The Impact of Governance Reform

This post comes from Richard Price and Brian Rountree of Rice University, and Francisco Roman of Texas Tech University.

Corporate governance systems are designed to ensure investors receive a return on their investment. Using cross country analysis, the governance literature has demonstrated that stronger governance systems lead to more efficient allocations of capital resources, which in turn spurs economic growth and increases the likelihood of investors receiving a return. What is less clear is how an economy with generally weak governance can bring about change in order to improve the investment climate and stimulate economic development. In our forthcoming Journal of Financial Economics paper entitled The Impact of Governance Reform on Performance and Transparency, we investigate the efficacy of mandated changes in corporate governance and investor protection in Mexico, which is a classic example of an emerging market economy dominated by concentrated ownership and without a demonstrated commitment to minority investor protection.

Similar to a number of emerging market economies, Mexican regulators have recently implemented a Code of ‘Best’ Corporate Practices (hereafter the Code) and require companies to publicly disclose their compliance with these suggested practices each year. In addition, the laws governing securities markets have been strengthened in 2001, 2003, and 2005. These efforts are all aimed at improving the investment climate and attracting foreign capital to Mexico.

We find that companies generally increased their compliance with the reforms over the 2000-2004 time period, which indicates companies believe there is a benefit to compliance or cost of non-compliance. However, our analyses of performance and transparency fail to reveal a significant relation to the reforms illustrating there are still substantial concerns about the ability of these actions to improve economic development. Instead, we find companies that comply more with the reforms are more likely to pay dividends, which indicates that better governed companies are forced to resort to costly signals in order to reduce agency costs as opposed to reaping the benefits from improved transparency. Our results indicate market monitoring mechanisms by themselves are not strong enough to induce significant changes in economic behavior and suggest extensive changes in the legal and/or political environment are necessary in emerging market countries like Mexico to ensure adequate investor protections.

The full paper is available for download here.

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