How corporate governance affect firm value? Evidence on a self-dealing channel from a natural experiment in Korea

Prior work in emerging markets provides evidence that better corporate governance predicts higher market value, but very little evidence on the specific channels through which governance can increase value. We provide evidence, from a natural experiment in Korea, that reduced tunneling is an important channel. Korean legal reform in 1999 changed the board structure of “large” firms (assets > 2 trillion won) relative to smaller firms. In event studies of the reform events, we show that large firms whose controllers have incentive to tunnel earn strong positive returns, relative to mid-sized firms. In panel regressions over 1998–2004, we also show that better governance moderates the negative effect of related-party transactions on value and increases the sensitivity of firm profitability to industry profitability (consistent with less tunneling).     

Trade Credit,Future Earnings,and Stock Returns: A Self-Dealing Perspective

Chinese listed firms are characterized by a great magnitude of long-duration accounts receivable from controlling shareholders and their affiliates, and they often do not make bad debt allowances. On many occasions, these receivables are never collected. We find that firms with a great magnitude of accounts receivable demonstrate a low level of future profitability and low stock returns. It does not appear that the low earnings persistence of these firms is responsible for their poor future performance as predicted by the accrual anomaly, because the firms also report low concurrent earnings. In the context of the Chinese stock market, we interpret the results as being consistent with self-dealing through trade credit by controlling shareholders. This study contributes to the self-dealing literature by identifying a more subtle channel of expropriation of minority shareholders in China.