The Interaction Effect of Corporate Governance and Trade Liberalization: Evidence from the Korea-U.S. FTA

Abstract

This thesis models the interaction between corporate governance and trade liberalization to examine how the interaction effect influences firm performance. The increase in world trade has outpaced world output and world GDP in recent decades, and scholars and policymakers alike are showing greater interest in the impact of trade liberalization on market structure. The removal of barriers to trade exposes firms to increased product market competition, but at the same time, freer trade also promotes growth opportunities by opening up foreign markets. In this vein, this paper examines the macro-micro linkage of trade liberalization and firm performance by investigating how corporate governance enables firms to enhance those growth opportunities. The methodology benefits from exploiting a quasi-natural experiment, the enactment of the Korea-U.S. Free Trade Agreement, which provides plausible exogenous variations in trade shocks that mitigate simultaneity and endogeneity concerns. Furthermore, the study constructs its main corporate governance variable by exploiting the outside director system for publicly listed firms in Korea. Since the 1997-98 Asian financial crisis, Korean statutory law has mandated a minimum ratio of outside directors to board size for firms traded on the KOSPI and KOSDAQ indices. This standardization across firms enables a convenient setup which mitigates selection bias. The findings from this study provide empirical evidence of the interaction effect between corporate governance and trade liberalization and its positive influence on firm performance. The main hypothesis, that firms with better corporate governance reap greater benefits from the expansion in trade opportunities, is supported by findings which are robust across many alternative specifications. Using a sample of publicly listed manufacturing firms in Korea from 2009 to 2014, this thesis finds that the interaction effect remains significant even when tested with different and complementary measures of independent and dependent variables in addition to an array of control variables.