Does Public Enforcement Work in Weak Investor Protection Countries? Evidence from China

Abstract

We examine the efficacy of public enforcement in weak investor protection countries by examining the outcomes of a comprehensive public enforcement campaign in China. The campaign, launched in 2007, was designed to help enforce China’s first mandatory Corporate Governance Code, issued in 2002. The 2007 campaign was characterized by several important features: (i) the campaign required firms to identify their problems before the securities regulators conducted on-site inspections; (ii) the campaign provided a detailed check-list of the status of a firm’s compliance with the Code; (iii) the campaign was transparent with regard to the disclosure and correction of identified problems; and (iv) the campaign threatened penalties for firms that failed to correct the identified governance problems in a timely manner. Our empirical analyses suggest that the 2007 campaign was effective in improving publicly listed firms’ corporate governance. The corporate governance improvement was associated with a reduction in earnings management, higher earnings response coefficients, and higher operating accounting performance. In addition, we find preliminary evidence that the detailed check-list is partially responsible for the efficacy of the campaign. Our results suggest that public enforcement, if properly implemented, works in increasing shareholder value in weak investor protection countries.

Keywords: public enforcement; weak investor protection countries; China; shareholder value

JEL Classification: G34, G38, M41, K22