Does corporate governance matter? : evidence from China and Hong Kong

Abstract

In this study, a corporate governance index (CGI) is constructed to measure the quality of corporate governance practices of the 100 largest listed firms in China from 2004 to 2006 and the constituent stocks of four major indexes in Hong Kong from 2002 to 2005. The results reveal that listed companies from both China and Hong Kong have been attaining progress in the field of corporate governance reform. In the context of Chinese firms, the findings show a positive relation between market valuation and overall corporate governance practices, as measured by the CGI. Further investigation reveals that the rights of shareholders serve as the main driver in the relationship. In the Hong Kong market, a positive relation between CGI scores and various measures of firm performance is also found. Furthermore, the findings suggest an asymmetric market response to changes in the quality of corporate governance practices. Specifically, the magnitudes of the decline in stock returns when firms show deteriorating CGI scores are much larger than the magnitudes of return increases when firms show improving CGI scores. In addition, investors reward low-CGI companies for improvement, but do not impose any penalty for deterioration. In parallel, they penalize high-CGI companies for deterioration, but provide no reward for improvement. Finally, the results indicate that stock returns are more responsive to deteriorating rights of shareholders and improving disclosure and transparency than to changes in other aspects of governance.