Governance Quality in a 'Comply or Explain' Governance Disclosure Regime

22 Pages Posted: 30 Oct 2014

See all articles by Steven Salterio

Steven Salterio

Queen's University - Smith School of Business

Yan Luo

San Diego State University - Accountancy

Date Written: November 2014

Abstract

Manuscript Type. Empirical.

Research Question/Issue. Do firms take advantage of the flexibility of the “comply or explain” corporate governance disclosure regime to adopt governance practices that are best suited to their needs and value‐added to the firms as predicted by economic theories of the firm? Using the Canadian “comply or explain” corporate governance disclosure regime, we construct a board score measure based on the Canadian code's 47 “best practices.” We employ a unique approach by positing that the “explain” disclosures indicate higher agency costs of best practice adoption or indicate the ability of the firm to improve its governance practices relative to “best practices” in light of firm specific circumstances.

Research Findings/Insights. We find that our measure is strongly and positively associated with higher firm value and weakly and positively associated with better operational performance. Further, our measure is more strongly associated with both than best practice adoption measures.

Theoretical/Academic Implications. Our unique measure of governance quality reveals differences in governance efficiency and effectiveness that are consistent with the theorized advantages of “comply or explain” governance disclosure regimes. Further, our results suggest that firms in a “comply or explain” regime are not employing, on average, the discretion permitted by such a regime to avoid improvements to their corporate governance practices.

Practitioner/Policy Implications. Our results support the proposition that the flexibility of a “comply or explain” governance regime provides tangible financial benefits to shareholders in terms of higher firm value and returns on shareholders' equity investment.

Keywords: Corporate Governance, Agency Costs, Comply or Explain, Firm Performance, Firm Value

Suggested Citation

Salterio, Steven E. and Luo, Yan, Governance Quality in a 'Comply or Explain' Governance Disclosure Regime (November 2014). Corporate Governance: An International Review, Vol. 22, Issue 6, pp. 460-481, 2014, Available at SSRN: https://ssrn.com/abstract=2516569 or http://dx.doi.org/10.1111/corg.12072

Steven E. Salterio

Queen's University - Smith School of Business ( email )

Kingston, Ontario K7L 3N6
Canada
613-533-6926 (Phone)

HOME PAGE: http://smith.queensu.ca/faculty_and_research/faculty_list/salterio-steven.php

Yan Luo

San Diego State University - Accountancy

United States

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