Capital MarketsPeer-Reviewed Research

Paper Work

Stacks of papers
  • Because fair markets are central to a vibrant economy, in 1999 the Mexican government enacted regulations to bring more transparency to financial reporting. 
  • Despite the new regulations, companies remained largely inefficient. 
  • To revamp its capital markets, Mexico needs a slew of changes including commitment to enforcing financial regulations that protect minority shareholders.

Theoretically, at least, capital markets allow millions of investors to allocate resources in a way that maximizes competitiveness and efficiency. When these markets are fair, they play a central role in a vibrant economy and society. Transparent financial markets lure capital, allowing economies to pick up steam and grow more quickly. Without transparency, on the other hand, investors are more easily defrauded. Inequality spreads. A country’s economy can quickly decline. 

In 1999, Mexico initiated a Code of Best Corporate Practices in order to ensure greater market efficiency and better corporate performance.  The following year, roughly 28 percent of publically traded firms complied with three-quarters or more of the criteria. By 2004, compliance jumped to 79 percent.  One would think that this compliance with the new regulations would mean that corporate performance generally would increase. 

But good intentions are one thing and reality another. After studying market behavior, Rice Business professors Brian Rountree, Richard Price (now at the University of Oklahoma) and Francisco Roman (now at George Mason University) found that compliance with the code had little, if any, effect on Mexican firms’ overall corporate performance. In fact, the regulations also showed little if any effect on overall earnings management or return on equity.

To reach these conclusions, the professors analyzed a sample that included all nonfinancial firms listed on the Mexican stock exchange as well as stock returns, financial statement data, and governance data over the period of 2000 to 2004. Governance data was collected from each company’s annual Code of ‘Best’ Corporate Practices questionnaire filed with Mexico’s regulator. 

As a proxy for governance strength, the researchers devised a “governance score” based on the level of compliance with the code’s recommended provisions.

So what went wrong with the code? On paper, its mandates were exemplary. Company boards were supposed to include at least 25 percent independent directors, and firms were to limit their size to 20 directors and use audit committees led by independent directors. But while many provisions of this code are mandatory, there was little in the way of oversight by regulators. Company reports were simply not questioned. 

The same held for investor protections. Firms from Mexico that were cross-listed in the United States often escaped enforcement of insider trading laws by the Securities and Exchange Commission. And as late as 2010, the Mexican judicial system’s commitment to minority shareholder protection was still untested, prompting significant questions about the perceived improvements in minority shareholder protection by stock market participants.

Regulations, in sum, are only as good as efforts to enforcement. And while insider trading laws have existed in Mexico since 1975, the first enforcement attempt didn’t occur until 2005. Even then, the action was spurred by the United States, without firm commitment from Mexican authorities.

And those companies that complied with the letter of the law still had to adopt costly measures to signal their investment worthiness to the market. These firms, the scholars found, had a higher propensity to pay dividends and give marginally greater dividend yields than did the lower-compliance firms that also paid dividends. In other words, to reduce agency concerns, the Mexican firms with higher governance scores resorted to the costly mechanism of paying dividends, because the market simply did not value compliance with the code.

The researchers theorize that the weak links they found between company performance and compliance could be related to the limited competition among Mexico’s public firms. Together, the concentrated ownership environment and weak legal system muffled the impact of the new regulatory code on Mexican capital markets. Market monitoring alone was just not enough to create fundamental economic changes.

The results suggest that Mexico’s efforts to boost transparency must be supplemented with stronger enforcement. It’s unclear, however, whether the conflict between insiders and minority outside shareholders can be overcome without major changes in the company ownership structures. While the groundbreaking 1999 code showed the will to improve market efficiency, the scholars warned, only enforcement and perhaps restructuring can pave the way. 


For further reading please see: Price, R., Román, F. J., & Rountree, B. (2011). The impact of governance reform on performance and transparency. Journal of Financial Economics 99(1), 76–96.

Brian Rountree is a tenured Associate Professor of Accounting at the Jesse Jones Graduate School of Business at Rice University.