Reduction of Asymmetric Information Through Corporate Governance Mechanisms – The Importance of Ownership Dispersion and Exposure toward the International Capital Market

• Author: Finn Schøler,Claus Holm
• Published date: 01 January 2010
• Date: 01 January 2010
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00777.x

Reduction of Asymmetric Information

Through Corporate Governance Mechanisms –

The Importance of Ownership Dispersion

and Exposure toward the International

Capital Market

Claus Holm* and Finn Schøler

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: The purpose of this study is to examine how differences in “ownership dispersion” and

“exposure to the international capital market” affect the particular use of the corporate governance mechanisms “transpar-

ency” and “board independence” in listed companies.

Research Findings/Insights: Our f‌indings are based on a Danish dataset that includes 100 listed companies. We f‌ind that

transparency is a more importantcorporate governance mechanism for companies with exposure to the international capital

market, while differences in ownership dispersion do not affect the use of the transparencymechanism. In contrast, we f‌ind

that board independence in the context of a two-tier board member system is an important corporate governance mecha-

nism for companies with widely dispersed ownership and not for companies with exposure to the international capital

market.

Theoretical/Academic Implications: The relationships identif‌ied in our studycontribute to improved understanding of the

contextual relationship between good corporate governance and the companies’ choice of corporate governance mecha-

nisms within a given corporate governance system. This is important in order to interpret inconsistencies in prior research

f‌indings and provide insight for the design of future studies into the seemingly endogenous nature of many corporate

governance relationships.

Practitioner/Policy Implications: The requirement to adhere to the “comply or explain rules”for corporate governance has

become commonplace for listed companies. The study provides insight into valid reasons for differences in compliance.

Regulators and other capital market participants should acknowledge that companies may differ in their use of corporate

governance mechanisms for various reasons, including differences in ownership dispersion and exposure to the interna-

tional capital market.

Keywords: Corporate Governance, Transparency, Board Member Independence, Ownership Dispersion, International

Capital Market

INTRODUCTION

The preamble of the “OECD Principles of Corporate

Governance” declares that corporate governance

should be considered as a key element in improving eco-

nomic eff‌iciency and growth as well as enhancing investor

conf‌idence (e.g., OECD, 2004). In accordance with the argu-

ments adduced by the Organization for Economic Coopera-

tion and Development (OECD), it has been suggested that

the capital market will reward companies exercising good

corporate governance.

The underlying conditions for companies to adhere to

good corporate governanceprinciples vary with institutional

*Address for correspondence: Departmentof Business Studies, Aarhus School of Busi-

ness, University of Aarhus, Denmark. E-mail: hoc@asb.dk

32

Corporate Governance: An International Review, 2010, 18(1): 32–47

© 2010 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00777.x

and economic country differences (Berglöf & Pajuste, 2005;

Chua, Eun, & Lai, 2007; Li, 1994; Pedersen & Thomsen, 1997).

In effect, the corporate governance mechanisms favored by

national governance codes should ideally ref‌lect differences

in corporate governance systems or models (Shleifer &

Vishny, 1997). A number of studies have looked at the impact

of international capital mobility on the convergence of cor-

porate governance models (Deeg & Perez, 2000) or conver-

gence of f‌inancial accounting models (Forker & Green, 2000;

Gray, Meek, & Roberts, 1995). In a comparison of Germany,

France, Spain, and Italy, the main f‌inding by Deeg and Perez

(2000) is that convergence toward one corporate governance

model is not as strong as expected when considering the

mobility of capital. They argue that the politics of f‌inancial

reform may counteract the convergence and that countries

are susceptible to various types of international pressure.

Forker and Green (2000) expand the comparison of corpo-

rate governance models to the role of accounting model

choice. They recommend thatapplying different models will

better suit the interests of investors across different styles of

corporate governance.

The agency perspective suggests that corporate gover-

nance mechanisms are used to reduce asymmetric informa-

tion between the companies and f‌inance providers (Shleifer

& Vishny, 1997). Company specif‌ic characteristics have been

suggested as important contributors for understanding dif-

ferences in the use of corporate governance mechanisms

in a given corporate governance system (Weir, Laing, &

McKnight Phillip, 2002). Of course companies may differ in

a number of ways including such characteristics as size, age,

strategy, industry, governance structure, and ownership

composition. In this study, we consider the potential impor-

tance of company differences in ownership dispersion and

exposure toward the international capital market. This

ref‌lects that our understanding of corporate governance

mechanisms have to be contextual, i.e., we contend that at

least three differences should be considered: (1) corporate

governance mechanisms may work differently across corpo-

rate governance systems; (2) different corporate governance

mechanisms may not be perfect substitutes within a given

corporate governance system; and (3) particular corporate

governance mechanisms may be more important for some

listed companies than for others.

Ownership structure such as dispersion of shareholdings

directly affects the composition of corporate governance

mechanisms in place for aligning the interests between

company and f‌inance providers (OECD, 2004). Companies

with less dispersed (more concentrated) ownership are

inf‌luenced by the ability and motivation of large stockhold-

ers to monitor their interests directly (Shleifer & Vishny,

1997). Observing the level of ownership dispersion for com-

panies within a given corporate governance system will

inf‌luence the expected degree of corporate accountability to

minority shareholders (Chua, Eun, & Lai, 2007; Li, 1994;

Thomsen, Pedersen, & Kvist, 2006).

International exposure to the capital marked has the

potential to affect the choices of corporate governance

mechanisms for companies within a given corporate gover-

nance system (Luo, 2005). Chizema and Buck (2006) propose

that companies seeking foreign capital will demonstrate

a higher propensity to adapt to international acclaimed

governance patterns. Differences in international exposure

among companies are important in light of increased global-

ization of the capital markets. Even within a given corporate

governance system, the interpretation of relevant corporate

governance mechanisms could be challenged because poten-

tial f‌inance providers come from a range of different corpo-

rate governancesystems (Deeg & Perez, 2000; Gray, Meek, &

Roberts, 1995).

The purpose of this study is to examine how “ownership

dispersion” and “exposure toward the international capital

market” of listed companies affect two of the prime corpo-

rate governance mechanisms identif‌ied by OECD (2004),

namely “transparency” and “board independence.” Trans-

parency is traditionally considered an external corporate

governance mechanism as compared to board indepen-

dence, which is considered an internal mechanism in one-

tier board systems (Brennan & Solomon, 2008; Weir, Laing,

& McKnight Phillip, 2002). The interpretation of our f‌ind-

ings should be considered in light of a major caveat related

to causality. Even though we cast our f‌indings in terms of

corporate governance mechanisms as dependent variables

using OLS analysis, the causality is not our main concern.

We acknowledge the endogenous nature of many (or most)

corporate governance relationships, hence the importance

of our f‌indings is related to the company differences

associated with use of different corporate governance

mechanisms.

Our f‌indings are based on a Danish dataset that includes

100 companies listed on the Copenhagen Stock Exchange.

Our f‌indings suggest that transparency is a more important

corporate governance mechanism for companies with expo-

sure to the international capital market, while differences in

ownership dispersion do not affect the use of the transpar-

ency mechanism. In contrast, our f‌indings suggest that

board independence in the context of a two-tier board

member system is an important corporate governance

mechanism for companies with widelydispersed ownership

and not for companies with exposure to the international

capital market.According to the agency perspective, the dif-

ferences in importance will imply varying applicability of

the mechanisms for reducing information asymmetry and

thus cost of capital. We contribute to the academic literature

by explicitly demonstrating that different corporate gover-

nance mechanisms are not perfect substitutes within a given

corporate governance system. Our study provides insight

into valid reasons for differences in compliance to corporate

governance codes. Because companies have different

agendas they maydiffer in their use of corporate governance

mechanisms. This insight is an important enabler for fair

assessments of company differences of “good” corporate

governance at country level as well as across corporate gov-

ernance systems in different countries.

The remainder of the paper is structured in the following

way. In the second section we provide the motivation for the

hypotheses by examining prior literature. In the third

section we describe the methodology, i.e., the particularities

of the Danish dataset and the model development. In the

fourth section we provide the analyses and results in accor-

dance with the two corporate governance mechanisms con-

sidered in this study. Finally we conclude the paper in the

f‌ifth section.

OWNERSHIP DISPERSION AND INTERNATIONAL CAPITAL MARKET 33

Volume 18 Number 1 January 2010© 2010 Blackwell Publishing Ltd