Corporate governance: institutional arrangement or market choice?

Abstract

Purpose – The purpose of this paper is to investigate the relationship between corporate governance mechanism and firm value of the listed companies in China. Does the better corporate governance lead to the higher firm value? Or does the higher firm value make it easy to choose a better governance mechanism? Or they affect each other? In other words, this paper tries to answer whether the corporate governance mechanism is only decided by institutional arrangement, or by market choice according to firm value or performance or by the interaction of institutional arrangement and market choice? It tries to answer whether institutional arrangement maximizes the firm value, or an invisible hand pushes them to arrive at its maximum. Design/methodology/approach – This paper establishes an analytic framework of simultaneous equations based on causality, which includes five endogenous variables: ownership of larger shareholders, managerial ownership, director compensation, debt financing and firm value. It adopts 1,644 data samples from 274 Chinese listed companies in Shanghai and Shenzhen Stock Exchange during 2007- 2012 after the non-tradable shares reform. Ordinary least squares (OLS) estimation of single equation, 2SLS and 3SLS estimation of simultaneous equations are respectively done to show the differences of these three kinds of estimations. Findings – The empirical results show that differences exist among OLS, 2SLS and 3SLS estimation. Finally, 3SLS estimation should be adopted because the OLS and 2SLS estimation are biased. There are endogenous relationships between corporate governance mechanism and firm value. Through the 3SLS estimation, it is found that first, ownership concentration and firm value affect each other positively. Second, managerial ownership and firm value affect each other positively; third, director compensation and firm value affect each other negatively, while director compensation and firm performance affect each other positively. Finally, debt financing level and firm value are negatively related to each other. Practical implications – It means that ownership of large shareholders, managerial ownership, director compensation and debt financing in the Chinese listed companies are found to have a root in the interaction between institutional arrangement and market choice. It is also found that adverse selection occurs when creditors loan to the listed companies. Managerial compensation is positively related to accounting profit, but it is negatively related to firm value because managers increase profit due by earning management. This could only increase the accounting profits and obtain huge cash compensation, but not increase firm value and even harm the interests of shareholders. Originality/value – This paper not only shows the difference between OLS and 2SLS estimation but also compares the estimation of 2SLS and 3SLS in terms of empirical methods. It gives answers to the following questions: whether the relationship is one-way causality or bilateral causality between ownership concentration, managerial ownership, director compensation and firm value; whether governance mechanism affects firm value by institutional arrangement, or market drives both of them to strike a balance by an invisible hand. In other words, does it make them arrive at equilibrium through the competitive selection process when shareholders, directors, managers and creditors attempt to maximize themselves of their interests?

The Role of Corporate Governance Mechanism in Enhancing Firm Value

“…Therefore, managerial ownership can decrease moral hazard by the manager (agent) because of the sense of belonging to the company. This result is in line with Ahmed and Nor [12] and Du et al [13] that managerial ownership and firm value affect each other positively.…”

“…This study implies that investors still have reservations about the ability of boards to enhance earnings numbers in Malaysia, although efforts were taken to reform the corporate governance mechanisms following the Asian financial crisis. Du et al [13] found that managerial ownership and firm value affect each other positively. H3: Managerial Ownership has a positive relationship with firm value…”

Dynamic study of corporate governance structure and firm performance in China

“…According to agency theory, concentrated shareholders can monitor corporate operating management effectively, alleviate agency costs and information problems and, consequently, improve firm performance (Blair, 1996;Shleifer and Vishny, 1997). There is also evidence that Dynamic study concentrated shareholders can increase their own benefits at the expense of minority shareholders (Porta et al, 2002;Claessens and Yurtoglu, 2013;Liu et al, 2011;Du et al, 2014). A large body of empirical study has utilized ownership concentration (in the form of either institutional ownership or other block-holder ownership) as a proxy to explore its impact on firm performance (Yu, 2013;Hess et al, 2010;Lin et al, 2009;Gul et al, 2010;Ma et al, 2010;Kang and Kim, 2012;Yixiang, 2011).…”

“…Previous seminal studies have noted that a high level of managerial ownership contributes to integrating the interests of managers and shareholders and improving firm performance (Jensen and Meckling, 1976;Demsetz and Lehn, 1985). Specifically, there is an alignment of interest when managers are also shareholders (Jiang and Kim, 2015;Du et al, 2014). However, managers also tend to maximize their own benefits, regardless of firm benefits (Fama and Jensen, 1983;Demsetz, 1983), leading to a negative relationship between managerial ownership and firm performance (the "managerial entrenchment" hypothesis).…”

Diversity of Managerial Perspectives from Inside China

“…In a word, the institutional change was a result of both institutional arrangement and market selection among shareholders, directors and executives for the sake of their own interests (Du 2014 ). Before the equity division reform at the end of 2006, China's listed companies adopted the equity division of state-owned shares, legal person shares and individual shares.…”