Legal Liability vs. Proportional Representation: What Works in Improving Poor Investor Protection?

There are two alternative ways of improving board’s monitoring function; increasing their legal liability or allowing more proportional representation of minority shareholders. We evaluate their relative effectiveness by taking advantage of sequential regulatory changes in Korea, which has been widely known for poor investor protection. We find that market reacts positively when board members become more easily liable for making decisions that harm shareholders’ interest, and this effect is more pronounced for firms with low market-to-book ratios. In contrast, market reacts negatively when minority shareholders are provided with more proportional representation on board. Our results suggest that while market participants welcome prevention of “tunneling”, they may be concerned about potential confrontations in boardrooms which may distort strategic decisions.