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Black, Bernard S.; Kim, Woochan; Nasev, Julia (October 2017): How Does Corporate Governance Affect Firm Behavior? Shock-Based versus Panel Data Methods. SSRN : Social Science Research Network
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Most studies of how corporate governance affects firm behavior provide evidence on association, not causation. How likely are these results to be causal? We provide evidence on that question. We begin with an unusually “clean” natural experiment in Korea. Under 1999 Korean legal reforms, large firms (assets over 2 trillion won, about US$2 billion) faced a major, exogenous shock to their board structures, with no similar shock to smaller firms. We first exploit this shock using the strongest available design, which combines difference-in-difference (DiD) and regression discontinuity (RD) methods -- we estimate annual “leads-and-lags” DiD coefficients on a subsample limited to a bandwidth around the RD threshold, for a variety of governance, financial, and accounting outcomes. The shock significantly predicts change in only one outcome measure (a “Disclosure Subindex”). We then compare these results to those from weaker research designs -- both “classic” panel data designs (pooled OLS, firm random effects, firm fixed effects, and first differences), applied to a “Korean Corporate Governance Index, KCGI”), and simpler causal designs exploiting the 1999 shock (DiD alone; RD in the post-shock period, and instrumental variables (IV), also in the post-shock period. With panel methods, KCGI predicts higher Tobin’s q, lower investment, slower growth, lower absolute abnormal accruals, and more extensive MD&A disclosure. However, only the Tobin’s q results survive with simpler causal methods, and those fall away with the “leads and lags plus RD” design. We thus provides case study evidence that classic panel methods can provide a weak guide to causation, and simpler causal methods can also be non-robust.