Corporate governance and performance : an analysis of listed companies in China

Abstract

This study investigates the corporate governance system in China. Prior literature of corporate governance mechanisms uses data from the developed economies such as U.S. and the U.K. I examine how the governance mechanisms operate in China using data from Chinese listed firms. If the Chinese corporate governance system is effective, there will be an alignment between managerial compensation and firm performance. Furthermore, governance mechanisms will be able to reduce agency costs and aid the removal of ineffective managers. On agency cost control, I find that firms with foreign shareholding incur higher agency costs. There is limited but weak evidence that concentrated ownership is associated with lower agency costs. Contrary to previous studies, I find no evidence that legal person shareholding is more effective in reducing agency costs. While it is usually assumed that government share ownership in China creates inefficiencies and agency problems, I find that there is no difference between government and nongovernment controlled firms. The composition of the board of directors, as reflected in the proportion of non-executive directors, has no association with agency costs. I also examine the top management compensation and I find that, similar to the developed economies, there is a positive pay-performance relation in China; I also find evidence to support the argument that concentrated ownership and government ownership act to both reduce compensation levels and induce performance related pay for CEOs. The presence of a foreign shareholder is associated with higher pay and I attribute this to foreign investors demanding better qualified management and the willingness to pay for them. There are mechanisms to remove ineffective managers in China. I find that there is a significant relationship between turnover and performance and this relationship is more significant in a forced turnover situation. The removal of the key management figure in response of performance deterioration is a natural response of a bureaucratic shareholder and I argue this is the 'scapegoat' behavior. I also argue as government influence is paramount, the ownership structure would not impose any difference in removal mechanism. I also find that there are higher turnovers in both good and poor performing firms. While poor performing managers are removed as a result of poor performance, good performing managers are transferred and promoted in the government hierarchy. Finally, I study the substitution and complimentarity effect of the different corporate control components. Corporate governance research has identified a number of mechanisms that are intended to ensure that management teams act in the best interests of shareholders. I use the simultaneous equation method to examine the interaction of six ownership and governance control mechanisms. There is evidence of interdependence in the use of different control mechanisms. The empirical results also show that there are significant relationships between corporate governance control mechanisms and firm performance, but the significance of those control mechanisms disappears in the simultaneous equation estimation. This result is consistent with the hypothesis that there is an optimal use of corporate governance mechanisms for an individual firm.