Every day, institutional investors in emerging markets must make practical decisions on the basis of incomplete and at times conflicting information. So, it is critically important that they make the best use of this imperfect knowledge. Moreover, investors too often enter emerging markets with misguided perceptions of the underlying realities. And worse, they may cling to a conceptual framework of governance that does not allow them even to consider the searching questions they should be asking.
This Private Sector Opinion, by Melsa Ararat and George Dallas, explicitly highlights this problem. The authors identify a serious gap in research on emerging markets—between high-level cross-country studies, with their inconclusive findings on good governance indicators at the macro level, and the separate effort to establish firm-level or country-specific governance metrics, typically based on what works “in the West.” Unfortunately, fewer than one percent of the research papers available on corporate governance focus on emerging markets.
The challenge for institutional investors is how to weight country factors, even if the investors conclude, as this paper notes, that “optimal governance is firm-specific.” Alongside the country factors—rule of law, risk of corruption, competitive intensity, and capital market capabilities—the indicator that bridges to the firm-specific context is the structure of ownership. The heart of this paper is an exploration of two key dimensions of ownership structure: the quality of board independence, and mitigation of the risks of business group affiliations. The authors also provide practical guidance to investors in each of these areas.