英國dissertation網提供英國留學生MBAdissertation代寫.Corporate governance and market valuation in China
aa Faculty of Business and Economics, The University of Hong Kong, Hong Kong, China
b Tsinghua University, Beijing 100084, PR China
Received 15 April 2003
Bai, Chong-En, Liu, Qiao, Lu, Joe, Song, Frank M., and Zhang, Junxi—Corporate governance
and market valuation in China
In this paper, we investigate empirically the relationship between governance mechanisms and themarket valuation of publicly listed firms in China. We construct measures of corporate governanceand market valuation for all publicly listed firms on the two stock markets in China from the firm’sannual reports between 1999 and 2001. Using this three-year panel, we examine the effect ofcorporate governance variables on market valuation after controlling for factors commonly consideredin market-valuation analysis. Our empirical results support several theoretical predictions; forexample, we find that both high concentration of non-controlling shareholding and issuing sharesto foreign investors have positive effects on market valuation, while a large holding by the largestshareholder, the CEO being the chairman or vice chairman of the board of directors, and the largestshareholder being the government have negative effects. Journal of Comparative Economics 32 (4)(2004) 599–616. Faculty of Business and Economics, The University of Hong Kong, Hong Kong,China; Tsinghua University, Beijing 100084, PR China.
? 2004 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.
JEL classification: G34; G32
* Corresponding author. Present address: Department of Economics, School of Economics and Management,
Tsinghua University, Beijing 100084, PR China
E-mail address: C.-E. Bai).
0147-5967/$ – see front matter ? 2004 Association for Comparative Economic Studies. Published by Elsevier
Inc. All rights reserved.
doi:10.1016/j.jce.2004.07.002
600 C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616
Keywords: Corporate governance; Market for corporate control; Ownership; Market valuation
1. Introduction
The emerging market crisis in 1997 and 1998 rekindled worldwide interest in the issueof corporate governance. In recent years, advocating higher governance standard has becomea regular campaign with the participation of an increasing number of parties, namely,academics, media, regulatory authorities, corporations, institutional investors, internationalorganizations, and shareholder rights watchdogs.1 Numerous initiatives have been proposedand launched by Asian countries to enhance their corporate governance practice, forexample, new listing and disclosure rules, mandatory training for board directors, and enforcedcodes of governance. International organizations are also very keen on governanceissues. The International Monetary Fund has demanded that governance improvementsbe included in its debt relief program. In 1998, the Organization of Economic Cooperationand Development (OECD) issued an influential document (OECD, 1999), which isintended to assist member and non-member countries in evaluating and improving the legal,institutional and regulatory framework for better corporate governance. In addition,private companies, e.g., Standard & Poor, California Public Employees’ Retirement PensionSystem (CaLPERS), CLSA, and McKinsey, are also calling for sweeping reforms ofgovernance practice in emerging economies.Corporate governance is paramount in China. The Chinese government opened stockexchanges in the early 1990s to raise capital and improve the operating performance ofstate-owned enterprises (SOEs). In less thantwelve years, China’s stock markets havegrown to become the eighth largest in the world with a market capitalization of over $500billion. Chinese companies, especially SOEs, have benefited substantially from the rapidgrowth in issuance and the general public’s enthusiasm on equitymarket.Meanwhile, stockmarket regulations have been evolving to address the tradeoff between growth and controlin which a liberal approach fosters fast growth while a controlled approach leads to slowergrowth. Even though issuance approval, pricing, and placement systems have been liberalizedsignificantly, they are still controlled tightly compared to other Asian markets.Nonetheless, poor governance practices are rampant among the Chinese listed companies.#p#分頁標題#e#
In 2001, the largest shareholder ofMeierya, which had been a profitable company, colludedwith other related parties and embezzled $44.6million or 41% of the listed company’s totalequity. In the same year, the largest shareholder of Sanjiu Pharmacy extracted $301.9 millionor 96%of this listed company’s total equity.2 Although Chinese companies, especiallySOEs, obtain considerable capital from the public through either the banking system or the
1 Recent research by McKinsey finds that articles featuring the term corporate governance in major internationaleconomics and finance newspapers or magazines, e.g., the Financial Times, the Asian Wall Street Journal,and the Far-East Economic Review, have increased ten-fold from the pre-crisis period in 1996 to 1997 to theperiod from 2000 to 2001 (McKinsey & Company, 2002). In the academic literature, the crisis has spawned avoluminous body of research on governance related issues, especially in emerging markets.
2 Liu and Lu (2002) find that most listed companies manage their earnings in response to a variety of regulatoryloopholes. However, the incentives are stronger for firms with poorer governance practice.
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616 601capitalmarket, they remain extremely inefficient. For example, recent official statistics suggestthat about one-third of all SOEs are loss-makers, another third either break even or areplagued with implicit losses, while the remaining one-third are marginally profitable. Ineffectivegovernance is widely believed to be the root cause of this lackluster performanceso that improving corporate governance should be a crucial objective of China’s furthereconomic reform.
To improve corporate governance, the government must strengthen laws that protectshareholder interests and increase enforcement of such laws and regulations. Equally important,firms must also act to improve the situation. Corporate governance must providethe appropriate market incentives. For a firm’s corporate governance practice to have a positiveeffect on its market value, two conditions must be satisfied. First, good governancemust increase the returns to firm’s shareholders; second, the stock market must be sufficientlyefficient so that the share prices reflect fundamental values. These conditions aremore likely to be satisfied in maturemarkets than in emerging markets. In fact, share priceson China’s stock markets are often considered to be driven by purely speculative activitiesand to bear no relationship to fundamentals.Practitioners believe that good corporate governance does increase the firm’s marketvaluation. Recently, McKinsey conducted a series of surveys with institutional investorsand private equity investors focusing on emerging markets (McKinsey & Company, 1999–2002). The evidence indicates 80% of these investors are willing to pay a premium to wellgovernedfirms. Black (2001), Black et al. (2002), Gompers et al. (2003), and Joh (2003)find a positive correlation between performance measures and governance level.3 In thispaper, we investigate this issue systematically for publicly listed firms in China.We analyzeempirically the effects of corporate governance practices on the market valuation of thefirms based on a three-year panel data set collected from the firms’ annual reports. Ratherthan rely on survey data, weuse the actual corporate governance practices of all publiclylisted firms in China between 1999 and 2001. Controlling for a number of variables thatare typically included in studies of the firm market valuations, we use various measures#p#分頁標題#e#
of corporate governance to determine Tobin’s q values for these firms. In our empiricalanalysis, we pay particular attention to an important characteristic of Chinese firms, namelythe dominance of state-owned shares.
Regarding the literature, Qian (1995) provides a comprehensive discussion of corporategovernance issues in China. Groves et al. (1994) and Li (1997) present evidence that improvedincentives in the reform process increase the productivity of the firms. On the otherhand, Xu (2000) and Shirley and Xu (2001) show empirically that performance contractsare relatively ineffective. Qian (1996) and Che and Qian (1988) emphasize the importantrole played by the Chinese government in corporate governance. Zheng et al. (1998), Xuand Wang (1999), Zhang et al. (2001), Li and Wu (2002), Sun and Tong (2003), and Tian(2002) investigate the impact of state-ownership on enterprise performance and generallyfind a negative effect. For example, Sun and Tong (2003) consider the impact of share issuanceprivatization (SIP) and legal person shares on firm performance. They find that SIPis effective in improving SOEs’ earning ability, real sales, and workers’ productivity but
3 See also CLSA Emerging Markets (2001).
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it does not improve profit returns and leverage. They also find state ownership to have anegative impact and legal-personownership to have a positive effect on firm performance.
Aharony et al. (2000) show how earnings management in the financial packaging of China’sSOEs for public listing depends on the firm’s relationship with the central governmentand on where the securities are listed. In this literature, the studies of Xu andWang (1999),
Tian (2002), and Sun and Tong (2003) are related most closely to our work because theyare empirical studies using stock market data from China. Our contribution is to considera comprehensive list of corporate governance mechanisms and to investigate their impactson the market valuation of the firms. Hence, we assess the relative importance of variousgovernance mechanisms in increasing the market valuation. Furthermore, in contrast to Xuand Wang (1999) and Tian (2002), our study is based on a panel data set, which allows usto mitigate a possible endogeneity problem by estimating fixed-effects models.
Most empirical studies of the relationship between corporate governance and firmperformance in other countries focus on a particular aspect of governance, e.g., boardcharacteristics (Millstein and MacAvoy, 1998, and Bhagat and Black, 1999), shareholders’activism (Karpoff et al., 1996, and Carleton et al., 1998), compensation to outside
directors (Bhagat et al., 1999), anti-takeover provisions (Sundaramurthy et al., 1997), andinvestor protection (La Porta et al., 2002). Recently, several papers study the effects of generalcorporate governance practices on firm value, primarily in emerging markets. Most ofthese either use a small single-country sample (Black, 2001, and Gompers et al., 2003)or multi-country samples that contain only the largest firms in each country (Durnev and#p#分頁標題#e#
Kim, in press, and Klapper and Love, in press). Our paper is closest to the study by Blacket al. (2002) on Korean firms in the sense that all listed firms in the respective market areincluded. However, these authors use a different method to control for the endogeneity,namely instrumental variables.
Our paper is organized as follows. Section 2 reviews the theoretical literature on corporategovernance and summarizes major governance mechanisms. Section 3 discussesthe variables used in our empirical study. Section 4 presents the econometric analysis andSection 5 concludes with a summary of the results and policy implications.
2. Corporate governance mechanismsOver three hundred years ago, Adam Smith raised the issue of the separation of ownership
and stewardship in joint-stock corporations. Hence, a set of effective mechanisms toresolve the conflict of interests between the firm’s owners and its managers is necessary.
The seminal work by Berle and Means (1932) argues that, in practice, managers of a firmpursue their own interests rather than the interests of shareholders. The contractual natureof the firm and the principal-agent problem highlighted by Berle and Means led to thedevelopment of the agency approach to corporate finance. Allen and Gale (2001) addressthe issue of shareholders ensuring that non-ownermanagers pursue the shareholders’ interests.
However, another conflict of interests arises as controlling shareholders take actionsto benefit themselves at the expenseof minority shareholders. La Porta et al. (1998) assert
that the central agency problem in large corporations is to restrict expropriation of minorityshareholders by controlling shareholders. This expropriation takes a variety of forms,
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e.g., excessive executive compensation, loan guarantees for, and transfer pricing between,related companies, and dilution by new share issues. Johnson et al. (2000) use the termtunneling to describe the transfer of resources out of firms for the benefits of controllingshareholders. Evidence from the Asian financial crisis indicates that tunneling is a serious
agency problem in emerging markets. The recent debacles of Enron, Worldcom, andGlobal Crossing suggest that tunneling is possible even in mature economies. Taking thesevarious agency problems into account, Denis and McConnell (2003) consider corporategovernance to be the set of mechanisms, both institutional and market based, that induce
the self-interested controllers of a company to make decisions that maximize the value ofthe company to its owners. Practitioners share the view; e.g., TIAA-CREF defines corporategovernance as the set of mechanisms that maintain an appropriate balance between therights of shareholders and the needs of the board and management to direct and manage
the corporation’s affairs (TIAA-CREF, 2004).In essence, good corporate governance consists of a set of mechanisms to ensure thatsuppliers of finance get an adequate return on their investment. There are two competingviews of the appropriate type of corporate governance, namely the market-based approachused in the US and the UK and thecontrol-based model found commonly in emergingeconomies and in continental Europe. The market-based governance model consists of anindependent board, dispersed ownership, transparent disclosure, active takeover markets,#p#分頁標題#e#
and well-developed legal infrastructure. In contrast, the control model emphasizes an insiderboard, a concentrated ownership structure, limited disclosure, and reliance on familyfinance or the banking system. Academic research comes to mixed conclusions regardingthe relative superiority of either type. Rather than rendering judgment on which of the twomodels is better suited for China, we focus on a particular set of corporate governancemechanisms and assess their impact on the market valuation of listed companies.
Broadly speaking, there are two classes of mechanisms to resolve the conflict betweenowners and managers and between controlling shareholders and minority shareholders.4
The first type consists of internal mechanisms, e.g., the ownership structure, executive
compensation, the board of directors, and financial disclosure. The second are externalmechanisms, e.g., the external takeovermarket, the legal infrastructure, and productmarketcompetition. Of the four internal governance mechanisms, ownership structure is crucialo the firm’s value maximization. Concentrated equity ownership gives the largest shareholderssubstantial discretionary power to use the firm’s resources for personal gain at the
英國dissertation網提供英國留學生MBAdissertation代寫expense of other shareholders. Claessens et al. (2000) find that cross-holding and pyramidalownership are common in Asian economies. This ownership arrangement allows thecontrolling shareholders to obtain even more control for minimal capital expense so thattunneling becomes easier.
Although cross-holding, pyramidal schemes and deviations from one-share-one-voteare not common in China, listed companies usually have one major owner holding a significantpercent of the shares.5 Hence, the transfer of resources out of listed companies
4 Although many different governance frameworks exist, our approach is similar to that used in recent researchon corporate governance, e.g., CLSA Emerging Markets (2001), McKinsey & Company (2002), and Allen andGale (2001).
5 On average, the largest shareholder in listed companies holds 44.8% of the total shares.
604 C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616into parent or other related parties’ accounts is feasible. Several recently disclosed corporatescandals in China concern unconstrained large shareholders misusing firm resources.6
On the other hand, ownership concentration may have a positive effect on corporate governance.
If ownership is initially dispersed, the emergence of a large shareholder mitigatesthe free-rider problem among shareholders attempting to monitor the managers (Shleifer
and Vishny, 1986). However, this effect is negligible in China because ownership is seldomdispersed. We posit a second salutary effect of ownership concentration, which becomes
significant when the degree of concentration is high.#p#分頁標題#e#
Tunneling is inefficient for the entire group of shareholders because it wastes resources.
If the largest shareholder has a sufficiently big stake to align his interest with that offirm, the largest shareholder has no incentive to engage in inefficient tunneling. In summary,the relationship between firm value and ownership concentration is complex. Atfirst, increasing ownership concentration from a low level addresses the free-rider problemamong shareholders so that it has a positive effect. However, a further increase in ownershipconcentration has a negative effect if it reduces the constraint on tunneling from
other shareholders. Finally, as ownership concentration approaches one-hundred percent,the effect becomes positive again because the incentive to tunneling is removed. Without
the last effect, the relationship between firm value and ownership concentration would beinverse U-shaped, as Morck et al. (1988) find for US firms. In China, the second effect islikely to dominate and the first effect is negligible. Hence, we expect to find a U-shapedrelationship between firm value and ownership concentration among Chinese firms. Such aresult should hold even if the largest shareholder is the government because, contrary to theview of a benevolent government, agents who control the firm on behalf of the governmenthave incentives to expropriate. Tian (2002) makes a similar argument for a U-shaped relationshipby contrasting two characteristics of the government, namely, the grabbing handand the helping hand.
The board of directors is a second instrument through which shareholders can exert
influence on the behavior of managers to ensure that the company is run in their interests.However, this influence may be less effective when managers dominate the board.Nonetheless, empirical findings on the relationship between board composition and firmperformance are mixed. First, firms with boards containing a majority of independent directors
do not perform better than firms without such boards. Second, a moderate numberof inside directors is associated with greater profitability. Third, although the presenceof outside directors on the board has no effect on the sensitivity of Chief Executive Office(CEO) turnover to either earnings or stock-price performance in Japan, concentrated equityownership and ties to a main bank do have a positive effect. Finally, a strong inverse relationshipbetween CEO turnover and firm performance exists in some countries as Hermalinand Weisbach (2003) discuss in their survey. Therefore, we have no prior expectation onthe effect of board composition on firm value.
The third mechanismto align the interests ofmanagers and shareholders is appropriatelystructured managerial compensation, linked to both stock valuations and accounting-based
6 A recent survey conducted by the Shanghai-based Shenying and Wangguo Securities Co., Ltd. finds that the
controlling shareholders of 130 surveyed companies owe these companies $40 million, on average, in the form#p#分頁標題#e#
of accounts receivables or parent borrowing (Caijing, June 2002).
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616 605
performance measures. Although most empirical studies are constrained by data availability,
Murphy (1999) finds a positive relationship between executive pay and performance
in the US, Germany and Japan. Finally, financial transparency and adequate information
disclosure are crucial in developing countries. Sufficient, accurate and timely information
regarding the firm’s operations, its financial status, and the external environment is
important for shareholders to be able to monitor the firm, to make investment decision affecting
the firm, and to exercise control over the firm through other means. Bushman and
Smith (2001) survey the relationship between financial accounting information and corporate
governance. Therefore, we expect to see more value in firms that link managerial
compensation to performance and pursue actively financial transparency and information
disclosure.
Among the external mechanisms, an active market for corporate control is considered
to be essential for the efficient allocation of resources. This market allows able managers
to gain control of sufficient shares in a short period of time to remove inefficient managers.
Proxy fights are not usually successful in deposing the existing board of directors
because share holdings are often dispersed among small shareholders. Friendly mergers
and takeovers occur in all countries and account for most of the transactions in the market
for corporate control. In developed countries, the percentage of these activities ranges from
60 to 90. Hostile takeovers occur fairly frequently in the US and the UK, but much less
so in Germany, France and Japan. Empirical studies suggest that takeovers increase significantly
the market value of target firms, although the gain for bidding firms is zero and
possibly even negative. Studies using accounting data find that changes and improvements
in operations can explain partially takeover premiums (Shleifer and Vishny, 1997).
A series of studies by La Porta et al. (1997, 1998, 1999, 2002) emphasize the role
played by the legal framework and legal foundation in disciplining managers and controlling
shareholders’ opportunistic behavior. These authors find that, in countries with
common law tradition, governance standards are generally higher and minority shareholders
are better protected. In contrast, countries pursuing continental law systems normally
have poor minority shareholder protection and lower governance standards. Interestingly,
they find that cross-country differences in equity valuation, the cost of capital, and the
magnitude of external financing are explained by a country’s legal origin. Obviously, legal
infrastructure is an effective externalmechanism to ensure that investors get a fair return on#p#分頁標題#e#
their investment. Chinese listed companies are regulated by a uniform legal system; hence,
this external mechanism plays no role in explaining cross-sectional differences in governance
practices. However, many Chinese companies do list shares on stock exchanges for
which different jurisprudences prevail, e.g., H shares and ADRs.
Finally, competition in productmarket can be a powerfulmechanism for solving agency
problems. If the managers of a firm waste resources, the firm will eventually fail. Hence,
increased competition reduces managerial slack and limits efficiency losses. Moreover,
product market competition curtails the tunneling activities of the controlling shareholder.
In summary, good corporate governance protects shareholders and ensures that investors
get a fair return on their investment. In the next section, we investigate how these mechanisms
promote good corporate governance and increase market valuation of listed firms in
China.
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3. Quantifying corporate governance mechanisms and market valuation
We begin this section by quantifying some measures of corporate governance. Starting
with ownership variables, we denote the stake of the largest shareholder as top1. We use
this variable to measure both the largest shareholder’s interest in a company and also the
largest shareholder’s power on the board. As discussed above, we expect the relationship
between a firm’s market valuation and this variable to be U-shaped, although it should be
negative if we restrict the relationship to be linear. In addition, we consider a dummy variable
that equals 1 if a firm has a parent company and 0 otherwise and denote this as parent.
If the largest shareholder of a listed company is a firm, the scope for tunneling is large
because a company has more channels available than does an individual. The parent company
can expropriate other shareholders through various business dealings with the firm or
by connected transactions. Of these, the most commonly observed are loan guarantees for
related companies, manipulated transfer prices, and the dumping of non-performing assets
from the parent company to the listed company.
With respect to the board of directors, we create a dummy variable that equals 1 if
the CEO is the chairman or a vice chairman of the board of directors and 0 otherwise
and denote it ceo_is_top_dir. The monitoring role of board of directors is compromised
when a CEO controls fully or partially the board. Therefore, we expect this variable to
have negative impact on a company’s market valuation. To measure the degree of outside
control of the board, we take the ratio of the number of directors who are not members of
the management team and denote it out_ratio. If the board is dominated by members of the#p#分頁標題#e#
management team, we do not expect it to play an effective monitoring role.
Regarding executive compensation, we note that stock options are rare in China. Furthermore,
the information on executive pay is not complete and often inaccessible. Hence,
we choose the following alternative variable to capture the alignment of interests between
the managers and the shareholders.We define the top executives of the firm to be its CEO,
the executive vice presidents, the chairperson and the vice chairpersons of the board of
directors. We take the percentage of shares held by these top executives and denote it
top_shares as a measure of their economic interests in a company. The interests of the top
managers are better aligned with the interests of shareholders if they have a larger stake in
the firm.
Regarding financial transparency, most listed companies in China are audited by local
accounting firms but no reliable information exists to determine which accounting firms
are more reputable. However, companies that issue H shares, which are traded on the Hong
Kong Stock Exchange, or B shares, which are open mainly to foreign investors in domestic
stock exchanges, must adopt international accounting standards.We take a dummy variable
that equals 1 if a company has H shares traded in the Hong Kong Stock Exchange or
B shares traded in Shanghai or Shenzhen stock exchange and 0 otherwise and denote it
hbshare.
Turning to the external mechanisms, we measure the market for corporate control by
the concentration of shares in the hands of the second to the tenth largest shareholders.We
take the natural logarithmof the sum of squares of the percentage points of shareholding by
the 2nd to the 10th largest shareholders and denote it cstr2_10. This variable should have
a positive effect on firm valuation for three reasons. First, large shareholders other than the
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616 607
largest one are obstacles to tunneling activities by the largest shareholder because these
shareholders have incentives to monitor and restrain the largest shareholder. Second, the
efficiency of the market for corporate control is enhanced because these large shareholders
can either initiate a fight for corporate control or assist an outsider’s fight for control
when the existing management underperforms. Third, these large shareholders have an incentive
to monitor the management directly. Therefore, the higher is the concentration of
shareholding in the hands of these large shareholders, the higher should be the value of the
firm.7
As explained above, the Chinese listed companies are regulated uniformly by Chinese
jurisprudences. However, companies that have issued H shares or B shares are subject to
stricter legal rules. Hence, the dummy variable hbshare can be viewed as a proxy for a#p#分頁標題#e#
better legal environment. With respect to product market competition, we do not have a
good measure for this mechanism. However, its effect on market valuation is ambiguous.
On the one hand, productmarket competition enhances corporate governance. On the other
hand, product market competition erodes the profitability of the firm. Hence, we make no
attempt to include this effect.
In addition to these seven measures of corporate governance derived from conventional
economic theory, we consider one final variable to indicate whether or not the controlling
shareholder is the government.8 We define a dummy variable that equals 1 if the government
is the controlling shareholder and 0 otherwise and denote it so_top1. The government
is likely to have goals other than profitmaximization, such as maintaining employment and
social stability. A controlling government stakeholder can use the listed company as a vehicle
to achieve these other policy goals even though they may conflict with shareholders’
interests (Bai et al., 2000). Therefore,we expect government control to have negative effect
on the firms’ market valuation.
Since we aim to study the impacts of corporate governance mechanisms on the market
valuations of the firms, we must define appropriate measures of market valuation.We take
the widely used measure of valuation for listed companies, namely, Tobin’s q. This measure
is normalized with respect to the size of the firm; details about the variable definition
are given in Appendix A. Another frequently used measure of firm valuation is the marketto-
book ratio of the firm’s total assets. Since Tobin’s q and the market-to-book ratio are
highly correlated having a correlation coefficient of 0.996 in our sample, we use only Tobin’s
q.When we used the market-to-book ratio in our empirical work, results were similar
to those with Tobin’s q.
7 The construction of this variable follows the Herfindahl index of industry concentration. As a robustness
check, we use the ratio of the total shareholding by the second to the tenth largest shareholders with respect to the
shares not held by the largest shareholder and the main results do not change. Using a sample of firms that are in
serious financial trouble and are hence given special treatment status and subject to more stringent regulation by
the securities regulatory agency, Bai et al. (2004) estimate that increased competition for the control over a firm
triggered by the special treatment status results in an average abnormal return of 31%. They also find that the
abnormal return is positively correlated to cstr2_10, implying that concentration of shareholding in the hands of
the second to the tenth largest shareholders enhances competition for the control over the firm and thus increases
its market valuation.
8 The state-controlling shareholder also includes legal-person shares that are controlled by various levels of#p#分頁標題#e#
governments.
608 C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616
One difficulty with these definitions is that a large proportion of shares of the listed firms
in China cannot be traded freely and therefore do not have market prices. No consensus
exists about how to compute the total market value of firms with a substantial percentage of
non-tradable shares. One straightforward approach is to use the price of the tradable shares
as a proxy for the price of the non-tradable shares, which we define as the variable Tq.
However, this method overstates the market valuation of the firm because non-tradable
shares should have a lower price than the tradable ones. Chen and Xiong (2002) find that
the non-tradable state-owned shares and legal-person shares in China have an average illiquidity
discount of between 70 to 80% when they are traded on informal markets. Hence,
we define two additional valuation measures: Tq_70 is computed by taking a 70% discount
and Tq_80 is computed by taking an 80% discount for non-tradable shares. These
discounted measures may reflect better the market valuation of China’s listed firms.
Our data source is China Stock Market & Accounting Research Database (CSMAR),
compiled by The University of Hong Kong and GTA Information Technology Company
Limited in Shenzhen according to the format of CRSP and Compustat. The sample includes
all listed companies on both the Shanghai and Shenzhen Stock Exchanges between 1999
and 2001. Because information about whether a firm has a parent company is available
only for 2000, we use only firms that had been listed by that year. Therefore, the sample
size for year 2001 is the same as that for year 2000. Table 1 reports the summary statistics
for the eight corporate governance variables.
The largest shareholder in each firm holds a significantly large stake as the mean of
the top shareholder’s holding is 44.8% and the highest value is 88.6%. A large majority
(79%) of the publicly listed firms in China have a parent company. More than one third
of the CEOs are also either the chairman or a vice chairman of the board of directors,
which impedes the board from playing an effective monitoring role. The proportion of
outsider directors on the board is surprisingly high, with a mean of 70.6% and a standard
deviation of 18.3%. Top managers typically own very little of their companies’ shares, on
average only 0.1%. Themean and the standard deviation for the concentration of the second
to the tenth largest shareholders are −5.98 and 2.72, respectively.9 Neither dual listing
nor multiple listing is common for Chinese firms as the average proportion of companies
issuing H or B shares is about 10%. Finally, over 50% of companies are controlled by the
government. The correlation coefficients among the eight corporate governance variables#p#分頁標題#e#
are given in Table A1. Only one pair of variables has a correlation coefficient greater than
0.5, namely top1 and cstr2_10, and this is negative as one would expect.
The summary statistics for the valuation variables are given in Table 2. If non-tradable
shares are not discounted, the publicly listed firms are highly valued by shareholders. The
overall mean value of Tobin’s q, at 2.99, is significantly higher than the international norm.
However, if non-tradable shares are discounted, the average adjusted Tobin’s q values are
1.72 and 1.54, which are more comparable with those in other major stock markets. In the
following section, we present the regression results based on these corporate governance
variables.
9 The value of the concentration variable is negative because it is defined to be the natural logarithm of the
Herfindahl index of shareholdings and the Herfindahl index is less than 1.
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616 609
Table 1
Summary statistics for the governance variables
Year Variable No. of obs. Mean S. D. Min. Median Max
1999 top1 865 0.458 0.180 0.023 0.452 0.886
parent 865 0.790 0.408 0 1 1
ceo_is_top_dir 865 0.402 0.491 0 0 1
out_ratio 865 0.706 0.183 0 0.714 1
top_shares 865 0.001 0.004 0 0.000 0.109
hbshare 865 0.105 0.307 0 0 1
cstr2_10 865 −5.918 2.601 −13.476 −5.440 −1.771
so_top1 865 0.491 0.500 0 0 1
2000 top1 1020 0.450 0.178 0.021 0.446 0.886
parent 1020 0.786 0.410 0 1 1
ceo_is_top_dir 1020 0.329 0.470 0 0 1
out_ratio 1020 0.723 0.178 0 0.727 1
top_shares 1020 0.001 0.004 0 0.000 0.130
hbshare 1020 0.100 0.300 0 0 1
cstr2_10 1020 −6.005 2.780 −14.434 −5.421 −1.938
so_top1 1020 0.561 0.497 0 1 1
2001 top1 1020 0.439 0.178 0.019 0.432 0.850
parent 1020 0.790 0.407 0 1 1
ceo_is_top_dir 1020 0.314 0.464 0 0 1
out_ratio 1020 0.733 0.161 0.143 0.727 1
top_shares 1020 0.001 0.005 0 0.000 0.149
hbshare 1020 0.094 0.292 0 0 1
cstr2_10 1020 −5.993 2.767 −13.828 −5.356 −1.932
so_top1 1020 0.605 0.489 0 1 1
Total top1 2905 0.448 0.179 0.019 0.443 0.886
parent 2905 0.789 0.408 0 1 1
ceo_is_top_dir 2905 0.346 0.476 0 0 1
out_ratio 2905 0.722 0.174 0 0.727 1
top_shares 2905 0.001 0.005 0 0.000 0.149
hbshare 2905 0.099 0.299 0 0 1
cstr2_10 2905 −5.975 2.723 −14.434 −5.416 −1.771
so_top1 2905 0.556 0.497 0 1 1
Table 2
Summary statistics for the valuation measures
Year Variable No. of obs. Mean S. D. Min. Median Max
1999 Tq 865 2.574 1.385 0.576 2.260 13.379
Tq_70 865 1.462 0.780 0.309 1.306 8.569
Tq_80 865 1.303 0.711 0.220 1.154 7.882
2000 Tq 1020 3.645 2.049 0.880 3.219 18.342
Tq_70 1020 2.076 1.134 0.500 1.802 10.438#p#分頁標題#e#
Tq_80 1020 1.852 1.022 0.396 1.606 9.309
2001 Tq 1020 2.689 1.864 0.682 2.202 25.744
Tq_70 1020 1.576 1.233 0.317 1.302 21.437
Tq_80 1020 1.417 1.158 0.241 1.166 20.822
Total Tq 2905 2.990 1.870 0.576 2.519 25.744
Tq_70 2905 1.717 1.113 0.309 1.463 21.437
Tq_80 2905 1.536 1.022 0.220 1.315 20.822
610 C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616
4. Empirical results on corporate governance and market valuation
In this section, we investigate empirically the effects of the chosen corporate governance
mechanisms on the market valuation of the firms.We use three different measures of
market valuation, namely Tq, Tq_70, and Tq_80, as dependent variables. The explanatory
variables include the eight corporate governance variables, together with size, the leverage
ratio, the capital-sales ratio, the operation income-sales ratio, and industry dummies as
control variables.We choose control variables that are used in corporate valuation studies,
e.g., Cho (1998) and Joh (2003). As a proxy of firm size, we take the natural logarithm of
main operating income and denote it ln_sales. We include the capital to sales ratio, calculated
as the ratio of the book value of total tangible assets to total sales, and denote it k_s.
In addition, we use the operating income to sales ratio, defined as the ratio of operating
profit divided by total sales and denoted y_s, and the leverage ratio, defined as the ratio
of the book value of debt to the book value of total asset and denoted leverage. Finally,
we include industry dummies, which are defined according to the industrial classification
of the Chinese Security Regulatory Commission (CSRC). All listed firms are classified
into sixteen industries; we take agriculture to be the reference industry. After controlling
for these effects, we identify the impact of corporate governance variables on market valuation.
In the estimations, we also include the square term of the variable top1, denoted
top1_sq, because the relationship between market valuation and the percent of shares held
by the largest shareholder is expected to be non-linear.
We estimate both a fixed-effects model and a random-effects model using the threeyear
panel data set. The fixed-effects model mitigates, but does not necessarily eliminate,
the endogeneity problem. However, some of the corporate governance variables are timeinvariant
so that their influence cannot be estimated by a fixed-effects model. On the other
hand, the random-effectsmodel does allowus to estimate the impact of these time-invariant
variables. Table 3 presents the results for the fixed-effect models using the three variants
of Tobin’s q as dependent variables.
As Table 3 indicates, the effect of the shareholding of the proportion of shares held by
the largest shareholder is non-linear. The coefficient of top1 is negative and statistically#p#分頁標題#e#
significant and the coefficient of top1_sq is positive and statistically significant. Hence, we
find the expected U-shaped relationship between a firm’s market valuation and the proportion
of shares held by its largest shareholder. In addition, the higher is the degree of
concentration among other large shareholders, the higher will be the firm’s market valuation.
Hence, potential competition for corporate control and the constraints imposed by
other large shareholders on the largest shareholder’s aspiration to tunnel are important determinants
of firm valuation. Moreover, if a company’s CEO is also a top director of the
board, the company’s valuation is reduced. However, the ratio of outside directors on the
board has no significant effect on the firm’s market valuation. Perhaps outside board members
are not really independent of the management in China’s listed companies. Finally,
we find that increasing the shareholdings of top managers may not be value enhancing in
China, perhaps because these shareholding are relatively small in the listed companies.
Among the four control variables, the size of the firm is negatively correlated with
Tobin’s q, indicating that smaller firms have higher valuation. The leverage ratio of the
firm has a statistically significant positive effect on firm valuation, for which we have no
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616 611
Table 3
Fixed effect estimation
Tq Tq_70 Tq_80
top1 −5.6123** −2.2581*
(2.339) (1.970) (1.857)
top1_sq 7.0036** 3.0115* 2.4412*
(2.519) (1.913) (1.733)
ceo_is_top_dir −0.2281** −0.1365** −0.1235**
(2.404) (2.541) (2.568)
out_ratio −0.0884 −0.0427 −0.0362
(0.324) (0.276) (0.261)
top_shares −0.3000 0.1561 0.2213
(0.024) (0.022) (0.035)
cstr2_10 0.0871** 0.0444** 0.0383**
(2.528) (2.276) (2.195)
ln_sales −0.4236*** −0.2329*** −0.2057***
(5.610) (5.448) (5.377)
k_s 0.0199 0.0050 0.0029
(1.223) (0.546) (0.352)
y_s −0.0014 −0.0065*** −0.0072***
(0.310) (2.589) (3.220)
leverage 1.8142*** 1.5115*** 1.4683***
(14.387) (21.168) (22.981)
Intercept 12.1278*** 6.5032*** 5.6997***
(7.565) (7.163) (7.017)
No. of obs. 2905 2905 2905
No. of firms 1051 1051 1051
Overall-R2 0.203 0.298 0.325
Between-R2 0.192 0.271 0.295
Within-R2 0.191 0.323 0.359
Note. The numbers in parentheses are t -statistics.
* Significance at the 10% level.
** Idem., 5%.
*** Idem., 1%.
explanation. The other control variables are not significant. In the second and the third
regressions, we use illiquidity-discount adjusted values of Tobin’s q and find results that
are mainly consistent with those in the first regression. One difference is that the coefficient#p#分頁標題#e#
of the operating income to sales ratio becomes statistically significant, for which we have
no satisfactory explanation. In summary, the results from the fixed-effects regression using
Tobin’s q are robust and mostly consistentwith the predictions from the theory of corporate
governance.
The estimation results of the random-effects models are reported in Table 4. The coefficients
of the corporate governance variables that appear in both the fixed-effects models
and random-effects models are qualitatively similar in both cases, although the non-linear
effect of the largest shareholder is less pronounced and all the control variables are highly
significant. The random-effectsmodel allows us to estimate the influence of time-invariant
variables. We find that listing a firm on the Hong Kong Stock Exchanges or trading in B
shares has a statistically significant positive effect on firm valuation. In addition, if the gov612
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616
Table 4
Random effect estimation
Tq Tq_70 Tq_80
top1 −0.9745 −1.0061* −1.0085*
(0.936) (1.702) (1.885)
top1_sq 3.6901*** 1.2479* 0.8980
(3.219) (1.917) (1.524)
parent −0.0959 −0.0251 −0.0150
(0.971) (0.448) (0.294)
ceo_is_top_dir −0.1694** −0.0958** −0.0857**
(2.454) (2.446) (2.430)
out_ratio 0.1568 −0.0006 −0.0229
(0.815) (0.005) (0.233)
top_shares 5.6239 4.0656 3.8308
(0.812) (1.034) (1.079)
hbshare 0.4624*** 0.3700*** 0.3553***
(3.631) (5.113) (5.411)
cstr2_10 0.1451*** 0.0333*** 0.0174*
(8.132) (3.284) (1.905)
so_top1 −0.1248* −0.0799** −0.0731**
(1.771) (1.997) (2.025)
ln_sales −0.6797*** −0.3612*** −0.3150***
(20.425) (19.117) (18.426)
k_s −0.0306** −0.0205*** −0.0187***
(2.361) (2.788) (2.839)
y_s −0.0192*** −0.0167*** −0.0162***
(4.837) (7.434) (8.026)
leverage 0.9522*** 0.9996*** 1.0134***
(9.617) (17.808) (20.063)
Intercept 16.5434*** 8.8120*** 7.6912***
(22.157) (20.788) (20.053)
No. of obs. 2905 2905 2905
No. of firms 1051 1051 1051
Overall-R2 0.329 0.388 0.409
Between-R2 0.388 0.417 0.430
Within-R2 0.159 0.303 0.341
Notes. 1. The Industrial Dummies are included but are not reported. 2. The numbers
in parentheses are t -statistics.
* Significance at the 10% level.
** Idem., 5%.
*** Idem., 1%.
ernment is the largest shareholder in a firm, Tobin’s q is significantly lower. Both of these
results confirm our theoretical predictions.
Some potential problems in interpreting these results should be mentioned. First, since
we have eight regressors, multicollinearity may be a problem. However, the pair-wise#p#分頁標題#e#
correlation coefficients of the main regressors are low and most of the regressors are statistically
significant. Second, a potential endogeneity problem exists; the fixed-effects model
mitigates but does not solve fully this issue.
C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616 613
5. Conclusion
We analyze empirically the impact of eight corporate governance measures on the market
valuation of listed firms in China with standard control variables included. We take
Tobin’s q, and its adjusted values for the illiquidity of the Chinese market, as measures
of market valuation.We use a three-year panel data set and estimate both fixed-effects and
random-effectsmodels. Consistent with theoretical predictions, we find that both high concentration
of shareholding among the second to the tenth largest shareholders and issuing
shares to foreign investors have statistically significant and positive effects on market valuation.
In addition, a large holding by the largest shareholder, the CEO being the chairman
or vice chairman of the board of directors, and the largest shareholder being the government
all have statistically significant and negative effects on Tobin’s q. Our results are
robust to the different measures of market valuation.
These findings have implications for both the security regulators and the listed companies
in China. Security regulators in much of the world, including both developed
and developing countries, recognize the importance of corporate governance in enhancing
firms’ investment values. Various best practice codes are imposed to improve a firm’s
overall governance standard. Our study sheds light on the relative importance of various
corporate governance practices; hence, it provides useful information to the Chinese regulatory
authorities to design best practice codes tailored to both the Chinese institutional
background and the current level of capital market development in China. In addition,
these results are a useful guide for firms that are designing their corporate governance
mechanisms to enhance their market valuation and, thus, provide additional value to their
shareholders and reduce their future investment cost.
Acknowledgments
We thank two anonymous referees and especially John Bonin for their valuable comments
and suggestions, and Li Chuntao for his excellent research assistance. We acknowledge
financial support from the Center for China Financial Research (CCFR) in the Faculty
of Business and Economics of the University of Hong Kong.
Appendix A. Calculation of Tobin’s q
Tobin’s q is defined as10
T q = MVCS + BV PS + BVLTD + BVINV + BVCL − BVCA
BV TA
,
where MVCS is the market value of the firm’s common stock shares, BVPS is the book
value of the firm’s preferred stocks, BVLTD is the book value of the firm’s long-term debt,#p#分頁標題#e#
BVINV is the book value of the firm’s inventories, BVCL is the book value of the firm’s
10 We follow Chung and Pruitt (1994) in this definition.
614 C.-E. Bai et al. / Journal of Comparative Economics 32 (2004) 599–616
Table A1
Correlation coefficients between governance variables
top1 parent ceo_is_top_dir out_ratio top_shares hbshare cstr2_10
parent 0.3926
(0.0000)
ceo_is_top_dir −0.0844 −0.1025
(0.0000) (0.0000)
out_ratio −0.0725 0.0339 −0.3534
(0.0001) (0.0678) (0.0000)
top_shares −0.0347 0.0076 0.0396 −0.0273
(0.0614) (0.6840) (0.0326) (0.1414)
hbshare −0.0410 0.0340 −0.0384 −0.0018 0.0118
(0.0273) (0.0666) (0.0385) (0.9208) (0.5264)
cstr2_10 −0.6745 −0.2471 0.0292 0.1198 0.0311 0.0908
(0.0000) (0.0000) (0.1154) (0.0000) (0.0933) (0.0000)
so_top1 0.2155 0.0070 0.0265 −0.0784 −0.0532 0.0265 −0.1813
(0.0000) (0.7055) (0.1535) (0.0000) (0.0041) (0.1539) (0.0000)
Note. The p-values are in parentheses.
current liabilities, BVCA is the book value of the firm’s current assets, and BVTA is the
book value of the firm’s total assets. Because no preferred stock exists in China, the above
formula reduces to
T q = MVCS + BVLTD + BV INV + BVCL − BVCA
BV TA
.
In addition, we adjust the measurement of Tobin’s q to take account of illiquidity discounts
of 70 and 80% in the Chinese market. Specifically, we multiply the amount of
tradable shares by the market price and the amount of non-tradable shares by 30 and 20%
of themarket share price respectively to obtain the value of equity in the Tobin’s q formulae
denoted by Tq_70 and Tq_80, respectively.

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