Endogeneity of Brazilian corporate governance quality determinants

Abstract

Purpose -This paper aims to investigate the determinants and the evolution of voluntarily adopted firm-level corporate governance practices in Brazil from 1998 to 2004 using broad corporate governance scores.Design/methodology/approach -The authors employ a robust panel-data procedure that accounts for the main sources of endogeneity to a very representative panel of Brazilian firms over a six-year period. They address the endogeneity that arises from the simultaneous determination of the quality of corporate governance practices, the dependent variable, and possibly several firm attributes that are commonly employed as the determinants of such practices and are supposedly independent. Specifically, theoretical arguments and empirical evidence strongly suggest that the quality of corporate governance practices may influence some of the variables commonly used as its determinants just as much as they may be influenced by them.Findings -The paper finds that firm-level corporate governance practices are steadily improving but there is much room for improvement. Heterogeneity has increased. Voluntarily adhering to new stricter listing requirements is associated positively with improvements in firm-level corporate governance practices. Reducing or not using non-voting shares improves corporate governance practices.Research limitation/implications -The authors found no clear evidence of the influence of other potential determinants of the quality of corporate governance, such as growth prospects, firm size, firm value, and ownership structure. Thus, they doubt previous findings that suggest a causal relationship from value and ownership to corporate governance practices because value and ownership seem to be determined endogenously.Practical implications -Policies directed to reduce the use of non-voting shares should be implemented. Creating strict listing requirements that may be adopted voluntarily by firms could be a feasible solution to improve the quality of corporate governance practices in emerging market countries. Firms in an emerging market that find that issuance in the USA became too expensive or demanding may offer a substitute listing environment with credible requirements to foreign investors. Premium listings may partially compensate emerging market exchanges for their loss of trading to major markets.Originality/value -The paper examines the evolution of the voluntary adoption of corporate governance practices in Brazil from 1998 through 2004 while most studies use cross-section samples over one or a few years. Further, this is one of a few papers to analyze the impact of ownership structure on the quality of corporate governance practices by segregating control and cash flow rights.

Ownership concentration, top management and board compensation

“…Durnev and Kim (2005), for example, formulated a theoretical model that attained empirical support stating that a lower degree of ownership concentration causes companies to adopt better CG practices. Moreover, as emphasized in Silveira et al (2010), there is probably an endogeneity problem due to reverse causality between the quality of CG practices and the degree of ownership concentration, since a decrease in the latter may increase the quality of CG, which, in turn, may contribute to the degree of ownership concentration decline. Table 4 shows two versions of model 4 for TMC in Table 3 that include a dummy variable that represents good CG practices (N2NM) and indicates that the company trades in one of the premium segments, Level 2 or Novo Mercado, of BM&FBovespa, as suggested by Silveira et al (2010).…”

“…Moreover, as emphasized in Silveira et al (2010), there is probably an endogeneity problem due to reverse causality between the quality of CG practices and the degree of ownership concentration, since a decrease in the latter may increase the quality of CG, which, in turn, may contribute to the degree of ownership concentration decline. Table 4 shows two versions of model 4 for TMC in Table 3 that include a dummy variable that represents good CG practices (N2NM) and indicates that the company trades in one of the premium segments, Level 2 or Novo Mercado, of BM&FBovespa, as suggested by Silveira et al (2010). Model 1 in Table 4 does not include a degree of ownership concentration variable and Model 2 adds the total degree of ownership concentration of the five largest shareholders (T5), which was the degree of ownership concentration variable that obtained the largest coefficient in the regressions of Table 3.…”

“…The literature suggests that there should be an association between the administrator compensation and company performance, even though empirical tests suggest that it may not be very strong (Bebchuk & Fried, 2004;Murphy, 1985). This study used the return on assets on two separate dates, 2009 (ROA09) and 2008 (ROA08), to measure performance because the stock of some companies display low liquidity, rendering the computation of a reliable average stock return difficult (Leal & Carvalhal-da-Silva, 2007;Silveira, Leal, Carvalhal-da-Silva, & Barros, 2010). The option for the average stock return to represent performance would require a RAC, Rio de Janeiro, v. 17, n. 3, art.…”

“…Net revenues and total assets are common company size measures in the literature. This study employed the natural logarithm of total assets (TA), defined in the Appendix, as the size variable in Equation 1, following other Brazilian studies, such as Silveira, Leal, Carvalhal-da-Silva, and Barros (2010) and Leal and Carvalhal-da-Silva (2007).…”

“…To the extent that better CG practices increase transparency and investor protection, they may contribute to containing the remuneration of administrators. Following Silveira et al (2010), we used a dummy variable indicating listing in the Level 2 or Novo Mercado premium trading segments of BM&FBovespa (N2NM) in a final set of tests. The premium trading segments require many additional CG and transparency practices that are not mandated by law.…”