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. Last Updated: 07/27/2016

Better Corporate Governance with Shame

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The media can force a company to address grievances with corporate governance by raising managers' concerns about their reputation. It is beneficial to managers when their company has a reputation of acting in the best interests of its shareholders. The same is also true for the regulators, who are more likely to enforce corporate governance rules when they know a large audience is watching.

Reputation is an effective constraint, however, only when there is an informed target audience, such as investors, shareholders, government regulators and the mass media. Moreover, the media often is not interested in collecting information about the behavior of managers when it is expensive to obtain or when it is difficult to package in a way that makes it entertaining.

That said, corporate governance abuses in Russia were very extreme, very common, and very visible during the late 1990s. The standard mechanisms to address these abuses were either nonexistent or completely ineffective -- for example, corrupt courts.

It is interesting to look at the Hermitage Fund, which used a media strategy very effectively to force changes on corporate governance. Founded in 1996 as a generic hedge fund with a Russia focus, the Hermitage Fund found itself drawn in several heated corporate governance battles. As the largest foreign investor in Russian equities, it could not remain passive in the face of major corporate governance abuses. With weak legal remedies at its disposal to protect its investments, the Hermitage Fund chose to actively "shame" Russian companies in the international press, hoping to hurt their reputation and that of the government officials who were charged with regulating these firms.

A case study of two companies, the Sidanco oil company and Moscow City Telephone, or MGTS, shows how a carefully planned and executed media strategy can be used as a powerful tool for enacting real change in corporate governance.

In both the Sidanko and MGTS cases, the issue of corporate malfeasance centered on the illegal attempt by majority shareholders to dilute the shares of minority shareholders. The Hermitage Fund had a significant stake in Sidanco but no stake in MGTS. Sidanco's dilution of shares was reported in 23 news articles, 14 of which were in credible international publications (nine in the Financial Times, four in various editions of The Wall Street Journal and one in The Economist). By contrast, MGTS had only three articles in credible international press (all in the Financial Times). In the Sidanco case, the stock dilution was reversed, but in MGTS it went through quickly.

The main issue is whether press coverage has any impact on the probability that a corporate governance violation is partially or completely addressed.

In a country where legal remedies are not available, the only source of leverage against these violations is international reputation, which we try to capture through three indicators:

• the percentage of foreign ownership in the firm;

• the presence of the European Bank of Reconstruction and Development among the company's lenders;

• the number of joint ventures between a company and foreign partners.

Of these, only the presence of the EBRD as a creditor has a significant impact on outcome, increasing the probability of full redress by 18 percentage points.

When adding a measure of foreign press coverage (number of articles published in the Financial Times and The Wall Street Journal in the two months following the event) to the other indicators, press coverage plays a positive and statistically significant role in forcing changes in corporate governance. One standard deviation increase in the number of articles published in foreign newspapers increases the probability of full redress by 10 percentage points.

Publication in The Wall Street Journal seems to have more impact: one standard deviation increase in the number of The Wall Street Journal articles increases the probability of a good outcome by 10 percentage points versus one percentage point of the Financial Times articles.

Russian newspapers, even when credible, do not seem to have played much of a role. Hence, we infer that the main source of leverage is access to an international audience.

The presence of the Hermitage Fund among the shareholders more than triples the average coverage and supports the thesis that media coverage has a direct effect on corporate governance.

What are the main mechanisms through which the press can influence corporate behavior?

• Roughly 35 percent of the cases reach (at least partially) a positive outcome as a result of the intervention of a regulator. What does press coverage have to do with the decision of a regulator to intervene? Press coverage makes more people aware of the issues involved, thus increasing the reputation costs of regulatory inaction.

• Another 15 percent of the cases get resolved because of political intervention. In a typical democracy, politicians feel compelled to intervene on highly visible issues because their political reputation is at stake. In Russia, the important factor is the reputation vis-a-vis foreign investors -- particularly British-American investors.

• In another 30 percent of the cases, a more positive resolution is due to the fact that press coverage strengthened the existing opposition. For example, in the case of the truck maker KamAZ, the EBRD was fighting the share dilution approved by the company. Press coverage strengthened the EBRD case because it increased the awareness of investors and, thus, increased the reputation cost of committing corporate malfeasance.

• In the remaining 20 percent of the cases, it looks like the company voluntarily changed its course of actions, and it is more difficult to establish media's role.

In sum, it looks like the primary mechanism through which media coverage has an effect is by increasing the reputation cost of corporate malfeasance. Obviously, the success of this strategy is highly dependent on the importance that corporations give to their reputation.

This result might have very important policy consequences. It means that by interacting with developing countries, the developed countries can exert a very positive influence on corporate governance.

Since businesses are eager to "look good" in the public opinion, a successful media strategy can be used by investors and shareholders to coerce corporations to improve their governance standards and practices.

Alexander Dyck is professor at the University of Toronto; Natalya Volchkova is a senior economist at CEFIR, Moscow; Luigi Zingales is professor at the Graduate School of Business of the University of Chicago. This comment is a summary of their paper "The Corporate Governance Role of the Media: Evidence From Russia."