As the tentacles of financial integration extend further into emerging market economies (EMEs), intertwining them more intricately with the rest of the world, these regions gain access to a broader capital base. Yet, this interconnectedness also renders them more susceptible to global financial shocks. With increasing integration, an essential inquiry arises: Have the institutional and legal frameworks within these emerging markets evolved sufficiently to fortify themselves against the volatile external environment?
This chapter spotlights the tripartite relationship among corporate governance, investor protection, and financial stability within emerging market economies. Corporate governance and investor protection encompass a blend of national and corporate-level rules and practices that dictate how investors safeguard returns on their investments. Financial crises in key emerging markets have underscored how deficiencies in corporate governance can precipitate financial instability.
The Evolution of Corporate Vigilance
Over the past two decades, there has been a discernible enhancement in the corporate governance and investor protection within EMEs. This progress is evident across indicators at both the enterprise and national levels. Despite these advancements, significant disparities persist among emerging markets, highlighting ample room for further improvement.
Strengthening Against Global Shocks
The analysis corroborates the notion that a robust framework of corporate governance and investor protection bolsters emerging markets’ resilience against global financial shocks. This chapter introduces new indices for corporate-level governance within emerging markets and applies novel empirical methods. The findings suggest that sound corporate governance fosters deeper, more liquid capital markets capable of better absorbing shocks. Improved governance also enhances stock market efficiency, thereby reducing share price sensitivity to external shocks and decreasing the likelihood of price crashes. For instance, when governance indicators at the national and corporate levels escalate from lower to higher echelons, the average impact of global shocks on emerging market enterprises diminishes by approximately 50%. Companies in emerging markets with well-established corporate governance and investor protection typically exhibit healthier balance sheets. Notably, firms with superior governance structures tend to have a lower proportion of short-term debt and a reduced probability of default, with the capacity to secure longer-term debt. This mitigates the firms’ vulnerability during financing droughts, bolstering financial stability.
The Imperative of Reform
The financial stability benefits derived from refined corporate governance underscore the need for continued reform. While no single model fits all, good corporate governance shares some common characteristics. The chapter thus puts forth the following policy recommendations:
- All emerging market economies should persist in reforming legal, regulatory, and institutional frameworks to heighten the effectiveness and enforceability of corporate governance systems.
- The majority of emerging markets should continue to strengthen the rights of external investors, especially minority shareholders.
- Many emerging markets need to enhance disclosure requirements to fully align with international best practices. Increasing the independence of boards of directors is also likely to yield benefits.
