Corporate Governance and Equity Prices: Evidence from the Czech and Slovak Republics
34 Pages Posted: 20 Apr 2016
Date Written: February 1995
More concentrated ownership is generally expected to improve corporate governance. Evidence from Czechoslovakia's mass privatization program supports this hypothesis. Equity prices in the Czech and Slovak Republics are higher when a domestic or foreign investor has majority firm ownership, and lower when ownership is shared among many investors.
The 1992 Czechoslovakia mass privatization program involving about 1,500 enterprises and implemented through a voucher scheme with competitive bidding was a bold step in changing the ownership and governance of a large part of the economy. It represents a clear test case of one approach, and other countries may benefit from its lessons.
At the time, much skepticism was voiced about mass privatization: it would lead to diffuse ownership, and no effective corporate governance would result. But innovative forces led to the emergence of investment funds that collected much of the individuals' voucher points, leading to a much more concentrated ownership structure. It has been expected that this concentrated ownership would lead to improved corporate governance.
But the jury is still out. So far, only limited and largely anecdotal evidence is available on the impact investment funds have on the way firms are being managed. Too little time has passed and too many shocks have occurred (for example, the split of the Czech and Slovak Republics) to expect to find discernible changes in corporate governance on measures of actual firm performance.
An alternative approach is to investigate whether firms that ended up with more concentrated ownership - and possibly improved governance - sell for higher prices, either in the last voucher round or in the secondary market since then. In a forward-looking financial market, one can expect prices to incorporate the effects of better ownership on future firm performance and associated dividends to shareholders. Put differently, one would expect that two firms with different shareholding structures, but otherwise identical, would trade at different prices - with the firm with a more concentrated ownership, and presumably better corporate governance, trading at a higher price. On a cross-sectional basis, ownership structure may thus be significant in explaining (relative) share prices.
Claessens explores this line of reasoning. Controlling for a number of firm and sector-specific variables, he finds that: - Majority ownership by a domestic or foreign investor has a positive influence on firm prices. - Firms with many small owners have lower prices. - Ownership by many small-scale investors makes it easier for any single investor to establish effective control, but such control does not necessarily translate into higher prices.
Claessens provides two possible explanations of why higher prices appear to be associated only with majority ownership by a single investor: - The corporate legal framework and the difficulty in collecting proxy votes in the Czech and Slovak Republics may prevent a small investor from making the necessary changes in the way firms are managed, thus keeping prices low. - Commercial banks are both managers of investment funds and creditors of individual firms. Funds managers may face conflicts of interest and not be interested in increasing the value of equity alone but also the value of credits. This could explain why prices are relatively lower for those firms in which investment funds have effective control.
This paper - a product of the Private Sector and Finance Team, Technical Department, Europe and Central Asia, and Middle East and North Africa Regions - is part of a larger effort in the Bank to study corporate governance in transition economies.
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