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THE RELATIONSHIP BETWEEN CORPORATE GOVERNANCE AND THE STOCK PRICE OF LISTED COMPANIES IN MAI USING FELTHEM – OHLSON VALUATION MODEL Supranee Sugaraserani September 4, 2014 6th ICFC, 2014

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Do the investors use publicized CG Rating in trading stocks in MAI? 6th ICFC, 2014

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THE OBJECTIVE OF THE STUDY To examine the relationship between corporate governance (CG) and the stock price of listed companies in the Market for Alternative Investment (MAI) by using a valuation model 6th ICFC, 2014

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Corporate Governance (CG) Rating annual surveys on the state of corporate governance by the Thai Institute of Directors (IOD) annual surveys on the state of corporate governance by the Thai Institute of Directors (IOD) since 2001 (2544) since 2001 (2544) The sources for scoring are – company annual report, annual information filling (Form 56-1), notice and minutes of companies' shareholders meeting, company website, information on SET/SEC database, and other publicly available information. The sources for scoring are – company annual report, annual information filling (Form 56-1), notice and minutes of companies' shareholders meeting, company website, information on SET/SEC database, and other publicly available information. After scoring, listed companies are classified into six groups. After scoring, listed companies are classified into six groups. 6th ICFC, 2014

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Figure 1: Classified CG scores, Logo, and description Score Range number of Logo (publicized) Description90-100Excellent 80-89 Very Good 70-79Good 60-69 Satisfactory 50-59 Pass Lower than 50No logo givenN/A Source: Corporate Governance Report of Thai Listed Companies (CGR) 2006. 6th ICFC, 2014

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Previous studies - CG Black (2001), Gompers, Ishii and Metrick (2003), found positive correlation between CG and firm performance. Black (2001), Gompers, Ishii and Metrick (2003), found positive correlation between CG and firm performance. Drobetz, Schilhofer and Zimmerman (2004), Durnev and Kim (2007), Klapper et al. (2002), Black, Jang and Kim (2006) found positive impact of CG to firm‘s value and investors gave their attention to performance of the good CG firms, especially in countries with weaker legal systems. Drobetz, Schilhofer and Zimmerman (2004), Durnev and Kim (2007), Klapper et al. (2002), Black, Jang and Kim (2006) found positive impact of CG to firm‘s value and investors gave their attention to performance of the good CG firms, especially in countries with weaker legal systems. Morey et al. (2009) studied the correlation between governance quality and share prices in emerging markets, using samples from 21 countries, they found that improvements in CG were associated with higher share prices. Morey et al. (2009) studied the correlation between governance quality and share prices in emerging markets, using samples from 21 countries, they found that improvements in CG were associated with higher share prices. 6th ICFC, 2014

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Basic FO valuation model 6th ICFC, 2014

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Main assumptions of FO model The relevance of publicly accounting information and firm‘s market value. The relevance of publicly accounting information and firm‘s market value. The PV of expected future dividends determines the intrinsic firm value (considering a fair game). The PV of expected future dividends determines the intrinsic firm value (considering a fair game). 6th ICFC, 2014

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Clean Surplus Relation - concept derives from conservative accounting. Clean Surplus Relation - concept derives from conservative accounting. Linear Information Model - the relationship of control variables must exist in a linear equation (Ota, 2002). Linear Information Model - the relationship of control variables must exist in a linear equation (Ota, 2002). 6th ICFC, 2014

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Test Clean Surplus Relation Decoded using 4-level rating scale YES Qualitative data 6th ICFC, 2014

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Transformed model P t = β 0 + β 1 CG t-1 BVA t + β 2 CG t-1 BVL t + β 3 CG t-1 AE t + β 4 CG t-1 + ℰ 6th ICFC, 2014

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Hypotheses H1 : The relationship of CG rating meets the assumption of Clean Surplus Relation H2 : The relationship of stock price, CG rating, firm‘s size, liability, and abnormal earning must exist in a linear equation. 6th ICFC, 2014

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Limitations Population Population The data were 45 listed companies in MAI which their securities were first traded before 2008 (2551) and had reported and disclosed of financial information and others non-accounting information, continuously, through the year 2012 (2555). 6th ICFC, 2014

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Variable Measurement Variable MeasurementVariableDefinition Calculation and Measurement PtPtPtPt Firm’s value at period t Market price per share at the end of period BVA t Firm’s size at period t Common logarithm of moving average of the book value of assets at the end of period BVL t Liability at period t Common logarithm of moving average of the book value of liabilities at the end of period AE t Operating efficiency or abnormal earning at period t The percentile ranks of abnormal earnings. Abnormal earning is the difference between moving average of operating profit after tax and a return, at risk free rate, to the moving average of equity at the beginning of period. CG t-1 Corporate governance rating at previous period a)FO valuation model- using 4-level rating scale instead of the volume of logo. b)Testing clean surplus relation- a ceiling score of each group will be used instead of the volume of logo. 6th ICFC, 2014

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RESULT OF THE STUDY H1 : The relationship of CG rating meets the assumption of Clean Surplus Relation Using Simple Regression: 6th ICFC, 2014

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Table 2: Simple regression analysis output Significant level at 0.05 (n=45) 6th ICFC, 2014

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The Corporate Governance rating has met the assumption of the Clean Surplus Relation. The Corporate Governance rating has met the assumption of the Clean Surplus Relation. The longer the IOD conveys its survey the higher the power of the impact of current period CG to following period CG ( The longer the IOD conveys its survey the higher the power of the impact of current period CG to following period CG ( R 2 ) As the constants’ coefficient is decreasing, Curve Fit is tested and the predictions from equations without constants are better, so, the constants are removed from equations. 6th ICFC, 2014

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CG 09 =0.567CG 08 ………..……… (2.1) CG 10 =0.751CG 09 ……………..… (2.2) The relationship of CG rating meets the assumption of Clean Surplus Relation and the null hypothesis is rejected. 6th ICFC, 2014

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H2 : The relationship of stock price, CG rating, firm‘s size, liability, and abnormal earning must exist in a linear equation. Using Multiple Regression: 6th ICFC, 2014

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Table 3: Multiple regressions analysis output Significant level at 0.05 6th ICFC, 2014

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Test the autocorrelation - Compare DW values to the critical value 2009: the result cannot conclude whether there is an autocorrelation or not. 2009: the result cannot conclude whether there is an autocorrelation or not. 2010: the result can conclude that there is no autocorrelation. 2010: the result can conclude that there is no autocorrelation. 2011: the result cannot conclude whether there is an autocorrelation or not. 2011: the result cannot conclude whether there is an autocorrelation or not. 6th ICFC, 2014

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The findings have proved that all control variables can explain the change in stock price and the relationship exists in a linear equation. The null hypothesis is rejected. P 09 = 4.01(+/-3.0129) + 3.75BVA 09 + 0.27BVL 09 + 2.15AE 09 – 24.89CG 08..……. (3.1) P 10 = 2.75(+/-3.429) + 3.23BVA 10 – 0.58BVL 10 + 0.87AE 10 – 15.80CG 09 ……… (3.2) ……… (3.2) P 11 = 0.71(+/-3.171487) + 3.82BVA 11 – 1.16BVL 11 - 0.57AE 11 – 14.69CG 10 …….... (3.3) …….... (3.3) 6th ICFC, 2014

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SKEPTICISM ISSUES FROM THE FINDING FO model is predictive valuation model that emphasizes on growth. So, all control variables shall have positive correlation. FO model is predictive valuation model that emphasizes on growth. So, all control variables shall have positive correlation. 2 control variables that have negative correlation – CG rating and liability. a) CG rating – the finding implies that investors do not pay attention to the CG rating and do not use it for decision making (Bauer et al., 2004, Beiner et al., 2006). a) CG rating – the finding implies that investors do not pay attention to the CG rating and do not use it for decision making (Bauer et al., 2004, Beiner et al., 2006). 6th ICFC, 2014

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b) Liability - the liability and equity of listed companies in MAI at the time of the study may not be relevant to determine the firm‘s value and its operating results in the future (Modigliani and Miller, 1958). b) Liability - the liability and equity of listed companies in MAI at the time of the study may not be relevant to determine the firm‘s value and its operating results in the future (Modigliani and Miller, 1958). 6th ICFC, 2014

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Explanatory power of the models - show a weak power of explanation. Explanatory power of the models - show a weak power of explanation. During 2008-2011, Thailand had economic downturn and that would cause abnormalities to the capital market. The investors‘ decision to weigh the risks with the benefits received would be different from normal capital market (Fama, 1965, 1969). During 2008-2011, Thailand had economic downturn and that would cause abnormalities to the capital market. The investors‘ decision to weigh the risks with the benefits received would be different from normal capital market (Fama, 1965, 1969). Typically, investors' behavior, securities could not be evaluated in isolation, but only as a group Markowitz (1952). Typically, investors' behavior, securities could not be evaluated in isolation, but only as a group Markowitz (1952). 6th ICFC, 2014

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