Relation between Equity Method Stock Investment, Firm Value, and Corporate Governance

Using the data set of investment in equity method stocks, we examine the effect of long term equity investment on firm value and also examine how corporate governance affects such investment. We find that firm value is positively associated with the amount of cash spent in purchasing equity method stocks. The result suggests that long term investment in equities classified as equity method stock tends to be a positive NPV(net present value) project on average. We also find that firms are not less likely to invest in equity method stocks as the score of their corporate governance index for overall governance, shareholders’ right protection, or income distribution increases. Regarding the magnitude of investment, firms tend to spend a smaller amount of cash in equity method stock as they have a higher score of the sub-index for shareholders’ right protection. Strong shareholders’ right strengthens the influence of outside shareholders and so is known to reduce agency problems of the firm’s managers or owner managers. Outside shareholders such as institutional or foreign shareholders, however, have an incentive to pursue their own short-term investment profit including large dividends. As a result, they may be hesitant about firm’s long term investment decision. Our empirical result gives an implication that strong governance tends to decrease long term equity investment although such investment actually increases firm value on average.