168 companies, 58 firms are eitherH-shares or red chips.12

4.2 Regression Analyses

The main research question is to assess whether good corporate ance practices lead to higher firm values in Hong Kong Regressionanalyses between the CGI measure and explanatory and control variablesshould provide an additional insight Figure 1 provides the first indica-tion of a possible relation between corporate governance practices andmarket valuation Using the MTBV as a proxy for market value, Figure

govern-1 shows a positive and statistically significant correlation between the

CGI and the market value This implies that companies with highercorporate governance scores also have higher MTBVs, and vice versa.Our results provide initial support for the conclusion that good corporategovernance is positively related to market valuation Table 4 lists thecorrelation coefficients between all variables with a statistical significance

at the 5 per cent level or better

4.2.1 Regression results for market performance (market-to-book value).

Table 5 displays ordinary least squares regression results for the CGI andcontrol variables, excluding 19 financial institutions in the sample asnoted earlier.13The first column in Table 5 shows the result of regressingMTBV on CGI The CGI coefficient is 0.0330 and is statisticallysignificant at the 5 per cent level We progressively add control variables

in models (2) and (3), and obtain similar results: CGI is positively andsignificantly associated with market performance, as measured byMTBV When all control variables are included in model (3), thecoefficient for CGI is 0.0337, which is still statistically significant at the

5 per cent level The consistent results in Table 5 show that severalcontrol variables explain the variation in MTBV The first set of controlvariables are financial characteristics that may be related to marketvaluation For example, it is reasonable to expect that investors evaluatelisted companies based on their profitability Therefore, ROA, anindicator for firm profitability, is likely to be associated with MTBV

We find that ROA is positively and significantly related to MTBV in tworegression models as shown in Table 5 In models (2) and (3), thecoefficients are all statistically significant at the 5 per cent level or better,implying that investors value Hong Kong listed companies based onprofitability Turning next to firm size, Black et al (2006) claim that firmsize can plausibly affect both a firm’s market value and its governancepractices Consistent with prior research (e.g., Lang and Stulz, 1994),models (2) and (3) in Table 5 show coefficients for firm size that arenegative and statistically significant at the 5 per cent level or better Interms of risk factors, both capital structure and leverage can affect afirm’s MTBV and, potentially, CGI We include the current ratio anddebt/equity ratio to control for liquidity and financial risk The coeffi-cients are not statistically significant in any of the regression resultsshown in Table 5

Both board structure and shareholding structure are important ments of corporate governance practices These characteristics are