Do Internal Governance Mechanisms Impact on Firm Performance? Empirical Evidence from the Financial Sector in China Yuan George Shan* and Lei Xu† The financial sector plays an important intermediary role in the Chinese economy. However, there has been very limited research concerning improvement in corporate governance within this sector. Using an unbalanced data set of 139 firm-year observations covering 1999 to 2009, this study examines the impact of internal governance mechanisms on performance of Chinese listed financial institutions. Our findings suggest that state ownership, legal person ownership, board size and supervisory board meetings are negatively related to the profitability of these institutions, whereas factors including ownership concentration, foreign ownership, independent directors, board meetings and supervisory board size have no impacts.
KEYWORDS financial institution, ownership structure, board of directors, supervisory board, China JEL Codes: G21, G34 and M48
1. Introduction The recent Global Financial Crisis (GFC) has brought renewed attention to the important issue of internal governance mechanisms in financial institutions. Inadequate internal governance practices by large international financial institutions have been attributed as one of the decisive contributors to the GFC. However, to date, researchers have focused most of their attention on the corporate governance and performance of financial institutions in developed countries (e.g.,Doucouliagos, Haman & Askary, 2007; de Andres & Vallelado, 2008; Hagendorff, Collins & Keasey, 2010), particularly the United States where the GFC originated (e.g., Hagendorff, Collins & Keasey, 2007; John, Mehran & Qian, 2010). As a consequence, there is a paucity of research into issues surrounding the corporate governance and performance of the financial industry in developing countries. China, the largest emerging economy nowadays, has grown to be one of the most influential economic powers in the global marketplace. Despite the instability of the world economy, China has enjoyed 9.3% average annual GDP growth during the past three decades (Yao, 2010), seemingly unaffected by the GFC. However, there has been a surprising lack of research into China‟s financial institutions which are now amongst the largest globally post-GFC. This study addresses this gap by examining the internal governance mechanisms of financial institutions in China. As an important sector financial/banking institutions received attention in literature of performance examination in developed economies (Williams, 2003; *
Corresponding author, Dr. Yuan George Shan, Business School, University of Adelaide, 10 Pulteney Street, South Australia 5005, Australia. Phone: + 61 8 8303 6456, Fax: +61 8 8223 4782, Email:
[email protected] † Dr. Lei Xu, Business School, University of Adelaide, 10 Pulteney Street, South Australia 5005, Australia. Phone: + 61 8 8303 7272, Fax: +61 8 8223 4782, Email:
[email protected]
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DeYoung & Rice, 2004; Kosmidou et al., 2006; Stiroh & Rumble, 2006; Hirtle & Stiroh, 2007; Kosmidou, Pasiouras & Tsaklanganos, 2007; Athanasoglou, Brissimis & Delis, 2008; Sturm & Williams, 2010). But there are little concerns about bank performance in developing economies (Sufian, Fadzlan & Chong, 2008; Sufian, Fadzlan1, 2009; Sufian, Fadzlan & Habibullah, 2009; Zulkafli, Amran & Samad, 2009). From corporate governance perspectives, either principal-agent or principalprincipal, prior studies have given less consideration to corporate governance mechanisms impact on firm performance. For example, with regard to the Chinese banking sector, Sufian (2009) examines the factors affecting the profitability of the Chinese banking sector including the four State Owned Commercial Banks and the 12 Joint Stock Commercial Banks during the post reform period of 2000–2007. His results suggest that firm size, credit risk and capitalization have a positive association with the profitability, while liquidity, overhead costs and network embeddedness show negative impacts. On the other hand, there is now a large literature that has examined the impacts between corporate governance mechanisms and firm performance in China (Xu & Wang, 1999; Hovey, Li & Naughton, 2003; Aivazian, Ge & Qiu, 2005; Xu, Zhu & Lin, 2005; Wei, 2007; Yuan, Xiao & Zou, 2008; Lin & Su, 2009; Hu, Tam & Tan, 2010; Wang, 2010). However, these studies either were taken before the latest major financial reforms (eg., Xu & Wang, 1999; Xu, Zhu & Lin, 2005) or excluded those firms from the sample (Firth, Fung and Rui, 2006; Wei, 2007; Yuan, Xiao and Zou, 2008). The primary objective of this study is to examine the factors of internal governance mechanisms that affect performance of Chinese financial institutions. In the context of studying a principal-principal conflict of interest between the controlling shareholders and minority shareholders for Chinese listed financial institutions, this is the first study, to our best knowledge, to provide a comprehensive empirical analysis of the key parameters that underlie internal governance mechanisms in China during an important period of regulatory change and organizational reform between 1999 to 2009. These internal governance mechanisms are ownership structure, board of directors and supervisory board. Strikingly, we discover that the performance of Chinese financial institutions is not improved by introduction of modern corporate governance and the controlling shareholders received most of benefits from the latest financial reform through the stock market, while the interest of minority shareholders was expropriated from unimproved performance of these institutions. The remainder of the paper is organized as follows. The following “Institutional Background” section provides an overview of the history and legal framework for the Chinese financial industry. The “Literature and Hypotheses” section investigates the literature on internal governance mechanisms and also develop three sets of hypotheses accordingly. Our “Research Methodology” section outlines the methodology and describes the variables, while “Results and Discussion” section presents the results analyses and discusses the findings. Lastly, we discuss the implication of our findings in “Conclusion” section.
2. Institutional Background Since the foundation of the People‟s Republic of China in 1949 until the introduction of the “open door” policy in 1978, China operated under the centrally planned economy and its financial system consisted of a single bank, the People‟s Bank of China (PBOC). Attached to the Ministry of Finance (MOF) the PBOC was both the 2
central bank and the only commercial bank which controlled around 93% of the total financial assets and handled all financial transactions within the country. There were two nation-wide financial reforms in the early 1980s. First, at the end of 1979 the PBOC became a parallel government agency to the MOF and reported directly to the State Council. Second, the “Big Four” state-owned banks were established to take over commercial banking from the PBOC. The Bank of China (BOC) specialized in foreign currency related transactions. The People‟s Construction Bank of China (later the China Construction Bank, CCB) handled fixed asset transactions for the manufacturing industry. The Agriculture Bank of China (ABC) served the vast rural areas and the Industrial and Commercial Bank of China (ICBC) took over the rest of commercial banking from the PBOC. Following these reforms, local banks (owned by local government) and various other financial institutions (owned either by the central government or local government) such as securities firms, insurance firms, and trust and investment companies (TICs), were introduced during the 1980s and 1990s to compensate uncovered business categories by the “Big Four” banks. Rural credit cooperatives (RCCs) and urban credit cooperatives (UCCs) were formed under the supervision of the ABC and later the PBOC. Since 1995, UCCs have started to transform into city commercial banks, such as the Beijing Bank and the Nanjing Bank. RCCs have started to become rural commercial banks, such as Shanghai Rural Commercial Bank. Only as late as 1995 did China commit to establishing its legal framework over its financial industry. The People’s Bank of China Law (1995), the Commercial Bank Law (1995), the Guarantee Law (1995), the Company Law (1995), the Commercial Paper Law (1995), the Insurance Law (1995), the Securities Law (1999) and other laws have been gradually made to regulate its fast growing financial institutions. Joining the World Trade Organization (WTO) in December 2001, China commenced the introduction of its post-WTO financial reforms. As one of most significant reforms, China established the China Banking Regulatory Commission (CBRC) in 2003 according to the State Council’s No. 8 Document (2003) hoping that regulation over banking industry would be strengthened and grow sustainably in the long run. Later that year the People‟s Congress of China approved the CBRC and modified the People’s Bank of China Law (1995) and passed the China Banking Regulation Law (2003). Since then the PBOC has focused on monetary policies and terminated the role of bank monitoring and supervision. As shown in Figure 1 China‟s current banking regulatory framework is similar to the Glass-Steagall Act (1933) that separates commercial banking from investment banking. The Commercial Bank Law (1995 and its 2003 Amendment) and the General Rules over Loans (1996) prohibit investment in equity from proceeds of loans. Similarly the Securities Law (1999 and its 2004 Amendment) restricts fund flows from banks to the securities market. In addition, banks are not allowed to invest in the securities market other than government bonds. The Insurance Law (1995 and its 2002 Amendment) also restricts insurance companies in their business and investment scopes other than providing insurance products. In short, banks, securities companies and insurance companies have been confined to their core activities.
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FIGURE 1 Regulatory Framework of Chinese Finance Industry
Most financial institutions in China used to be wholly state-owned, either directly such as through the “Big Four” banks (ICBC, ABC, BOC and CCB), or indirectly, such as through the joint-stock commercial banks. There have been very few privately-owned financial institutions. Up to now the Minsheng Bank is believed the first private bank in China. The highly centralized government ownership of Chinese financial institutions has been heavily criticized (Berger, Hasan & Zhou, 2009; Jia, 2009). As another part of the noticeable financial reforms in the post-WTO era, financial institutions are rushing to get listed at stock exchanges. On one hand, there has been a common belief that state ownership is the root of low efficiency and bad performance of financial institutions, especially among the big banks (e.g., Lu, 2006; Berger, Hasan & Zhou, 2009; Jia, 2009). On the other, before the end of 2006 when China lifted the barrier to all foreign financial institutions, foreign financial institutions widely invested into their Chinese counterparts to enter the market, especially the banks. Despite the 20% of single foreign investor ownership and maximum 25% aggregate foreign ownership of Chinese banks stipulation as regulated by the CBRC No. 6 Decree (2003), foreign institutions rushed to invest in Chinese banks. Consequently most of the major financial institutions in China have foreigners as investors as well as board directors. For example, both the president and the CEO of the Shenzhen Development Bank (SZDB) were foreigners. Due to the limited size and bearish A-share market between 2001 and 2005, large financial institutions, such as the Ping‟An Insurance (PAI) and the ICBC, have managed to get listed on the A-share market since 2006. Some Chinese financial institutions sought listing on the Stock Exchange of Hong Kong (SEHK) first before listing on the A-share market. Prior to 1999 there were only a few small financial institutions listed in China, such as the SZDB and the Pudong Development Bank
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(PDDB). However, since 2006, there has been a noticeable surge in the number of financial institutions listing on the A-share market. China‟s securities market commenced in the early 1990s, consisting of two stock exchanges (SHSE and SZSE) which are now among the most active securities markets in the world. Since early 2001 the corporate financial scandals involving listed companies in China (e.g. Guanxia Industry Co. Ltd, Macat Optics and Electronics Co. Ltd, Sanjiu Pharmaceutical Co. Ltd and Lantian Co. Ltd) prompted the policy-makers, regulators and officials at the China Securities Regulatory Commission (CSRC) and the State Economic and Trade Commission (SETC) to make corporate governance a priority issue for their 2002 agenda. The central government came under increasing public pressure to improve its policy regarding corporate governance mechanisms. Additionally and importantly, as per its WTO entry agreement, China should be committed to capital market liberalisation and corporate reform, in particular with respect to state-owned enterprises (SOEs). Consequently, The Code of Corporate Governance for Listed Companies in China (The Code) was issued by the CSRC and the State Economics and Trade Commission (SETC) in January 2002. The Code is applicable to all listed companies in China, and is the major measuring standard for evaluating corporate governance standards practised listed companies. All listed companies, including companies in the financial sector, are required to act in the spirit of The Code in their efforts to improve corporate governance. With the objective of eliminating the dominant managerial powers of the boards of directors in China‟s listed companies, the CSRC also issued The Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies (The Guidelines) in August 2001, mandating that by 30 June 2003, at least one-third of board members shall be independent directors.
3. Literature and Hypotheses Traditionally, agency theory has concentrated on a set of the principal-agent problems stemming from the complex set of contracts engaged in by the firm. Such contracts may be either explicit or implicit in the separation of ownership from control of the firm. Perhaps best known of these principal-agent problems is where a divergence of interests between owners and managers causes the agent (management) to fail to maximize the welfare of the principal (shareholders) (Jensen & Meckling, 1976). To moderate the conflict of interests related to the principal-agent problem, appropriate governance structures, managerial incentives and board of directors must function effectively to enhance the maximization of firm‟s value (Jensen & Meckling, 1976; Shleifer & Vishny, 1997). This argument is commonly accepted by literature and widely used for the studies of corporate governance in developed economies, but it is less significant for emerging economies due to their predominant ownership concentration. Instead, a principal-principal problem is introduced as a major concern of corporate governance in emerging economies. In such economies, high ownership concentration, extensive family ownership and control, business group structures, and weak legal protection of minority shareholders cause the principal-principal conflicts between controlling shareholders and minority shareholders (Dharwadkar, George & Brandes, 2000; Young et al., 2008). According to Hu, Tam and Tan (2010) we expect the three internal governance mechanisms (i.e., ownership structure, board of directors and supervisory board) to play a substantial role in China in addressing the principal-principal problem and its impact on firm performance.
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3.1 Ownership Structure Ownership concentration of companies may reduce managers‟ freedom to make strategic decisions and take risks, and thus take advantage of opportunities. High levels of concentration in ownership, through the pressure that controlling investors can exert on managers, can be expected to affect management incentives and corporate policy choices (Brickley, Lease & Smith, 1988; Pound, 1988; Bushee, 1998). Thus while a large total share of the equity might improve the effectiveness of a group of shareholders in monitoring management, to prevent this group from taking advantage of other shareholders their powers must be restrained (Clarke, 1998). High ownership concentration provides controlling shareholders and managers with both incentives and opportunities to engage in expropriation from minority shareholders (Morck, Shleifer & Vishny, 1988; Shleifer & Vishny, 1997; La Porta, Lopez-deSilanes & Shleifer, 1999). This reflects the enhancement to their own invested capital that may result from such actions, particularly in the Chinese financial sector due to the nature of highly concentrated ownership and state control. From this perspective the key aspects of corporate ownership are its concentration and composition. This suggests that within the corporate governance context the most important factor in shaping the corporate governance system is the type of ownership structure (Aoki, 1995). While evidencing a variety of forms of ownership, the state still remains the major shareholder. This has resulted in a highly concentrated ownership structure, an outcome of China„s partial privatisation (Tam, 2002). A dominant feature of the concentrated ownership by the state is the non-tradable nature of the equity ownership of the state, which is held either through direct investment or indirectly through holdings of domestic institutions. These institutions are entirely or partially owned by either China‟s central or its provincial governments. Thus China‟s privatisation program is different from that of many other transition economies, such as Poland, the Czech Republic, Russia and other former Eastern European socialist economies. First, we believe that state shareholders often seek objectives other than efficiency or profitability, and so they may place a high priority on maintaining social order and affecting wealth redistribution that may favour increasing employment, rather than considerations of efficiency or profitability for public shareholders (Xu & Wang, 1999). Second, we suggest that the state ownership lacks a direct personal stake in the company‟s profit, and individual politicians have incentives to expand their political base through transferring the control rights of state-owned shares (Shleifer & Vishny, 1997). The legal person shareholders are not an independent group of shareholding because they are ultimately owned by the state. Of course they enjoy much more autonomy and are held to higher accountability standards than the state shareholders (Xu & Wang, 1999). Xu and Wang (1999) and Qi, Wu and Zhang (2000) find that firms with better performance have a higher proportion of legal personal ownership. They argue that legal person shareholders will put pressure on listed firms to increase efficiency and maximize profits and they will closely monitor firm performance. However we disagree with their argument. As a sensitive industry, banks and other financial companies are dominantly controlled or monitored by the state, thus the degree of their autonomy is doubtful. Moreover, both the state and legal person shareholders have much less concern about the market value of the share price because most of their shares are non-tradable in the stock market (Chen, Firth & Rui, 2006; Firth, Fung & Rui, 2006).
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The dominant objective of foreign shareholders is to maximize profits and shareholders‟ wealth. Most of these foreign shareholders are financial institutions based in developed economies such as Europe, North America, Japan and Hong Kong. Therefore they have resources to analyse firm performance and have experience as well as capability to effect operational and management changes when profitability and efficiency are poor (Chen, Firth & Rui, 2006). Prior empirical studies concluded that foreign ownership is positively related to superior performance in Chinese listed firms (Zhang, Zhang & Zhao, 2001; Wei, Xie & Zhang, 2005). However, the foreign shareholders have own relatively small stakes in Chinese listed firms and this may cause some difficulties in fulfilling their role to monitor the performance of managers (Chen, Firth & Rui, 2006; Firth, Fung & Rui, 2006). In contrast, Berger, Hasan and Zhou (2009) argue that even minority foreign ownership may still increase the efficiency of Chinese banks. They reason that foreign investors can play active and positive roles and bring about improvements in the corporate governance, technological advancement and risk management practices of Chinese banks. In light of the above theoretical discussion and the overall pattern of empirical results, we form our first set of hypotheses as follows: Hypothesis 1a: Ceteris paribus, ownership concentration has a negative impact on the performance of listed Chinese financial institutions. Hypothesis 1b: Ceteris paribus, state ownership has a negative impact on the performance of listed Chinese financial institutions. Hypothesis 1c: Ceteris paribus, legal person ownership has a negative impact on the performance of listed Chinese financial institutions. Hypothesis 1d: Ceteris paribus, foreign ownership has a positive impact on the performance of listed Chinese financial institutions. 3.2 Board of Directors The agency problem presents an essential element of the so-called contractual view of the company (Jensen & Meckling 1976; Fama & Jensen, 1983a, b). Berle and Means (1932) identify that the joint-stock equity structure has led to a transfer of corporate control from individual to professional managers in the joint-stock firm. When control is distinct from ownership, those in control may deploy assets in ways that benefit themselves rather than the owners. These principle-agent problems are the specific result of this separation of ownership and control. More generally, the essence of the ownership and control agency problem is the separation of management and finance (Shleifer & Vishny, 1997). This is because an owner or manager of an enterprise can raise funds from investors either to put into production or to cash out their holdings in the company. Financiers expect and require the manager‟s specialised capital to generate returns on their funds. In contrast, the manager needs financiers‟ funds because owners‟ funds are either not enough to pursue investment opportunities or are necessary to meet the financial obligations of the company. Thus, the agency problem has placed governance issues at the forefront of financiers‟ concerns. They seek corporate governance monitoring mechanisms that can provide assurances that their funds are not expropriated or wasted on wealth reducing projects. Such side-effects of transitional reforms are at the forefront of the concerns of China‟s policy-makers and regulators. In the context of the Chinese system, corporate players not only need to protect the interests of all shareholders, including both controlling and minority shareholders, but also confront the conflicts of interest when the principal-principal problem arises between two shareholder groups (Young et al., 2008). China has adopted a two-tier board system as a means to promote better 7
governance. This choice was made in the early 1990s, partly because many directors and their enterprises were perceived to be engaged in questionable related-party transactions. The Code, issued in January 2002 by the CSRC and SETC, reinforces the role that the two boards are supposed to play in corporate governance. It gives particular attention to aspects of the boards. Since 2003 at least one-third of the directors on the board of directors have been required to be independent. Independence is required from both the listed company that employs them and its major shareholders. It also requires that their role in the listed company is limited to that of an independent director. Independence may be argued to be important due to its behavioural motivations. From this perspective, independent directors work in the best interests of the minority shareholders in order to maintain their good reputation in society (Fama & Jensen, 1983b). This suggests that both larger boards and those with a higher proportion of independent directors will have more individuals with these incentives, improving corporate policy decisions. To extend this assumption we expect that board meetings work as a good means to discuss and solve the most widely shared problem that directors face (Lipton & Lorsh, 1992) and the number of board meetings is an important resource in improving the effectiveness of a board (Conger, Finegold & Lawler III, 1998). Based on a consideration of the above with taking the characteristic of the conflicts of interest between controlling and minority shareholders in the principal-principal problem we form our second set of hypotheses as follows: Hypothesis 2a: Ceteris paribus, the size of the board of directors is positively related to the performance of listed Chinese financial institutions. Hypothesis 2b: Ceteris paribus, the number of independent directors on the board of directors is positively related to the performance of listed Chinese financial institutions. Hypothesis 2c: Ceteris paribus, the frequency of meetings of the board of directors is positively related to the performance of listed Chinese financial institutions. 3.3 Supervisory Board Consistent with requirements of The Code, Dahya et al. (2003) clearly outline the range of competencies required for a supervisory board to effectively fulfil its stated roles. The Code identifies four distinct types of roles that supervisory boards may undertake, depending on the independence and competencies of the board members. These include honoured guest, friendly advisor, censored watchdog, and independent watchdog. If the supervisory board takes on the role of honoured guest, friendly advisor or censored watchdog, its annual supervisory board report is unlikely to provide useful information to minority shareholders and investors. The role of independent watchdog, however, requires that members on the supervisory board have the necessary competencies in terms of knowledge and experience to act with expertise and sufficient independence. Logically those supervisory boards that have a higher number of members with appropriate professional knowledge or work experience should be in better position to improve corporate performance. Those with true independence from the board of directors should be better placed to demonstrate their competencies. With respect to the norms for the Chinese system, it is likely that most supervisory boards fall under the first three types of roles, rather than fulfilling the role of independent watchdog. The supervisory board is small in size and usually has members derived from political office (party members), leaders of the nonfunctional trade union and close friends and allies of major shareholders/senior manager representation (Tam, 2002; Dahya et al., 2003; Lin, 2004). Thus, the board is 8
expected to be inefficient. The frequent meetings of the supervisory board, like the meetings of the board of directors, are also expected to improve the effectiveness and efficiency for the board (Conger, Finegold & Lawler III, 1998). Accordingly, we form our third set of hypotheses as follows: Hypothesis 3a: Ceteris paribus, the size of the supervisory board is positively related to the performance of listed Chinese financial institutions. Hypothesis 3b: Ceteris paribus, the frequency of board meetings of supervisory boards is positively related to the performance of listed Chinese financial institutions.
4. Research Methodology 4.1 Sample and Data This study employs an unbalanced data set during the period 1999–2009 and consists of 139 firm-year observations. Our sample covers all 28 financial institutions listed on either the SHSE or the SZSE by the end of 2009. In this study, the corporate governance and financial data was retrieved through use of a database (Osiris) as well as manually from the annual report of each listed firm. The stock prices were also manually collected from the official websites of the SHSE and the SZSE. 4.2 Dependent Variables In the corporate governance literature, there is debate over whether firm performance should be measured by use of an accounting profit ratio–ROE or Tobin‟s Q. Demsetz and Villalonga (2001) suggest that these two measures differ in two ways. The first relates to the time horizon. Accounting profit ratios are backwards-looking measures of corporate performance, while Tobin‟s Q is a forward-looking measure. Accounting profit ratios are affected by accounting practices and emphasise management accomplishments, while Tobin‟s Q reveals the value investors assign to a firm‟s tangible and intangible assets based on predicted future revenue and cost streams. The second difference relates to who calculates the measure of firm performance. Accounting profit measures are commonly adopted by accountants constrained by accounting standards and accountability. The Tobin‟s Q measure is widely used by a community of investors constrained by their perceptions, including their acumen, optimism or pessimism. Demsetz and Villalonga (2001) believe that the later method is favoured by most economists, who have a better understanding of market constraints than of accounting constraints. As a consequence, we employ both ROE and Tobin‟s Q for this study in order to ascertain whether the results are consistent regardless of the measure of performance used. This approach is consistent with other prior empirical studies which have used both measures of accounting profit and Tobin‟s Q (Demsetz & Lehn, 1985; Holderness & Sheehan, 1988; Morck, Shleifer & Vishny, 1988; McConnell & Servaes, 1990; Denis & Denis, 1994; Wei & Varela, 2003; Wei, 2007; Harjoto & Jo, 2008). Tobin‟s Q is equal to the market value of stock and book value of debt divided by the book value of total assets. ROE is equal to a fiscal year's net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares). 4.3 Independent Variables The independent variables used to explain the firm performance of financial institutions are grouped three main categories in accordance with three internal governance mechanisms of China‟s principal–principal problem (Hu, Tam & Tan, 2010). The first category, ownership structure, consists of: (1) ownership 9
concentration (TOP10) which is the proportion of total shares held by the top 10 shareholders; (2) state ownership (STATE) which represents the proportion of shares held by the state; (3) legal person ownership (LEGALPERSON) which measures the proportion of shares held by legal person; (4) foreign ownership which measures the proportion of shares held by foreign investors. The second category, board of directors, comprises: (1) BOARDSIZE which represents the number of directors on the board of directors; (2) INPD which represents the number of independent directors on the board of directors; (3) BMEETING which represents the number of meetings held by the board of directors in the fiscal year. The third category, supervisory board, consists of: (1) SBSIZE which represents the number of supervisors on the supervisory board; SBMEETING which represents the number of meetings held by the supervisory board in the fiscal year. 4.4 Control Variables Control variables include firm size, firm age, leverage and price–earnings ratio. Firm size (FIRMSIZE) is measured by the natural logarithm of total assets, which is often found to have a significant impact on internal governance mechanisms. Firm age (FIRMAGE) measures the number of years since initial listing. Leverage (LEVERAGE) is measured as long-term debt to total assets ratio. Price-earnings ratio (PE) is equal to market value per share divided by earnings per share. 4.5 Model Specification Based on the three groups of hypotheses presented in this paper, the linear panel regression model to be empirically investigated is as follows: Performance (TOBINSQ/ROE) i,t 1TOP10i,t 2STATEi,t
3 LEGALPERSO N i,t 4 FOREIGNi,t 5 BOARDSIZEi,t 6 INDPi,t 7 BM EETINGi,t 8SBSIZE i,t 9SBM EETINGi,t 10FIRM SIZEi,t 11FIRM AGEi,t 12LEVERAGE i,t 13PE i,t i ,t
As shown in Table 1 Panel A, there are no correlations between independent variables that reach 0.8. However, a certain degree of multicollinearity may still be a concern even where the bivariate correlation coefficients are low. The reason is that one independent variable may be a linear function of a set of several of the other independent variables (Gujarati, 2003). Hence, the presence of multicollinearity is also examined for through estimation of the Variance Inflation Factor (VIF).1 The results, reported in Table 1 Panel B, highlight that the largest VIF is 5.23 while the remainder are below 4.34. Thus, there is no evidence of a serious multicollinearity problem being present in the regression model. The Hausman test for a comparison between the random effects estimator and the fixed effects estimator was made. The test generates a 2 with degrees of freedom and probability (p-value). We found that the p-value is less than 0.05, thus the null hypothesis was rejected, which indicates that ordinary least squares (OLS) fixed effects estimator with the White cross-section covariance2 should be used in this study.
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TABLE 1 Multicollinearity Diagnostics Panel A: Spearman Matrix (1) (1) TOP10 (2) STATE (3) LEGALP ERSON (4) FOREIG N (5) BOARDS IZE (6) INDP
(7) BMEETI NG (8) SBSIZE (9) SBMEETI NG (10) FIRMSIZ E (11) FIRMAG E (12) LEVERA GE (13) PE
– – 0.39 7*** – 0.05 – 0.09 7 – 0.14 7† 0.06 7 – 0.04 1 – 0.06 8 –0.1
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11 )
(12 )
(1 3)
– – 0.44 3*** – 0.02 6 – 0.13 7 – 0.02 8 – 0.00 9 – 0.16 3† 0.02 3
0.04
0.03 6
– 0.29 4*** – 0.24 7** – 0.00 3
– 0.29 5*** – 0.07 8 – 0.00 5
– – 0.22 6** 0.09 3
–
0.34 8***
–
– 0.10 6 – 0.22 8*** 0.08 4
– 0.42
0.71 6***
–
0.08 5
0.10 2
0.12 7
–
0.34 8***
0.72 6***
0.72 2***
0.17 3*
–
– 0.43 5*** – 0.29 2*** – 0.02 7 – 0.07 1 0.14 6†
0.30 5***
0.19 9*
0.23 8**
0.37
0.19 4*
–
***
0.52 3***
0.64 2***
0.58 4***
0.25 6**
0.61 6***
0.46 6***
–
– 0.23
– 0.25 7** 0.32 9***
– 0.17 7* 0.16 7*
0.19 2*
– 0.05
0.05 3
0.01 1
0.22 7**
0.19 6*
– 0.24 9** 0.49 9***
– 0.24 1**
– 0.28 3***
– 0.08
– 0.32 5***
– 0.21 9***
– 0.37 3***
***
**
– 0.30 5*** – 0.17 3*
– – 0.1 13 – 0.0 55
– – 0.0 54
–
Panel B: VIF Diagnostic Variables (1) TOP10 (2) STATE (3) LEGALPERSON (4) FOREIGN (5) BOARDSIZE (6) INDP (7) BMEETING (8) SBSIZE (9) SBMEETING (10) FIRMSIZE (11) FIRMAGE (12) LEVERAGE (13) PE Mean VIF
VIF 2.82 2.41 2.92 1.44 5.23 2.79 1.46 3.47 1.57 4.34 1.49 1.33 1.22 2.50
SQRT VIF 1.68 1.55 1.71 1.20 2.29 1.67 1.21 1.86 1.25 2.08 1.22 1.15 1.10
Tolerance 0.3547 0.4150 0.3430 0.6956 0.1913 0.3582 0.6858 0.2885 0.6366 0.2305 0.6720 0.7522 0.8196
R2 0.6453 0.5850 0.6570 0.3044 0.8087 0.6418 0.3142 0.7115 0.3634 0.7695 0.3280 0.2478 0.1804
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Notes: Two-tailed p-values are used in determining significance: † if p < 0.10, * if p < 0.05; ** if p < 0.01; *** if p < 0.001
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5. Results and Discussion 5.1 Descriptive Statistics TABLE 2 Descriptive Statistics on Variables Variable TOBINSQ ROE TOP10 STATE LEGALPERSON FOREIGN BOARDSIZE INDP BMEETING SBSIZE SBMEETING FIRMSIZE FIRMAGE LEVERAGE PE
Mean 1.387 0.12 0.581 0.227 0.295 0.039 14.065 4.504 9.072 6.856 4.619 25.115 7.396 0.079 63.017
Median 0.648 0.128 0.554 0.163 0.192 0.00 15.00 5.00 9.00 7.00 4.00 25.657 8.00 0.041 30.527
Min. 0.075 –0.468 0.31 0.00 0.00 0.00 5.00 0.00 3.00 3.00 0.00 20.035 0.00 0.00 –89.67
Max. 28.344 0.52 0.865 0.915 0.675 0.333 19.00 8.00 20.00 11.00 13.00 30.098 19.00 0.962 1865.04
Std. Dev. 3.083 0.116 0.275 0.242 0.321 0.069 3.775 2.03 3.394 2.486 2.168 2.522 5.474 0.132 176.52
The descriptive statistics presented in Table 2 provide a profile of the corporate governance characteristics of the listed Chinese financial institutions in our sample. With respect to performance indicators–TOBINSQ and ROE, the mean ratios are 1.387 and 0.12 respectively, with a range of 0.075 and 28.34 for TOBINSQ and –0.468 to 0.52 for ROE. Both mean and maximum ratios of TOBINSQ show that the market value of equity of a certain financial institution was very high due to its surging stock price. From this point we suggest that the financial institutions utilize the stock market as a means to benefit the controlling shareholders and expropriate the interests of minority shareholders, which is indicated in accordance with poor ROE. In light of ownership structure we find that the mean of ownership concentration (TOP10) is 58.1%, with a range from 31% to as high as 86.5%. The means of state ownership (STATE) and legal person ownership (LEGALPERSON) are 22.7% and 29.5% respectively. However, the mean of foreign ownership (FOREIGN) is around 3.9% only. These statistics once again confirm that the controlling parties are the real beneficiaries from the latest financial reforms. With respect to the board of directors, the means of board size (BOARDSIZE) and number of independent directors on the board (INDP) are 14.1 and 4.5 respectively, which indicate the ratio of independent directors on the board is around 32%. I This suggests that the firms sampled only just satisfied the minimum ratio required by The Guidelines, i.e., at least one–third of the board of directors is to be independent. In terms of supervisory board, we find that the mean for size of supervisory board is 6.86, with a range from 3 to 11, and it is well below than the average size of board of directors.
13
TABLE 3 Panel Regression Results a Fixed-Effect b Expected sign Constant TOP10 STATE LEGALPERSON FOREIGN BOARDSIZE INDP BMEETING SBSIZE SBMEETING FIRMSIZE FIRMAGE LEVERAGE PE Observation Adjusted/McFadden R2 F/LR –statistic
– – – + + + + + + + + + +
Model (1) TOBINSQ Coefficient t-stat. 34.101 2.729** 0.5065 0.545 –1.889 –2.248* 0.13 0.108 0.87 0.549 –0.48 –5.366*** –0.146 –1.488 –0.032 –0.378 –0.321 –1.555 0.096 1.219 –1.237 –2.488* 0.359 4.146*** 2.782 1.984* 0.009 4.642*** 139 0.7572 11.7597
Model (2) ROE Coefficient t-stat. –1.021 –1.474 –0.103 –1.192 0.046 0.928 0.079 0.816 –0.071 –0.457 –0.018 –3.483*** –0.011 –1.464 –0.003 –0.599 0.019 1.57 0.002 0.422 0.051 1.871† 0.007 1.196 0.055 0.722 0.0006 1.232 139 0.301 2.4853
Binary Logit c Model (3) TOBINSQ Coefficient z-stat. 50.031 4.949*** 1.48 0.928 2.44 1.124 –2.287 –1.659† –3.452 –0.64 –0.339 –2.286* 0.347 0.777 0.008 0.029 –0.046 –0.172 –0.43 –2.759** –2.087 –4.043*** 0.086 1.692† 8.63 2.31* –0.003 –1.308 139 0.7303 140.72
Model (4) ROE Coefficient z-stat. –11.866 –3.133** –0.684 –0.634 –0.272 –0.22 1.814 1.492 –0.762 –1.458 –0.311 –2.6** 0.216 1.214 0.069 0.824 0.044 0.284 –0.395 –2.785** 0.548 2.821** –0.059 –1.298 –0.965 –0.467 –0.012 –0.752 139 0.2992 57.64
The table reports the results of panel regression model:
Performance (TOBINSQ/ROE) i,t 1TOP10i,t 2STATEi,t 3 LEGALPERSON i,t 4 FOREIGN i,t 5 BOARDSIZE i,t 6 INDPi,t
7 BMEETINGi,t 8SBSIZE i,t 9SBMEETINGi,t 10FIRMSIZE i,t 11FIRMAGE i,t 12LEVERAGE i,t 13PEi,t i ,t Where, TOBINSQ (the dependent variable) = market value of stock and book value of debt divided by book value of total assets; ROE (the dependent variable) = return on equity; TOP10 = ownership concentration, proportion of shares held by top 10 shareholders; STATE = proportion of shares held by the state; LEGALPERSON = proportion of shares held by legal person; FOREIGN = proportion of shares held by foreign shareholders; BOARDSIZE = board size, the number of directors on the board of directors; INDP = the number of independent directors on the board of directors; BMEETING = the frequency of meetings held by the board of directors in the fiscal year; SBSIZE = the number of members on the supervisory board; SBMEETING = the frequency of meetings held by the supervisory board in the fiscal year; FIRMSIZE =
14
natural logarithm of book value of total assets at the end of fiscal year; FIRMAGE = years since initial listing; LEVERAGE = measured as long-term debt to total assets ratio; PE = market value per share divided by earnings per share Notes: a The panel data set is unbalanced because it includes some firms were listed between 2000 and 2009. b Hausman test for a comparison between the random effects estimator and the fixed effects estimator was made. The test generates a statistic with degrees of freedom and probability (p-value). We found that p-value is less than 0.05, thus the null hypothesis was rejected, which means that fixed effects estimator should be used. c In Binary Logit Regression model we coded as 1 if TOBINSQ/ROE is greater than the median value, otherwise coded as 0. Two-tailed p-values are used in determining significance: † if p < 0.10, * if p < 0.05; ** if p < 0.01; *** if p < 0.001 2
15
5.2 Regression Analyses Table 3 provides the panel data regression results of OLS fixed effect method and binary logit method3 to examine the three sets of hypotheses. These regression results report adjusted R2s of 0.7572 and 0.301 for OLS fixed effect regression using TOBINSQ and ROE respectively, and McFadden R2s of 0.7303 and 0.2992 for binary logit regression using TOBINSQ and ROE respectively. The F/LR–statistics for all models indicate that statistically significant components of the variation in the chosen of measures of TOBINSQ and ROE are explained by variation in the set of independent variables. With respect to ownership structure, the first set of hypotheses, we expect the internal governance mechanisms combined with the latest financial institution reform and their efficiency to mitigate the principal-principal conflict in China‟s financial sector. The results of all models in Table 3 do not support our hypotheses except state ownership (STATE) in Model (1) with the performance measurement by TOBINSQ and legal person ownership (LEGALPERSON) in Model (3) with the performance measurement by TOBINSQ. Thus, we reject Hypotheses 1a and 1d, and accept Hypotheses 1b and 1c.4 The interesting finding is that ownership concentration (TOP10) has no impact on firm performance, and is consistent with the finding by Hovey, Li and Naughton (2003). A possible explanation for this is that the financial institutions in China are all highly concentrated, the minority shareholders and market are thus conditioned to this dominant-controlled financial environment. The controlling shareholders, on the other hand, are not concerned about firm performance as most of them are not “real” owners. We are not surprised to find that state ownership (STATE) and legal person ownership (LEGALPERSON) have negative impacts on firm performance. State shares are retained by the State Asset Management Bureau (SAMB) of the central or provincial governments or their agencies and are not usually allowed to be publicly traded. Legal person shares are held by domestic institutional investors, and are also non-tradable. Our findings also support the principal-principal conflict of agency theory in the controlling shareholders, no matter whether state shareholders or legal person shareholders, weaken managerial incentives to achieve the goal of profit maximization. Inconsistent with the finding of Berger, Hasan and Zhou (2009), our results do not support Hypothesis 1d and indicate that foreign ownership is not associated with improved profitability. Our results indicate that foreign ownership in the financial sector only is quite small (3.9% on average in our sample) in comparison with state and legal person ownership due to the restrictions for foreign investor. This reduced the efficiency of foreign shareholders to actively monitor managers‟ performance (Chen, Firth & Rui, 2006). In terms of the board of directors, we found that board size (BOARDSIZE) is statistically significantly related to TOBINSQ and ROE in all four models but in the opposite direction to that hypothesized. Thus, we reject Hypothesis 2a. The results also show that the number of independent directors on the board of directors (INDP) and the frequency of meetings held by the board of directors (BMEETING) have no significant effect on firm performance. Thus, Hypotheses 2b and 2c are rejected. Wei (2007) suggests that the nature of the board of directors is regarded as “window dressing” in Chinese listed companies. It is perhaps the best description to interpret our finding. The key problems of board independence are related to the directors and managers. Most of the directors are insiders or executive directors, and few companies have many independent directors and only meet the one-third ratio required by The Guidelines. This results in insider control in most Chinese listed 16
companies (Feinerman, 2007). Regarding the nature of independence, Tan and Wang (2007) submit that most independent directors in Chinese listed companies are appointed by the board members or controlling shareholders. Hence they owe their loyalty and patronage to their appointers. Additionally, within the Chinese network of guanxi the appointed independent directors are installed for the “giving of face” (gei mianzi) to their patrons. The independent directors therefore will not act as objective and independent watchdogs, but rather will act according to the interests of the controlling shareholders and their patrons in order to maintain their secured positions within this network. This may be another possible explanation as to why the number of independent directors and the number of meetings had no observable effect on firm performance. With respect to supervisory board, we found that supervisory board size (SBSIZE) is not statistically significant related to TOBINSQ and ROE in all models. Although supervisory board meeting (SBMEETING) is not statistically significantly related to the performance indicators in Models (1) and (2), it is significant in Models (3) and (4), but in the opposite direction to that hypothesised. Accordingly, we reject Hypotheses 3a and 3b. But how can highly frequent supervisory board meetings be associated with poorer firm performance in our sample? It can be speculated that the supervisory boards of Chinese listed financial institutions have tended to become “censored watchdogs” in the words of Dahya et al. (2003) during a period when rapid corporate expansion and the dominance of the board of directors has occurred. A previous study of supervisory board members of listed companies or linked entities in China, (Xiao, Dahya & Lin, 2004, p.47) concluded that supervisory board members describe their behaviour as where “You sometimes have to open one eye and close the other”. If “censored watchdog” is the role of the supervisory board, then perhaps what is occurring is that the more qualified are the supervisory board members, the greater the internal effort that is made to censor their review work in areas such as related-party transactions, which could include information deemed sensitive to board of directors and controlling shareholders. In reality, these supervisory board members could be regarded as “rubber stamp” directors. In terms of control variables, FIRMSIZE shows significant and negative relationships with TOBINSQ in Models (1) and (3) but positive and significant associations with ROE in Models (2) and (4). The possible explanation for the negative relationship with TOBINSQ is that large firms may have an opportunity for appropriation and exploitation of firm value by the controlling shareholders (Hu, Tam & Tan, 2010). The controlling shareholders of Chinese financial institutions are less concerned about the forward–looking performance measure, Tobin‟s Q. They know that the minority shareholders have no other choices and have to invest in these highly concentrated listed financial companies predominated by the state and/or legal entities. The alternative explanation for the positive association with ROE is that the controlling directors/supervisors of large firms may factiously aggrandize accounting measures of performance through earnings management or tunneling for their political promotion. FIRMAGE revealed significant and positive associations with TOBINSQ in Models (1) and (3). The interpretation is possibly that longer listing firms take advantage of their historical reputation to attract more investment from the market. Lastly, the significant and positive relationships between TOBINSQ and LEVERAGE/PE indicate that Chinese financial institutions are concerned with the market response from their debtholders and investors.
17
TABLE 4 Pooled Regression Results Binary Logit a
OLS Model (1) TOBINSQ Coefficient t-stat. 7.881 3.318** –0.23 –0.361 –0.879 –0.901 0.775 0.931 –0.91 –1.581 –0.39 –3.003** –0.259 –2.102* 0.052 0.904 0.01 0.817 0.154 1.491 –0.162 –1.426 –0.058 –1.365 0.315 0.324 0.01 4.374*** 139 0.6255 18.7263
Expected sign Constant TOP10 STATE LEGALPERSON FOREIGN BOARDSIZE INDP BMEETING SBSIZE SBMEETING FIRMSIZE FIRMAGE LEVERAGE PE Observation Adjusted R2 F–statistic
– – – + + + + + + + + + +
Model (2) ROE Coefficient t-stat –0.391 –3.028** 0.021 0.624 0.055 1.129 0.024 0.628 –0.146 –1.437 –0.01 –1.666† –0.003 –0.471 0.001 0.257 0.017 1.742† –0.007 –1.701† 0.02 3.143** 0.001 0.547 –0.051 –1.068 0.0003 0.007 139 0.1637 3.0773
Model (3) TOBINSQ Coefficient t-stat. 4.754 15.884*** 0.334 0.531 0.143 0.721 –0.262 –1.92† –0.638 –1.242 –0.005 –0.313 –0.03 –1.133 0.016 1.186 0.015 0.811 –0.04 –3.156** –0.179 –9.737*** 0.009 1.831† 0.656 3.107** –0.0001 –1.46 139 0.6721 22.759
Model (4) ROE Coefficient t-stat. –1.902 –3.475*** –0.153 –0.737 –0.053 –0.229 –0.339 –1.753† –1.133 –1.372 –0.059 –2.83** –0.049 –1.664† 0.007 0.573 0.003 0.125 –0.066 –3.274** 0.11 3.712*** –0.007 –0.913 –0.203 –0.611 0.0004 3.772*** 139 0.2581 4.6934
The table reports the results of pooled regression model: Performance (TOBINSQ/ROE) TOP10 STATE LEGALPERSON FOREIGN BOARDSIZE INDP 1
2
3
4
5
6
BMEETING SBSIZE SBMEETING FIRMSIZE FIRMAGE LEVERAGE PE where, TOBINSQ (the dependent variable) = market value of stock and book value of debt divided by book value of total assets; ROE (the dependent variable) = return on equity; TOP10 = ownership concentration, proportion of shares held by top 10 shareholders; STATE = proportion of shares held by the state; LEGALPERSON = proportion of shares held by legal person; FOREIGN = proportion of shares held by foreign shareholders; BOARDSIZE = board size, the number of directors on the board of directors; INDP = the number of independent directors on the board of directors; BMEETING = the frequency of meetings held by the board of directors in the fiscal year; SBSIZE = the number of members on the supervisory board; SBMEETING = the frequency of meetings held by the supervisory board in the fiscal year; FIRMSIZE = 7
8
9
10
11
12
13
18
natural logarithm of book value of total assets at the end of fiscal year; FIRMAGE = years since initial listing; LEVERAGE = measured as long-term debt to total assets ratio; PE = market value per share divided by earnings per share Notes: a In Binary Logit Regression model we coded as 1 if TOBINSQ/ROE is greater than the median value, otherwise coded as 0; Two-tailed p-values are used in determining significance: † if p < 0.10, * if p < 0.05; ** if p < 0.01; *** if p < 0.001
19
5.3 Robustness Check In order to check the robustness of the results discussed above, we have performed a sensitivity analysis. We formed a pooled cross section by combining the eleven–year observations of our 28 samples. A panel data set consists of a time series for each cross–sectional member in the data set. The key differences between pooled cross section and panel data set is whether the same cross–sectional units are followed over a given time period (Wooldridge, 2006). The purpose of using a pooled cross section approach as a robustness check for this study is to examine whether time series issue occurred in our data set and result in different explanation. As shown in Table 4, with respect to ownership structure, we reject all hypotheses (Hypotheses 1a, 1b, 1c and 1d) in the first set. This is inconsistent with the finding in Table 3 using a panel data set, i.e., Hypotheses 1b and 1c are supported. A possible explanation of the different results is that the banking/financial reforms over the eleven-year period are not taken into account in pooled regression. In terms of board of directors, Hypotheses 2a, 2b and 2c are rejected, but a striking finding is that INDP shows negative relationships with TOBINSQ in Model (1) and with ROE in Model (4). This is probably that the gradual improvement of board independence required by The Code and The Guidelines in 2002 and 2003 respectively has not moderated for the performance of independent directors in the pooled regression model. With respect to supervisory board, we reject Hypotheses 3a and 3b, which is consistent with the findings in Table 3. Thus, these findings support our argument that the supervisory board in Chinese financial institutions play a “rubber stamp” role.
6. Conclusion The financial sector plays a vital intermediary role in China‟s economy. In order to achieve the requirements associated with the WTO agreement, since 2002, China has embarked on financial reform with the aim to improve the efficiency and profitability of financial institutions. Meanwhile, The Code was issued by the CSRC and the SETC, and is applicable to all Chinese listed companies for their corporate governance improvement. The primary objective of this study was to examine whether the performance of financial institutions is affected by internal governance mechanisms from the perspective of principal–principal conflict between the controlling shareholders and minority shareholders. We used an unbalanced data set covering the years 1999 to 2009 to assess the impact of ownership structure, board of directors and supervisory board within the Chinese institutional context. Our sample was comprised of all 28 financial institutions with a total of 139 firm–year observations. The empirical findings suggested that state ownership, legal person ownership, board size and supervisory board meetings are negatively related to the profitability of Chinese financial institutions. Other internal governance mechanisms including ownership concentration, foreign ownership, independent directors, board meeting and supervisory board size, were found to have no impact on a firm‟s financial performance. Several implications may be drawn from this study. We believe that the corporate governance reforms relating to the board of directors and the supervisory board in Chinese financial institutions have not been sufficient to ensure that they properly fulfil their roles of oversight. Rather, they are perhaps playing more so a “window dressing” or “rubber stamp” role within the current two-tier corporate governance system. In terms of principal-principal perspective, our findings also 20
imply that the controlling party can expropriate the interests of the minority shareholders, and the later party is only regarded as “free-riders”. Since most financial institutions in China are still state–owned or controlled, and there are less effective rules to govern the board of directors and the supervisory board of SOEs as in The Company Law (1995, its 2004 and 2005 Amendments),5 the state ownership may have resulted in inefficient corporate governance among the financial institutions. Despite the financial reforms such as mandating the introduction of independent directors and minority foreign ownership after China‟s entrance into the WTO in 2001, the dominance and influence of state ownership have not changed. State shareholders are the largest beneficiaries of the latest financial reforms. We observe insignificant improvement among these institutions in their corporate governance. Consequently, the corporate governance mechanisms of Chinese financial institutions may still be questionable after these inadequate reforms. Nevertheless, corporate governance mechanisms will continue to change and develop with the Chinese government‟s commitment to reform. As an example of this, the recently released Provisional Rules on Assessing Directors’ Performance at Commercial Banks6 now require supervisory board members to assess directors‟ performance in order to, amongst other things, reduce conflicts of interests and to address non-performance of directors. Detailed standards are yet to be developed for this new legislation and as a consequence fundamental reform, especially in terms of corporate governance for the finance industry in China, is still a medium-to-long term prospect.
21
Notes: 1. The critical value of the VIF to test for multicollinearity is 10. Gujarati (2003) suggests that there is no evidence of multicollinearity unless the VIF of a variable exceeds 10. All values used in this study were well below this critical level. 2. Heterokedasticity is very common in panel data (Baltagi, 2005). In this study we use the Breusch-Pagan Lagrange Multiplier (LM) test to detect heteroskedasticity. The results indicate that both models, measured by ROE and Tobin‟s Q, encounter a unknown nature of heteroskasticity. Thus, heterokedasticity robust standard errors are computed so that the t– and F–statistics remain valid (Wooldridge, 2006). The standard errors in the regression analyses of this study are corrected by using the White cross-section covariance method. 3. In binary logit model we coded as 1 if TOBINSQ/ROE is greater than the median value of the sample, otherwise coded as 0. Removing extreme variables may reduce the representational faithfulness of the sample, thereby undermining the validity of the results. Hence, we utilize binary logit regression analysis as alternative technique is robust when using non-normal data (Hair et al., 1998). 4. The association between TOBINSQ and LEGALPERSON is weakly inverse in Model (3) of binary logit regression which is indicated by z = –1.659 and p < 0.10. 5. The Company Law, 1995, 2004 & 2005 Amendments, Article 65-71, The People‟s Congress of China. 6. CBRC 2010 No.7 Decree, Provisional Rules over Assessing Directors’ Performance at Commercial Banks, December 10, 2010.
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