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by the same time leads to a concentration of power and the election of less independent board

members.

[Insert Table 5 about here]

6. Robustness Tests

In this section, we conduct a number of checks on the robustness of our results. First, we em-

ploy an alternative measure of firm valuation. Following Loderer and Peyer (2002), LaPorta,

Lopez-de-Silanes, Shleifer, and Vishny (2002), Gompers, Ishii, and Metrick (2003), and oth-

ers, we define an industry-adjusted Tobins Q as Tobins Q minus the median Q of the corre-

sponding industry. Accordingly, we exclude the industry dummies from the regression equa-

tions. In contrast to our earlier findings, the results of an OLS regression of the industry-

adjusted Tobins Q (labeled adjusted Q ) on the six control mechanisms and a set of control

variables reveals that the coefficients on CGI and Bsize are no longer statistically significant.

The results are reported in column (2) of Table 6 while, for eased comparison, column (1)

repeats the results of the standard specification as reported in column (9) of Table 4. How-

ever, reestimating our system of seven simultaneous equations with Q replaced by adjusted Q

we again uncover a positive and statistically significant, even though somewhat reduced, co-

efficient on CGI (see column (2) of Table 7). An increase in our corporate governance index

by one point causes an increase of the industry-adjusted Tobins Q by approximately 6%, on

average. As the comparison with the results in column (7) of Table 5 (which is replicated for

eased comparison in column (1) of Table (7)) reveals, all other coefficients are robust to the

use of an industry-adjusted Tobins Q as well.

Second, we use the market-to-book ratio, defined as the market value of common stock di-

vided by the book value of common stock, as another alternative measure of firm value. Ascolumn (3) of Table 6 reveals, the coefficient on CGI remains positive and statistically sig-

nificant at the 5% level. Furthermore, the coefficients on all other variables are similar to the

values reported in column (1) of Table (6). Consistently, the simultaneous estimation of our

system of equations produces similar results as obtained for Q and the industry-adjusted

Tobins Q. The coefficients on CGI , Stocksod , and Bsize even increase in magnitude and re-

main statistically significant at the 5% level or higher. Overall, these results confirm that the

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importance of our corporate governance index as a major determinant of firm value is robust

to the choice of alternative measures of firm value.

Finally, we investigate whether our results depend on the weighting of the five categories of

our index. As described in section 4, our index consists of 38 governance attributes divided

into five categories. Since the 38 attributes are all equally weighted in our index while the

number of attributes differs across the five categories, this simple and transparent weighting

scheme leads to different weights assigned to the five categories:

(1) Corporate governance commitment: 13.16%

(2) Shareholders rights: 18.42%

(3) Transparency: 13.16%

(4) Management and supervisory board matters: 39.47%

(5) Auditing: 15.79%

To check whether our results are robust to an equal weighting of the five categories, we con-

struct an alternative index, labeled CGI_12345 , which attributes 20% to each of the five cate-

gories. The results of an OLS regression (reported in column (4) of Table 6) and a 3SLS esti-

mation of our complete system (reported in column (4) of Table 7) reveal that our results arerobust to this alternative weighting scheme.

[Insert Table 6 about here]

[Insert Table 7 about here]

7. Conclusion

In this paper we address the question whether good corporate governance has a positive

impact on firm valuation. While most previous studies used US data to analyze this relation-

ship, we investigate a broad sample of Swiss firms. This is interesting, because Switzerland

has recently taken several important steps to improve its transparency standards in the corpo-

rate sector. For example, the Directive on Information Relating to Corporate Governance

and the Swiss Code of Best Practice have become effective in 2002. Observing the intense

public discussion since then, these new rules have undoubtedly increased the general con-

sciousness for the importance of internationally recognized governance practices.

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Our most important result supports the widespread hypothesis of a positive relationship be-

tween firm-level corporate governance and Tobins Q. Specifically, an increase in the corpo-

rate governance index by one point (where the index ranges from 1 to 100) causes an increase

of the market capitalization by roughly 8.6%, on average, of a companys book asset value.

This result is robust to possible endogeneity, i.e., our analysis confirms that causation runs

from corporate governance to firm value, but we also find evidence of reverse causality, with

higher valued firms adopting better corporate governance practices.

Our results also emphasize the importance to control for possible interrelationships between

different control mechanisms and Tobins Q. To provide a comprehensive analysis of corpo-

rate governance, we use a broad corporate governance index and additional variables related

to ownership structure, board characteristics, and leverage. Our corporate governance index

for the most part relates to the recommendations and suggestions of the Swiss Code of Best

Practice. However, one may suspect that important substitution effects between these differ-

ent governance mechanisms exist, i.e., where one mechanism is used less, others may be used

more, resulting in the same valuation effects. Therefore, to avoid spurious results and capture

the possibly complex interrelationships between the different control mechanisms, we de-

velop a comprehensive system of simultaneous equations and apply three stage least squares

(3SLS). This setup allows each of the control mechanisms to affect Tobins Q, while at the

same time Tobins Q is also allowed to affect the choice of each mechanism. Our empirical

results allow us to infer several other interesting results on the relationship between Tobins Q

and the different control mechanisms. For example, firm valuation significantly increases

with higher shareholdings of officers and directors and higher leverage. In addition, higher

shareholdings of officers and directors are associated with a lower fraction of outsiders on the

board, which indicates possible substitution effects.

Our results also have an important policy implication. It is widely agreed that investor protec-

tion and prosecution capabilities form the basis for good corporate governance (e.g., Klapper

and Love (2003)). Hence, although the task of reforming investor protection laws and improv-

ing judicial quality is a lengthy process, requiring the support of many interest groups, it

seems like a worthwhile objective in the public interest. However, once adequate disclosure

and transparency standards are in place, our results strongly suggest that it is ultimately the

capital market which rewards good governance practices and punishes bad ones. We conclude

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that corporate governance should be understood as a chance rather than an obligation from the

perspective of a firms decision makers.

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31

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Table 1: Summary of variables

Endogenous variables:

Q Ratio of market value to book value of assets. Market value of assets iscomputed as market value of equity plus book value of assets minus bookvalue of equity.

CGI Index scaled to a value between 0 and 100, taking into account 40 differ-ent aspects of the corporate governance structure in the company

Stocksod Percentage of equity owned by officers and directors (if SCAT = 1: nomi-nal values of different share categories are used for weighting)

Blockout Percentage of cumulated voting rights exercised by large investors with>5% of voting rights (excluding officers, directors, and related persons)

Bsize Number of directors on the board of the company

LV Leverage, measured as the ratio of total (nonequity) liabilities to total as-sets

Outsider Outsider membership on the board, measured by the percentage of boardseats held by non-officers without relationship to the founding family (if any)

Exogenous variables:

ADR 1, if the company is issuing American Depositary Receipts; 0 otherwise

Beta Beta estimated from 60 monthly stock returns

Blockonr Number of outside shareholders with an equity stake >5%

Ceop 1, if the CEO is also the president of the board; 0 otherwise

Div 1, if the company paid out a dividend form the earnings of 2002; 0 other-wise

Founder 1, if the CEO or the president of the board founded the company; 0 other-wise

Growth Average annual growth of sales over the past three years (2000-2002)

Industry 12 industry dummy variables

Intang Ratio of intangible assets to total assets

Lnage Natural log of age of the firm

Lnassets Firm size, measured by the natural logarithm of book value of total assets

ROA Ratio of operating income to total assets (return on assets)

Scat 1, if the firm has different share categories with different voting rights at-tached; 0 otherwise

SMI 1, if the company belongs to the Swiss Market Index; 0 ohterwise

Sown 1, if state owns >5% of the firms equity; 0 otherwise

Vola Standard deviation of stock returns estimated from 60 monthly stock re-turns

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Table 2: Descriptive statistics of the endogenous variables

Variable Mean Median S.D. Maximum/

MinimumQ 1.3390 1.0606 0.7618 5.6637 / 0.6004

CGI 58.4561 59.2105 14.3384 90.1316 / 25.0000

Stocksod 0.1201 0.0059 0.1899 0.7878 / 0.0000

Blockout 0.3274 0.2292 0.2923 1.0000 / 0.0000

Bsize 7.3486 7.0000 2.7161 16.0000 / 3.0000

LV 0.6234 0.6266 0.2183 0.9855 / 0.0890

Outsider 0.8927 1.0000 0.1333 1.0000 / 0.4000

ADR 0.1101 0.0000 0.3145 1.0000 / 0.0000

Beta 0.7918 0.6261 0.5833 2.2455 / -0.0843

Blockonr 1.7064 2.0000 1.3492 5.0000 / 0.0000

Ceop 0.1468 0.0000 0.3555 1.0000 / 0.0000

Div 0.7339 1.0000 0.4439 1.0000 / 0.0000

Founder 0.1009 0.0000 0.3026 1.0000 / 0.0000

Growth 0.1277 0.0597 0.4188 3.9722 / -0.6080

Intang 0.0756 0.0261 0.0968 0.3727 / 0.0000

Lnage 3.6513 3.8067 1.2397 6.2766 / 0.6931

Lnassets 14.2414 13.9571 2.1072 20.8897 / 9.1714

ROA 0.0215 0.0365 0.0908 0.1861 / -0.6002

Scat 0.2202 0.0000 0.4163 1.0000 / 0.0000

SMI 0.1835 0.0000 0.3889 1.0000 / 0.0000

Sown 0.1193 0.0000 0.3256 1.0000 / 0.0000

Vola 0.1004 0.0927 0.0515 0.2589 / 0.0061

This table includes summary statistics of all variables included in the study. The sample size is 109.

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Table 3: Correlation matrix between control mechanisms and Tobins Q

CGI Stocksod Blockout Bsize LV Outsider

Q 0.2417 0.0785 -0.1475 0.0296 -0.2457 -0.1247

CGI -0.0449 -0.3688 0.0725 -0.0171 0.0116

Stocksod -0.2152 -0.0431 -0.3252 -0.1684

Blockout 0.1787 0.2035 0.1678

Bsize 0.2454 0.3062

LV 0.3472

This table contains correlation coefficients between Tobins Q and the control mechanisms. The sample

size is 109.

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Table 4: Results from OLS regressions of Q on the different control mechanisms (N=109)

Independent Dependent variable = Q

Variable (1) (2) (3) (4) (5) (6) (7) (8) (9)

Constant 1.4716(0.1059)1.3279

(0.1443)0.9271

(0.2744)1.5987*(0.0877)

1.6958*(0.0683)

1.5359*(0.0919)

1.7930*(0.0811)

1.8662*(0.0838)

1.0988(0.2713)

CGI 0.0083**(0.0316 ) 0.0089**(0.0370 )

0.0102**(0.0126 )

Stocksod 0.4441(0.2828)2.9932**(0.0111 )

0.2478(0.5438)

3.1225***(0.0067 )

Stocksod^2 -4.6343**(0.0214 ) -5.1789***(0.0092 )

Blockout -0.2319(0.2950)-0.0587(0.8062)

0.0718(0.7454)

Bsize 0.0451*(0.0668 ) 0.0509**(0.0388 )

0.0465**(0.0423 )

LV -0.4864(0.1824)-0.2284(0.5212)

-0.4425(0.2090)

Outsider -0.3741(0.3457)-0.3846(0.3173)

-0.0468(0.9036)

Lnassets -0.0782(0.2312)-0.0395(0.5373)

-0.0195(0.7499)

-0.0500(0.4460)

-0.0843(0.2309)

-0.0299(0.6474)

-0.0451(0.4876)

-0.1051(0.1414)

-0.0773(0.2407)

ROA 2.3144***(0.0008 ) 2.2236***(0.0009 )

2.0627***(0.0014 )

2.1357***(0.0010 )

2.4448***(0.0006 )

2.0967***(0.0016 )

2.1836***(0.0007 )

2.5726***(0.0004 )

2.3832***(0.0015 )

Growth 0.8856***(0.0000 ) 0.8977***(0.0000 )

0.8067***(0.0000 )

0.8895***(0.0000 )

0.9061***(0.0000 )

0.8850***(0.0000 )

0.8800***(0.0000 )

0.8860***(0.0000 )

0.7919***(0.0000 )

Beta 0.3331***(0.0039 ) 0.3502***(0.0021 )

0.3069***(0.0036 )

0.3382***(0.0031 )

0.3857***(0.0009 )

0.3444***(0.0024 )

0.3572***(0.0019 )

0.3503***(0.0015 )

0.2996***(0.0030 )

Industry Included Included Included Included Included Included Included Included Included

Wald test 13.3497(0.0000)15.8149(0.0000)

13.8571(0.0000)

12.8430(0.0000)

17.6135(0.0000)

14.4592(0.0000)

13.2111(0.0000)

10.6880(0.0000)

9.0383(0.0000)

Adjusted R 2 0.4224 0.4151 0.4512 0.4096 0.4198 0.4139 0.4075 0.4280 0.4711

Estimates from OLS regressions of Tobins Q on individual control mechanisms and all control mechanismstogether along with the exogenous control variables included in equation (7) of our system of equations. Thesample size is 109. A Wald test is performed for the simultaneous significance of all coefficients (except theconstant and the industry dummies). The numbers in parentheses are probability values for two-sided tests.***/**/* denotes statistical significance at the 1%/5%/10% level.

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Table 5: Results from 3SLS regressions of six control mechanisms and Tobins Q

Dependent variable

Independent

variable

CGI

(1)

Stocksod

(2)

Blocko

(3)

Bsize

(4)

LV

(5)

Outsider

(6)

Q

(7)Constant 31.0543(0.2501)

0.5070(0.1169)

0.7639(0.1166)

-7.0730*(0.0611)

0.6315(0.1602)

0.9410***(0.0000)

-2.4950(0.2426)

CGI 0.0017(0.7448)-0.0056(0.5115)

-0.0523(0.3375)

-0.0144***(0.0082 )

-0.0043(0.1208)

0.0856***(0.0001 )

Stocksod -48.2519**(0.0129 ) -0.4199(0.3216)

6.2162**(0.0377 )

-0.9362**(0.0137 )

-0.5433**(0.0230 )

4.2523***(0.0049 )

Blocko -1.5175(0.8760)-0.0930(0.4751)

-1.0073(0.5672)

-0.0049(0.9766)

0.1028(0.3919)

0.1732(0.8268)

Bsize -0.6485(0.6111)0.0146

(0.4141)0.0521**(0.0210 )

0.0026(0.9026)

0.0404***(0.0009 )

0.0527(0.5992)

LV -52.9497***(0.0015 ) -0.3076(0.3724)

0.6167(0.1408)

-3.1731(0.3557)

-0.2851(0.1489)

4.5932***(0.0001 )

Outsider -24.7488

(0.2721)

-0.2684

(0.3701)

-0.4301

(0.3169)

4.1186

(0.2050)

-0.4933

(0.1907)

2.1156

(0.2332)

Q 10.9801***(0.0001 ) 0.0242

(0.6025)0.0071

(0.9131)-0.2140(0.6183)

0.1779***(0.0009 )

0.0853**(0.0425 )

SMI 1.4106(0.5480)

ADR -0.3527(0.9074)

Intang -1.3810(0.8139)0.0253

(0.9352)

Lnassets 5.5368***(0.0004 ) -0.0221(0.4153)

-0.0442(0.2903)

1.0850***(0.0001 )

0.0777**(0.0110 )

-0.4871***(0.0011 )

ROA -54.0191***(0.0018 ) -5.3579**(0.0415 )

-0.7910**(0.0169 )

-0.1496(0.3833)

4.7483***(0.0006 )

Growth-11.3071***

(0.0067 )-0.0437(0.3932)

-0.0506(0.4935)

-0.1841***(0.0084 )

-0.1016**(0.0216 )

1.0333***(0.0000 )

Beta 0.0413(0.6069)

Lnage 0.0236(0.1368)0.0061

(0.6601)

Scat 0.0956*(0.0800)0.0382

(0.6860)

Founder 0.1021(0.1458)-0.0065(0.8959)

Sown 3.4026***(0.0001 ) -0.1327*(0.0628 )

Blockonr 0.0922***(0.0000 )

Ceop-0.1134***(0.0021 )

Div 0.0110(0.7522)

Vola 0.1736(0.6713)-0.2316(0.6993)

Industry Included Included Included Included Included Included Included

Wald test 79.4102(0.0000)31.8098(0.0015)

55.1592(0.0000)

79.4526(0.0000)

27.5855(0.0037)

32.2411(0.0010)

44.2430(0.0000)

Results from a three stage least squares (3SLS) estimation of equations (1)(7) of our system of linear equa-tions. The sample size is 109. A Wald test is performed for the simultaneous significance of all coefficients(except the constant and the industry dummies). The numbers in parentheses are probability values for two-sided tests. ***/**/* denotes statistical significance at the 1%/5%/10% level.

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Table 6: Checks on the robustness of our OLS results

Independent Dependent variable

Variable Q(1) Adjusted Q

(2)MTB-Ratio

(3)Q(4)

Constant 1.0988(0.2713)-0.2777(0.6850)

-0.8341(0.6871)

1.0938(0.2813)

CGI 0.0102**(0.0126 ) 0.0059

(0.1215)0.0253**(0.0242 )

CGI_12345 0.0083**(0.0344 )

Stocksod 3.1225***(0.0067 ) 3.1966***(0.0036 )

6.3800**(0.0229 )

3.0552***(0.0086 )

Stocksod^2 -5.1789***

(0.0092 )

-5.1290***

(0.0086 )

-9.9031**

(0.0263 )

-5.0714**

(0.0119 )

Blockout 0.0718(0.7454)0.1171

(0.5129)-0.4721(0.4950)

0.0408(0.8553)

Bsize 0.0465**(0.0423 ) 0.0284

(0.1961)0.0685

(0.2873)0.0441*(0.517 )

LV -0.4425(0.2090)-0.0813(0.7769)

2.5069(0.1995)

-0.4417(0.2161)

Outsider -0.0468(0.9036)0.0277

(0.9355)-0.9850(0.3423)

-0.0370(0.9257)

Lnassets -0.0773(0.2407)-0.0430(0.4076)

-0.0983(0.5485)

-0.0698(0.2897)

ROA 2.3832***(0.0015 ) 1.8136***(0.0024 )

2.0590(0.4597)

2.3349***(0.0017 )

Growth 0.7919***(0.0000 ) 0.7053***(0.0000 )

0.9868***(0.0028 )

0.7947***(0.0000 )

Beta 0.2996***(0.0030 ) 0.2745***(0.0043 )

0.7790***(0.0033 )

0.3087***(0.0023 )

Industry Included Excluded Included Included

Wald test 9.0383(0.0000)9.3138

(0.0000)5.0310

(0.0000)8.7809

(0.0000)

Adjusted R 2 0.4711 0.3423 0.2808 0.4633

Columns (2) and (3) show estimates from OLS regressions of an industry-adjusted Tobins Q and the market-to-book ratio, respectively, on all five con-trol mechanisms together along with the exogenous control variables includedin equation (7) of our system of equations. Column (3) reports the estimates of a regression of Q on an alternatively weighted governance index, the other fivecontrol mechanisms and the standard set of control variables. For eased com-

parison, column (1) shows the results of the standard specification as reportedin column (9) of Table 4. The sample size is 109. A Wald test is performed for the simultaneous significance of all coefficients (except the constant and theindustry dummies). The numbers in parentheses are probability values for two-sided tests. ***/**/* denotes statistical significance at the 1%/5%/10% level.

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Table 7: Checks on the robustness of our 3SLS results (reported is only equation 7)

Dependent variable

Independentvariable

Q(1)

Adjusted Q(2)

MTB-Ratio(3)

Q(4)

Constant -2.4950(0.2426)-3.0832*(0.0662)

-9.1026*(0.0681)

-2.0796(0.3155)

CGI 0.0856***(0.0001 ) 0.0598***(0.0000 )

0.1976***(0.0000 )

CGI_12345 0.0785***(0.0001 )

Stocksod 4.2523***(0.0049 ) 3.5316***(0.0049 )

7.9984**(0.0233 )

3.2323**(0.0244 )

Blocko 0.1732(0.8268)0.1690

(0.7537)-0.9452(0.6057)

-0.5266(0.4705)

Bsize 0.0527(0.5992)0.1141

(0.1726)0.0518

(0.8263)0.0349

(0.7183)

LV 4.5932***(0.0001 ) 3.3493**(0.0106 )

11.0070***(0.0001 )

4.7125***(0.0001 )

Outsider 2.1156(0.2332)1.8612

(0.2136)5.3943

(0.1924)2.092356(0.2257)

Lnassets -0.4871***(0.0011 ) -0.3917***(0.0015 )

-0.9526***(0.0053 )

-0.4762***(0.0008 )

ROA 4.7483***(0.0006 ) 3.4240***(0.0013 ) 6.4354**(0.0437 ) 4.1558***(0.0014 )

Growth 1.0333***(0.0000 ) 0.8982***(0.0000 )

1.4626**(0.0112 )

1.0068***(0.0000 )

Beta 0.0413(0.6069)0.0716

(0.4789)0.0840

(0.6779)0.0668

(0.4442)

Industry Included Excluded Included Included

Wald test 44.2430(0.0000)43.9690(0.0000)

38.6688(0.0000)

45.3091(0.0000)

Coefficient estimates for equation (7) of the system of seven equations ob-tained by estimating the complete system simultaneously by 3SLS. Columns(2) and (3) show estimates obtained by replacing Q by an industry-adjustedTobins Q and the market-to-book ratio, respectively. Column (3) reports theestimates obtained by introducing an alternatively weighted governance in-dex. For eased comparison, column (1) shows the results of the standardspecification as reported in column (7) of Table 5. The sample size is 109. AWald test is performed for the simultaneous significance of all coefficients(except the constant and the industry dummies). The numbers in parenthesesare probability values for two-sided tests. ***/**/* denotes statistical signifi-cance at the 1%/5%/10% level.

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Figure 1: The empirical distribution of our Corporate Governance Index (CGI)

0

2

4

6

8

10

12

14

20 30 40 50 60 70 80 90 100

Corporate Governance Index

N u m

b e r o

f F i r m s

All Firms

SMI Firms

The distribution of the survey-based corporate governance index (CGI) for the 109 Swiss firms. Theindex represents an unweighted sum of the basis points (on a five-scale answering range) for all gov-ernance proxies in five the five categories: (1) corporate governance commitment, (2) shareholdersrights, (3) transparency, (4) management and supervisory board matters, and (5) auditing. CGI is nor-malized to have a value between 0 and 100, with better-governed firms having higher index scores.Dark grey represents firms included in the Swiss Market Index (SMI).