Independent directors are an integral part of corporate governance. Despite the copious scholarly debates surrounding board independence, little progress has been made in studying the inner workings of public boards. Taking China as an empirical site, in our paper, Independent Directors’ Dissent on Boards: Evidence from Listed Companies in China, which was recently made publicly available on SSRN, we offer one of the first statistical investigations of the circumstances under which so-called “independent” directors voice their independent views. Unlike most of the previous models that view boards as a monolithic entity that “shares a common agenda on all matters” (Hermalin and Weisbach, 2003), our data allow us to see boards as consisting of individuals with different utility functions and to examine board behaviors at the individual director level. We view this as the first step in a long research journey.
Posts Tagged ‘China’
In the paper, The Sensitivity of Corporate Cash Holdings to Corporate Governance, forthcoming in the Review of Financial Studies, my co-authors (Qi Chen, Xiao Chen, Yongxin Xu, and Jian Xue) and I analyze the change in cash holdings of a large sample of Chinese-listed firms associated with the split share structure reform that required nontradable shares held by controlling shareholders to be converted to tradable shares, subject to shareholder approval and adequate compensation to tradable shareholders. The reform removed a substantial market friction and gave controlling shareholders a clear incentive to care about share prices, because they could benefit from share value increases by selling some of their shares for cash.
We predict and find that this governance improvement led to reduced cash holdings of affected firms, and that the effect is more pronounced for private firms than for state-owned enterprises (SOEs), for firms with more agency conflicts, and for firms for which financial constraints are most binding. We interpret these results as consistent with both a direct free cash flow channel and an indirect financial constraint channel. These results are robust to several alternative specifications that address concerns about endogeneity and concomitant effects. They provide strong evidence that governance arrangements affect firms’ cash holdings and cash management behaviors. To the extent that cash management is a key operational decision that affects firm value, our findings suggest an important mechanism for corporate governance to affect firm value.
I recently returned from a trip to Beijing, where I launched the Mandarin translation of a book that I co-authored with Theresa Hamacher entitled The Fund Industry: How Your Money is Managed.
The book was translated because the Chinese fund industry is expanding rapidly; Chinese mutual funds were introduced in 2001 yet held over $340bn in assets by the end of 2011.
However, the future development of the Chinese fund industry faces a stiff headwind. In China, most retail investors buy mutual funds hoping to score a quick short-term gain, rather than to generate long-term returns. The high turnover is usually costly to investors and stunts the development of the fund industry.
The short-term mentality of Chinese investors is reinforced by the fund industry, which spews forth an incredible number of new funds each year. Though fewer than 1,000 mutual funds exist in China, the industry launched 136 new funds in 2010 alone.
This flood of new funds is partly caused by large up-front commissions on fund sales paid to distributors, who also receive smaller fees on an annual basis. To collect these up-front commissions, distributors hype the new funds and investors rush to buy. But these investors hold for a relatively short time – until the next wave of new funds.
As a result, there are very few large funds in China that attract assets through long-term performance. One helpful reform would be to reduce up-front commissions on fund sales and put more emphasis on annual trailer fees that are collected only as long as shareholders remain in the fund.
In the paper, The Need for Both Strong Regulators and Strong Laws: Evidence from a Natural Experiment, which was recently made publicly available on SSRN, I analyze whether strong law is effective in the presence of weak regulatory institutions. This is a live-issue for policy setters as they attempt to reform the financial system to prevent future market misconduct. This has become particularly relevant as the EU has attempted to reform securities laws under the Markets in Financial Instruments Directive (MiFID), and the regulation of financial markets in the US has sustained recent criticism. I use a difference-in-difference methodology to disentangle the effects of the design of news laws from their actual implementation, and I find that strong law in the presence of weak regulations might actually worsen market conditions. This provides additional empirical support for the prediction in Bhattacharya and Daouk (2009) that ‘no law’ can sometimes be better than ‘good law’. This also suggests that empirical law and finance work should carefully distinguish between the mere presence of laws, and their enforcement.
The Federal Reserve’s decision this week to confer Comprehensive Consolidated Supervision (“CCS”) status to three state-owned Chinese banks has been long awaited and paves the way for major Chinese banks to enter retail commercial banking in the United States by acquiring U.S. banks. We view the Federal Reserve’s decision, which is the first CCS determination with respect to a major jurisdiction in nearly 10 years, as encouraging for banks from other emerging economies that wish to expand their activities in the United States by acquiring U.S. banks or electing to become financial holding companies (“FHCs”). Since many developed economies have attained CCS status, the key markets that might, over time, indirectly benefit from the China CCS determination include Dubai, India, Malaysia, Saudi Arabia, Singapore and South Africa. Brazilian and Mexican banks already benefit from earlier CCS determinations. There are, however, a few lessons to be learned from the Chinese experience, which we take to mean that CCS determinations will require patience and persistence. These lessons are:
- A willingness on the part of the Chinese government and major Chinese banks to make the CCS determination a policy priority across a range of trade, economic and strategic relationships;
- A willingness to invest in smaller U.S. community and regional banks by Chinese banks with a traditional commercial banking profile;
- A strong, reciprocal desire by U.S. financial institutions to enter or expand their presence in the Chinese market;
- A determined effort on the part of the Chinese government and Chinese regulatory authorities to enhance their overall supervisory framework, as well as their anti-money laundering controls; and
- An appreciation that, in today’s environment, CCS determinations may be incremental and more likely to be made on a bank-by-bank basis (or at least with respect to similar banks in the same country).
The 2005 split-share reform allowed for restricted stocks worth hundreds of billions of dollars to become tradable over a short period, sharply increasing liquidity in the Chinese stock market. In our paper, Is the Stock Market Just a Side Show? Evidence from a Structural Reform, which was recently made publicly available on SSRN, we use this episode as a way to flesh out links between stock market activity and real business activity.
We evaluate the impact of the 2005 reform exploiting various institutional features associated with its implementation. One of such feature is a pilot experiment conducted at the beginning of the reform schedule. Another is the gradual, large-scale share conversion that took place within a 16-month window. These features are unique and present both opportunities and challenges for our empirical tests. It is possible, for example, that better-managed firms were chosen to participate in the pilot trial that initiates the conversion program because of political motivation to showcase the reform. In addition, after the pilot stage, firms were free to join the reform at the time of their choosing. Thus, the treatment assignment might also be endogenous due to self-selection. To minimize these concerns, our analysis employs quasi-experimental methods that make the outcome variation before and after conversion conditionally independent from the compliance date.
Last week, Industrial and Commercial Bank of China announced that it had entered into an agreement to purchase 80 percent of the outstanding common stock of the U.S. subsidiary bank of The Bank of East Asia, Limited, a privately held Hong Kong-based bank. Bank of East Asia also has an option to sell to ICBC its remaining 20% interest in the U.S. bank for a period of 10 years following the acquisition. Although relatively small in size, this transaction is a most significant precedent. The ICBC deal would mark the first control acquisition by a mainland Chinese bank of a U.S. bank since Congress passed a law in 1991 substantially tightening the regulation of foreign banks operating in the U.S. following the collapse of BCCI. The transaction could be the start of a very significant new dynamic in U.S. bank M&A.
In the paper Bank Loans with Chinese Characteristics: Some Evidence on Inside Debt in a State-Controlled Banking System, forthcoming in the Journal of Financial and Quantitative Analysis, we study the process of bank lending to corporations in a transitional environment. A simple model of a pooling equilibrium suggests that both negative and positive announcement effects are possible, depending on whether the banking system is run on purely commercial terms or is subject to political goals. Empirical results are based on a sample of large loans from Chinese banks to listed Chinese borrowers. We find that poorly performing firms are more likely to receive bank loans, and these loans appear intended to keep troubled firms afloat as subsequent long-run performance is typically poor. Stock values for Chinese borrowers typically decline significantly around bank loan announcements. Furthermore, these negative announcement effects are heightened for borrowers with frequent related-party transactions, poor subsequent performance, high state ownership, no foreign class shares, loans from local bank branches, or loans intended to repay existing debt. Thus, the Chinese stock market appears to understand corporate performance and what these loans mean, and responds accordingly, in contrast to the widely-held perception that it is inefficient.