Corporate events’ performance and corporate governance: the Brazilian evidence

• DOI: https://doi.org/10.1108/CG-11-2016-0219
• Pages: 14-34
• Date: 05 February 2018
• Published date: 05 February 2018
• Author: Bruno Funchal,Jedson Pereira Pinto
• Subject Matter: Strategy,Corporate governance

Corporate events’performance and

corporate governance: the Brazilian

evidence

Bruno Funchal and Jedson Pereira Pinto

Abstract

Purpose –The purpose of this paper is to investigate the relation between corporategovernance and

corporateevents’ performance. Firms that engagein corporate events seem to perform atleast as bad as

similar firms that did not. Based on agency theory, the authors hypothesize that lower corporate

performanceis associated to differences in governance levels.

Design/methodology/approach –Bessembinder and Zhang’s (2013) approach to evaluate the

performance of corporate events has been expanded by considering unique corporate governance

featuresfrom Brazilian stock market.

Findings –The results suggest that after controlling for governance levels, event rms and control rms

have similarperformance. A number of analyses wereperformed to rule out alternative explanations.

Originality/value –The results call attentionfor the role of agency costs in evaluating corporateevents’

performance.

Keywords Corporate governance, Corporate event performance

Paper type Research paper

1. Introduction

This paper investigates the relation between corporate governance and corporate events’

performance. Firms that engage in corporate events seem to perform at least as bad as

similar firms that did not[1]. One potential explanation for such finding relies on issues

related to (unobservable) agency costs. Companies in which managers have higher

discretion might be more likely to engage in projects that are not optimal for the firm,

resulting in lower future performance. Nevertheless, stronger governance mechanisms

could mitigate such detrimental discretion, preventing managers to engage in value-

destroying projects.

Studying the role of governance mechanisms in financial markets is important especially in

countries where there is less investor protection or in countries where regulatory institutions

may not be as effective as observed in developed countries(La Porta et al.,1997). In these

economies, firms are more likely to use governanceschemes as mechanisms to reduce the

agency problem, attracting more investments and cheaper funding (Funchal and Monte-

Mor, 2016). As a consequence, investors will consider corporate governance practices

when evaluating new projects, such as corporate events[2]. Therefore, we conjecture that

governance levels could helpexplain mixed evidence about corporate event performance.

Corporate governance are mechanisms and structures that identify rights and

responsibilities among corporate agents aiming to assure returns to stakeholders on

their investment (Shleifer and Vishny, 1997). These mechanisms help stakeholders by

reducing the likelihood of corporate misconduct (Chhaochharia and Grinstein, 2007),

Bruno Funchal is Professor

at the Fucape Business

School, Vitoria, Brazil.

Jedson Pereira Pinto is PhD

Candidate at UNC at the

Department of Accounting,

Kenan-Flagler Business

School, University of North

Carolina, Chapel Hill, North

Carolina, USA.

Received 23 November 2016

Revised 18 June 2017

Accepted 28 August 2017

PAGE 14 jCORPORATE GOVERNANCE jVOL. 18 NO. 1, 2018, pp. 14-34, © Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-11-2016-0219

empire-building (Ashbaugh-Skaife et al.,2006) and other value-destroying practices,

thus, affecting firms’ valuation. In a standard principal–agent model, stronger

governance would assure that managers engage in net positive valued projects by

guaranteeing managers’ high effort.

However, measuring governance has been a challenge in the literature since different

governance dimensions have different effects on firms’ returns or firms’ characteristics

(Bebchuk et al.,2009).To deal with this issue, we exploit a unique characteristic of Brazilian

stock exchange in which there are four standardized different governance listing levels (in

the stock exchange) that firms can enroll at. Each level has its own requirements. However,

a firm cannot be listed in a higher governance level if it does not satisfy lower listing levels.

For example, in the lowest governance level (“Tradicional”), firms are not requiredto have a

minimum free float; Chief Executive Officer (CEO) can accumulate positions and an annual

public meeting is not mandatory. However, to be listed in higher levels, firms need to

maintain a minimum of 25 per cent free float, the CEO and Chief Financial Officer (CFO)

cannot be the same person, directors need to rotate every two years and firms must meet

have at least one annual public meeting per year[3].

The standardization provides common knowledge about what better governanc e means.

Hence, we can verify the effect of corporate governance in Brazilian companies by analyzing

the difference at the listing levels in the stock exchange. Companies that have American

Depositary Receive (ADR) level 2 or 3 programs require the US depositary bank to register the

ADRs representing the issuer’s securities under the Securities Act by filing out Form F-6 ,

following Sarbanes–Oxley (SOX) rules. Firms subjected to the Securities and Exchange

Commission (SEC) and to the SOX regulation have better governance mechanisms

(Holmstrom and Kaplan, 2003). Charetou et al. (2007) found empirical evidence on the

relationship between cross-listing and corporate governance level. Therefore, in additional

tests, we compare governance levels by examining whether firms have ADRs.

We conjecture that corporate governance is positively associated with financial

performance. Higher governancecan reduce and help solve conflicts among stakeholders,

especially in the year after a corporate event. Nevertheless, there are important reasons

why we could find no empirical relation between corporate governance and firms’

performance. First, higher corporate governance could have no first-order effect on firms’

performance. For example, higher governance could increase the time in the decision-

making process, which could be detrimental to financial performance. Moreover, higher

governance could decrease beneficial managers’ discretion, which would be associated

with negative performance. Finally, higher governance could decrease firms’ performance

by reducing firms’ systematic risk. Therefore, examining the relation between governance

and corporate performance is an empirical question.

We test this hypothesis using monthly data from Brazilian Initial Public Offers (IPOs),

Seasoned Equity Offers (SEOs) and mergers and acquisitions (M&A) from 2004 to 2014 for

265 event firms in the sample and 265control firms. Specifically, our sample is made by 92

SEOs, 68 M&A and 105 IPOs and their respective control firms. The control sample is

constructed by firms in the same industry and similar book to market near the event date

that did not engage in any corporate event in a one-year window[4]. We focused on the

year after the corporate event since most challenges and changes are likely to happen in

the first year after the corporate event. Robustness analysis provides similar inferences

when focusing on shorter periods such as the first quarter after the corporate event or first

month (untabulated).

Descriptive analysis suggests that event firms systematically differ in terms of risk, liquidity,

volatility, market value, return momentum and corporate governance from control firms

which are variables known to affect return (Ang etal.,2006;Amihud, 2002;Jegadeesh and

Titman, 1993). Hence, controlling for change in firms’ characteristics is important when

VOL. 18 NO. 1, 2018 jCORPORATE GOVERNANCE jPAGE 15