Dominant Shareholders, Corporate Boards and Corporate Value: A Cross-Country Analysis

TLDR: In this article, the authors investigate the relation between corporate value and the proportion of the board made up of independent directors in 799 firms with a dominant shareholder across 22 countries and find a positive relation, especially in countries with weak legal protection for shareholders.

Abstract: We investigate the relation between corporate value and the proportion of the board made up of independent directors in 799 firms with a dominant shareholder across 22 countries. We find a positive relation, especially in countries with weak legal protection for shareholders. The findings suggest that a dominant shareholder, were he so inclined, could offset, at least in part, the documented value discount associated with weak country-level shareholder protection by appointing an 'independent' board. The cost to the dominant shareholder of doing so is the loss in perquisites associated with being a dominant shareholder. Thus, not all dominant shareholders will choose independent boards.

Figures

Table I Descriptive statistics on firms with a dominant shareholder

Table IV Regressions of Tobin’s Q on ln (INDDIR%) and control variables for subsamples classified by LEGAL

Table II Tobin’s Q across legal and firm-specific characteristics

Table III Regressions of Tobin’s Q on LEGAL, INDDIR%, board size, and control variables

Table V Two-stage instrumental variables regressions of ln (INDDIR%) and Tobin’s Q in firms with a dominant shareholder

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Purdue University
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Purdue CIBER Working Papers Krannert Graduate School of Management
1-1-2006
Dominant Shareholders, Corporate Boards and
Corporate Value: A Cross-Country Analysis
Jay Dahya
e City University of New York
Orlin Dimitrov
York University
John J. McConnell
Purdue University
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Dahya, Jay; Dimitrov, Orlin; and McConnell, John J., "Dominant Shareholders, Corporate Boards and Corporate Value: A Cross-
Country Analysis" (2006). Purdue CIBER Working Papers. Paper 41.
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Dominant Shareholders, Corporate Boards and Corporate
Value: A Cross-Country Analysis
Jay Dahya
The City University of New York
Orlin Dimitrov
York University
John J. McConnell
Purdue University
2006-001

Dominant Shareholders, Corporate Boards and Corporate Value:
A Cross-Country Analysis
Jay Dahya
Orlin Dimitrov
and
John J. McConnell
*
August 9, 2006
Dahya is from Baruch College, The City University of New York, Dimitrov is from
Schulich Business School, York University, and McConnell is from the Krannert School
of Management, Purdue University. This paper has benefited from the helpful comments
and suggestions of Naveen Daniel, David Denis, Diane Denis, Mara Faccio, Andrew
Karolyi, E. Han Kim, Alexei Ovtchinnikov, Raghu Rau, René Stulz, Michael Weisbach
David Yermack, and seminar participants at Baruch College (CUNY), Concordia
University, IUPUI, Purdue University, University of Iowa, University of Oklahoma,
Vrije University of Amsterdam, and York University. Dahya acknowledges financial
support from the Eugene M Lang Junior Faculty Fellowship and Baruch College Fund,
CUNY. Dimitrov acknowledges financial support from CIBER at Purdue University.
*
Corresponding author: John J. McConnell, Krannert School of Management, Purdue University, West
Lafayette, IN 47907. mcconnell@mgmt.purdue.edu

Dominant Shareholders, Corporate Boards and Corporate Value:
A Cross-Country Analysis
Abstract
We investigate the relation between corporate value and the fraction of independent
directors in 799 firms with a dominant shareholder across 22 countries. We find a
positive relation, especially in countries with weak legal protection for shareholders. The
findings suggest that a dominant shareholder, were he so inclined, could offset, at least in
part, the documented value discount associated with weak country-level shareholder
protection by appointing an ‘independent’ board. The cost to the dominant shareholder
of doing so is the loss in perquisites associated with being a dominant shareholder. Thus,
not all dominant shareholders will choose independent boards.

Dominant Shareholders, Corporate Boards and Corporate Value:
A Cross-Country Analysis
This paper is an empirical investigation of the relationship between corporate
value and board composition in firms with a dominant shareholder. The question
addressed is whether a ‘strong’ board can offset the market value discount in firms
domiciled in countries with weak legal protection for shareholders. Such a discount has
been documented by Claessens, Djankov, Fan and Lang (CDFL) (2002), Durnev and
Kim (DK) (2005), and La Porta, Lopez-de-Salanes, Shleifer, and Vishny (LLSV) (2002).
This discount is often attributed to the ability of a dominant shareholder to divert
corporate resources from other shareholders to himself for personal consumption,
especially in countries with weak legal shareholder protection. In essence, the question
that we address is whether a dominant shareholder could, were he so inclined, increase
firm value by appointing a ‘strong’ board with a mandate of assuring minority investors
that he will refrain from diversion of the firm’s resources and whether the effect of board
composition on firm value, if there is any, is different between countries with weak and
those with strong legal shareholder protection.
The studies most closely related to ours are Durnev and Kim (DK) (2005) and
Klapper and Love (KL) (2004). Among other things, these studies empirically
investigate the relationship between firm value and the ‘quality’ of a firm’s corporate
governance where the proxies for the quality of governance are two firm-specific indices:
the Credit Lyonnais Securities Asia (CLSA) corporate governance scores and the
Standard & Poor’s (S&P) transparency rankings. As do the other studies cited above,

Frequently asked questions

Q1. What are the contributions in "Dominant shareholders, corporate boards and corporate value: a cross-country analysis" ?

The authors investigate the relation between corporate value and the fraction of independent directors in 799 firms with a dominant shareholder across 22 countries. This paper is an empirical investigation of the relationship between corporate value and board composition in firms with a dominant shareholder. The findings suggest that a dominant shareholder, were he so inclined, could offset, at least in part, the documented value discount associated with weak country-level shareholder protection by appointing an ‘ independent ’ board. 

Q2. What is the technique used to estimate the endogenous variables?

The estimation technique the authors use is two-stage least squares instrumental variable regression (2SIV) which requires that the authors find suitable instruments for the endogenous variables. 

Q3. What is the frequently cited mechanism of diversion by dominant shareholders?

Perhaps the most frequently cited mechanism through which dominant shareholders are alleged to divert resources is by arranging disadvantageous transactions between the publicly traded firms that they control and other firms also controlled by the dominant shareholder in which the dominant shareholder has a larger ownership position. 

Q4. What is the question that arises when a dominant shareholder decides to appoint?

Should the dominant shareholder decide to appoint a strong board, a question thatarises is whether a sufficiently independent board could recover the full value discount associated with the firm operating in a weak legal environment. 

Q5. What is the relationship between Qs and the fraction of the board composed of independent directors?

The authors also find that, after controlling for country-level of legal shareholder protection (and other5factors), Qs are positively correlated with the fraction of the board composed of independent directors: a higher fraction of independent directors is associated with a higher Q ratio. 

Q6. In what model can the dominant shareholder choose to list the shares of his firm on the stock exchange?

In the DKS (2004b) model, the dominant shareholder can choose to list the shares of his firm on the stock exchange of a country with stronger legal shareholder protection. 

Q7. What is the degree to which a strong board can offset the loss in value due to weak?

As might be expected, the degree to which a strong board can offset the loss in value due to weak country-level legal shareholder protection depends on the initial level of investor protection and the level to which the dominant shareholder aspires. 

Q8. What is the relationship between the proportion of independent directors and the number of shareholders?

After controlling for other factors, the occurrence of related party transactions is negatively correlated with the fraction of the board comprising independent directors: a higher proportion of independent directors is associated with a lower likelihood of a related party transaction. 

Q9. What is the likely case for a dominant shareholder to reduce his diversion of corporate resources?

In some instances, however, a dominant shareholder may be willing to reduce his diversion of corporate resources in exchange for an increase in firm value.