Aurora Borealis
1 February 2013 CFA Institute Journal Review

Government Ownership and Corporate Governance: Evidence from the EU (Digest Summary)

  1. Nicholas Tan, CFA

According to the authors, government ownership is generally associated with lower corporate governance quality in firms, although government intervention is positively related to governance quality in common law countries versus civil law countries. They also find that preferential voting rights of golden shares held by governments are bad for governance quality.

What’s Inside?

Direct government ownership in publicly traded corporations in the EU has increased since 2008. Although it is possible that greater government ownership will lead to greater monitoring and improved governance, government interests may not be aligned with shareholder interests. The authors examine the impact of government ownership on corporate governance using a sample of firms in the EU. They explore the effect of a country’s legal system and a government’s ownership of golden shares on corporate governance. A firm that uses golden shares gives the government special controlling powers, analogous to additional voting rights relative to normal shares of stock.

How Is This Research Useful to Practitioners?

The impact of government ownership on corporate governance is an important consideration for investors; they should be aware of the implicit risks of investing in state-owned or state-controlled companies. Corporations aim to maximize shareholder wealth, but governments may be more inclined to focus on stakeholder wealth or on the wealth of the society as a whole.

The authors find that government ownership is generally detrimental to corporate governance. This finding suggests that the state encourages a centralized power structure in firms, possibly as a way to streamline the decision-making process or to ease a transfer of control when government intervention is required. The government attempts to maintain control through concentrating power within a firm by decreasing the number of board committees and augmenting CEO power.

The results also indicate, however, that the framework of common law countries has a positive impact on the relationship between government ownership and corporate governance. In a common law legal environment, which is more conducive to good corporate governance and effective monitoring, state owners can enforce regulations and ensure that recommended practices are followed at the firm level.

Finally, the authors show that golden shares are damaging to corporate governance because the government is able to leverage its voting power.

How Did the Authors Conduct This Research?

The authors gather information about the sample companies from Thomson Worldscope Fundamentals for firm accounting data and from RiskMetrics’ Corporate Governance Quotient (CGQ) database for corporate governance figures. The sample of companies with CGQ data and corresponding financial data includes 373 companies from 14 EU countries during 2003–2008. The CGQ scores are matched to the previous month’s accounting data.

The CGQ scores are weighted against eight core categories: board of directors, audit issues, charter/bylaw provisions, anti-takeover provisions, compensation, progressive practices, ownership, and director education. A higher CGQ score indicates better corporate governance. Six subcomponents of the CGQ score are also extracted: board independence, number of board committees, board entrenchment, committee independence, board transparency, and CEO power.

Out of the 373 sample firms, 133 are government-owned companies. On average, the sample firms have 8.4% government ownership, the main proportion of which is holdings by national governments (6.72%). Governments own golden shares in 18.4% of the government-owned firms. Almost 83% of the sample firms reside in civil law countries.

The authors test their hypothesis by regressing CGQ scores on government ownership. They then use logit regressions to test whether the six CGQ subcomponents are related to government ownership.

First, the authors determine whether government ownership is related to corporate governance by regressing corporate governance quality proxies against government ownership. The results suggest that government ownership has a detrimental impact on corporate governance because those firms have fewer board committees and grant a greater amount of power to the CEO.

The authors then test whether governments in common law countries have different incentives from those in civil law countries. In particular, they examine the impact of the firm’s legal environment on the relationship between government ownership and corporate governance. They find that in common law countries, there is a positive relationship between central government ownership and corporate governance; in civil law countries, the relationship is negative.

Finally, the authors investigate how corporate governance quality is affected if the government has retained a golden share in a firm. They find that the presence of a golden share reduces the quality of corporate governance with regard to board independence, board committees, and board transparency.

Abstractor’s Viewpoint

Investors may be able to use the findings from this paper to study whether there are any systemic risks inherent in state-controlled companies within the same country, especially in the case of civil law countries. Because corporate governance of a firm is affected by government ownership, it may affect the financial health of companies in the long run. Furthermore, a portfolio of investment in firms that are owned by a government may prove risky if there is a default by that government in the future.

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