How Much Value Does Corporate
Governance Add to a Firm?
S.C. Lee*
Edward Lin**
P.T. Chang*
*Yuan Ze University
**National Chiao-Tung University and University of Adelaide (Australia).
1
Motivation
 The
importance of Corporate Governance
has well been documented for firm value.
 La Porta et al. (1998, 2000, 2002) in Law
and Finance Literature
 Gompers et al. (2003), Brown & Caylor
(2006) on the positive relationship
between governance measures and firm
value.
2
Motivation
 Bai
et al. (2004), Black et al. (2006), and
Choi et al. (2007) for international studies.
 However, existing studies tends to be ad
hoc and lacks a valuation framework to
test the value of corporate governance.
 Essentially, what is the intrinsic value of
corporate governance?
3
The Ohlson (1995) Model

Based on the Dividend Discount Model, Ohlson
(1995) develops a residual income valuation
model,

Pt  BVt   R  Et ( RI t  )
 1

where
RI t 1  RI t  vt   1t 1
v t 1  v t   2 t 1
4
The Ohlson (1995) Model
Pt  BVt   1 RI t   2 t
where
 1   /( R   )  0
and
 2  R /( R   )( R   )  0
 Other
information may include
 Analyst forecast (Dechlow et al., 1999)
 Order backlog (Myers, 1999)
 Dividends (Hand and Landsman, 1998)
5
The Ohlson (1995) Model

R&D expenses (Callen and Morel, 2005)
 Audit and non-audit fees (Brown and Caylor,
2005)
 We hypothesize that other information contains
a firm’s governance measures.
 Our study not only tests the validity of the
Ohlson model but more importantly, looks at the
intrinsic value of corporate governance.
6
Data

We use firms from Taiwan for our study
 It contains more information in terms of depth and
scope about a firm’s governance practices than the
IRRC and ISS. It includes 32 governance measures
in 5 categories.
 U.S. studies tend to focus on board size and
composition after the Enron and Worldcom
scandals, and the Sarbanes Oxley Act (Yermack
(1996), Cheng (2008), Coles et al. (2008)
7
Data
 Other
categories of governance for firms in
East Asian countries may be more important.
 e.g. Divergence between cash flow rights
and control rights. (Classens et al., 2002 and
Lemmon and Lins 2003)

8
Methodology

Since the Ohlson model is in time-series and
both market value and book value exhibit
nonstationary behaviour. We use cointegration
method.

Essentially, we test if market value is
cointegrated with book value, residual income
and the governance measures.
9
Table 3
Percentage
of
stationarity
Mean
Std. Dev
Q1
Market value
-1.64
1.72
-2.44
-1.86
-0.60
13.24
Book value
-1.57
1.44
-2.25
-1.66
-0.74
10.96
residual income 1 - (RI1t)
-2.77
1.96
-3.61
-2.72
-1.78
43.84
residual income 2 - (RI2t)
-2.67
1.96
-3.58
-2.58
-1.62
38.36
residual income3 - (RI3t)
-3.48
1.56
-4.07
-3.41
-2.66
68.95
Median
Q3
Panel A: Ohlson Factors
10
Table 3 - continued
Panel B: Ownership Structure (CG1)
Shareholdings of directors and
supervisors (SDS)
-1.63
1.17
-2.07
-1.52
-1.00
10.50
Shareholdings of the largest
Shareholder (SLS)
-1.59
0.95
-2.23
-1.50
-1.02
7.31
Total shareholdings of family (TSF)
-1.56
1.37
-2.08
-1.45
-0.92
10.05
Critical Control Level (CCL)
-2.86
18.41
-3.02
-2.25
-1.43
26.48
Shareholdings of individuals (SID)
-2.17
1.59
-2.72
-1.78
-1.195
22.83
11
Table 3 - continued
Panel C: Divergence Between Cash Flow Rights and Control Rights (CG2)
Voting Rights (VR)
-1.54
1.25
-2.10 -1.41
-0.87
10.05
Direct Shareholdings by Family (DSF)
-10.03 125.18
-2.07 -1.38
-0.87
11.42
Cash Flow Rights (CFR)
-1.69
1.37
-2.23 -1.54
-0.96
11.42
Times of Seating to Cash Flow (TSC)
-1.76
1.38
-2.15
-1.61
-1.12
10.96
Times of Seating to Voting (TSV)
-1.82
1.35
-2.16
-1.66
-1.17
12.33
Excess of Critical Control Level
(ECL)
-1.97
1.37
-2.59
-1.77
-1.14
14.16
Table 4
Mean
Std. Dev
Q1
Median
Q3
Percentage of
stationarity
Panel A: Ohlson Factors
Market value
-4.90
1.64
-6.02
-5.12
-3.77
85.39
Book value
-4.81
1.76
-5.82
-5.00
-3.75
82.65
residual income 1 - (RI1t)
-5.38
2.89
-6.90
-5.45
-3.00
75.80
residual income 2 - (RI2t)
-5.41
2.89
-6.91
-5.45
-3.19
76.71
residual income3 - (RI3t)
-6.34
2.46
-7.25
-6.15
-5.16
94.52
13
Table 4 - continued
Panel B: Ownership Structure (CG1)
Shareholdings of directors
and supervisors (SDS)
-5.83
5.11
-5.85
-5.47
-5.04
95.89
Shareholdings of the largest
Shareholder (SLS)
-5.52
1.23
-5.92
-5.55
-5.40
96.80
Total shareholdings of
family (TSF)
-5.66
2.48
-6.20
-5.52
-4.93
95.43
Critical Control Level
(CCL)
-8.05
12.18
-6.43
-5.67
-5.40
87.21
Shareholdings of
individuals (SID)
-5.59
2.17
-6.30
-5.67
-5.22
88.58
14
Table 4 - continued
Panel C: Divergence Between Cash Flow Rights and Control Rights (CG2)
Voting Rights (VR)
-5.70
1.88
-6.24
-5.56
-4.99
95.89
Direct Shareholdings by
Family (DSF)
-8.77
48.45
-6.09
-5.51
-4.94
93.61
Cash Flow Rights (CFR)
-5.62
2.42
-6.18
-5.54
-4.95
94.52
Times of Seating to Cash
Flow (TSC)
-5.59
2.54
-6.25
-5.59
-5.02
95.89
Times of Seating to Voting
(TSV)
-5.62
1.60
-6.20
-5.52
-5.03
95.89
Excess of Critical Control
Level (ECL)
-6.06
2.42
-6.83
-5.85
-5.09
93.61
Cointegration results
Mean
Std. Dev
Panel A: Residual Income I – (RI1t)
-2.76
1.20
Ohlson
CG1
-4.35
1.03
CG2
-4.42
1.14
CG-Total
-5.06
1.10
Panel B: Residual Income 2 – (RI2t)
Ohlson
-2.77
1.25
CG1
-4.36
1.05
CG2
-4.43
1.15
CG-Total
-5.07
1.12
Panel C: Residual Income 3 – (RI3t)
Ohlson
-2.75
1.16
CG1
-4.26
1.07
CG2
-4.40
1.10
CG-Total
-5.11
1.10
Q1
Median
Q3
Percentage of
Stationarity
-3.39
-5.00
-5.06
-5.84
-2.73
-4.26
-4.44
-4.94
-2.20
-3.67
-3.61
-4.32
40.64
94.06
93.15
97.72
-3.43
-5.02
-5.14
-5.85
-2.72
-4.27
-4.43
-4.95
-2.22
-3.66
-3.68
-4.34
40.64
94.52
93.15
97.26
-3.41
-5.03
-5.12
-5.84
-2.68
-4.17
-4.40
-5.06
-2.12
-3.53
-3.72
-4.34
42.92
90.87
92.24
98.63
16
Conclusions
 Book
Value and Residual Income alone
cannot adequately explain market value
 Adding governance measures of
ownership structure and divergence
between cash flow rights and control rights
account for more variation of stock price
value over time.
 Governance practises are at least equally
important as the accounting factors in
explaining market value.
17