Skip to main content
SpringerLink
Log in

Corporate governance and product market competition: evidence from import tariff reductions

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

Using large reductions in import tariffs as an exogenous shock to the competitive environment, this paper examines how an increase in foreign competition affects the importance of corporate governance. Consistent with prior studies, weak governance is associated with lower firm value, lower operating performance, lower labor productivity, higher capital expenditures, higher non-production expenses, and higher wages in the absence of increased competition. However, the differences between weak and strong governance firms along each of these dimensions are reduced or eliminated after a tariff cut. The effects are concentrated among firms in previously noncompetitive industries, defined as having sales concentration above the median or import penetration below the median in the year before the tariff cut. These conclusions are supported through the use of multiple alternative measures of operating performance and corporate governance. Altogether, the evidence indicates that an increase in competition can mitigate agency costs and serve as a substitute for traditional corporate governance mechanisms.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3

Similar content being viewed by others

Notes

  1. By combining data from Compustat, the U.S. Department of Commerce, and the U.S. Bureau of Labor Statistics, the fitted HHI improves upon the traditional HHI measured using only Compustat sales data in that it captures the influence of both public and private firms.

  2. See Frésard (2010), Valta (2012), and Frésard and Valta (2016) for further details on the data and the validity of the quasi-natural experiment.

  3. The tariff data are available on the websites of Laurent Frésard and Philip Valta.

  4. Related papers using similar matching approaches to investigate the effects of import tariff reductions include Amore and Žaldokas (2015), Frésard and Valta (2016), Dasgupta et al. (2018), and Atawnah et al. (2018).

  5. The choice of matching on 2-digit SIC code rather than 3-digit SIC code allows for a larger pool of potential control firms while reducing the likelihood that matched control firms in closely related industries are also affected by an import tariff reduction.

  6. Before winsorization, the maximum and minimum values of ROE are 5.07 and \(-790.61\). For comparison, the median value is 0.14. After winsorization at the 2.5% level in each tail, the maximum and minimum values of ROE are 1.00 and \(-1.70\). Before winsorization, the maximum and minimum values of NPM are 0.54 and \(-5.09\). For comparison, the median value is 0.15. After winsorization at the 2.5% level in each tail, the maximum and minimum values of NPM are 0.40 and \(-0.46\).

  7. A correlation matrix is presented in Table IA1 in the Internet Appendix.

  8. These observations are consistent with other findings in related papers. Figure 2 in Frésard and Valta (2016) presents average tariffs over a seven year window around a tariff cut for treated and matched industries during the 1974 to 2005. The average tariff rate for control industries declines gradually over the seven year window, while the average tariff rate for treated industries drops by almost half in the event year and continues to decline in the subsequent years. Figure 1b of Dasgupta et al. (2018) illustrates an upward trend in average import penetration in control industries during a five year window around a tariff cut, while average import penetration for treated industries begins to trend up starting in the event year.

  9. Following Gompers et al. (2003), firm fixed effects are not used due to insufficient variation in the G-Index within a firm over time.

  10. Dasgupta et al. (2018) use a tariff cut dummy variable to identify the three years following a tariff cut, but they exclude the tariff cut event year from their analysis.

  11. For robustness, Sect. 5.1 presents results using alternative clustering methods (SIC-3 industry, SIC-4 industry, or SIC-4 industry and year) and definitions for industry fixed effects (SIC-3 or SIC-4).

  12. The approach of replacing missing values for explanatory variables with the sample mean value is known as the zero-order regression method (see Wilks 1932 and Afifi and Elashoff 1966).

  13. Since all non-dummy explanatory variables are standardized within each year to a mean of zero and standard deviation of one, this conclusion only applies to a firm with an average G-Index (i.e., standardized G-Index equal to zero). The overall impact of a tariff cut would be calculated as the sum of the coefficient on the tariff cut dummy and the product of the standardized G-Index value times the coefficient on the G-Index and tariff cut interaction term.

  14. This procedure results in an equal number of tariff cuts classified as occurring in competitive industries and noncompetitive industries. However, because the number of firm-year observations associated with each tariff cut is not necessarily equal, the number of observations in competitive and noncompetitive industries in Tables 4 and 5 are not exactly equal.

  15. See Table IA2 in the Internet Appendix for a listing of these states as well as the timing of the legislation.

  16. Unlike the G-Index and the E-Index, the passage of BC laws represents plausibly exogenous variation in the strength of corporate governance. However, because anti-takeover legislation was implemented at the state of incorporation level, it may be a noisier measure of the strength of corporate governance compared to firm-level measures such as the G-Index and E-Index.

  17. Since the data for the Hoberg and Phillips (2010) fitted HHI begin in 1984, the industry HHI in these regressions is calculated based on Compustat sales data. Results are qualitatively similar if the fitted HHI is used and the sample period is restricted to 1984–1995, or if the Compustat HHI is used to fill in missing values for the fitted HHI over the full sample period of 1976–1995.

  18. The choice to match on 3-digit SIC code rather than 2-digit SIC code (as in the primary analysis) follows Amore and Žaldokas (2015), but the results using each method are qualitatively similar.

  19. Amore and Žaldokas (2015) define the period of increased competition as all years after the passage of the Canada-U.S. Free Trade Agreement in 1989.

References

  • Afifi AA, Elashoff R (1966) Missing observations in multivariate statistics: I. Review of the literature. J Am Stat Assoc 61:595–604

    Google Scholar 

  • Allen F, Gale D (2000) Corporate governance and competition. In: Vives X (ed) Corporate governance: theoretical and empirical perspectives. Cambridge University Press, Cambridge, pp 23–94

    Chapter  Google Scholar 

  • Ammann M, Oesch D, Schmid MM (2013) Product market competition, corporate governance, and firm value: evidence from the EU area. Eur Financ Manag 19:452–469

    Article  Google Scholar 

  • Amore MD, Žaldokas A (2015) Corporate governance and international trade. Working paper, Bocconi University and Hong Kong University of Science & Technology

  • Atawnah N, Balachandran B, Duong HN, Podolski EJ (2018) Does exposure to foreign competition affect stock liquidity? Evidence from industry-level import data. J Financ Market 39:44–67

    Article  Google Scholar 

  • Bebchuk L, Cohen A, Ferrell A (2009) What matters in corporate governance? Rev Financ Stud 22:783–827

    Article  Google Scholar 

  • Berger A, Hannan T (1998) The efficiency cost of market power in the banking industry: a test of the “quiet life” and related hypotheses. Rev Econ Stat 80:454–465

    Article  Google Scholar 

  • Bertrand M, Mullainathan S (2003) Enjoying the quiet life? Corporate governance and managerial preferences. J Polit Econ 111:1043–1075

    Article  Google Scholar 

  • Burke QL, Eaton TV, Wang M (2019) Trade liberalization and conditional accounting conservatism: evidence from import competition. Rev Quant Finance Account 53:811–844

    Article  Google Scholar 

  • Chhaochharia V, Grinstein Y, Grullon G, Michaely R (2017) Product market competition and internal governance: evidence from the Sarbanes-Oxley law. Manag Sci 63:1405–1424

    Article  Google Scholar 

  • Dasgupta S, Li X, Wang AY (2018) Product market competition shocks, firm performance, and forced CEO turnover. Rev Financ Stud 31:4187–4231

    Article  Google Scholar 

  • De Loecker J, Goldberg PK (2014) Firm performance in a global market. Annu Rev Econ 6:201–227

    Article  Google Scholar 

  • Fama E, Jensen M (1983) Separation of ownership and control. J Law Econ 26:327–349

    Article  Google Scholar 

  • Feenstra R (1996) U.S. imports, 1972–1994: data and concordances. Working paper, National Bureau of Economic Research 5515

  • Feenstra R, Romalis J, Schott P (2002) U.S. imports, exports, and tariff data, 1989–2001. Working paper, National Bureau of Economic Research 9387

  • Frésard L (2010) Financial strength and product market behavior: the real effects of corporate cash holdings. J Finance 65:1097–1122

    Article  Google Scholar 

  • Frésard L, Valta P (2016) How does corporate investment respond to increased entry threat? Rev Corp Finance Stud 5:1–35

    Google Scholar 

  • Giroud X, Mueller H (2010) Does corporate governance matter in competitive industries? J Financ Econ 95:312–331

    Article  Google Scholar 

  • Giroud X, Mueller H (2011) Corporate governance, product market competition, and equity prices. J Finance 66:563–600

    Article  Google Scholar 

  • Gompers P, Ishii J, Metrick A (2003) Corporate governance and equity prices. Q J Econ 118:107–155

    Article  Google Scholar 

  • Graham D, Kaplan D, Sibley D (1983) Efficiency and competition in the airline industry. Bell J Econ 14:118–138

    Article  Google Scholar 

  • Grosfeld I, Tressel T (2002) Competition and ownership structure: substitutes or complements? Evidence from the Warsaw Stock Exchange. Econ Transit 10:525–551

    Article  Google Scholar 

  • Gupta A, Misra L, Shi Y (2017) Product-market competitiveness and investor reaction to corporate governance failures. Int Rev Econ Finance 48:134–147

    Article  Google Scholar 

  • Hoberg G, Phillips G (2010) Real and financial industry booms and busts. J Finance 65:45–86

    Article  Google Scholar 

  • Hou K, Robinson D (2006) Industry concentration and average stock returns. J Finance 61:1927–1956

    Article  Google Scholar 

  • Januszewski SI, Köke J, Winter JK (2002) Product market competition, corporate governance and firm performance: an empirical analysis for Germany. Res Econ 56:299–332

    Article  Google Scholar 

  • Jensen M (1993) The modern industrial revolution, exit, and the failure of internal control systems. J Finance 48:831–880

    Article  Google Scholar 

  • Karuna C (2007) Industry product market competition and managerial incentives. J Account Econ 43:275–297

    Article  Google Scholar 

  • Li WL, Zheng K (2017) Product market competition and cost stickiness. Rev Quant Finance Account 49:283–313

    Article  Google Scholar 

  • Masulis RW, Wang C, Xie F (2007) Corporate governance and acquirer returns. J Finance 62:1851–1889

    Article  Google Scholar 

  • Nickell S (1996) Competition and corporate performance. J Polit Econ 104:724–746

    Article  Google Scholar 

  • Schott P (2010) U.S. manufacturing exports and imports by SIC or NAICS category and partner country, 1972 to 2005. Working paper, Yale School of Management and National Bureau of Economic Research

  • Shleifer A, Vishny R (1997) A survey of corporate governance. J Finance 52:737–783

    Article  Google Scholar 

  • Tang Y (2018) When does competition mitigate agency problems? J Corp Finance 51:258–274

    Article  Google Scholar 

  • Valta P (2012) Competition and the cost of debt. J Financ Econ 105:661–682

    Article  Google Scholar 

  • Wilks SS (1932) Moments and distributions of estimates of population parameters from fragmentary samples. Ann Math Stat 3:163–195

    Article  Google Scholar 

  • Yang T, Zhao S (2014) CEO duality and firm performance: evidence from an exogenous shock to the competitive environment. J Bank Finance 49:534–552

    Article  Google Scholar 

  • Zhang H (2019) Product market competition and corporate governance: substitutes or complements? Evidence from CEO duality. Working Paper, University of Toronto

Download references

Author information

Authors and Affiliations

  1. Farmer School of Business, Miami University, Oxford, OH, USA

    David Gempesaw

Authors
  1. David Gempesaw
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to David Gempesaw.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

I am grateful to the editor Cheng-Few Lee and two anonymous referees for insightful comments and suggestions which significantly improved the quality of this paper.

Electronic supplementary material

Below is the link to the electronic supplementary material.

Supplementary material 1 (pdf 106 KB)

Appendix

Appendix

See Table 11.

Table 11 Variable definitions
Full size table

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Gempesaw, D. Corporate governance and product market competition: evidence from import tariff reductions. Rev Quant Finan Acc 56, 1437–1473 (2021). https://doi.org/10.1007/s11156-020-00931-8

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-020-00931-8

Keywords

JEL Classification

Search

Navigation