Does Macroeconomic Performance Affect Corporate Governance? Evidence from Turkey

• Author: Mehmet Ugur,Melsa Ararat
• Date: 01 July 2006
• DOI: http://doi.org/10.1111/j.1467-8683.2006.00510.x
• Published date: 01 July 2006

DOES MACROECONOMIC PERFORMANCE AFFECT CORPORATE GOVERNANCE?

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DOES

MACROECONOMIC PERFORMANCE AFFECT CORPORATE

GOVERNANCE?COPRORATE GOVERNANCE

*Address for correspondence:

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Does Macroeconomic Performance

Affect Corporate Governance?

Evidence from Turkey

Mehmet Ugur* and Melsa Ararat

Recent work on corporate governance has highlighted the effects of corporate governance

quality on macroeconomic crises, especially in the context of South-East Asian economies.

However, the possibility of reverse causation from macroeconomic performance to corporate

governance has been overlooked. This paper aims to address this issue by examining the

relationship between macroeconomic stabilisation and corporate governance reforms in

Turkey since the 1999 and 2001 crises. We demonstrate that the prospect of macroeconomic

stability has led to extensive corporate governance reforms for two reasons. First, recent return

to macroeconomic stability has been underpinned by public governance reforms, which

spilled over to the area of corporate governance. We call this the statutory reform effect.

Second, macroeconomic stability tended to have a positive effect on f‌irms’ investment in

corporate governance quality. We call this the voluntary reform effect. To substantiate these

f‌indings, we examine the post-1999 developments in the following areas: (i) the effectiveness

of regulatory authorities; (ii) disclosure and transparency rules; and (iii) the quality of the

enforcement regime.

Keywords: Corporate governance, institutional quality, macroeconomic stability, Turkey

Introduction

he debate on the relationship between

corporate governance and macroeco-

nomic performance is a fairly recent one. It

emerged in the context of the South-East Asian

crisis and was geared towards discussing the

impact of poor corporate governance (CG)

quality on the crisis in Japan and other coun-

tries. Studies focusing on Japan argue that eco-

nomic stagnation in that country has been due

to weaknesses in the Japanese CG regime,

which made the economy vulnerable to

adverse shocks. Specif‌ically, it is argued that

the f‌inancial keiretsu system led to misalloca-

tion of capital and plunged Japan into excess

T

capacity and liquidity problems (Morck and

Nakamura, 1999). Studies focusing on coun-

tries with a pegged exchange rate regime, on

the other hand, have discovered that weak CG

regimes have typically worsened the currency

crises in emerging market economies (Johnson

et al

., 1999). The effect is explained as follows:

The looming crisis led to lower returns on

investment. Faced with lower returns, man-

agers were induced to engage in expropriation

– which was possible because of poor CG stan-

dards. This, in turn, had an adverse effect on

investor conf‌idence, leading to massive capital

outf‌lows, which eventually led to excessive

fall in stock prices and the price of domestic

currency. Another study (Castren and Takalo,

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CORPORATE GOVERNANCE

© 2006 The Authors

Journal compilation © Blackwell Publishing Ltd. 2006

Volume 14 Number 4 July 2006

2000), demonstrates that poor CG standards

have increased the supply-side rigidities and

made a speculative attack more likely.

The innovative approach adopted in these

studies has drawn attention to an issue that

has been overlooked in the traditional corpo-

rate governance literature: the impact of CG

standards on macroeconomic volatility. Yet,

there is no a priori reason to assume that the

causation between CG quality and macro-

economic performance is a one-way process.

There may well be a reverse causation from

macroeconomic performance to CG quality. In

fact, a careful reading of the works cited above

suggests that this is the case. In Johnson

et al

.,

the trigger for the crisis is not poor CG quality

per se, but the onset of falling returns on

investment that, under poor CG standards,

has made tunnelling activities both necessary

and feasible. In other words, the starting point

in the chain of causation between the macro-

economic environment and CG quality is the

falling rate of returns – an outcome closely

related to the macroeconomic environment.

In Castren and Takalo, on the other hand,

poor CG quality does increase the risk of

macroeconomic instability, but there is no

reason as to why the macroeconomic environ-

ment should not affect the observed level of

CG quality in the f‌irst instance. In fact, this

possibility is accepted implicitly by Castern

and Takalo when they state that, under credit

constraints, CG reforms may be counter-

productive. Under severe credit constraints,

CG reforms may be counter-productive be-

cause they may lead to a “f‌inancial accelerator

effect” that may worsen the f‌inancial crisis.

In other words, under certain macroeconomic

conditions that generate credit constraints

both corporate actors and public policy-

makers may refrain from CG reforms.

To put it bluntly, even though CG quality

can affect macroeconomic outcomes, the mac-

roeconomic environment itself can also affect

CG quality in emerging markets. We think this

type of reverse effect has been at play in

Turkey in the 1990s and in recent years. In

other words, we think that the macroeconomic

instability of the 1990s was associated with

low CG quality, whereas the return to macro-

economic stability after 2001 has been con-

ducive to noticeable improvement in the

quality of Turkey’s CG regime. To demon-

strate this effect, we proceed as follows. In the

following section, we f‌irst highlight the causes

and levels of macroeconomic instability in the

1990s and elaborate on its likely effects on CG

quality. We then examine the transition to a

rule-based macroeconomic policy framework

with a view to identifying the scope for eco-

nomic stability and the likely impacts of the

latter on CG reforms. The next section exam-

ines recent CG reforms in three areas: (i) emer-

gence of regulatory authorities; (ii) change in

disclosure and transparency rules; and (iii)

change in the quality of the enforcement

regime. We demonstrate that the onset of

macroeconomic stability has been associated

with visible improvements in Turkey’s CG

regime. Finally, we conclude by arguing that

CG reforms in emerging markets are likely to

remain limited and enforcement to be weak

until policy-makers establish macroeconomic

stability on the basis of a rule-based policy

framework and corporate actors consider the

new policy framework as credible.

Macroeconomic performance and

CG quality in Turkey: the tale of

two decades

Throughout the 1980s and 1990s, the Turkish

economic policy was characterised by a sym-

biotic relationship between discretionary poli-

cies and rent-seeking behaviour. As a result,

Turkey’s macroeconomic performance has

deteriorated over time and the risks faced by

corporate actors have increased. As can be

seen from Table 1, the average growth rates

have declined from 4.76 percent in the 1970s

to 3.93 percent in the 1990s, whereas the

coeff‌icient of variation for growth rates has

increased from 51 percent to 137 percent over

the same period.

The negative impact of volatility on GDP

growth is more signif‌icant than the negative

association ref‌lected in Table 1. According to

a recent work by Hnatkovska and Loayza

(2005), a one-standard-deviation increase in

volatility would lead to lower average per-

capita income growth by 0.5–2.2 percentage

points – depending on the period of esti-

mation and the regression technique used.

When the authors account for simultaneous

and reverse causation in the volatility–growth

relationship, they f‌ind out that, in the 1990s, a

one-standard-deviation increase in volatility

would lead to a 2.2 percentage-point decrease

in the growth rate of per-capita GDP. The

authors also report that the negative associ-

ation between volatility and growth tends to

be stronger in countries with weak institu-

tional quality and pro-cyclical f‌iscal policies.

This f‌inding is very signif‌icant for Turkey – a

country that was characterised by poor insti-

tutional quality and f‌iscal indiscipline through-

out the 1990s.

1

The major cause of the macroeconomic

instability that plagued Turkey over the 1990s

was excessive discretion in the conduct of f‌is-

cal policy. Atiyas and Sayin (1997) conf‌irm that