Corporate Governance in Emerging Markets

George Dallas is Director of Corporate Governance at F&C Investments. This post is based on an International Finance Corporation report by Mr. Dallas and Melsa Ararat, Director of the Corporate Governance Forum of Turkey and faculty member at Sabanci University; the full report is available here.

Emerging markets play an increasingly important role in the global economy, given their high economic growth prospects and their improving physical and legal infrastructures. Combined, these countries account for nearly 40 percent of global gross domestic product, according to the International Monetary Fund.

For some investors, emerging markets offer an attractive opportunity, but they also involve multifaceted risks at the country and company levels. These risks require investors to have a much better understanding of the firm-level governance factors in different markets.

The Complexity of What Matters in Emerging Markets [1]

Over the past two decades, the relationship between corporate governance and firm performance has received considerable attention from inside and outside academia. Most cross-country studies on corporate governance focus on the relationships between economic performance and countries’ different legal systems, particularly the level of investor protections.

On a different track, researchers have investigated how different firm structures determine corporate governance and the effect of those firm-level governance choices on firm performance. These studies, largely based on data from developed countries with dispersed ownership, assess several governance indicators that could be associated with higher valuation and better performance. [2]

However, country-specific research on emerging markets has delivered mixed results, suggesting that empirical evidence on the relationship between corporate governance indicators and firm performance in emerging markets is inconclusive. Governance arrangements that are optimal for investor protection in one country could be suboptimal for companies in another. For example, the level of ownership concentration at which owners are more likely to expropriate minority shareholders changes from country to country, depending on the regulations and the level of enforcement. Further, in some circumstances, “friendly” outside directors may also be more trusted and more knowledgeable than “independent” directors.

For the past three years, approximately 1,000–1,200 papers have been published each year on the Social Sciences Research Network with the term “corporate governance” appearing as a key word in the abstract. However, fewer than 1 percent of these papers focus on emerging markets. These numbers indicate a relatively limited scholarly focus on emerging markets, possibly due to data limitations. Much of the work thus far has focused on board structures, for which data are relatively more available.

Whatever the underlying reasons, we are left with comparatively little specific scientific research to guide companies or investors in emerging markets—which is why the Global Corporate Governance Forum has supported the Emerging Markets Corporate Governance Research Network. This network informs the Forum and its partners, among others, about the most recent literature on corporate governance and development. It also identifies priorities for future research in the Forum’s areas of activity, generates and publishes discussion papers and research working papers, and promotes a research strategy that supports academic research capacity in developing countries on corporate governance.

Factors That Shape Firm Performance

Despite being limited, country-specific empirical studies do reveal fundamental differences among individual emerging markets. Also, scholars and practitioners reached consensus that optimal governance is firm-specific. In other words, the best governance structure for a particular firm will depend heavily on the context in which it operates—even in the same market.

Several factors have proven to be fundamentally important in shaping firms’ governance choices in emerging markets: [3]

  • The quality of public governance affects the level of law enforcement and, in turn, the extent of bribery and other forms of corruption. These factors influence the quality of corporate governance and corporate transparency in a country. Compliance with the law and the avoidance of bribes can be a source of competitive disadvantage in countries where compliance adds to the operating costs and runs counter to business norms that tolerate bribery. [4] Further, research suggests that it is a misconception that all companies in countries with weak investor protection have weak corporate governance systems.
  • In countries where state ownership is common, the incentives and the quality of government officials and regulators are key determinants of corporate behavior. For example, state ownership is associated with better performance in some countries, such as in China; in others, such as in Turkey, the correlation is negative. This difference, which can be attributed to many factors, is usually contingent on the incentive structures for public officials.
  • Product market competition, although frequently considered a positive influence on corporate governance practices, is generally far from perfect in emerging markets, particularly in protected sectors.
  • Financial market development is often hampered by weak legal foundations and enforcement. As a result, the controlling shareholders invest their free cash in new businesses that they control. Such diversified investments under common control lead to the formation of business groups. In some emerging markets, such as India, business group structures that function as internal financial markets are correlated with better performance. In others, such as Colombia, group affiliation is negatively associated with performance. Based on our analysis, this variation likely depends on the primary motivation for the emergence of business groups in the first place, which varies from tax optimization to lowering transaction costs to diversifying risks. There is also a question of how—and whether—group structures are regulated. In Taiwan, for example, connected enterprises are mandated to disclose crossholdings and pyramidal links. In India, under the new Company Law, a company can hold as many subsidiaries as it likes, but a subsidiary cannot act as the holding company of another company. These provisions aim to prevent private control over public companies through pyramidal structures.
  • Ownership structures determine the nature of the relationship between the board and performance. In many emerging economies, controlling families occupy managerial positions in listed firms, and succession planning is often focused on family members and not on professional managers. Family presence, especially the founders’ presence on the board, is associated with better performance in some countries where relationships matter more and the business elite are tightly connected, such as in Thailand. In other markets, such as the Republic of Korea, the presence of outsiders has a positive effect on performance.

Traditional econometric research provides relatively little guidance at this point, because the interplay between institutions and their effect on performance outcomes is very difficult to model.

Yet, corporate governance remains a key risk factor for investors in emerging markets and an important determinant of portfolio investment decisions. This is the case at both the country level, where rule of law, regulatory quality, and corruption are key drivers for country-level risks, and at the firm-specific level, where controlling shareholders (state, families, or other financial or industrial groups) play a decisive role and are a source of strength or weakness. These risks are relevant to equity investors and fixed-income investors.

The Role of Investors

For companies with high-quality governance in weak legal regimes, the comparatively few companies with good governance are likely to be valued more highly.

Even though investors tend to assign some form of discount in their valuation of firms in countries with relatively poor corporate governance, one option for active investors is to work with companies to improve their governance. The longer-term endgame should be to realize value by reducing, or possibly eliminating, this governance discount.

Notwithstanding the constraints they face, investors can and should play a role in shaping governance practices in emerging markets. This role should involve informed voting and, perhaps more importantly, ongoing engagement with companies and regulators.

  • Voting: In practical terms, voting by institutional investors tends to have a minimal near-term effect on the outcome of general assembly resolutions. Within the current prevailing ownership structures, the outcome typically is determined by the way the controlling shareholder votes. However, voting does deliver a message to management about specific investor concerns. Particularly for those companies that want to cultivate international investors for longer-term capital-raising purposes, expressions of minority investor confidence—or concerns—through the voting process provide important feedback and can be an influential agent for change.
  • Engagement: Many forms of engagement are possible, such as face-to-face meetings, letters, and e-mail, and it can occur unilaterally by individual investors or collectively by a group of investors. Unlike voting, engagement allows investors to focus on specific issues for in-depth dialogue with company management, and the nature of feedback is not limited to ballot items. Engagement can be productive, if investors understand the peculiarities of different markets and firms. It also helps if investors understand the underlying reasons for a company’s deviations from generally accepted norms of good governance.

Both voting and engagement present the same challenge: to understand which choices matter in individual companies, especially given the external governance factors, and then to focus on those choices. Emerging market firms are generally affiliated with multiple networks connected by formal or informal ties. These structures present challenges for quantification of governance risks.

Board Independence and Business Group Affiliation

The rest of this article discusses two internal corporate governance factors with broad relevance: 1) board independence, and 2) business group affiliation. We chose the first topic because it is the most researched aspect of boards in emerging markets and the second because scholarly research indicates that ownership structure is a key determinant of governance choice at the firm level. For each factor we present a summary of related scientific research, an outline of the warning signs for associated risks, and a list of recommended remedies to mitigate these risks. Although the individual recommendations may not be relevant for every company, they may provide a useful reference for framing investor-firm dialogue.

1) Board Independence

In emerging markets where external governance mechanisms are weaker, boards’ ability to effectively monitor managers on behalf of shareholders has been crucially important for corporate governance. However, this board function may be undermined if shareholders and managers (ownership and control) are not fully separated. This is a particular concern for minority shareholders in emerging market companies. Therefore, corporate governance codes commonly recommend a high level of board independence—especially independence from management. [5] A study of outside directors in Korea, for example, shows that their impact depends on the board’s overall composition and the market in which the firm operates. Independent directors perform their role more effectively in diverse boards, such as when boards include foreign directors. In countries where independent members are not mandated by law, the labor market for independent directors does not develop, which, in turn, affects the quality of independent board members.

Review of Research on Board Independence

Paradoxically, empirical evidence to support this view is limited. Three comprehensive surveys of the literature in developed markets find that “there is little to suggest that board composition has any cross-sectional relationship to firm performance.” [6] Regarding board independence in particular, existing studies on emerging markets also present inconclusive results. Some studies report a significantly positive relationship between board independence and performance, while others present insignificant or negative relationships.

One possible interpretation of mixed results is that the nominally independent directors are not independent enough or not really independent at all. The independent directors may also be in such a minority on many boards that they are ineffective in the face of nonindependent or affiliated directors. There is some empirical support for arguing that a critical mass of independent directors would decrease the likelihood of their marginalization. [7]

Scholars generally agree that the existence of a controlling shareholder in a firm has fundamental influence on the meaning of independence and the board’s role. [8] A variety of possible links between the dominant shareholders and the independent directors may not be captured by the letter of the corporate governance codes. Some researchers also report that independent directors’ incompetence and their insufficient devotion of time contribute to their ineffectiveness, citing the ceremonial role they play in many controlled companies. [9]

A further complication arises in business groups, since important decisions are frequently made outside the board at the apex of the group, and the board meetings of subsidiaries remain a symbolic formality. More research is needed to clarify these issues.

Investor Perspective

Despite limited evidence of the impact of director independence in emerging markets, our review of investment policies of major institutional investors shows that many of them still expect boards to have a meaningful composition of independent directors to protect their minority interests, especially in companies controlled by families, other firms, or governments. Listed below are the risks of a nonindependent board, potential red flags, and possible remedies or best practices regarding board independence.

Key Risks:

  • Weak or ineffective boards—crowded by family members—that do not provide a constructive challenge to controlling shareholders. This, in turn, can lead to poor strategic decisions or to controlling shareholders pursuing an agenda that benefits neither the company nor minority shareholders.
  • Entrenchment of weak executive management. This is a particular risk factor in family companies, where attracting and retaining high-caliber professional staff can prove difficult if top jobs are reserved for family members.
  • Incentive systems that do not align the interests of executive management with those of long-term shareholders.

Red Flags (Indicators):

  • Lack of board independence—lack of independent members of significant number and relevant expertise, or lack of information concerning board members’ qualifications and skills.
  • No evidence of effective succession planning.
  • Lack of disclosure on board practices, poor shareholder access to board members, or disclosure that suggests poor attendance or a lack of rigor in board deliberations.
  • Poor disclosure on executive remuneration, or remuneration policies that focus on short-term performance.

Recommended Measures:

  • Independent directors. Even where there are controlling or majority shareholders, there should be enough quality independent directors to staff key committees, particularly the audit committee. At a minimum, this implies at least two or three independent directors—constituting at least one-third of the board.
  • Succession planning. The company should have clear and transparent succession-planning processes to guide the selection of new executive managers. The board should establish explicit policies to prioritize professional management standards and insulate executive appointments from political interference or inappropriate influence from controlling shareholders.
  • Remuneration. The company should develop a remuneration strategy—approved by independent directors—that aligns executive management with minority shareholders through a focus on long-term value creation.
  • Best practices to enhance board effectiveness and independent oversight. These can include:
    • Identification of a specific director contact for investor outreach;
    • Access to timely information flows, including financial statements and risk-management reports;
    • Private meetings of independent directors without the presence of executive management and controlling shareholders;
    • An independent board audit committee, whose members have relevant financial experience;
    • Disclosure of the risk-management process. There should be clarity on how the board and executive management define and oversee management of risks, including financial, operational, and reputational risks. Relevant structures, policies, and processes should be featured in company public disclosures.

2) Business Group Affiliation

Many of the risks to shareholder value ultimately relate to concentrated ownership, which is the predominant form of ownership in most emerging market companies. [10] In many cases, controlling shareholders can be a positive influence by providing strong oversight over executive management and by fostering a corporate culture focusing on long-term value creation.

Too often, however, controlling shareholders have the opportunity to engage in abusive behavior, a circumstance that can be exacerbated in jurisdictions where transparency is poor and where a weak rule of law fails to give minority investors proper judicial recourse.

For example, the case of Satyam Computer Services in India in 2009 demonstrates how a controlling owner can perpetrate fraud and serve the owner’s interests at the expense of minority shareholders. Similar examples exist in other markets. In 2008, Sibir Energy in Russia agreed to engage in property transactions to accommodate one of the company’s largest shareholders. In Gome Electrical Appliances in China, the company’s chairman and controlling shareholder was convicted in 2010 of manipulating the company’s stock—and has attempted to control the company from prison.

Business group structures that bring together diversified businesses under the common control of a controlling shareholder add further complexity to concentrated ownership. In many countries, most firms are affiliated with a business group that is controlled by an owner through a complex web of ownership structures.

Review of Research on Business Group Affiliation

Most of the empirical studies focus on understanding the role of business groups as an internal market. Intragroup transactions involve transfer of labor, materials, goods, assets, and financial capital. These related-party transactions may be subject to conflicts of interest or may have hidden objectives, because businesses are frequently organized into groups that include a diversified portfolio of firms controlled by the same controlling shareholder. [11]

A key risk in business group affiliations is the potential for expropriation or use of a company to serve the interests of controlling shareholders rather than the company’s own interests. The likelihood of expropriation increases when the controlling shareholder is a minority owner but controls the majority of the votes by corporate pyramids and cross shareholdings. Family-owned business groups (multiple firms controlled by a single family) are likely to adopt a pyramidal ownership structure. Researchers present evidence of a significant amount of tunnelling [12] that takes place in such firms. [13] Diversion of cash flow is higher in firms placed in a pyramidal structure than in firms controlled directly by families. The lower the direct ownership, the higher is the diversion. Transfers can be accomplished via loans with no or low interest or even without any expectation of repayment, via overpayment for services, or by selling a firm’s assets for a fraction of its market price.

On the other hand, controlling owners may also act as a positive force and inject resources into a controlled company. There is some evidence that, in state-controlled business groups, the state can provide constructive support to firms in a way that benefits minority shareholders by preventing managerial overinvestment. [14] However, in other cases, state influences in emerging market companies can reflect government agendas that suggest limited commercial motivation or regard for the interests of minority shareholders. For example, in Chinese state-owned enterprises, the rotation of chief executives from one state-controlled firm to another (sometimes competing firms) raises questions about commercial effectiveness and succession planning.

Corporate governance literature indicates a consensus that business groups function primarily as tunnelling devices for their controlling shareholders, yet strategy literature argues that business groups can substitute for weak market institutions in emerging economies. [15] Business groups can effectively nurture and manage human capital through resource sharing or internal labor markets to compensate for a shortage of skilled labor, and they can leverage free cash to substitute for inefficient public capital markets. There is also some evidence that group companies perform better than stand-alone firms, based on productive capabilities, although in some countries the results indicate the reverse. [16]

Investor Perspective

Many investors take an agnostic view of business group affiliations. They recognize that the presence of controlling shareholders can serve a positive or negative function, and so their influence should be assessed on a case-by-case basis. Listed below are the risks of business group affiliations, potential red flags, and possible remedies or best practices.

Key Risks:

  • Controlling shareholders that pursue private benefits of control at the expense of minority shareholders or creditors.
  • Mild or extreme forms of expropriation through asset transfers and self-dealing.
  • Related-party transactions involving transfers of wealth on uneconomic terms that deprive minority shareholders of value. (Some related-party transactions are beneficial to both parties.)

Red Flags (Indicators):

  • Opaque ownership structures.
  • Mismatch between economic stake and voting rights—a system of different share classes that grants voting influence to the controlling shareholder in excess of its ownership stake.
  • Weak regulatory environment for shareholder protections, compounded by a corrupt or ineffective judiciary.

Recommended Measures:

  • Disclosures on ownership. Clarify the ownership structure (particularly ultimate beneficial ownership), [17] relationships with third-party affiliates, and the relationship between economic stake and voting control.
  • Ensure that voting rights match economic ownership. This can include eliminating voting-rights differentials between different share classes or merging share classes following an independent valuation exercise to ensure that the rights of each class of owners are protected. Where this is not done, companies should at a minimum guarantee tag-along rights to owners of preferred or other nonvoting shares.
  • Related-party transactions. Investors should insist that related-party transactions of a material nature be scrutinized and approved by independent board members, who should, in turn, ensure that they are conducted on the basis of independently vetted arms-length valuations.
  • A relationship agreement. This is an arrangement whereby the controlling shareholder undertakes through a contractual agreement to promote the interests of the firm as a whole, and therefore to respect in full the rights of its minority shareholders and creditors. The terms of this form of agreement can relate to the appointment of board directors, the approval of capital transactions, areas of potential conflict where controlling shareholder-appointed directors cannot vote, and other forms of related-party transactions involving the controlling shareholder.


More research is needed to better understand the many aspects of the relationship between corporate governance and firm performance in emerging markets. Published research is limited. But, because emerging market firms are generally affiliated with multiple networks connected by formal or informal ties, the structures themselves present challenges for quantification and scientific data analysis.

Recent corporate governance research has been interdisciplinary, including law and finance research as well as investigation from organizational, management, and sociology perspectives. [18] These studies reflect the importance of looking at corporate governance holistically to gain a better understanding of how drivers of “good” governance are supported or undermined by the institutional framework.

The guidance and recommendations presented in this paper must be framed within the overarching context of complexity. Firms need to engage in a more systematic outreach to minority investors to demonstrate how their own approach to governance addresses investor risks and concerns. Doing so could carry the benefit of reducing, or possibly eliminating, discounts that are often made on emerging market firms, reflecting both macro and micro governance concerns.

Also, institutional investors in emerging market firms should take greater responsibility for building a sustained dialogue with the boards and executive management of the firms they invest in. This means that investors should exhibit the patience necessary to take a long-term view and to work with firms to help them improve their governance standards—and ultimately their valuations, over time. This process of engagement has the potential to add value to firms and to investors.

Finally, the dialogue between academia and the investment community should improve further. This is where the Global Corporate Governance Forum has a role: supporting research on corporate governance in emerging markets and facilitating a dialogue between the scientific community and investors. The Forum is addressing this need through the Emerging Markets Corporate Governance Research Network.


[1] The analysis of existing research on corporate governance in emerging markets draws in part from M. Ararat’s scholarly articles (available at and an F&C Investments report, Corporate Governance in Emerging Markets: An Investor’s Roadmap, December 2008 (available at
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[2] See La Porta et al. (1998) for anti-directors index, which uses governance indicators related to board contestability; Djankov et al. (2008) for anti-self dealing index; and Gompers, Ishii, and Metrick (2003) and Bebchuk, Cohen, and Ferrell (2009) for governance indexes.
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[3] See Fan, John Wei, and Xu (2011) for a review.
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[4] See United States Department of Justice (2006) “Foreign Corrupt Practices Act Antibribery Provisions” for a summary of discussions on how American companies were operating at a disadvantage due to the Foreign Corrupt Practice Act, which led the U.S. government to negotiate, with OECD, the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.
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[5] See Zattoni and Cuomo (2010) for an overview of requirements related to board independence in corporate governance codes.
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[6] See Hermalin and Weisbach (2003) and Bhagat and Black (2000) for reviews of literature on developed markets.
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[7] For example, see Konrad, Kramer, and Erkut (2008) for an empirical study on the effect of diversity, suggesting that minority opinions are marginalized below a threshold of three.
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[8] See Bebchuk and Hamdani (2009) for an excellent explanation of this position.
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[9] See Li et al. ( 2011) for an explanation of the ineffectiveness of independent directors in the context of China.
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[10] Bebchuk and Hamdani (2009).
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[11] See, for example, Kar (2010).
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[12] Tunnelling is a transfer of assets and profits out of firms for the benefit of their controlling shareholders.
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[13] See Bertrand, Mehta, and Mullainathan (2002); Almeida and Wolfenzon (2006); and Morck, Wolfenzon, and Yeun (2005) for ample evidence of the tunnelling propensity of controlling shareholders.
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[14] Yu, Van Ees, and Lensing (2009).
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[15] See Khanna and Yafeh (2007) for an explanation of the role of business groups in allocating scarce resources and capital in the absence of effective labor and capital markets.
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[16] See Mahmood and Mitchell (2004) for a discussion on innovation and business group affiliation.
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[17] Ultimate beneficial ownership refers to ultimate shareholders with voting rights whose ownership is disguised by institutional ownership.
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[18] Aguilere et al. (2008).
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