Revista Brasileira de Finanas

ISSN: 1679-0731
rbfin@fgv.br
Sociedade Brasileira de Finanas
Brasil

Carvalhal da Silva, Andr Luiz; Pereira Camara Leal, Ricardo

Corporate Governance Index, Firm Valuation and Performance in Brazil
Revista Brasileira de Finanas, vol. 3, nm. 1, 2005, pp. 1-18
Sociedade Brasileira de Finanas
Rio de Janeiro, Brasil

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Corporate Governance Index, Firm
Valuation and Performance in Brazil
Andre Luiz Carvalhal da Silva*
Ricardo Pereira Camara Leal**

Abstract
This study investigates the relationship between the quality of a firms corporate gover-
nance practices and its valuation and performance, through the construction of a broad
firm-specific corporate governance index for Brazilian listed companies. The empirical re-
sults indicate a high degree of ownership and control concentration. We can also note a
significant difference between the voting and total capital owned by the largest sharehold-
ers, mainly through the existence of non-voting shares. Panel data results indicate that less
than 4% of Brazilian firms have good corporate governance practices, and that firms with
better corporate governance have significantly higher performance (return on assets). There
is also a positive relationship between Tobins Q and better corporate governance practices
although the results are not statistically significant.
Resumo
Este estudo investiga a relacao entre a qualidade das praticas de governanca corporativa
das empresas e seu valor de mercado e desempenho, atraves da construcao de um ndice
de governanca corporativa para as empresas brasileiras listadas. Os resultados empricos
indicam um alto grau de concentracao do controle e propriedade. Pode-se notar tambem
uma diferenca significativa entre o capital votante e o capital total dos maiores acionistas,
principalmente atraves da existencia de acoes sem direito de voto. Os resultados da analise
de painel indicam que menos de 4% das firmas brasileiras possuem boas praticas de
governanca corporativa e que as firmas com melhor governanca corporativa tem um de-
sempenho (retorno sobre o ativo) significativamente superior. Existe tambem uma relacao
positiva entre o Q de Tobin e a qualidade das praticas de governanca corporativa, embora
os resultados nao sejam estatisticamente significativos.
Keywords: corporate governance index; firm valuation and performance; Brazil.
JEL codes: G32; G34.

Submited in October 2004. Revised in April 2005. We thank the editor, two anonymous referees
and seminar participants at the Brazilian Finance Association Conference for comments and grants re-
ceived from FUJB (Jose Bonifacio University Foundation), CAPES (Coordenacao de Aperfeicoamento
de Pessoal de Nvel Superior), IADB (Inter-American Development Bank), CNPq (Conselho Nacional
de Desenvolvimento Cientfico e Tecnologico), and FAPERJ (Fundacao Carlos Chagas Filho de Am-
paro a Pesquisa do Estado do Rio de Janeiro). We also thank the Coppead Graduate School of Business
of the Federal University of Rio de Janeiro for additional support. Corporate Governance Index, Firm
Valuation and Performance in Brazil.
*Assistant Professor of Finance. The Coppead Graduate School of Business. Federal University
of Rio de Janeiro (UFRJ). PO Box 68514 Rio de Janeiro, RJ 21941-972, Brazil Phone: (+55-21) 2598-
9878 Fax (+55-21) 2598-9817. E-mail: andrec@coppead.ufrj.br
**Professor of Finance. The Coppead Graduate School of Business Federal University of Rio de
Janeiro (UFRJ). PO Box 68514 Rio de Janeiro, RJ 21941-972, Brazil. Phone: (+55-21) 2598-9871 Fax
(+55-21) 2598-9817. E-mail: ricardoleal@coppead.ufrj.br

Revista Brasileira de Financas 2005 Vol. 3, No. 1, pp. 118

2004
c Sociedade Brasileira de Financas
 Revista Brasileira de Financas v 3 n 1 2005

1. Introduction

The corporate governance concept itself is very broad, and different gover-
nance mechanisms have been suggested in the literature to alleviate the agency
problems between managers and shareholders, and between controlling and mi-
nority shareholders. The relationship between corporate goverance and firm valu-
ation has attracted particular attention. One corporate governance aspect that has
been widely analyzed is the relationship between ownership (cash flow rights) and
control (voting rights) structures and firm valuation. Shleifer and Vishny (1997)
consider that the ownership structure, along with the country legal protection, is
one of the most important determinants of corporate governance.
Most of the literature that first studied the problem of the separation between
ownership and control has done it in an environment where ownership was diffuse,
i.e., there were many small shareholders, each one with a very small portion of the
capital. Berle and Means (1932) studied the ownership structure of large firms in
the United States and observed that most of them had their capital diluted among
many small shareholders. This idea was extensively accepted as the corporation
model in modern economies. However, recent studies (La Porta et al., 1998, 1999)
concluded that very few countries are actually characterized by diffuse ownership
firms.
The understanding of corporate governance structures is very important since it
influences directly the efficiency of the market for corporate control and may have
a positive impact on firm valuation and performance. First, corporate governance
structures show a potential agency problem in the management of the firm. Agency
problems make investors pessimistic about firm performance, because managers
may not be maximizing shareholders value. When there is a stockholder that
exerts control of a company, a new agency problem can arise between controlling
and minority shareholders. Claessens et al. (2000a,b) point out that good corporate
governance practices decrease the firm cost of capital because they reduce share-
holders monitoring and auditing costs, decreasing the possibility of expropriation
of minority shareholders.
Jensen and Meckling (1976) and Morck et al. (1988) have provided impor-
tant contributions to the research on ownership structures and corporate valuation.
Jensen and Meckling concluded that concentrated ownership is beneficial for cor-
porate valuation because large investors are better at monitoring managers. Morck
et al distinguish between the negative control effects and the positive incentive
effects of higher shares of ownership. They suggest that the absence of separa-
tion between ownership and control reduces conflicts of interest and thus increases
shareholder value.
Recent research suggests that higher cash flow rights are associated with higher
valuation. In contrast, the concentration of control rights and the separation of
voting from cash flow rights have a negative effect on firm value. Shleifer and
Vishny (1997), La Porta et al. (1998, 1999, 2000, 2002), Morck et al. (1988) and
Claessens et al. (2000a,b) studied the conflicts of interest between large and small

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Corporate Governance Index, Firm Valuation and Performance in Brazil

shareholders. When large investors control a corporation, their policies may result
in the expropriation of minority shareholders. Such companies are unnattractive to
small shareholders and their shares present lower market valuations.
Besides ownership and control structures, previous studies concentrated on
other specific aspects of governance, such as takeover defenses (Gompers et al.,
2003), executive compensation (Loderer and Martin, 1997), blockholdings (Dem-
setz and Lehn, 1985), board size (Yermack, 1996) and (Eisenberg et al., 1998), or
board compostion (Hermalin and Weisbach, 1991) and (Bhagat and Black, 2002).
However, all these governance mechanisms can be adopted simultaneously
or alternatively to some extent. Therefore, in order to analyze the relationship
between the quality of a firms corporate governance practice and its valuation
and performance, we construct a broad firm-specific Corporate Governance Index
(CGI) for Brazilian listed companies.
This approach has become popular in the literature only recently. For example,
Black et al. (2003), Klapper and Love (2004), Drobetz et al. (2004), and Beiner
et al. (2003) construct a survey-based governance index and report that better-firm
level corporate governance is associated with higher firm valuation. In Brazil, Leal
and Carvalhal da Silva (2005) and Da Silveira (2004) use this method. Leal (2004)
reviews the recent empirical literature on the subject in Brazil and elsewhere.
Brazil is a particularly interesting case to analyze, because the debate about
corporate governance structures was intensified only in the last decade, when fac-
tors such as privatizations, the opening of the economy, the entrance of new in-
vestors especially foreign and institutional ones, have stimulated new efforts to-
wards better corporate governance practices.
Although the market for corporate control has developed slowly during the
nineties, there have been great structural changes in the Law of Corporations and
observable attemps by many firms to adopt internationally recognized governance
principles in recent years. For example, the New Law of Corporations (Law
10303), passed in 2001, increased minority shareholders rights and enhanced the
quality of information commonly provided by companies.
In Brazil, companies were allowed to issue non-voting shares in an amount up
to two-thirds of the total capital (Law 6404 Law of Corporations). In 2001, the
New Law of Corporations (Law 10303) changed the maximum amount of non-
voting shares from 2/3rds to 50% of the total capital, but this rule is mandatory only
for firms that decided to go public after October 2001 and for new corporations.
This mechanism allows companies to issue shares without relinquishing control
and is therefore a way of separating ownership from control.
Another important initiative to improve corporate governance in Brazil was
the creation of the Code of Best Practices by the Brazilian Institute of Corpo-
rate Governance (IBGC), the Corporate Governance Recommendations by the
Brazilian Securities Exchange Comission (CVM), and the New Market by the
Sao Paulo Stock Exchange (BOVESPA), which is a listing segment designed for
the trading of shares issued by companies that voluntarily undertake good corpo-

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 Revista Brasileira de Financas v 3 n 1 2005

rate governance practices and disclosure requirements in addition to those already

required by the Brazilian legislation. Companies are classified into 3 levels, de-
pending on the degree of commitment to corporate governance assumed by the
firm. The main requirements to a Level I firm are: the maintenance of a free-float
of at least 25% of total capital; improved disclosure of quarterly information; dis-
closure of shareholding agreements and stock option programs; and provision of
an annual calendar of corporate events. To be classified as Level II, in addition
to the obligations of Level I, the company must adopt a much broader range of
corporate governance practices and minority shareholders rights, such as a sin-
gle one-year mandate for the entire board of directors; the annual balance sheet
available in accordance to US or IAS GAAP; granting all common shareholders
the same conditions obtained by the controlling shareholders on the transfer of the
firm control and 70% of these conditions to non-voting shareholders (tag along
rights); voting rights granted to non-voting shares in certain circumstances, such
as transformation, incorporation, spin-off and merger of the company; adherence
to arbitration as the vehicle to resolve corporate conflicts. To be classified as Level
III (called New Market), in addition to the obligations of Level II, the company
may not issue non-voting shares.
The purpose of this paper is to construct a broad corporate governance index,
in order to provide a comprehensive description of firm-level corporate governance
of Brazilian firms and to analyze the relationship between the quality of a firms
corporate governance and its valuation and performance. The paper is structured
as follows. The next section describes the data and the methodology used in the
tests. Section 3 presents the empirical results for the corporate governance index
and its relationship with valuation and performance of Brazilian firms. Section 4
concludes.

2. Data and Methodology

From an empirical point of view, there has been a long debate in the literature
on how to measure the quality of firm corporate governance. In order to analyze the
relationship between corporate governance and firm valuation and performance,
we use a broad corporate governance index, instead of looking at a single control
mechanism, to provide a comprehensive description of firm-level corporate gover-
nance for a broad sample of Brazilian firms. This approach has recently become
very popular in the literature (Black et al., 2003, Klapper and Love, 2004, Drobetz
et al., 2004, Beiner et al., 2003).
Our corporate governance index, further referred to as CGI, is not survey-
based. Therefore, all questions are answered from public information disclosed
by listed companies and not by means of potentially subjective or qualitative inter-
views. Sources of information are company filings, charters, and annual reports.
The financial and accounting information comes from the Economatica database,
which contains financial statements and time series data of companies for the main
Latin American countries.

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Corporate Governance Index, Firm Valuation and Performance in Brazil

The CGI serves as a broad measure of firm-specific corporate governance qual-

ity and reflects different governance attributes, which are not legally required but
considered as a good corporate governance practice by international standards.
It is also based on the recommendations and suggestions of the Brazilian Institute
of Corporate Governance (IBGC), the Brazilian Securities Exchange Comission
(CVM), and the Sao Paulo Stock Exchange (BOVESPA), which establish guide-
lines - not legally required - for publicly listed companies in an attempt to improve
the overall level of corporate governance.
The CGI is a composite of 15 items, covering 4 broad categories: disclosure,
board compostion and functioning, ownership and control structure, and share-
holder rights. The number of items was set so that it is neither too small, that
would not capture the multivariate nature of corporate governance, nor too large,
that would render data gathering difficult and subjective. Each item corresponds to
a yes or no answer to a specific question. If the answer is yes, then the value
of 1 is attributed to the question, otherwise the value is 0. The index is the sum of
the points for each question. The maximum index value is 15. Index categories are
simply for presentation purposes and there is no weighing among questions. Table
1 shows the CGI questions applied to Brazilian companies.
Table 1
Corporate governance index questions applied to Brazilian companies

Disclosure
1. Does the company produce its legally required financial reports by the required date?
2. Does the company use an international accounting standard (IASB or US GAAP)?
3. Does the company use one of the leading global auditing firms?
Board Composition and Functioning
4. Are the Chairman of the Board and the CEO not the same person?
5. Is the board clearly not made up of corporate insiders and controlling shareholders?
6. Is the board size between 5 and 9 members?
7. Do board members serve consecutive one-year terms?
8. Is there a permanent Fiscal Board?
Ownership and Control Structure
9. Do controlling shareholders own less than 50% of the voting shares?
10. Is the percentage of voting shares in total capital more than 80%?
11. Is the controlling shareholders ratio of cash-flow rights to voting rights greater or equal to 1?
12. Is the free-float greater than or equal to what is required in the Sao Paulo Stock Exchange
New Market (25%)?
Shareholders Rights
13. Does the company charter establish arbitration to resolve corporate conflicts?
14. Does the company charter grant additional voting rights beyond what is legally required?
15. Does the company grant tag along rights beyond what is legally required?
Each question corresponds to a yes or no answer. If the answer is yes, then the value of 1 is
attributed to the question, otherwise the value is 0. The index is the sum of the points for each
question. The maximum index value is 15. Index dimensions are simply for presentation purposes
and there is no weighing among questions. All questions are answered from public information
disclosed by listed companies and not by means of potentially subjective interviews. Sources of
information are company filings, charters, and annual reports.

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 Revista Brasileira de Financas v 3 n 1 2005

Each question corresponds to a yes or no answer. If the answer is yes,

then the value of 1 is attributed to the question, otherwise the value is 0. The
index is the sum of the points for each question. The maximum index value is 15.
Index dimensions are simply for presentation purposes and there is no weighing
among questions. All questions are answered from public information disclosed
by listed companies and not by means of potentially subjective interviews. Sources
of information are company filings, charters, and annual reports.

2.1 Disclosure
The disclosure category contains 3 governance attributes: disclosure date of
financial reports, the utilization of an international accounting standard (US or
IASB GAAP), and the quality of the auditing firm. Firms adopting international
accounting standards must meet a number of requirements that make them disclose
more information and be more transparent. Greater disclosure in general leads to
more value (Klapper and Love, 2004). Michaely and Shaw (1995) finds that more
prestigious auditors are associated with US IPOs that are less risky and that per-
form better in the long run. Coffee (2003) presents a thorough legal and economic
discussion about the role of the external auditor. Therefore, our hypotheses are
that firms which produce financial reports by the legally required date, use an in-
ternational accounting standard and one of the leading global auditing firms are
considered to have good corporate governance disclosure.

2.2 Board composition and functioning

The second category is related to board composition and functioning. The
board size is an important control mechanism because the board of directors role
is to monitor and discipline firms management. Lipton and Lorsch (1992) and
Jensen (1993) argue that large boards may be less effective than small boards be-
cause large boards can make coordination and decision making more cumbersome.
Yermack (1996) finds an inverse relationship between board size and firm value in
the U.S. On the other hand, a small board size may prevent minority shareholders
acess to the board of directors, and may have a negative effect on firm valuation
because of potential expropriation. Jensen (1993) suggests an optimal board size
of 7 to 8 directors, while the Brazilian Institute of Corporate Governance suggests
an ideal board size of 5 to 9 directors.
The Brazilian Institute of Corporate Governance also establishes one-year con-
secutive terms for board members. According to the Law of Corporation, share-
holders are allowed to use a mechanism known as the multiple vote, in which they
can concentrate all of their votes on a single candidate in order to elect that in-
dividual to the board of directors. In a system in which board terms are unified
and renewed yearly, the multiple vote mechanism becomes more efficient, since it
enables investors to more easily and quickly elect a director.
Another point is that, when there are short consecutive terms, if board members
are pursuing shareholders interests, they probably will be re-elected. On the other

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Corporate Governance Index, Firm Valuation and Performance in Brazil

hand, if board members have poor performance, new directors will replace them. It
is therefore believed that one-year consecutive terms create an incentive to prevent
severe governance malfunctions.
The independence of the board is related to the presence of outside directors in
the board. Since the board of directors is responsible for evaluating senior manage-
ment and replacing it if it does not pursue shareholders interests, an independent
board is considered a mechanism to prevent governance malpractices. Rosenstein
and Wyatt (1990) and Agrawal and Knoeber (1996) find that there is a relationship
between the representation of outsiders on the board and firm valuation.
We verified the names of the board members and analyzed if they were related
to the controlling shareholders (for example, belonging to the same family). We
also compared the names of the board members with those of key executives of
the company. Although the Law of Corporations allows up to 1/3 of the board
members to belong to the companys management, only firms with board members
different from the management executives were classified as having independent
board of directors in our study.
We also analyzed if the CEO and the Chairman of the Board of Directors are
the same person, suggesting that these firms are less likely to remove the CEO,
because he may have influence not only on senior management, but also on other
board members. Therefore, it is believed that firms where the CEO and the Chair-
man of the Board of Directors are the same person have a low valuation. Da Sil-
veira et al. (2003) present Brazilian evidence that supports this aspect.
Another important board functioning aspect in Brazil is the fiscal board,
whose role is somewhat similar to that of the audit committee in other countries.
Fiscal boards, however, do not get as much involved in the planning and super-
vision of the audit process, in the hiring and firing of auditors, and in other key
aspects of corporate risk management and of handling conflicts of interest. The
Brazilian Law of Corporations requires the existence of the fiscal board, but
companies are free to establish if it is a transitory or permanent board. There-
fore, if the fiscal board is not permanent, shareholders must call a meeting in order
to elect it. Our hypothesis is that a permanent fiscal board is more effective in
monitoring and disciplining firms management.

2.3 Ownership and control structure

The ownership and control structure category is related to the recent literature
(Shleifer and Vishny, 1997), La Porta et al. (1998, 1999, 2000, 2002), Morck et al.
(1988) and Claessens et al. (2000a,b) suggesting that the concentration of voting
rights and the separation of voting from cash flow rights have a negative effect
on firm valuation because of the potential expropriation of minority shareholders.
Such companies are unnattractive to small shareholders and their shares have lower
valuation.
Carvalhal da Silva (2004) and Leal et al. (2002) provide evidence of the high
degree of ownership and control concentration in Brazil, mainly through the vio-

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 Revista Brasileira de Financas v 3 n 1 2005

lation of the one share-one vote rule. On average, the majority shareholder owns
76% of the voting capital and voting shares represent 53% of the total capital,
a little higher than the minimum amount of 50% required by the New Law of
Corporations.
In this paper, our attributes related to good ownership and control structures
are: the largest shareholder has less than 50% of the voting capital; the controlling
shareholders ratio of cash-flow rights to voting rights is greater than or equal to 1;
the percentage of voting shares in total capital is more than 80%, and the free-float
is greater than or equal to what is required by the New Market of the Sao Paulo
Stock Exchange (25%).

2.4 Shareholder rights

The shareholder rights dimension contains 3 attributes, all of which related to
rights granted by the company charter to its shareholders beyond what is legally
required, especially minority shareholders. Nenova (2001) reports that when the
law grants more rights to shareholders (for example, tag along rights), corporate
values tend to rise. Our questions are related to the use of arbitration as the vehicle
to resolve corporate conflicts, additional voting and tag along rights granted to
minority shareholders beyond what is legally required.

2.5 Sample and potential bias

Our sample consists of firms listed in Sao Paulo Stock Exchange (Bovespa)
from 1998 to 2002. We collected information on the shareholding structure from
the Infoinvest Database (Bowne Global Solutions). Our sample does not include
financial institutions, companies with incomplete or unavailable information, and
firms whose shares were not traded in Bovespa during the 1998-2002 period. The
final sample consists of 131 firms, which represent about 25% of the number of
firms listed by the end of 1998 and 33% of the firms listed by the end of 2002, and
approximately 71% of total market capitalization of Bovespa.
Our sample represents a snapshot of companies during a specific period of time
(1998-2002), which raises concerns about survivorship bias. Their governance
practices are probably better than that of companies that de-listed, of companies
that remain private, or of companies with incomplete or unavailable information,
and firms whose shares were not traded in Bovespa. However, including firms
that did not have complete information or did not have any market liquidity would
not allow us to compute some of the variables (specially the corporate governance
index) we need in our research.
Therefore, our results are representative of currently listed companies in Brazil
but most likely overstate the quality and importance of corporate governance prac-
tices for other public Brazilian companies that are not listed or that are listed and
were not included in the sample.

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Corporate Governance Index, Firm Valuation and Performance in Brazil

2.6 Description of variables and model

In order to analyze the relationship between the quality of corporate gover-
nance practices, measured by the CGI, and firm valuation and performance, we
used Tobins Q and return on assets (ROA) as dependent variables. Return on
assets (ROA) is measured as the EBITDA/Asset ratio.
Researchers have employed Tobins Q to measure the discount in market val-
ues resulting from expropriation (Morck et al., 1988, La Porta et al., 2002). It is
constructed as the market value of assets divided by the replacement cost of as-
sets. Dadalt et al. (2003) assert that Tobins original intent was to measure the
firms propensity to invest. However, Q has been used as a general measure of
relative value of firms and its original intent is not inconsistent with this use. An
estimate of the numerator of Tobins Q is the book value of assets minus the book
value of common equity plus the market value of common equity. The denomi-
nator is the book value of assets. Other forms of computing Q are described in
Dadalt et al. (2003). These authors find that simpler computations of Q should
be preferred over more complex estimates, particularly when data availability is a
concern, which is our case.
To provide an integrated framework, we also investigate other crucial control
mechanisms that are not contained in the CGI, but might influence the dependent
variables, previously identified and selected from the literature, such as leverage
(debt/asset ratio), size (ln (assets)), and ROA (EBITDA/Asset ratio). These vari-
ables were investigated by Klapper and Love (2004), Durnev and Kim (2003), and
Black et al. (2003) in order to control for endogeneity in case the control variables
are determinants of corporate governance practices. They believe that if gover-
nance is determined by their control variables, then, when those are included in a
model of performance as a function of governance and governance turns out to be
significant, that would control for endogeneity.
Since we have time-series cross-section data, we employed panel data analy-
sis, allowing flexibility in modeling differences in behavior across firms and time.
Equations 1 and 2 show the variables included in each model.

T obin s Qit = i + 1 CGIit + 2 Leverageit + 3 Sizeit + 4 ROAit + it (1)

ROAit = i + 1 CGIit + 2 Leverageit + 3 Sizeit + it (2)

The firm effect i is taken to be constant over time t and specific to the firm
cross-sectional unit i. There are two basic frameworks used to generalize this
model. The fixed effects approach takes i to be a firm specific constant term
in the regression model. The random effects approach specifies that i is a firm
specific disturbance. We considered these two approaches in this study. We ran
the Hausman (1978) test in order to check the more efficient model between fixed
and random effects.

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 Revista Brasileira de Financas v 3 n 1 2005

We also included industry dummy variables to control inherent characteristics

of specific sectors of the economy. The idea behind this adjustment is that each
industry may be in a different stage of maturity, growth and present some pecu-
liarities that determine the firm valuation and performance. We also included year
dummy variables to capture macroeconomic changes during the period.

3. Empirical Results
Table 2 shows descriptive statistics of all variables included in our analysis.
The average value of Tobins Q increased from 0.79 in 1998 to 1.07 in 2002,
while average ROA increased from 5.58% in 1998 to 8.49% in 2002. The mean
of CGI increased from 5.78 in 1998 to 5.90 in 2002, while the median of CGI is
6, indicating a relatively symmetric distribution. There are substantial differences
in firm level corporate governance between the 131 firms in our sample. The
minimum value is 1, and the maximum value is 14. This suggests that our CGI is
adequately selected to reach a sufficiently wide distribution.
Table 2
Summary statistics

Panel A: Year 2002

CGI Q ROA SIZE LEV VOT TOT VOT/ FREE-FLOAT
(%) (%) CAP (%) CAP (%) TOT (%) (%)
Mean 5.90 1.07 8.49 14.28 72.62 74.57 49.94 50.21 49.08
Min 2.00 0.41 -22.33 9.87 13.88 14.31 7.10 30.94 0.10
Max 14.00 7.85 34.46 18.62 761.80 100.00 99.00 100.00 92.90
Stdev 2.11 0.73 8.64 1.72 70.06 20.67 24.68 20.39 25.32
Median 6.00 0.95 8.42 14.33 63.01 77.81 48.13 40.83 51.53
Panel B: Year 2001
CGI Q ROA SIZE LEV VOT TOT VOT/ FREE-FLOAT
(%) (%) CAP (%) CAP (%) TOT (%) (%)
Mean 5.82 1.00 8.93 14.17 65.89 73.76 49.27 50.70 49.83
Min 1.00 0.41 -10.54 9.76 23.45 14.31 7.00 31.03 0.38
Max 12.00 6.59 34.27 18.47 642.69 100.00 99.00 100.00 93.00
Stdev 2.03 0.59 7.64 1.68 56.84 21.03 24.73 20.51 25.34
Median 6.00 0.91 9.07 14.17 59.95 76.34 46.61 41.50 52.40
Panel C: Year 2000
CGI Q ROA SIZE LEV VOT TOT VOT/ FREE-FLOAT
(%) (%) CAP (%) CAP (%) TOT (%) (%)
Mean 5.81 1.04 7.97 14.09 62.16 72.13 47.36 51.23 51.78
Min 2.00 0.36 -16.88 9.96 16.66 16.05 7.00 31.03 0.38
Max 10.00 5.38 27.38 18.39 515.33 100.00 99.00 100.00 93.00
Stdev 1.85 0.55 6.97 1.65 46.37 20.58 23.15 20.66 23.91
Median 6.00 0.93 8.12 14.09 56.44 75.23 44.55 42.34 54.70
Panel D: Year 1999
CGI Q ROA SIZE LEV VOT TOT VOT/ FREE-FLOAT
(%) (%) CAP (%) CAP (%) TOT (%) (%)
Mean 5.76 1.11 6.74 13.97 61.25 71.52 47.46 52.29 52.02
Min 2.00 0.32 -40.62 9.96 13.47 16.10 7.00 31.03 0.38
Max 10.00 4.38 28.42 18.26 397.09 100.00 99.22 100.00 93.00
Stdev 1.82 0.55 8.37 1.61 39.48 21.03 23.69 21.04 23.96
Median 6.00 0.98 6.74 13.94 57.12 75.23 45.26 44.95 54.50

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Corporate Governance Index, Firm Valuation and Performance in Brazil

Panel E: Year 1998

CGI Q ROA SIZE LEV VOT TOT VOT/ FREE-FLOAT
(%) (%) CAP (%) CAP (%) TOT (%) (%)
Mean 5.78 0.79 5.58 13.84 55.61 70.51 46.29 53.36 52.72
Min 2.00 0.22 -64.88 10.22 16.06 16.07 6.47 31.03 0.00
Max 10.00 1.76 26.01 18.29 168.67 100.00 100.00 100.00 93.53
Stdev 1.85 0.26 9.40 1.57 22.81 20.84 23.18 20.89 23.42
Median 6.00 0.77 5.75 13.80 53.13 70.92 44.17 47.20 55.83
CGI is a firm-level corporate governance ranking. Tobins Q is used as a proxy for market valuation and is
defined as the market value of assets divided by the book value of assets. ROA is a firm-level measure
of firm performance and is defined as EBITDA divided by total assets. Firm size is defined as the natural
log of total assets. Leverage is calculated as the total debt/total asset ratio. VOT CAP is the portion of
voting capital controlled by the largest shareholder. TOT CAP is the portion of total capital owned by
the largest shareholder. VOT/TOT is the percentage of voting capital in the total capital of the firm.
FREE FLOAT is the percentage of outstanding shares available for trading. Panel A through Panel E
show summary statistics for these variables during the 1998-2002 period.

Our results show a high degree of concentration of voting and total capital. The
largest shareholder owned on average 74.57% of the voting capital and 49.94% of
total capital in 2002. In 1998, the controlling shareholders portion of voting and
total capital was 70.51% and 46.29%, respectively. Due to this high concentration
of capital, the average free float of outstanding shares has been around 50% of the
total capital since 1998.
We also note a reasonable difference between the percentage of voting and total
capital held by large shareholders. In Brazil, the issuance of non-voting shares
appears to be used by large shareholders to maintain control of the firm without
having to hold 50% of the total capital. This mechanism allows companies to
issue shares without relinquishing control and is therefore a way of separating
ownership from control. The issueance of non-voting shares is common in Brazil
and voting shares represented, on average, 51% of the total capital during the 1998-
2002 period.
Table 3 classifies our sample of 131 firms into three groups, according to their
CGI: good corporate governance (CGI from 10 to 15), medium corporate gov-
ernance (CGI from 5 to 9), poor corporate governance (CGI from 0 to 4). Look-
ing at the year 2002, the results indicate that most of the Brazilian firms (70%) are
at the medium corporate governance practices level in 2002. Moreover, less than
4% of the firms are at the good corporate governance practices level, although
there has been a small increase in the number of firms in this segment since 1998.
Firms with poor corporate governance represented 26% of our sample.

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 Revista Brasileira de Financas v 3 n 1 2005

Table 3
Corporate governance rating

Rating CGI 2002 2001 2000 1999 1998

15 0.00% 0.00% 0.00% 0.00% 0.00%
14 0.76% 0.00% 0.00% 0.00% 0.00%
Good Corporate 13 0.00% 0.00% 0.00% 0.00% 0.00%
Governance 12 0.00% 0.76% 0.00% 0.00% 0.00%
11 0.00% 0.00% 0.00% 0.00% 0.00%
10 3.06% 2.29% 2.29% 1.53% 1.53%
Good CG 3.82% 3.05% 2.29% 1.53% 1.53%
9 6.10% 4.58% 4.58% 3.82% 3.82%
8 12.98% 12.98% 13.74% 12.21% 14.50%
Medium Corporate 7 16.03% 16.03% 13.74% 19.09% 16.03%
Governance 6 17.56% 22.90% 21.37% 18.32% 19.85%
5 17.56% 13.74% 19.85% 21.37% 22.13%
Medium CG 70.23% 70.23% 73.28% 74.81% 76.33%
4 12.98% 12.21% 13.74% 11.45% 9.17%
3 7.63% 9.17% 6.87% 7.63% 7.63%
Poor Corporate 2 5.34% 4.58% 3.82% 4.58% 5.34%
Governance 1 0.00% 0.76% 0.00% 0.00% 0.00%
0 0.00% 0.00% 0.00% 0.00% 0.00%
Poor CG 25.95% 26.72% 24.43% 23.66% 22.14%

CGI is a firm-level corporate governance index, composed of 15 questions.

All questions are answered from public information disclosed by listed companies
and not by means of potentially subjective interviews. Sources of information
are company filings, charters, and annual reports. Each question corresponds to a
yes or no answer. If the answer is yes, then the value of 1 is attributed to
the question, otherwise the value is 0. The index is the sum of the points for each
question. The maximum index value is 15. The 131 firms were classified into three
groups, according to their CGI: good corporate governance (CGI from 10 to 15),
medium corporate governance (CGI from 5 to 9), poor corporate governance
(CGI from 0 to 4). The percentage of firms belonging to each group is shown for
the 1998-2002 period.
Table 4 analyzes our sample according to each of the 15 attributes of the CGI.
Looking only at the year 2002, 92.4% of the firms published their financial reports
by the legally required date, 38.2% use international accounting standards (US or
IASB GAAP), and 82.4% use global auditing firms. In 64.9% of the companies,
the Chairman of the Board and the CEO are not the same person, although only a
few boards (36.6%) are not clearly made up of corporate insiders and controlling
shareholders. Board sizes between 5 and 9 members are very common (59.5% of
the firms), while consecutive one-year terms for board members are present only
in 26% of the firms in Brazil.

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Corporate Governance Index, Firm Valuation and Performance in Brazil

Table 4
Corporate governance index descriptive statistics

2002 2001 2000 1999 1998

Financial reports published by the required date 92.37% 96.18% 96.18% 96.95% 97.71%
International accounting standards 38.17% 38.17% 38.17% 38.17% 38.17%
Global auditing firms 82.44% 83.97% 86.26% 84.73% 84.73%
Different Chairman of the Board and CEO 64.89% 65.65% 63.36% 63.36% 68.70%
Independent board members 36.64% 32.06% 29.01% 25.95% 25.19%
Board size between 5 and 9 members 59.54% 62.60% 61.83% 61.07% 61.83%
Board members serve consecutive one-year terms 25.95% 23.66% 24.43% 21.37% 18.32%
Permanent Fiscal Board 27.48% 25.95% 25.95% 25.95% 26.72%
Controlling shareholder owns < 50% of the votes 6.87% 9.16% 9.16% 10.69% 10.69%
% voting capital in total capital > 80% 12.21% 12.98% 13.74% 14.50% 15.27%
Controlling shareholders cash-flow/vote ratio > 1 10.69% 12.21% 13.74% 13.74% 11.45%
Free-float greater than or equal to 25% 77.10% 77.86% 83.97% 83.97% 84.73%
Arbitration to solve corporate conflicts 3.05% 2.29% 0.00% 0.00% 0.00%
Additional rights beyond what is legally required 38.17% 36.64% 35.11% 35.11% 34.35%
Tag along rights beyond what is legally required 15.27% 2.29% 0.00% 0.00% 0.00%
CGI is a firm-level corporate governance index, composed of 15 questions. All questions are answered from
public information disclosed by listed companies and not by means of potentially subjective interviews.
Sources of information are company filings, charters, and annual reports. Each question corresponds to a
yes or no answer. If the answer is yes, then the value of 1 is attributed to the question, otherwise the
value is 0. The percentage of firms with an answer yes for each of the 15 corporate governance attributes
is shown for the 1998-2002 period.

CGI is a firm-level corporate governance index, composed of 15 questions.

All questions are answered from public information disclosed by listed companies
and not by means of potentially subjective interviews. Sources of information
are company filings, charters, and annual reports. Each question corresponds to a
yes or no answer. If the answer is yes, then the value of 1 is attributed to the
question, otherwise the value is 0. The percentage of firms with an answer yes
for each of the 15 corporate governance attributes is shown for the 1998-2002
period.
There are some corporate governance practices that are not very commom in
Brazilian companies: the permanent fiscal board (27.5% of the firms), the use of
arbitration as a means to resolve corporate conflicts (3.1% of the firms), a con-
trolling shareholder with less than 50% of voting capital (6.9% of the firms), a
percentage of voting capital in total capital of more than 80% (12.2% of the firms),
and a controlling shareholders ratio of cash-flow to voting rights greater than or
equal to 1 (10.7% of the firms). A free-float equal to or greater than 25% is com-
mon in 77.1% of the companies, while additional voting and tag along rights are
present in only 38.2% and 15.3% of the Brazilian companies, respectively. It is
worth noting that the number of companies granting tag along rights to minority
shareholders has been increasing since the publication of the New Law of Corpo-
rations in 2001.
Table 5 presents the results from the panel regressions (fixed and random ef-
fects) for Tobins Q and the ROA on the CGI, along with other control variables.
The fixed effects model, which assumes that differences across firms can be cap-
tured by differences in the constant term, does not show significant results. The
Hausman test statistic presents insignificant p-values and indicates the random ef-

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 Revista Brasileira de Financas v 3 n 1 2005

fects model is more efficient and should be used in order to make sure that the
results are consistent. The results for the random effects model indicate that CGI
has a statistically significant at the 1% level positive effect on firm perfor-
mance (ROA) even with the inclusion of control variables. Table 5 also shows that
the Tobins Q is positively related to the CGI, although the results are not statisti-
cally significant. Therefore, our findings for the Tobins Q are weaker compared
to the ROA analysis but the hypothesized positive sign is maintained.
Table 5
Corporate governance, firm valuation and performance

Dependent Variable
Tobins Q ROA
Variables Fixed Random Fixed Random
Effects Effects Effects Effects
Constant - 0.1166 - 0.0353
(0.5704) (0.4361)
CGI 0.0018 0.0101 0.0016 0.0070*
(0.8815) (0.3099) (0.6282) (0.0047)
Leverage 0.8765* 0.9084* 0.0180 -0.0119
(0.0000) (0.0000) (0.1048) (0.1441)
Size 0.1474* 0.0049 -0.0057 -0.0009
(0.0002) (0.7537) (0.5981) (0.7864)
ROA 0.5133* 0.7053* - -
(0.0013) (0.0000)
Industry
Dummy Yes Yes Yes Yes
Year
Dummy Yes Yes Yes Yes
Hausman 7.90 5.12
Test (0.44) (0.65)
Adj R2 0.86 0.86 0.51 0.49
The dependent variables, Tobins Q and ROA, measure firm valuation
(market value of assets divided by the book value of assets) and
firm performance (EBITDA divided by total assets), respectively.
CGI is a firm-level corporate governance ranking. Firm size is
defined as the natural log of total assets. Leverage is calculated
as the total debt/total asset ratio. Panel data are modeled using fixed
and random effects. The intercept terms for fixed effects, and the
coefficients of industry and year dummy variables are not reported.
The Hausman (1978) test statistic indicates that the random effects
model is more efficient than fixed effects. The numbers in parentheres
are the p-values. *, ** and *** indicate statistical significance
at the 1%, 5% and 10% levels, respectively.

Our results support the hypothesis that firms with better corporate governance
have significantly higher performance (ROA). The Tobins Q is positively related
to better corporate governance practices but the results are not statistically signif-
icant. We must note that our results may be biased in favor of larger firms due
to our own sample selection and possibly to the inclusion of questions 2 and 3 as
well.

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Corporate Governance Index, Firm Valuation and Performance in Brazil

4. Conclusion
Recent research suggests that corporate governance is associated with greater
firm valuation and performance. The purpose of this paper was to analyze the
relationship between the quality of a firms corporate governance practices and
its valuation and performance through the construction of a broad firm-specific
corporate governance index for Brazilian listed companies.
The CGI serves as a broad measure of firm-specific corporate governance qual-
ity and reflects different governance attributes, which are not legally required but
considered as good corporate governance practices by international standards.
It is also based on the recommendations and suggestions of the Brazilian Institute
of Corporate Governance (IBGC), the Brazilian Securities Exchange Comission
(CVM), and the Sao Paulo Stock Exchange (BOVESPA).
Brazil is a particularly interesting case to analyze because the debate about cor-
porate governance structures was intensified only in the last decade, when factors
such as privatizations, the opening process of the economy, the entrance of new
investors especially foreign and institutional ones, have stimulated new efforts
towards better corporate governance practices.
Our results show a high degree of concentration of voting and total capital. We
also note a reasonable difference between the percentage of voting and total capital
held by large shareholders. The issuance of non-voting shares appears to be used
by large shareholders to maintain control of the firm without having to hold 50%
of the total capital.
Panel data analysis is employed in order to allow flexibility in modeling dif-
ferences in behavior across firms and time. The results indicate that less than 4%
of Brazilian firms present good corporate governance practices and that firms
with better corporate governance have significantly higher performance (return on
assets). There is also a positive relationship between Tobins Q and better corpo-
rate governance practices although the results are not statistically significant. Our
results may be biased in favor of larger firms.

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