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This paper investigates what predicts corporate governance in emerging markets. Specifically, we examine what predicts governance changes and the level of governance itself. To conduct this study, we utilize a unique dataset from AllianceBernstein that consists of monthly firm-level corporate governance ratings for 24 emerging market countries for almost seven years. Since the AllianceBernstein ratings are time-series data, they allow us to determine the direction of change in a firm’s corporate governance, and the timing of these changes. Using these data, we find two main results. First, as firms grow they are more likely to improve their governance. Second, the level of political risk where the firm resides is negatively and significantly related to the level of firm governance but positively and significantly related to changes in firm governance. Hence, firm governance is better in countries with lower political risk but firms are more likely to improve their governance in countries with higher political risk.

A large literature has generally found that better governance is linked to better performing and valued firms in emerging markets.1 Despite this evidence, and the clear incentive to improve their governance, many similar firms make very different governance choices. To better comprehend why firms choose different governance schemes, one needs to examine what predicts firm governance in these emerging economies. This paper adds to this discussion. There are number of papers that have begun to examine what factors predict firm governance decisions in emerging markets. However, the findings of these papers have been disparate. For example, Doidge et al. (2007) and Durnev and Fauver (2010) find that country conditions explain much more of the variance in firm governance ratings than firm characteristics. Indeed, according to Doidge et al. (2007), firm characteristics don’t predict governance much at all. Conversely, Black et al., 2006b, Durnev and Kim, 2005 and Klapper and Love, 2004 and Klapper et al. (2006) all find that some firm characteristics are important to governance decisions, however they find that quite different firm characteristics are predictive. Case in point, while Durnev and Kim (2005) find that firm growth, the firm’s need for equity finance, and the amount of insider ownership predict better governance, Black et al. (2006b) find that none of these characteristics are significant. Instead they find that firm size and firm risk predict better governance but little else does. To make matters more complicated, Klapper and Love (2004) find that capital intensity of the firm is a predictor of worse governance while the other papers do not find such a conclusion. Indeed, the one consistent finding seems to be that few factors, if any, consistently predict governance. In fact, Black et al. (2006b) test 17 different factors and many controls, and find that only firm size and firm risk have any consistent predictive ability governance in Korea. Indeed, other than these two variables nothing else predicts governance decisions in Korea. In another paper, Balasubramanian et al. (2010) also find that very little predicts governance when examining governance decisions in India. In this paper we also examine what factors predict firm governance in emerging markets. However, we do this in a different way than the previously mentioned papers. While the other papers all use cross-sectional data, in this paper we use a dataset from AllianceBernstein that consists of monthly, time-series, firm-level, corporate governance ratings for 24 emerging market countries that span almost seven years. These data allow us to examine changes in corporate governance. Hence, while previous studies can examine what country and firm characteristics are linked to better governance, we can examine what, if anything, is causing firm governance to improve or deteriorate over a period of time. We feel this is worthy supplement to the cross-sectional approach as it allows us to see the effects of changes (in the country and in the firm) on firm governance and thus assess if such changes are worth pursuing to improve governance. While our major focus is on predicting changes in governance, we also use the more traditional approach of investigating what predicts the level of governance. We do this using a fixed effects, panel approach. The rest of this paper is organized as follows. Section 2 describes the data used in the study. Section 3 provides the methodology. In Section 4 we present our results and we conclude with Section 5.

While a number of papers have examined which firm and country factors are related to firm governance, this paper is the first, to our knowledge, to examine whether changes and/or levels in specific variables, such as country risk and firm characteristics, predict changes in firm-level governance ( Table 4, Table 5, Table 6, Table 7, Table 8 and Table 9). This is a worthy supplement to the cross-sectional approach as it allows readers to see the effects of changes in country/firm conditions on corporate governance and thus assess if such changes are worth pursuing to improve governance. In addition to seeing what predicts changes in firm-level governance we also examine what predicts the level and future changes in firm-level governance. Specifically we examine if the level of independent variables can predict the level of firm governance ( Table 10) and we examine if changes in the independent variables during an earlier period can predict changes in governance during a later period ( Table 11). To conduct this study we utilize a unique dataset from AllianceBernstein that consists of monthly firm-level corporate governance ratings for 24 emerging market countries that spans almost seven years. Since the AllianceBernstein ratings are time-series data, they allow us to determine when there are changes, and the magnitude of those changes, in a firm’s corporate governance. We find two main results that seem relatively robust to different specifications. First, changes in firm size are positively and significantly related to changes in firm governance. This implies that high firm growth predicts improvements in firm governance. Why this happens is still an open question. It may be that as firms grow they receive more attention from outside (and possibly foreign) investors who demand better governance to invest. It may also be that larger firms are more complicated firms and thus need better governance to run well. This is a subject for future research. Second, the level of political risk of the country where the firm resides is negatively and significantly related to the level of firm governance but positively and significantly related to changes in firm governance. Hence, firm governance is better in countries with lower political risk but firms are more likely to improve their governance in countries with higher political risk. This latter result suggests that firms try to compensate for the high political risk by improving their governance. Lastly, our paper is not without caveats. It is possible that the AllianceBernstein measures are not the most accurate measures of firm-level governance. Indeed, as with all ratings systems, the AllianceBernstein ratings are quite subjective. Moreover, because they are based on the MSCI EM index they are largely based on relatively large firms so small firms are not included much in our sample. But again the advantage of the ICRG indices and the AllianceBernstein corporate governance ratings is that they provide a time-series while other cross-country studies of corporate governance use cross-sectional data.