The Brazilian Fiscal Council — Protecting Minority Shareholders in a Weak Legal System

The Brazilian Fiscal Council can mitigate the consequences of the separation between cash flow and voting rights that is one of the problems of corporate governance in Brazil. The Fiscal Council that is set up in Brazilian companies should be composed of professionals who are nominated by the minority—noncontrolling common and preferred stockholders—and the majority shareholders. Its main function is to monitor the activities and financial statements of the company. The purpose of this chapter is to test, even in a weak legal system, whether there is any legal mechanism to increase the number of shareholders monitoring the management to get better results for them. As a consequence, an active Fiscal Council, as a reflection of better corporate governance, is associated with higher returns on equity, Tobin's Q and dividend payout, smaller betas, debt to equity ratios, lower costs of debt financing and more restrictions on earnings management. We found that the existence of an active Fiscal Council is associated with a higher ROE, which improves the firm's performance. We also found that firms with Fiscal Councils engage significantly less in their earnings management. The Brazilian Fiscal Council is capable of improving the shareholder protection and forcing companies to have better disclosure for their investors. Our research found real benefits for firms with a Fiscal Council in the form of higher returns on equity, lower debt costs and less earnings management. These benefits are important to firms with less corporate governance.