'In theory, [when] interest rates go down, stock prices should go up and firms should be able to invest more in physical capital and to make more investments in physical assets. In reality, though, people have found there to be only a small financial impact from liberalisation.'

Last month, Goyal and Professor Kee-Hong Bae, currently at York University, completed a research report entitled: 'Equity Market Liberalisation and Corporate Governance'. Its aim was to look into the decades-old paradox and explain why the theoretical effects of liberalisation were so different from their actual effects.

One of the key observations they aimed to prove was that the standard of corporate governance at the time of liberalisation could have a profound impact on the benefits of it. This is particularly important in developing nations, and the academic findings could have an effect on those nations' policies before they take the decision to liberalise equity markets.

The research was based on the experience of South Korea, which liberalised its stock market in January 1992. What the research found was that firms with poor corporate governance benefited far less than those with better governance.

'Those companies that were better governed saw a much larger stock price rise and they invested a lot more in fixed capital than poorly governed firms,' Goyal says. 'There was also a greater increase in foreign ownership in these firms.' Foreign investors are likely to feel they could be expropriated if a country does not have institutions to protect them and their investment.

They will stay away from poorly governed firms, that in turn will not experience the benefits of liberalisation. 'That's where the whole role of corporate governance comes in,' Goyal says.

In conducting the research, Goyal and Bae first had to determine how they could define which Korean companies had good corporate governance and which had bad corporate governance. They looked at three factors: chaebol affiliation, largest shareholder ownership and whether the company regularly paid dividends.

In Korea, firms can often be affiliated with business groups known as chaebol. Much of the control of these groups is in the hands of one family, which makes most of the key decisions for all chaebol member firms and creates a governance structure that the research describes as 'highly conducive to expropriation of outside investors'.

There are few outside directors and the professional managers hold little equity. The closer a firm is affiliated with chaebol, the poorer the corporate governance. 'Secondly, we looked at the ownership by the largest shareholder,' Goyal says.

'If the largest shareholder owns a lot of the stock, then their interests are going to be more aligned with those of the minority shareholders.'

The research, and previous studies done in Korea and other emerging markets, 'consistently shows that a firm's valuation is positively related to ownership concentration'.

The cost of expropriation in firms with a large major shareholder is higher than those without.

The third factor, dividends, was looked at as most research shows that dividend-paying firms exhibit better corporate governance. Dividends limit insider expropriation and they expose a company to greater external monitoring as they often have to turn to outside markets to get funds.

Having looked at these aspects of governance, the research showed that in the month following liberalisation those companies with good corporate governance experienced significantly higher returns.

Those firms that were not affiliated with chaebol experienced 10 per cent higher returns than those with affiliation to chaebol.

Firms that paid dividends experienced returns 9 per cent higher, while those with the largest shareholder owning a high percentage of stock also experienced abnormally high returns. The research also highlighted that firms with good corporate governance attracted far larger foreign ownership in the months after liberalisation. Another key point was that those firms with higher foreign ownership after liberalisation had higher investment growth rates.

Goyal explains that the findings can be used by firms and governments to better prepare for equity market liberalisation. 'Countries can focus on improving institutional institutions, which will improve the rights of investors, and look at implementing regulations that can have a beneficial effect on corporate governance structures.

'If they have proper institutions in place and have regulations that protect the rights of minority investors, then minority investors would be encouraged to invest in these countries and its companies when the market opens up.'