Transplantation of Anglo-American corporate governance and its impact on financial market growth: a comparative analysis of nineteen developing countries 1995-2014

• Pages: 884-922
• Date: 07 October 2019
• Published date: 07 October 2019
• DOI: https://doi.org/10.1108/CG-07-2018-0250
• Author: Navajyoti Samanta
• Subject Matter: Strategy,Corporate governance

Transplantation of Anglo-American

corporate governance and its impact on

financial market growth: a comparative

analysis of nineteen developing countries

1995-2014

Navajyoti Samanta

Abstract

Purpose –Since the late 1990s, developing countries have been encouraged by international financial

organisationsto adopt a shareholder primacy corporate governancemodel. It was anticipated that in an

increasingly globalised financial market, countries which introduced corporate governance practices

that favour investors would gaina comparative advantage and attract more capital leading to financial

marketgrowth. This paper aims to empirically test thishypothesis.

Design/methodology/approach –The present research paper quantitatively investigates whether

adopting shareholder primacy corporate governance norms has had any impact on the growth of the

financialmarket, focusing on nineteen developing countriesbetween 1995 and 2014. Time series indices

are prepared for corporate governance regulations, financial market development along with three

control indices. Then a lagged multilevel regression between these indices is used to investigate the

strength of causality betweenthe adoption of pro-shareholder corporate governanceand the growth of

the financialmarket.

Findings –The research paper finds that shifting towards a shareholder primacy model in corporate

governance has a very small effect on growth of financial market in developing countries. Overall the

financial,economic and technologicalcontrols havemuch more impact on the growthof financial markets.

Originality/value –This paper conclusively ends the discussion as to whether change in corporate

governance has any impact on financial market growth of a country. The papers uses Bayesian

econometric model. The paper thus signals the end of LLSV ledquestion as to whether law can affect

finance.

Keywords Bayesian statistics, Multi-level regression, Quantitativecorporate governance,

Graded response model, Leximetrics

Paper type Research paper

1. Introduction

Corporate governance has become a focal point for a wide variety of issues ranging from

business standards to accounting standards, from corporate social responsibility to supply

chain management, from a band aid to financial crisis, via a tool for ensuring macro/

microeconomic stability toa way of improving political economy.Corporate governance has

spread into almost all strands of interdisciplinary studies in law, economics and finance.

From the 1970s, with repeated accounting frauds and related crises, there was a growing

clamour for a solution to all these problems, and so theoreticians and practitioners dusted

Navajyoti Samanta is based

at the Department of Law,

University of Sheffield,

Sheffield, UK.

Received 29 July 2018

Revised 31 January 2019

Accepted 7 February 2019

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off old ideas and “reinvented”corporate governance in the early 1990s. Suddenly, the world

seemed to be in the grip of a new mania. This coincided with the period following the grand

success of neo-liberal economic ideology during the 1980s, and the fall of the Soviet Un ion

seemed to provide final proof of the superiority of “free market” principles. There followed a

period of intense transplantation of legal ideas, with the international financial organisati ons

emphasising that “[T]he improvement of corporate governance practices is widely seen as

one important element in strengthening the foundation for individual countries” long -term

economic performance and in contributing to a strengthened international financial system[1]’.

This economic rationale was also picked up by the United Nations Conference on Trad e and

Development which promised that improvements to corporate governance would “facilitate

investment flows and mobilize financial resources for economic development[2]”. This drove

convergence and transplantation, specifically in the area of company law and corporate

governance in developing countries.

The major international corporate governance code disseminated around this time period

was the OECD Principles of Corporate Governance, which was based primarily on the

shareholder value corporate governance model, although it also provided limited space for

stakeholder models. So, in effect what was being recommended to developing countries

was a shareholder value model based on the Anglo-Saxon model. The claim was that if a

country adopted a shareholder primacy corporate governance model, then foreign

investors would invest in that country, stimulating the financial market, and local investors

would also pitch in, leading to further growth of the financial market. Surplus capital can be

used for economically useful –but less well-funded –activities, leading to economic growth

and a sustainable future. The present researchpaper uses empirical analysis to investigate

these claims and tries to find out whether changing the corporate governance of a country

for the “better”, that is, by implementing a pro-shareholder approach, has any link with

financial market growth in that country.

The author has also produced a separate paper which analyses whether the corporate

governance regulations around the world are indeed converging towards a shareholder

primacy model, based on the OECD Principles of Corporate Governance, and calculates

the rate of such change over time. It shows that the corporate governance regime in all

developing countries rapidly converged to the OECD Principles, however the rate has

slowed down since 2008[3]. The present research paper will, for the first time, investigate

whether adopting shareholder primacy corporate governance has any long term overall

impact on the growth of the financial market in developing countries, to scrutinisethe claims

from international financial organisations that strong pro-shareholder corporate governance

is fundamentally linked to improvedlong-term financial and economic performance.

The quantitative research was undertaken in a number of steps. First, we replicate the

dynamic corporate governance index created in the companion paper[3]. Second, a

Bayesian factor analysis wasthen used to build up a separate multi-country multiyear index

of financial market growth, and three control indices of similar timescales comprised of a

total of ten variables taking into account macroeconomic indicators, financial inclusion

indicators and proxies for technological innovation.

Finally, a Bayesian multilevel lagged regression model was constructed, using the five

indices. The financial market index was used as a dependent variable, the dynamic

corporate governance index as predictor variable, and the three control indices as control

variables. Four country level control variables were used for each country. This is the most

comprehensive paper in the literature examining the impact of corporate governance. It

also uses innovative Bayesian modelling to better predict the actual impact of corporate

governance by taking into accountthe dynamic nature of legal development.

The research finds that a shift towards a pro-shareholder value model in developing

countries has little impacton the growth of financial markets, especially in comparisonto the

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impact of economic and other control factors like increased investment in R&D and growth

in high technology-led export-based industries. It also shows that the rule of law is twice as

important as the quality of corporate governance in promoting market growth. These

findings carry profound policy implications for developing countries: they should put more

emphasis on promoting the independence of market regulators, create efficient

enforcement of rights in the courts, and dispose commercial litigation quickly. Such

measures would be considerably more effective in terms of stimulating financial market

development than simply changing corporate governance regulations to make them more

shareholder-friendly. Similarly, improving economic growth factors and investing in R&D-led

high technology-based export industries would be far more effective in terms of boosting

financial market growth thansimply adopting more pro-shareholder regulations and norms.

This article is divided intofour parts. In Section 2, the paper reviews the existing literature on

the impact of corporate governance focusing on the limitation of the variable selection like

insufficient focus on shareholder primacy norms and inadequacy of methods used to

analyse the corporate governanceimpact. Section 3 discusses the innovative methodology

used in this research paper, which aims toovercome the limitations of the existing literature

by using Bayesian factor analysis and multilevel regression modelling. In Section 4, the

results are analysed, concentrating on the debates surrounding impact of adopt of

shareholder primacy corporategovernance on growth of financial markets.

2. Literature review

As explained before, this article solely focuses on finding out if change in corporate

governance model towards a more shareholder primacy approach had any positive impact

on financial growth of the countries adopting such stance. As such this review focuses on

literature which discusses on the dependent and control variables used in such impact

studies.

2.1 Literature on dependent variables

Dependent or outcome variables are defined as those which are affected by the

independent or predictor variables. In this study, the dependent variables are financial

market growth indicators? which are theorised to be affected by changes in the

independent or predictor variables, namely, corporate governanceregulations.

It is necessary to briefly review the dependent variables used by other researchers;

La Porta et al. (1997) divided dependent variables into measures of three categories –

equity finance, debt finance and microeconomic data (based on the WorldScope

database). As a measure of equity finance they usedthe ratio of stock market capitalisation

to GNP, number of listed firms in relation to its population, number of initial public offerings

(IPOs) in relation to its population; as a measure of debt finance the total bank debt of the

private sector and the total face value of corporate bonds were used; and four parameters

were used as a measure of microeconomic performance (limited to public companies): the

median ratio of market capitalisation to sales of companies, the median ratio of market

capitalisation to cash flow, the median ratioof total debt to sales of all firms and the median

ratio of total debt to cash flow. La Porta et al. (2006) refreshed their stock market

development parameters to adjust with the changes from public enforcement to private

enforcement. They use seven proxies to quantify the development of the financial market –

the first variable was “ratio of stock market capitalization to gross domestic product (GDP)

scaled by the fraction of the stock market held by outside investors”; the second variable

was a log of the “number of domestic publicly traded firms in each country relative to its

population”; the third variable was “the value of initial public offerings in each country

relative to its GDP”; the fourth variable sought to reflect the access to equity for new and

medium-sized firms from securities market, it was an index (scaled from 1-7) compiled by

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