How Useful are Commercial Corporate Governance Ratings in Emerging Markets?

A central issue in evaluating the effects of corporate governance (CG) is how to measure it. Some researchers measure firm-level CG using country-specific indices (CSIs), tailored to each country’s laws and institutions; several studies report that these indices can predict Tobin’s q in emerging markets, in a panel data framework with firm fixed effects. In contrast, commercial CG ratings (CCGRs) apply the same or similar elements across many countries. However, their power to predict relevant outcomes is not known. We assess the three best available CCGRs that cover emerging markets over a reasonable time period, from Asset4, Thomson Reuters, and MSCI. We find that these ratings have no power to predict Tobin’s q or profitability. We also provide suggestive evidence that the likely root cause is poor construction of the ratings, rather than whether a well-specified measure can predict Tobin’s q. One possible reason: disclosure (beyond country-mandated minimums) is the governance aspect that most consistently predicts firm value in emerging markets in CSI-based studies, yet none of these ratings includes measures of disclosure. The CCGRs have other important limitations, including using U.S.-centric elements; vague or subjective definitions of some elements; and some elements reflecting firm outcomes rather than governance.