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Property rights protection, corporate transparency, and growth

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Abstract

In countries with secure property rights, corporate transparency improves investment efficiency and increases growth by alleviating information asymmetry. However, in countries with insecure property rights, greater transparency can increase the risk of government expropriation. Therefore some firms that would benefit most from transparency cannot take full advantage of it, as they set sub-optimal transparency levels. Using data from 59 industries in 69 countries, we find that in countries with weak property rights protection, industries that would benefit the most from transparency exhibit worse investment efficiency and grow more slowly than industries that can efficiently operate at minimal levels of transparency.

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Notes

  1. We consider transparency in a broad sense. In our view, transparency is determined by a set of market mechanisms that facilitate information acquisition and processing by investors; a market structure that enhances informational content for consumers and suppliers and makes the contract between economic parties more efficient.

  2. The Sarbanes-Oxley Act of 2002 is perhaps the most well-known recent legislation aimed at increasing transparency in financial markets. Canada, Japan, and Australia, among others, have enacted similar legislation.

  3. One may argue that if expropriation is anticipated, such an expectation would be reflected in IPO pricing, giving shareholders a fair return. However, our argument builds upon the idea that firms reduce transparency in anticipation of expropriation. See a more detailed discussion in the Results section under Alternative Explanations. We would like to thank an anonymous referee for pointing this out.

  4. The costs and benefits of transparency are shown to vary across industries. Admati and Pfleiderer (2000) discuss how incentives to disclose information depend on industry competitiveness. A large degree of variation in transparency has also been documented empirically by Bharath, Pasquariello, and Wu (2009).

  5. As a robustness check we confirm that the results are not changed if clustering is performed by industry or by both country and industry.

  6. We do not include the transparency norm level in regression (1) because, for the same industry, it does not vary across countries.

  7. Using actual numbers, the transparency gap for the petroleum industry in Russia is large and equal to 1.490. It is the difference between its transparency norm of 1.570 (calculated using numbers for the US petroleum industry) and the low transparency practice of 0.080 observed among Russian companies.

  8. When a firm is present in both OSIRIS and Worldscope, and there is a discrepancy in accounting numbers (less than 1% of the sample of firms), we rely on a better known dataset, Worldscope.

  9. We exclude 1998 because of the Asian financial crises, which could contaminate our measures.

  10. Industry and market indexes exclude the firm in question to avoid spurious correlation between individual returns and the indexes.

  11. PCA is a statistical method to reduce multidimensional datasets to lower dimensions. The PCA can be viewed as an orthogonal linear transformation that alters the data to a new coordinate system such that the greatest variance by any projection of the data comes to lie on the first coordinate (called the first principal component), the second greatest variance on the second coordinate, and so on. See Stevens (1986) for details.

  12. The results remain robust if we control for past performance (measured as ROA per total assets) in Eq. (8), as suggested by Ashbaugh et al. (2003).

  13. Is financial development just a proxy for the level of property rights protection? While the correlation between financial development and expropriation risk is negative (−0.43), there are some exceptions. Several countries (e.g., South Africa, Malaysia, Jordan) have well-developed financial markets but weak property rights. On the other hand, countries like Finland, Denmark, and New Zealand respect property rights but have less developed financial markets.

  14. Presumably, the cost of making governance weaker varies across different categories of governance. For example, it is easier for companies to reduce transparency than to weaken governance by firing independent directors.

  15. More specifically, on page 1614 Stulz (2005) writes: “Greater transparency and boards dominated by outside directors are often viewed as hallmarks of good governance. When there are significant risks of expropriation by the state, neither of these two good-governance attributes are likely to enhance the wealth of shareholders. While transparency increases firm value, in that it makes it harder for insiders to expropriate from investors, it also decreases firm value because it makes expropriation by the state easier”.

  16. We exclude the disclosure component to concentrate on governance provisions other than transparency.

  17. These results are available from the authors upon request.

  18. The corporate tax rate is taken from Djankov et al. (2009). The corporate tax burden index is from the Economist Intelligence Unit. It is measured as the assessment of how corporate taxation impedes the development of private businesses.

  19. More specifically, the interaction of corporate tax burden has a significantly negative effect on investment efficiency in the presence of expropriation risk, and on industry growth in the presence of political risk. The main interaction effect of aggregate transparency gap remains negative and highly significant across all specifications. We do not tabulate the results, to save space; they are available from the authors upon request.

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Acknowledgements

We are grateful for helpful comments and suggestions by the editor, Lemma Senbet, anonymous referees, Henk Berkman, Stijn Claessens, Amrita Nain, Maria Petrova, Bernard Yeung, and the participants at the 2009 Darden International Finance Conference, Concordia University seminar, and Massey University seminar. Art Durnev's research is supported by Institut de Finance Mathématique de Montréal (IFM2) and the Social Sciences & Humanities Research Council of Canada (SSHRC). Vihang Errunza's research is supported by the Bank of Montreal chair in finance and banking, IFM2 and SSHRC. We thank Pat Akey for superb research assistance.

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Authors and Affiliations

  1. Desautels Faculty of Management, McGill University, Montreal, Canada

    Art Durnev & Vihang Errunza

  2. Department of Economics and Finance, Massey University, Auckland, New Zealand

    Alexander Molchanov

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  1. Art Durnev
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  2. Vihang Errunza
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  3. Alexander Molchanov
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Correspondence to Vihang Errunza.

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Accepted by Lemma Senbet, Area Editor, 24 June 2009. This paper has been with the authors for two revisions.

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Durnev, A., Errunza, V. & Molchanov, A. Property rights protection, corporate transparency, and growth. J Int Bus Stud 40, 1533–1562 (2009). https://doi.org/10.1057/jibs.2009.58

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