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Summary for Business Valuation & Corporate Governance
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Summary for the course Business Valuation & Corporate Governance. Contains the discussed chapters and articles.
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BV&CG – SummaryTable of Contents
BV&CG – Summary .................................................................................................................................. 1
Article 1 – Corporate governance in emerging markets: a survey ...................................................... 2
Article 2 – Foreign and domestic ownership, business groups, and firm performance: evidence
from a large emerging market ............................................................................................................ 8
Article 3 – Does governance travel around the world? Evidence from institutional investors ........ 12
Article 4 – Takeovers and (excess) CEO compensation ..................................................................... 16
Article 5 – Is the pay-performance relationship always positive? Evidence from the Netherlands . 20
Article 6 - Large shareholders, board independence, and minority shareholder rights: Evidence
from Europe ...................................................................................................................................... 23
Article 7 – Do women directors improve firm performance in China? ............................................. 27
Chapter 1 – Overview of valuation .................................................................................................... 31
Chapter 2 – Forecasting and valuing cash flows ............................................................................... 34
Chapter 3 – Estimating a firm’s cost of capital ................................................................................. 37
Chapter 4 – Forecasting financial performance ................................................................................ 42
Chapter 5 – Relative valuation using market comparables............................................................... 46
Chapter 6 – Enterprise valuation....................................................................................................... 50
,Article 1 – Corporate governance in emerging markets: a survey
Better corporate governance benefit firms through greater access to financing, lower cost of capital,
better performance, and more favorable treatment of all stakeholders.
Evidence also shows that voluntary and market corporate governance mechanisms have less effect
when a country’s governance system is weak.
1. Introduction
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2. What is corporate governance?
Definitions of corporate governance vary widely. They tend to fall into two categories. The first set of
definitions concerns itself with a set of behavioral patterns: that is, the actual behavior of corporations,
in terms of such measures as performance, efficiency, growth, financial structure, and treatment of
shareholders and other stakeholders. The second set concerns itself with the normative framework:
that is, the rules under which firms are operating—with the rules coming from such sources as the
legal system, the judicial system, financial markets, and factor (labor) markets.
Under a narrow definition, the focus would be only on the rules in capital markets governing equity
investments in publicly listed firms.
Under a definition more specific to the provision of finance, the focus would be on how outside
investors protect themselves against expropriation by the insiders.
The objective of a good corporate governance framework would be to maximize the contribution of
firms to the overall economy—that is, including all stakeholders.
One can operationalize the definition of corporate governance as the range of institutions and policies
that are involved in these functions as they relate to corporations.
3. How do countries differ in aspects relevant to corporate governance?
Emerging markets differ in some key aspects from advanced countries, but also show much variation
in some of these aspects across emerging markets
3.1. The diversity in economic and financial environments
GDP per capita → emerging markets and transition economies rank still much below advanced
countries.
GDP growth → GDP growth has been much higher recently in emerging markets and transition
economies than in advanced countries.
Trade → emerging markets and transition economies do not differ anymore much from advanced
countries, although there are large differences among emerging markets.
Foreign direct investment as a percent of GDP → differs much across countries, with emerging markets
and transition economies relying much less on FDI, than advanced countries do.
Private credit → advanced countries have much deeper financial systems, with ratios more than
double those of emerging markets and almost three times those of transition economies. But the
variation among emerging markets is very large as well.
Market capitalization as a share of GDP → 90% in advanced countries, versus 67% in emerging markets
and only 23% in transition economies.
,Stocks traded → emerging markets are more similar to advanced countries, but transition economies
show much lower turnover ratios than advanced countries do.
3.2. The diversity in institutional environments
Legal and judicial systems are crucial for corporate governance and financial markets development.
Common Law is generally considered to be better in terms of the overall strength of (formal) property
rights protection. On this score, reflecting past colonization, emerging markets do not differ much from
advanced countries, but transition economies do in that they all have Civil Law origin.
The strength of countries' formal legal rights, captured using an index based on various legal features
(column 2), shows little differences between advanced countries and transition economies, but
emerging markets tend to have less strongly defined rights.
The rights of creditors and shareholders (column 3 and 4) are on average equally strongly defined in
advanced countries as in emerging markets and transition economies, except for shareholder rights
which are less strongly defined in transition economies.
On average, enforcement is twice as high in advanced countries than in emerging markets and
transition economies. Also, corruption is much less, but with again large variation.
The next index shows the degrees to which corporations listed on local stock exchanges have to
disclose relevant financial and other information (column 7). Differences between advanced countries
and emerging markets are not large on average (data do not cover transition economies), but there is
much more variation among emerging markets.
An index of de-facto quality of corporate governance, based on actual corporations' behavior – how
accounting statements are being provided, earnings are being smoothed, and stock prices behave and
reflect information about the firm – is shown next (column 8). It shows emerging markets and
transition economies to score below advanced countries as a group, with again large differences
among emerging markets.
3.3. The diversity in ownership structure
The nature of the corporate governance problems importantly varies by ownership structures. For an
individual firm, ownership structure defines the nature of principal–agent issues.
Firms can be family-owned or financial institutions-controlled.
Most studies document a large shareholder with a controlling direct interest in listed companies in
emerging markets.
Almost everywhere, ownership tends to be concentrated following their initial public offering (IPO).
Ownership structures affect the nature of the agency problems between managers and outside
shareholders, and among shareholders. When ownership is diffuse, as is typical in the U.S. and the
U.K., agency problems stem from the conflicts of interests between outside shareholders and
managers who own little equity in the firm. When ownership is concentrated to a degree that one
owner (or a few owners acting in concert) has effective control of the firm, the nature of the agency
problem shifts away from manager– shareholder conflicts. Rather, since insider-held firms dominate,
the principal–agent problems in most countries around the world will be minority-versus-controlling
shareholder. This means that the protection of minority rights matters most.
, 3.4. The diversity in group affiliation and institutional investors
Many countries have large financial and industrial conglomerates and groups. In some groups, a bank
or another financial institution typically lies at the apex. In other countries, and most often in emerging
markets, a financial institution is at the center of the group.
Being part of a group can benefit firms, particularly in emerging markets, since using internal factor
markets can overcome missing or incomplete external (financial) markets. Groups or conglomerates
can also have costs, however, especially for investors.
Another aspect is the role of institutional investors. Ownership by institutional investors is generally
small in emerging markets.
4. How and through what channels does corporate governance matter?
We organize the literature according to how and through what channels identified corporate
governance impacts corporations and countries as follows:
• The first is the increased access to external financing by firms. This in turn can lead to greater
investment, higher growth, and greater employment creation.
• The second is a lowering of the cost of capital and associated higher firm valuation. This makes
firms more attractive to investors, leading to growth and more employment
• The third channel is better operational performance through better allocation of resources
and better management. This creates wealth more generally.
• Fourth, good corporate governance can be associated with less financial crises, important, as
highlighted recently again, given the large economic and social costs of crises.
• Fifth channel is that good corporate governance can mean generally better relationships with
all stakeholders. This helps improve social and labor relationships and aspects such as
environmental protection, and can help further reduce poverty and inequality.
4.1. Increases access to financing
Legal foundations matter crucially for a variety of factors that lead to higher growth, including financial
market development, external financing, and the quality of investment. Legal foundations include
property rights that are clearly defined and enforced and other key rules (disclosure, accounting,
regulation and supervision).
In weaker legal environments, firms not only obtain less financing but also invest less than optimal in
intangible assets.
As such, the general finding that better legal protection helps with capital market development is
confirmed.
This literature has shown that better creditor and shareholder rights are associated with deeper and
more developed financial markets.
In countries with better property rights, firms thus have a greater supply of financing available, and
firms invest more and grow faster.
Thus, in emerging markets, firm-level corporate governance and country-level shareholder protection
seem to be substitutes for each other in reducing the cost of equity.
4.2. Higher firm valuation and better operational performance
The quality of the corporate governance framework affects not only the access to and the amount of
external financing, but also the cost of capital and firm valuation. Outsiders are less willing to provide
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