Does good corporate governance pay off in the long run? Evidence from stock market segment switches in Brazil/Governanca corporativa compensa no longo prazo? Evidencia a partir de mudancas no segmento no mercado acionario brasileiro.
| Autor | Moura, Luiz |
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Introduction
Corporate governance and disclosure of information matter for financial growth and development, helping to reduce agency problems and asymmetric information in financial markets, improve the legal environment, and promote market discipline. The marginal value of good corporate governance is expected to be particularly high for emerging economies where economic and legal institutions are opaque, less developed or plagued by enforcement problems.
In this paper, we investigate the long-run effects of higher standards of corporate governance in the Brazilian stock market, which has expanded strongly in the last two decades. Brazil is on global rank eight in terms of GDP, has the largest stock market in Latin America, and accounts for a significant part of the capital invested in the continent. Several changes occurred in the regulatory framework, designed to make the market more accessible to foreign and retail investors. One of the biggest innovations was the introduction of the new listing segments Nivel 1, Nivel 2 and the Novo Mercado in December 2000 next to the traditional market. In the new segments, listed firms have to adopt higher corporate governance standards than those required by law, as well as the rules of the Sarbanes-Oxley Act (SOX) since July 2002. 46% of the firms listed on the Brazilian stock exchange (and 81% of the IPOs) switched to this segment since its creation (1). A listing on the Novo Mercado requires the exclusive issuance of common shares (one share, one vote), an annual report of the statutory audit committee, quarterly minutes of the board meetings, and various further strict requirements.
Our focus is on the long-run stock market performance after firms' segment switches. The literature has documented positive short-run effects of the market reform (e.g. Carvalho and Pennacchi, 2012), but there is virtually no evidence whether committing to higher standards of corporate governance in Brazil has paid off in the long run. There are several reasons why the long-run effects might differ from the short-term performance. First, the improved corporate governance and information disclosure due to the market reform represents a promise to investors, but it is unclear to what extent it has been honored by the firms or enforced by investors when under pressure (2). Second, earlier reforms such as the Brazilian Corporate Law reform (Lei das Sociedades por Acoes, approved by House of Representatives in 2001) that aimed at shaping the legal environment according to the needs of modern capital markets turned out to be insufficient (Carvalho, 2002). Third, firms that switch to the Novo Mercado must cope with non-trivial additional costs (3), making it harder to meet investors' return expectations. Fourth, international experience points to bubbles and bursts in the Novo Mercado's European counterparts, for example the German Neuer Markt, accompanied by insider trading, accounting scandals and corporate fraud. Hence, positive long-run effects of higher standards of corporate governance are by no means guaranteed (4).
We also investigate the rationale behind switching to the three new segments. If the firms that switch to the Novo Mercado outperform those switching to Nivel 1 and 2 in the long run, we can conclude, all else being equal, that committing to higher standards of corporate governance pays off. However, if their long-run performance is lower than that of others firms, the positive abnormal returns around the segment switch announcement documented in earlier studies might have been an irrational overreaction and possibly due to an index effect (Harris & Gurel 1986; Chan & Howard 2002; Elliot et al. 2006; Kappou, Brooks & Ward 2009; Kasch & Sarkar 2011) (5), or due to price pressure created by speculative traders around the event.
Next to the impact on returns, listing segment switches might affect the market microstructure of the stocks, leading to higher market quality. The higher standards of the Novo Mercado might help to increase the number of trades and the trading volume after the segment switch. Similarly, the liquidity of stocks might have increased because informational asymmetries have been reduced. Furthermore, considering that high levels of liquidity may reflect improved market expectations, firms' beta coefficients (the sensitivity to the market factor or contribution to systematic risk) are expected to decrease after the segment switch.
Finally, firms' financial health might influence the magnitude of the stock market reaction (e.g., Bebchuk, Cohen & Ferrell, 2009). We expect greater effects of corporate governance, the stronger a firm's financial health. The rationale behind this is that strong firms are likely to gain when asymmetric information is reduced, because they are no longer pooled with weak firms. We measure financial health using Altman's Z-score (Altman, 1968), adapted for the use of financial data made available by Bloomberg. It is a widely employed measure of the corporate financial health and directly related to firms' probability of default.
Based on data from all publicly-listed Brazilian firms that switch to a new listing segment during the period 2001-2016, we obtain the following results. We find that firms that switch to the Novo Mercado exhibit significantly higher cumulative abnormal returns than those that switch to the other levels. This result holds for a horizon of up to 1,000 trading days following the segment switch announcement. Furthermore, we find that this effect becomes stronger after the Global Financial Crisis. Measures of market microstructure for firms that switch to the Novo Mercado improve significantly in the long run, especially after the Global Financial Crisis. Finally, the stock market reaction to segment switches is stronger for more financially healthy firms. Our results are robust to alternative event windows, different post-announcement horizons, different models for abnormal returns, alternative sets of control variables, industry fixed effects, year fixed effects, different measures of financial health, and American Depositary Receipts issuance (ADR).
Our study contributes to the literature in two ways. First, we investigate the long-run effects of higher standards of corporate governance in the stock market. Despite the general literature on valuation effects of corporate governance (e.g., Shleifer & Vishny 1997; Becht, Bolton & Roell 2003; Bushman & Smith 2003; Gompers, Ishii & Metrick 2003; Jandik & Rennie 2005; Black, Carvalho, Gorga 2010), there is little evidence on long-run stock market impact of committing to different levels. Some studies analyze the short-term announcement effects after the introduction of the new listing segments in Brazil (e.g., Carvalho, 2002; Aguiar, Corrar & Batistella 2004; Rogers 2006; Procianoy & Verdi 2009; Carvalho & Pennacchi 2012). These studies document significantly positive short-term effects for firms that switch to segments that require higher corporate governance. However, to the best of our knowledge, none of these earlier studies has examined the long-run effects and, and importantly, their consistency with the short-term effects. Second, we investigate the market reaction for each listing segment separately, seeking to understand their incremental values. We show that firms that switch to the Novo Mercado--but not those that switch to the intermediate segments Nivel 1 and 2--experience significantly positive effects in the long run. Hence, firms only benefit if they make the full step towards the highest standard of corporate governance and information disclosure.
The remainder of this paper is organized as follows. In Section 2, we describe the institutional background and develop our hypotheses. In Section 3, we describe the data and method. In Section 4, we present the empirical results. In Section 5, we show evidence from further checks and robustness tests. Section 6 concludes.
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Institutional background and hypotheses
2.1 Institutional background
In the last three decades, the business environment and the corporate sector in Brazil have undergone major changes, accompanied by an intense debate regarding corporate governance and information disclosure. The entry of new investors in the Brazilian market (national and international institutions), the influence of global mergers and acquisitions, pressure to reduce the cost of capital, and the search for less-concentrated corporate control, resulted in a transition from the model of oligopolistic family-owned businesses to a new model with greater participation of institutional investors (Bridger, 2006). In this context, McKinsey and Co. and Standard and Poor's (2001) analyze corporate governance in Brazil and describe its key features. They show that there was a high concentration of ownership in the largest shareholders, low acknowledgment of minority shareholders' interests, overlap between ownership and board of directors in favor of the majority shareholder's interests, lack of a formal structure of the counsel and external advisors, and an insufficient level of transparency for investors. Leal, Silva, & Valadares (2002) examine the control structure of 225 Brazilian firms and show that the majority of firms are controlled by up to three shareholders. Furthermore, they show that controlling shareholders hold more than the legal minimum investment for publicly traded firms, implying that there exist private control benefits (Carvalho, 2002). Silva (2005) analyzes the control structure of publicly-listed firms and shows that for 90% of the firms a share of more than 50% of the voting capital is held by a single shareholder.
Given the political and institutional challenges to promote legal changes that would more effectively protect minority shareholders, and prompted by new listing segments in Europe in the second half of the 1990s (6), voluntary mechanisms to adopt good corporate...
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