The Relationship Between Corporate Governance and Firm Value: A Simultaneous Equations Approach for Analyzing the Case of Spain
50 Pages Posted: 15 Oct 2009 Last revised: 18 Apr 2010
Date Written: February 1, 2009
This paper assesses the relationship between the quality of governance and the market value of Spanish publicly traded firms. To address the problem of endogeneity and the possible reverse causality between governance and performance I use simultaneous equations applying three-stage least squares regressions. As a proxy for the quality of governance, a governance index is constructed based on the recommendations of the Spanish Code of Best Practices. The results show an overall positive impact of governance on firm value, but no evidence that firm value influences firm’s governance choices (reverse causality). The findings also support the agency theory by showing a positive impact of board ownership on firm value, which can be interpreted as evidence of the convergence of interest hypothesis. I also find a negative impact of board ownership on the overall firm quality of governance, which can be seen as evidence of a substitution effect between board ownership and a broad set of governance mechanisms and evidence that active shareholders increase their stake in high value firms, probably to profit from the private benefits of control.
Keywords: Simultaneous Equations Models, Corporate Governance, Governance Index, Firm Value
JEL Classification: C31, G34
Suggested Citation: Suggested Citation