*2.2. Corporate Governance Code and Company Value*

Studies on corporate governance compliance offer a wide range of qualitative and quantitative analyses revealing the degree, scope, and dynamics of compliance (Seidl et al. 2013; Shrives and Brennan 2015; Okhmatovskiy 2017), in addition to its relation to company performance and value (Stiglbauer and Velte 2014; Rose 2016; Roy and Pay 2017). Conceptually, studies are based on the assumption that companies with poor corporate governance should have lower valuations in comparison to companies with effective corporate governance, since investors do not tolerate higher risk of expropriation without receiving a premium for such investments (Gompers et al. 2003; Goncharov et al. 2006). A positive link between the quality of governance and performance is observed in studies on European (Drobetz et al. 2003; Gompers et al. 2003; Bauer et al. 2004; Goncharov et al. 2006; Renders et al. 2010; Bistrowa and Lace 2012), Japanese (Aman and Nguyen 2007), and American (Bhagat and Bolton 2008) companies.

Specifically, a series of studies analyze the dynamics of compliance with corporate governance codes and the link between the compliance and firm performance. Goncharov et al. (2006) examine the declared degree of compliance for a sample of German DAX30 and MDAX listed firms and find that "the compliance with the Code is value-relevant after controlling for endogeneity bias" (Goncharov et al. 2006, p. 432). Research on a sample of 140 German companies reveals that companies with a higher value of Tobin's Q are more likely to comply with the recommendation on disclosing the remuneration schemes of individual directors (Andres and Theissen 2008). A study on a large sample of 1199 observations on FTSE companies and 33,667 observations of Worldscope firms (Renders et al. 2010) shows that—when controlling for endogeneity by introducing instrumental variables and eliminating the sample selection bias—there is a positive link between the quality of corporate governance (measured by the rating variable) and company performance. The strength of this relationship depends on the quality of the institutional environment, while "improvements in corporate governance ratings over time result in decreasing marginal benefits in terms of performance" (Renders et al. 2010, p. 87). A positive link between company performance measured by return of equity (ROE) and return on assets (ROA) indicators and total corporate governance comply or explain disclosure scores is noted in a sample of Danish firms (Rose 2016). This study indicates a positive effect for two categories: board composition and remuneration policy, while no impact on performance is reported for increasing compliance with the recommendations on risk management and internal controls.

Similar results are shown in a study on the impact of corporate governance quality on stock performance in a sample of 116 firms from 10 Central and Eastern European countries for the period of 2008–2010 (Bistrowa and Lace 2012). Based on the model rating, the firms characterized by the highest corporate governance quality (top 25%) outperformed companies with the worst corporate governance quality (bottom 25%) by 0.98% on a monthly basis.

Although studies document a positive association between corporate governance compliance and firm value and performance (Goncharov et al. 2006; Renders et al. 2010; Rose 2016), the opposite may also be true (Bhagat and Black 2002). The assumed effect referring to higher company valuation, increased legitimization towards constituencies, and positive ethical spillovers may be constrained by a number of reasons. Firstly, the pricing effect takes place when investors believe in the reliability of information provided by firms to the market. This may not necessarily be the case, as the declaration of conformity is neither verified nor audited. Moreover, companies may choose to comply with provisions which are either relatively easy to follow or which appear useless from an investor standpoint (Goncharov et al. 2006; Sobhan 2016).

Secondly, the voluntary approach to compliance and the absence of enforcement mechanisms may lower the credibility of the conformity statement and may weaken the positive economic consequences (Healy and Palepu 2001; Goncharov et al. 2006). With the given institutional and ownership characteristics in emerging and post-transition economies, codes of best practice aim to resolve the inherent principal–principal conflict and add to the protection of minority investors (Mahadeo and Soobaroyen 2016). In spite of this, "publicly mandated commitment to corporate governance, business ethics and legal compliance" (Adelstein and Clegg 2016) is significantly constrained. Insufficient enforcement mechanisms, combined with institutional skepticism, increases "the declarative and instrumental use of corporate governance structures and their actual daily use" (Perezts and Picard 2015, p. 833). This can lead, as shown in a study on Hungary, to a "disjuncture between formal commitment to code adoption and its effective implementation" (Martin 2010, p. 145). Therefore, the effective implementation of codes of best practice depends on the perceived benefits and costs by majority shareholders.

Thirdly, compliance with the code guidelines may be viewed as explicit information on the corporate governance structure and standards for board functioning and investor protection. The declaration of conformity issued by listed companies may either not lead to better performance or higher firm value or not necessarily be motivated by a strategy of increasing shareholder value. Instead, compliance may be a product of the endogenously determined structure of internal firm governance or result from the isomorphic dynamics driven by company legitimization policy. Research reveals the impact of endogeneity in the process of board formation and monitoring (Hermalin and Weisbach 2003). The legitimacy driven effect should be particularly strong for poorly performing companies, which, by publishing a declaration of corporate governance conformity, intend to compensate shareholders reacting to unsatisfying financial results.

Fourthly, while we acknowledge the contribution of agency theory, we also consider the limitations of the rationale approach to corporate governance compliance. Since legitimacy is crucial for organization survival, as it provides access to resources from the environment (Deephouse 1996; Mizruchi and Fein 1999), companies may be "prone to construct stories about their actions that correspond to socially prescribed dictates about what organization should do" (Mizruchi and Fein 1999, p. 656). In addition, companies may tend to declare adherence with corporate governance principles without any substantive compliance.

Fifthly, legitimacy motivation is observed in many companies, regardless of the country of origin or operation. However, in the context of weaker institutions and insufficient investor protection, this declarative character (Okhmatovskiy 2017), overstatement (Sobhan 2016) or instrumental approach (Fotaki et al. 2019) to compliance may result in no effect on market valuation (Gherghina 2015).

We follow the approach proposed by Chen et al. (2011), who argue that the provisions of corporate governance codes are designed around companies in developed economies. They suggest that best practice "cannot mitigate the negative effect of controlling-shareholder expropriation on corporate performance" (Chen et al. 2011, p. 115). This is caused by two main limitations. Firstly, code provisions are designed to solve type I principal–agent problems between shareholders and managers, while they do not address conflicts between majority and minority shareholders. Secondly, the core of best practice code lies in the guidelines on board structure and operation, which structurally will not be implemented in a concentrated ownership context since majority shareholders appoint their own representatives to the board (Shleifer and Vishny 1997; Ferrarini and Filippelli 2013; Gaur et al. 2015). Put differently, not only are the code provisions not substantively implemented by boards, but they also fail to respond to the structural problems and challenges of corporate governance in emerging economies. Investors do not observe positive effects with regard to lower asymmetry, lower risk, or more efficient oversight; thus, there is no resulting higher valuation. In sum, recognizing the limitations of corporate governance codes in the context of concentrated ownership, we formulate the following hypotheses:

**Hypothesis 1a (H1a).** *Formal compliance with board best practice is negatively associated with firm value.*

**Hypothesis 1b (H1b).** *Minimum compliance with board best practice is negatively associated with firm value.*

**Hypothesis 1c (H1c).** *Substantive compliance with board best practice is negatively associated with firm value.*
