In the wake of the Enron and WorldCom financial scandals, the importance of corporate governance has become a top priority in today's business and financial world. There is now a large body of literature on this subject and arguments are increasingly being put forward that the legal protection of investors is key to effective corporate governance.
Adding to this growing body of literature on the importance of effective corporate governance are the findings of a research project led by Professor Kuo-Ching John Wei, Chair Professor of Finance at the Centre for Asian Financial Markets at the Hong Kong University of Science and Technology. Titled, Corporate Governance and Conditional Skewness in Stock Returns, the research investigates why stock returns in emerging markets tend to be more positively skewed than those in developed markets. Based on the project's findings, Professor Wei argues that the quality of corporate governance in a market affects the skewness of its stock returns.
In his findings, published in the Journal of Business (2006, vol 79, no 6, University of Chicago) Professor Wei points out that there are at least two reasons for the positive skewness in emerging markets and how corporate governance can affect returns.
Firstly, there is the risk-sharing factor where, due to cross-subsidies among group-affiliated businesses, earnings or returns of these organizations are more positively skewed. If an organization chooses to use its resources to support a distressed firm, the negative impact of the firm's failure may not be fully reflected in the stock's returns, particularly if there is an expectation in the market for the firm's bailout. In more regulated markets however, the protection of investor's property rights does not facilitate this shifting of income between different business groups or sections. Since business groups are a more prevalent organizational form in emerging markets, positive skewness in these markets is more pronounced.
Secondly, stock markets with poor corporate governance also tend to have poor information disclosure. In more developed markets, the United States for example, managers are bound by regulatory and governance mechanisms that ensure they act in the best interests of shareholders. In emerging markets, corporate governance is