Economics Essay Paper on Factors Affecting the Corporate Governance Efficiency

Factors Affecting the Corporate Governance Efficiency

Chapter 1: Introduction

  1. 1.1          Chapter Introduction

This chapter shall give a general introduction to the research topic by giving the background to the study. In addition, the chapter shall elucidate the aims and specific objectives of the study. The justification for carrying out this research will also be provided, and there shall be a brief discussion of the research design and approach that will be used. Finally, the chapter shall conclude with an overview of the structure of the dissertation.

  1. 1.2          Background to the study

            The term corporate governance is relatively new within the business lexicon (Cheffins 2013). The term came into the mainstream in the 1970s, and in the subsequent years, the subject of corporate governance has been extensively debated by a wide variety of stakeholders including academics, investors, executives and regulators. Currently, the term corporate governance is well entrenched in academic and regulatory circles. In tracing the evolution of corporate governance, Grant (2003) states that corporations, as they are currently known, originated from England after an 1844 Act allowed corporations to define their own purpose and trade as for profit ventures. After being established in the USA, Monks and Minnow (2002) state that they expanded and grew tremendously, transforming commerce and having a profound effect on all aspects of American life. The industrial revolution contributed significantly to the business incorporation mainly due to demand for tremendous amounts of capital. According to Monks and Minnow (2002), the principles of entrepreneurship and free enterprise prevalent in the USA made available an ideal climate for the growth of corporations.

According to Grant (2003), the ground for corporate governance was put in place in the 19th century when legislation provided for the structure for corporate responsibility to shareholders. As a theory, corporate governance is relatively broad, covering the alignment of shareholder and management interests. Levitt (2002) define corporate governance as that connection existing among the board of directors, the team of management and the shareholders of a corporation. The foundation of ideal corporate governance is open and honest communication between the three groups. Monks and Minnow (2002), state that the corporation is the best form for large enterprise due to its internal accountability that engenders trust, which helps to hold management responsible and accountable to shareholders. In advancing the stakeholder theory, Freeman (1984) suggests that corporations primarily exist to cater to the interests of stakeholders. Schilling (2000) states that the term shareholders includes a broad gamut of business constituents including shareholders, company employees, management, suppliers, clients, competitors and the community.

            Although the term corporate governance has become popular in the recent times, it is not a completely novel idea as it based on a similar concept, the agency theory that originated with the acquisition of corporate power by management in the early 20th century. Jensen and Meckling (1976) describe agency as an association where a person or persons called the principal appoint somebody else (the agent) to transact some activities on their behalf. This relationship entails the delegation of decision-making ability by the principal to the agent. A study of history shows repeated instances where corporations over-reach their limits leading to social turmoil (Grant, 2003). Growth in shareholder value and wealth increase in the 1990’s saw the illusion of good corporate governance prevail among many observers (Bianco 2002). However, the 2001 stock market crash brought back the reality that the good governance thought to exist was a mirage rather than a reality. In addition, the Asian financial crisis of 1997-1998 showed that emerging markets were equally at risk from poor corporate governance practices (Johnson et al., 2000; Lemmon and Lins 2003). Khatri et al. (2006) suggest that corporate financial scandals that have occurred in large corporations like Enron, Arthur Andersen and others show that there is a need to critically re-examine corporate accountability and where possible strengthen provisions of corporate governance.

            Lehuede et al. (2012) state that the financial turmoil that struck financial institutions in 2007 led to the deterioration of the global economy fundamentals. The crisis also led to the erosion of trust in market sustainability, bank solvency and credibility of monetary unions and some sovereign states (Gupta, Krishnamurti and Tourani-Rad 2013). In addition, the crisis, which is considered the severest financial crisis since the Great Depression, has led to a crisis in confidence in corporate governance. Although poor corporate governance was not the primary cause for the crisis, it also did not prevent the crisis from happening or escalating. However, case study analyses of failed banks show that poorly designed frameworks of corporate governance predisposed banks to vulnerability and possibility of collapse as the crisis unfolded (Financial Services Authority 2011). Most corporate frameworks used prior to the financial crisis involved giving executives stock options and equity participation in the belief that this will make the executive align their interests with those of the shareholders (Ladibo et al. 2008).

            Corporate governance exists primarily to protect shareholder value and to guard against unethical management practices. Therefore, the financial crisis can to some degree be credited to failing and downright collapse in corporate governance structures (Kirkpatrick 2009). Kirkpatrick (2009) states that the board is an area that is particularly weak in terms of composition and competence. An analysis of board performance after the crisis shows that some boards were largely ignorant of the risks facing the companies that they headed (Ladipo & Nestor 2009). This ignorance was instrumental in boards abdicating their responsibility of oversight and offering of guidance to management. In essence, management was free to do as it wished leading to indulging in overly risky behavior. The minimal guidance offered in the need and manner of risk disclosure in annual reports meant that company executives could run the company without due regard to process (Van Manen & de Groot 2009).

            In the recent past, there has been separation of ownership and management of the modern company, leading to the prominence of the idea of corporate governance (Prasanna &Menon 2012). The separation of ownership and management has led to agency problems and internal control issues due to the high cost of supervision, information asymmetry and hitchhiking psychology among others. Relying on external market governance mechanisms does not effectively constrain and control insiders, thus the importance of effective corporate governance (Peng& Cao, 2014; Lawrence 2010). The outbreak of the Asian financial crisis in 1997 sparked critical thinking among scholars and experts on corporate governance. One of the major causes of the financial crisis in these countries was a flaw in the corporate governance of companies, and hence improvements of corporate governance become an urgent problem that needed to be solved (Prasanna & Menon 2012). The more recent world financial crisis has led to intense concern about corporate governance (Solomon 2011).

            Corporate governance structures vary from country to country, and the corporate governance in China is no exception. There are many problems with the current status of corporate governance in Chinese companies including but not limited to untrue disclosure of information, violating of minority shareholders’ interests, senior executives’ defection, independent directors that do not function well and Boards of Supervisors that are a mere formality. Since the inception of the Chinese stock market, a number of listed companies have been designated as special treatment (ST) and then particular transfer (PT) on failing to return to profitability within a year. This has caused investors to suffer losses, and reflects the lack of corporate governance efficiency. Chinese corporate systems started late, and development of the market is incomplete. The regulatory regime is imperfect, and corporate scandals are commonplace due to the lack of efficiency of corporate governance.

            Improving the efficiency of corporate governance is not only fundamental to corporate governance, but also the core of corporate governance. Whether viewed from the longitudinal course of company development, or from the horizontal view of comparison of the company development with others, good corporate governance is a prerequisite to improving a company’s economic efficiency and enhancing the company’s competitive power. Corporate governance efficiency is affected by a confluence of factors. Some of the factors affecting corporate governance efficiency include ownership structure, board structure, and the debt structure and information disclosure, among others. Therefore, an analysis of the factors affecting the efficiency of corporate governance can provide useful recommendations to Chinese enterprises on how to improve their corporate governance efficiency.

  1. 1.3          Aims and Objectives

            The aim of this research is to determine which factors affect the efficiency of corporate governance, using the example of Chinese listed companies. 

Objectives:

The objective of this research shall be:

  • To explore the concept and measures of corporate governance, and factors affecting the efficiency of corporate governance;
  • To build and test a research model of the factors affecting the efficiency of corporate governance;
  • To make practical suggestions to the corporate governance of Chinese listed companies.

            A casual look at the history of corporations shows a repetitive cycle of corporations overextending themselves and causing serious social turmoil as they adversely affect the economic well being of the common person (Grant 2003). It remains the responsibility of governments to rein on rogue corporate behavior through regulations. The subject of efficiency of corporate governance, therefore, remains topical and relevant to regulators and academics. Through studying the factors that affect corporate governance efficiency, it is possible to come up with recommendations that can help in guiding policy formulation. It is necessary to protect investor assets if confidence in the integrity of the business environment is to be sustained.

            Although much has been done to improve corporate governance in China, a lot still remains to be done. Guo et al (2013) state that the Chinese government has done a lot to strengthen corporate governance in state-owned enterprises in a bid to incorporate and sustain international best practices. However the involvement of government in business does raise serious issues about the effectiveness of international corporate governance best practices (Guo et al. 2013). It is difficult for the state to be both an actor and impartial regulator of the market. This research is an attempt to elucidate the factors that affect corporate efficiency as a means of proposing a working model that can be adopted to enhance corporate governance efficiency.

  1. 1.5          Research Approach Followed

            The quantitative approach was to be used in this research, but difficulties in obtaining primary data that would be of significance were encountered. The quantitative approach would have allowed the establishment of the relationship between variables – the independent and dependent variable or variables. Since the purpose of this research is to determine the factors that impact the efficiency of corporate governance, in the circumstances, a qualitative approach shall be the most appropriate (Hopkins 2008). This research relied mostly on secondary data from credible sources which covered companies listed at the Shanghai Stock Exchange and Shenzhen Stock Exchange and were selected for analysis. To ensure that the findings are valid, the author limited data that had selection of companies to the manufacturing sector, and included data for all the companies, including those that are designated as ST or PT. The information obtained was then analyzed to determine whether the identified factors have significant impact on the efficiency of corporate governance.

  1. 1.6          Structure of the study

            This research dissertation looks at the factors which have an effect on the efficiency of corporate governance. It includes chapter 1 which serves as an introduction to the dissertation. Chapter 2 looks at the published literature on the subject while chapter three elucidates the research design and approach. Chapter 4 presents the data analysis while the last chapter contains the research conclusions, recommendations, limitations and future directions.

Chapter 2: Literature Review

2.1 Corporate governance

2.1.1 Concept of corporate governance

            In order to have a sound foundation for studying the efficiency of corporate governance, it is necessary to have a clear concept of corporate governance. According to Solomon (2011), the concept of corporate governance has a multi-angle and multi-level description. The concept of corporate governance is an important component of the modern enterprise system, and it can be defined in both a narrow and broad sense. It appears that the time is ripe for the concept of corporate governance to be entrenched in China (Clarke 2003). From a narrow perspective, corporate governance refers to the internal governance, including the board of directors, shareholders, the board of supervisors and the corporate governance structure constituted by the company’s management as well as the institutional arrangements constituted by the shareholders’ rights, board structure, ownership structure and other components (Donaldson 2010).

            Other scholars like Liu (1999) and Yin (1999) have proposed a Chinese definition of corporate governance. They consider corporate governance to be a system that regulates the relationships between parties that have an interest in a business organization. They consider the shareholders as the most important group. According to Clarke (2003), Chinese discourse on corporate governance is narrow, primarily focusing on agency problems within two main categories of firms: state-owned enterprises (SOEs) and listed companies, which Company Law designates as companies limited by shares (CLS). Corporate governance can be considered as mechanism for supervision, restraint and balance by the owner on a company operator. The primary goal of corporate governance is to ensure the maximizing of shareholders’ interests and regulation of executive behavior (Jensen 2010).

            In a broad perspective, corporate governance refers to a set of legal, institutional and cultural arrangements related to company control distribution and residual claims. Corporate governance is not strictly about directing and controlling, rather, it is about established structures for decision-making that determine the power individuals have on issues at particular occasions (Kaler 2002). These arrangements determine the corporate governance objectives, and determine the allocation of a range of issues between different members of the company, such as risks and benefits. Corporate governance, therefore, ensures that companies which are listed for public trading engage fairly and honestly with their different shareholders (Peters et al 2011). The broad corporate governance structure is considered to be specific to ownership arrangements. Broad corporate governance is not limited to the checks and balances between the owners and the operators but is also related to a wider range of stakeholders’ interest in the company (Ayuso, et al. 2014). Therefore, corporate governance refers to co-governance by various stakeholders through a series of formal, informal, internal and, or external mechanisms, in order to ensure the rationalization of the company’s strategic decision-making, and maximization of stakeholders’ benefits (Mallin et al 2005).

            Due to limitations in time and research skills of the researcher, the narrow concept of corporate governance was adopted for this research. This research assumes that each of external governance factors is established to study the internal governance factors influencing the corporate governance efficiency. The corporate governance efficiency model adopted for this research is limited to the efficiency of internal governance structures, assuming that the external factors are constant, and that the coordination and interaction of internal governance structures generate efficiency. Governance efficiency is usually measured by whether the established goals of corporate governance can be achieved, and the corporate governance objective is usually reflected in the maximization of shareholder wealth or maximization of corporate value (Erkens, Hung and Matos 2012). The corporate governance objectives can be expressed by the company’s operating performance. Therefore, the company’s performance of operations can be a measure of corporate governance efficiency. In this study, the company’s performance of operations is an alternative variable to the efficiency of corporate governance.

2.1.2 Measurement

            From the perspective of cost, revenue or value, corporate governance efficiency can be equivalent to the relationship between the company’s performance and governance mechanisms (Brav and Mathews 2011). From the existing research results, academic evaluation of the efficiency of corporate governance includes a variety of methods, and these evaluation methods, according to their ideas and content, can be grouped into three categories: profit category, the value category and the balanced scorecard category.

            The profit evaluation method is based on the gross revenue or gross profit rate a company generates. The assumption is that efficient corporate governance can enhance the company’s accounting profits (Giroud and Muller 2011). However, the profit evaluation method has some limitations: first of all, the profit evaluation method takes the maximization of accounting profit as the goal, which is not consistent with the modern corporate governance theory. Secondly, although accounting profits are easily measurable and manageable and the acquisition and calculation process is relatively easy, the profit target is a result of the accounting policy choices, and is highly dependent on the quality and accuracy of accounting information that is available. Therefore, this parameter is inevitably affected by a series of acts of earnings management, and is vulnerable to whitewash, arbitrary adjustments, and lacks objectivity and comprehensiveness (Hilb 2012). Therefore, the profit evaluation method that had been widely adopted in earlier studies, in recent years, is used as a complimentary tool of value evaluation methods.

            Value evaluation methods mainly use stock price, shareholder value, Tobin’s Q or Economic Value Added (EVA) as an evaluation index. These evaluation methods have been gradually developing accompanied by the development of financial management in the value of the company (Pham, Suchard & Zein 2011). Tobin’s Q ratio is equal to the ratio of market value to the replacement value, and its advantages are that it introduces the market value and the replacement value of the company’s capital, and thus indirectly introduces the right risk discount rate based on balance return, minimizing the errors between the tax laws and accounting practices (Perfect & Wiles 1994; Lewellen & Badrinath 1997). In addition, Tobin’s Q is, from the perspective of the market, suitable in evaluating the financial goal achievement extent of company value maximization, and thus became the choice of many scholars in the empirical study of evaluating corporate governance (Allayannis, Lel & Miller 2012). However, Tobin’s Q has some shortcomings, such as higher requirements on the capital market and the stock market. In addition, the calculation requires one to estimate the replacement value of the company. However, the replacement value is difficult to accurately measure, and it is difficult to calculate the q of a large number of untradeable legal person shares as well as state shares. Based on market conditions, Tobin’s Q is difficult to implement in the company’s internal management (Guenster, et al. 2011).Therefore, Tobin’s Q is only used in the empirical study at the later stage.

            Economic Value Added (EVA) is the economic profit obtained after deducting all of the capital costs including the cost of equity. Economic Value Added evolved from the residual income, and the primary goal is to evaluate the actual business performance of managers. It also helps to measure the value of the net increase in shareholder wealth created by managers within a specific period of time, with the goal being to maximize shareholder value (Balasubramanian, Black & Khanna 2010). EVA adjusts a number of accounting issues, and deducts the opportunity cost of all capital invested. In addition, it reduces the scope for financial manipulation, thus reflecting the actual ability of the companies to create value. Calculation of economic value added (EVA) is mainly from accounting data and it can be used in a variety of comprehensive management activities. EVA can help to establish a clear link between internal capital investment, corporate strategy, shareholder value and operational decisions. It is a useful evaluation tool commonly used in the theory and practice of corporate governance research.

            The most representative and balanced evaluation method is the balanced scorecard (BSC). BSC uses multiple parameters to evaluate the company’s operating performance, considerably simplifying the traditional profit or value evaluation methods. Balanced Scorecard takes into account both quantitative indicators and qualitative indicators from the company’s development vision. It then evaluates the operation efficiency of management in four areas including finance, internal processes, clients, and learning and growth (Creamer & Freund 2010). To control the corporate operation activities in the whole process of value creation has become the optimal choice of many companies’ strategic management practices. However, since the establishment of indicator system in the balanced scorecard depends on the company’s specific strategy and business processes, it is difficult to create a standard mode that can be applied to all companies. In addition, the linkage between the evaluation mechanism and incentive mechanism is not defined as clearly as economic value added. Thus, it is difficult to ensure that managers make decisions in accordance with the interests of all stakeholders to achieve the stated goal of corporate governance.

            The management evaluation methods and profit evaluation methods are susceptible to earnings management. In addition, goal orientation and operability is against the modern enterprise system in China. Due to the imperfect development of the Chinese capital market, the value evaluation methods such as stock price evaluation, Tobin’s Q and other indicators are difficult to apply. Balanced evaluation method represented by balanced scorecard is difficult to apply due to difficulties in formulating the standard mode that can be applied to all companies. Therefore, economic value added (EVA) that has the characteristics of rational objectives and effectiveness has become the optimal choice to evaluate the efficiency of corporate governance. In this research, the empirical study uses EVA as a measure of the efficiency of corporate governance.

2.2 Factors influencing the efficiency of corporate governance

2.2.1 Ownership structure

            Ownership structure refers to the composition and type of shareholding that a company possesses (Huafang and Jianguo, 2007). The ownership structure has a fundamental role in corporate governance, and is closely related to corporate governance efficiency (Connelly, et al. 2012). Under certain conditions, the ownership structure determines the company’s governance structure and some cases it is one of the decisive factors affecting the efficiency of corporate governance (Huafang and Jianguo 2007).  The ownership structure impacts on the efficiency of corporate governance through the adoption of international best practices and increased levels of voluntary disclosure (Huafang and Jianguo 2007).  A good ownership structure is the basis of efficient corporate governance (Bruton, et al. 2010). In this research, the author explores the relationship between ownership structure and corporate governance efficiency from two aspects – ownership concentration and balance.

            Although Berle and Means pioneered the study of the relationship between ownership concentration and corporate performance in the 1930’s, up to now, the academic community has yet to strike a consensus on the relationship between ownership concentration and corporate performance (Porta, et al. 2000). The study done by Berle and Means found that there is a positive correlation between ownership concentration and the efficiency of the company. When a company has dispersed ownership, there is a tendency for “free-rider” behavior, resulting in difficulties in the supervision of managers (Mizruchi 2004). The larger shareholders who have significant economic stake in the company have enough motivation and sufficient ability to monitor managers. The oversight provided by large shareholders reduces opportunism of managers to ensure that managers do not engage in activities damaging the interests of the shareholders (Sarkar and Sarkar 2000). Some scholars, such as Porta, et al. (2000) and Shleifer & Vishny (1997) support the view of Berle and Means that there is a significant positive correlation between ownership concentration and corporate governance efficiency.

            However, there are some scholars who believe that a dispersed ownership structure helps to improve corporate governance efficiency. Research done by Porta, et al. (2000) indicates that there is a serious conflict of interest between minority shareholders and controlling shareholders. On many occasions, major shareholders usually make decisions that are at the expense of minority shareholders’ interests. The major shareholders are motivated by the need to advance their own interests and maximize their returns. In the absence of external oversight, which can legislate for and enforce respect for all stakeholders’ interests, small shareholders rights are likely to be trampled indiscriminately. Therefore they believe that governance efficiency of companies with a dispersive ownership structure is superior to the companies with concentrated ownership structure (Byun, Lee and Park 2012). Although a number of studies have shown a correlation between ownership structure and efficiency of corporate governance, there are other studies which show that there is no significant correlation between ownership concentration and the efficiency of the company’s corporate governance (Mehran 1992).

            In the Western and other developed capital markets, there is a relatively complete legal system in place that protects the rights of investors (Tucker, 2014). The market regulators are more effective compared to Chinese regulators, and hence capital markets function efficiently. Western regulatory frameworks are clear and engender trust in the market due to greater transparency compared to the Chinese market (Pukthuanthong 2007). Therefore, in mature Western markets it is difficult to quantify the role of ownership structure in the changes of company value. From the literature reviewed, there is no clear and unequivocal evidence to indicate whether there is a significant correlation between ownership structure and corporate governance efficiency. However, the studies considered so far ware carried out in developed and mature capital markets. The Chinese circumstances may be different due to the immature capital market.

            A study done by Nagar, Petroni and Wolfenzon (2011) found that the performance of listed companies with multiple large shareholders or a company where the largest shareholder held a considerable proportion of share performed considerably better than listed companies where a large number of shareholders hold small portion of shares. Edwards & Weichenrieder (2004) studied a number of companies listed in the German capital markets, and found that increasing the ratio of shareholding of the second largest shareholder of listed companies will increase the value of the shares of the listed company. They postulated that this positive correlation in performance may be due to the supervision of the second largest shareholder on the largest shareholder. Nagar, Petroni and Wolfenzon (2011) findings are in contrast to those of O’Neal (1995) who found that when there are multiple large shareholders in the company, they tend to share common interests. Therefore, the big shareholders control of the Board of Directors and the voting rights, and they use this control to exploit the interests and rights of the small shareholders.

2.2.2 Structure of board

            There is no consensus within academia on what constitutes an ideal board size. There is no optimal number, with different researchers suggesting contrasting views on board size. The views on the linkage between the structure of the board and efficiency of corporate governance can be classified into two categories. One view argues that a smaller board size is conducive and beneficial if the board is to play its oversight role effectively and improve corporate governance efficiency. If the board is too large, it will exacerbate the agency problem, resulting in a bloated symbolic board that serves an ornamental purpose rather than being actively involved in corporate governance. Mangena, et al. (2012) suggest that the size of the board should be limited because having a large Board of Directors can lead to dysfunction in the company as decision-making becomes stymied in boardroom inertia. Mangena, et al., (2012) propose that the optimal size of the Board of Directors should be about 8 or 9 people and no more than 10 people at the maximum. Barontini & Bozzi (2011) argue that if the number of the board members is more than 7 to 8 people, the board is unlikely to play a useful role in corporate governance matters. A bloated board is unlikely to confront the CEO and hold the CEO accountable for their actions. Such a board is likely to be filled with the CEO’s lackeys, who have no authority over the CEO and will echo the CEO’s wishes, rather than looking out for the interests of the shareholders. A board filled with members loyal to the CEO is vulnerable to manipulation by the CEO, and cannot fulfill its critical role in enhancing and safeguarding corporate governance. Eisenberg, Sundrgen and Wells (1998) analyzed Finnish corporate data for small and medium-scale enterprises and found that the larger the board size, the worse the company’s performance.

            However, some academic studies have shown that the bigger the size of the board the better the corporate governance efficiency .Chaganti, Mahajan & Sharma (1985) argue that a larger board size can accommodate more  directors with relevant professional experience within its ranks. Therefore, the board can improve scientific decision-making, and help to improve corporate performance owing to the effective oversight provided by suitably qualified board members. A study done by Lam & Lee (2012) to determine the relationship between performance and board size found out that performance of companies with a board size of 12-17 people is better than those companies with smaller board sizes.

2.2.3 Debt structure

            The debt structure of companies can take different forms depending on the size of the company and the overall credit quality of the company (Colla, Ippolito & Li 2010). When the total financing of listed companies remains unchanged, increasing the proportion of total debt financing can lead to a corresponding reduction in the amount of equity financing (Dewji & Miller 2013).To a certain extent, increasing the stock equity in the hands of managers will make the interests of managers and shareholders’ to converge, hence inducing managers to work harder to secure the success of the company. Debt with a fixed interest payment has lower financing costs than equity financing and when the company expected future rate of return is greater than the cost of debt financing, it can contribute to valuable investment in listed company and improvement of corporate governance efficiency. In their study, Colla, Ippolito and Li (2010) found that small firms are generally unrated and tended to rely almost exclusively on either bank debt or capital leases as a source of financing. This constrained the ability of the companies to move flexibly in the market because some of their assets were used as security for company debts. Large companies, on the other hand, are generally rated and have a high credit quality. Therefore, these companies are able to obtain financing through a variety of means and can raise financing through multiple debt types. According to Colla, Ippolito and Li (2010), debt structure impacts on the decisions a company makes about capital structure.

            Rauh and Safi (2010) state that one of the reasons that firms use multiple debt types at any given time is to reduce the probability of incentive conflicts. However low credit quality firms are limited on the kind of debt they can acquire compared to high credit quality firms. Companies with low credit quality tend to have secured bank debt governed by tight covenants and a little non-bank debt that has loose covenants (Rauh & Safi, 2010). The main aim of seeking an optimal capital structure is to considerably reduce the cost of financing.

2.2.4 Information disclosure

            Information disclosure by listed companies is essential in helping investors to understand the financial health of a company. The way in which information is shared among participants affects the functioning of the capital markets (Ho & Wong 2003). Disclosed information helps investors to assess investment risk and return, and make decisions on the action they need to take in the market. Listed companies should make public the necessary information in accordance with normative standards of information disclosure. Information supplied by company annual reports is usually of two kinds. That which is compulsory and has been legislated for, and voluntary disclosure that company’s make at their own volition (Binh 2012). Information that is disclosed compulsorily is more important than voluntary disclosure because it helps in providing information that has a material effect on the investment decisions that investors make (Binh 2012). A sound and comprehensive information disclosure system is an important means of protecting the interests of investors since information disclosure has a significant impact on corporate governance efficiency.

            The annual reports provided by companies are a useful way through which the companies can be held accountable, and increases probity and good corporate governance. The annual reports give a picture of the reporting behavior of a company and have the potential to impact on the perception of accountability that stakeholders and the wider public have on a company (Flack and Douglas 2007). Information disclosure by companies is the main basis for investors to make decisions, and the quality of information disclosed directly affects the income of investors. An efficient and effective corporate governance framework ensures that there is an accurate and timely disclosure of information on all material matters. Material information is any information, which if omitted or misstated can have an influence on the economic decisions that are made by the information users. Transparency in information disclosure is necessary because information should be disclosed to all shareholders simultaneously so that no one person can gain an unfair advantage from the use of the disclosed information.

            The quality of disclosed information remains a matter of grave concern. Annual reports often provide information that is inadequate to users (Yuen et al. 2009). The information that is publicly available is poor and does not match the needs of different users. In addition, many of the items in the report are inadequately disclosed making the information to have limited value to the users. Studies have shown that annual reports may be public relations exercises because the reports do not introduce any new information, and at best, present very limited new information (Haw et al. 2000; Hooks et al. 2002). Some of the items that stakeholders consider important are rarely disclosed in the annual reports. Disclosure of information, whether voluntary or mandatory has led to information overload, most of it being too complex for the user to comprehend (KPMG  2014). The increase in volume of information disclosed does not correspond with an increase in quality of the information. The compulsory disclosure requirements have expanded in the recent past due to the high-profile financial failures and the increasing complexity of financial transactions carried out by companies.

Chapter 3: Methodology

3.1 Research method

This research employs the quantitative research method to analyze the factors affecting the efficiency of corporate governance. The quantitative research method has been widely adopted in the analysis of corporate governance and there are various qualitative indicators to measure corporate governance. Therefore, quantitative research method can be applied in this research to analyze the factors affecting the efficiency of corporate governance.

3.2 Data collection method

In this research, the author selects the study period from 2010-2012.  This research selects the A-share companies in the manufacturing sector that were listed before December 31, 2009 at the Shanghai Stock Exchange and Shenzhen Stock Exchange as samples. In order to ensure the validity of the data, the selected sample data are consistent with the research needs, as well as to eliminate the negative effects of abnormal sample data on the conclusion of this research, the author filter the raw data based on the following principles: (1) this research selects listed companies in the manufacture sector as example, on the one hand, it can eliminate the impact of different sectors on corporate governance efficiency in this study, on the other hand, the manufacturing sector has strong competition, and various financial indicators is less susceptible to human factors operation, reliability is high. In addition, China has become the world manufacturing power and manufacturing market has existed in the country for a long time and formed a good specification. So choosing a sample of manufacturing companies has a strong guiding significance in both theoretical and practical level. (2) This study is aimed to analyze the factors affecting efficiency of corporate governance, and does not exclude the data of ST, *ST, PT listed company, because the certain aspects of internal governance structure may be precisely the main reason that these companies become ST, *ST and PT. If this part of the data is removed, it will cause distortion of the findings and it is not conducive to identify factors that affect the efficiency of corporate governance. (3) This research excludes the data of the companies listed after 2010, and the sample data in this research only includes the company listed before December 31, 2009, in order to ensure the integrity of the data. (4) This research excludes the sample companies of incomplete information and the company whose data the author is unable to find out.

As used herein, the data is mainly secondary sources with additional insights sourced from the Chinese listed companies’ financial indicators database, Chinese corporate governance structure of the database in GTA CSMAR database, and some indicators data is from RESSET Royce database.

3.3 Data analysis method

First of all, the author uses the descriptive analysis method (such as mean, standard deviation and frequency distribution) to grasp the basic features of the data collected. Then, this research mainly uses the regression analysis to examine whether the factors have significant impact on the efficiency of corporate governance. The variables studied in this research include three categories, including dependent variable, explanatory variables and control variable. The dependent variable is the indicator to measure the efficiency of corporate governance and this research selects the Economic Value Added. The explanatory variables include the indicators of ownership concentration, ownership balance, the structure of board, debt structure and information disclosure.

3.4 Ethical issues

Ethical issues are critical and every research should consider and deal with it. In this research, the author only captures the secondary data and the ethical issues include the issues in data collection, data analysis and the information protection and basic right of these sample companies.

First of all, the author will collect the secondary data after acquiring the right of using the data and all of the secondary data collected in this research is from legitimated databases. Secondly, the author only uses the descriptive analysis methods and regression and correlation analysis methods to find out the factors affecting the efficiency of corporate governance. Thus the data will not be used for other purposes. Thirdly, the data will be stored in Mac pro lock with complicated password. The author will protect the information from leaking out. At last, the data cannot help to identify a specific company and the name of any specific company will not be mentioned in this research.

Chapter Four: Data Analysis

4.1 Chapter Introduction

The chapter seeks to address the procedure of analysis of the data that was collected. the points to be highlighted are on the data itself, its acquisition and the areas to be covered. Variables will be highlighted under investigation. Thereafter, the significance of the analysis will be outlined in the descriptive analysis.

4.2 Data and Variables

From the onset, data collection targeted Chinese listed companies’ financial indicators database, Chinese corporate governance structure of the database in GTA CSMAR database, and some indicators data from the RESSET Royce database. Information sourcing was geared towards acquisition of data that would be analyzed through regression analysis. The research had targeted a total of 100 companies 75 being A-share and 25 being B-share listed. Data acquired was less than 50% having gotten only 37 companies, 30 being A-share and 7 being B-share.

Unforeseen circumstances and difficulties made it hard for the data to be acquired. Having made the option of only analyzing data that would be accessible, secondary sources were consulted. This comprised mostly on data already passed through some statistical tools and thereby the author sought to make interpretations.

4.2.1 Dependent   Variable

            The dependent variable is the indicator to measure the efficiency of corporate governance and this research selects the Economic Value Added.

4.2.2 Explanatory variables and control variable

            The explanatory variables include the indicators of ownership concentration, ownership balance, the structure of board, debt structure and information disclosure.

4.3 Empirical results

4.3.1 Stock Exchange listing

            As of December 31, 2012, the stock exchanges of Shanghai had 954 A-share companies and 54 B-share companies while Shenzhen had 484 A-share companies and 54B-share companies too.

Table 1: Number of listed companies

Location Category Shanghai Shenzhen Total
Mainland A-share 954 484 1438
B-share 54 54 108

Source: Shanghai Stock Exchange

The process of reaching the parameters as highlighted before allowed us to break down the numbers until we reached 37 companies.

4.3.2 Manufacturing companies

            Of the companies listed on the Shanghai and Shenzhen stock exchanges, manufacturing accounted for almost half of the companies listed at 47%. From this, it was determined the 37 companies will meet the criteria that will allow the research have some significance.

4.4 Analyzing the indicators

            The analyzed sample is for the manufacturing companies that met the criteria needed for the research. The analysis is in phases. Firstly, all variables from the data related databases (GTA CSMAR database, and some indicators data is from RESSET Royce database) were reviewed and only those satisfying the conditions were chosen for analysis. That is, data is available, the same data sets cover more than one company, data are gathered annually in the period from 2010-2012 without intervals, the variables are statistically measured. Secondly, according to the aim of the paper, regression analysis was used as a statistical method to define the relationship between corporate governance efficiency and the indicators considered. In various basis,

A correlation coefficient of |0,30| is considered as the nominal level for the connection to be valid, but this will only be valid for large data samples (higher than 50 items). For a small data model as the one adopted for this study, the implication of the correlation coefficient can be ascertained by the application of the standard distribution designed by Student t test (Mason et al. 1999). Lastly, at the final stage of this investigation the set of variables are put through the regression analysis. The statistical approach allows us to forecast the dependable variable using independent variables. After several estimations of regression coefficients, minimal data set was defined. The calculated result of the analysis is presented in the standard statistical form produced by software (Table 2).

Table 2. The regression analysis of the chosen corporate governance indicators

variable Coefficient Std. Error t-statistic Prob.
C Ownership structure Structure of board Debt structure Information disclosure 0.021235 -0.241946 0.222971 0.000993 0.261849 0.002889 0.041923 0.042989 0.000428 0.044552 7.343498 -5.581499 5.185947 2.322014 5.865793 0.0000 0.0000 0.0000 0.0224 0.0000

Source: Researcher

In the above table, all the indicators are all statistically significant. When calculated, the R-squared for the estimated equation is 0.69. Therefore, the regression analysis shows the indicators as important, strongly influencing the corporate governance efficiency. This strong impact is in good agreement with management and efficiency logic, proving that the companies are affected in a similar way. As shown by the data the companies being subjected to the same determinants of corporate governance face the same path of efficiency. The management and efficiency logical results prove the validity of the analysis. This has the consequence of the spheres of concern to be looked into clearly and in more detail in order to achieve higher understanding that should translate to efficiency in corporate governance putting emphasis on the indicators under study.

4.5 Discussion of findings

4.5.1 Introduction

            Corporate governance has come a long way globally and in China it is even a topic of much more concern as their companies especially those listed seek to take their place on the global stage. This research has set out to look at the uniqueness of Chinese construction of corporate governance and its place in making sure investors, investments and stakeholders of companies have their interests covered. Corporate governance is considered crucial and plays a significant role in determining if a company is well run. It has been identified and determined that corporate governance as a concept is prone to many factors for it to become efficient. With this in mind, the study constructed a research model of the factors affecting efficiency around four parameters with the objective of making practical suggestions to the corporate governance of Chinese listed companies. The four factors identified were ownership structure, structure of the board, debt structure and information disclosure practiced by companies.

4.5.2 Ownership structure

            Chinese companies had their shares classified as either A-share or B-share with the commencement of the stock exchange. Prior to 2005, A-shares were only available to Chinese investors and B-shares only available to foreign investors (Oliver & Wise 2014). The trading of the A-shares was further complicated with the rigidity in which they were traded and this was geared towards state control. Although recently this has seen a significant change as the Chinese stock markets modernized and improved. Ownership has though largely been under influence by public concentrated ownership which brought about agency problems. Such ownership exerted pressure in the running of the company. SOE or the companies which had such a history have control in the shareholding under the state that refuses to relinquish control. With such an ownership structure, a company’s corporate governance is geared towards ensuring that the interests of the largest shareholders are met. Our prior data analysis has shown that ownership structure has an influence on the corporate governance of a company and it can be understood that, a company whose shareholding is overly bearing on the management experiences inefficient corporate governance.

4.5.3 Structure of the board

            The board of directors has a very crucial role on the running of any company as corporate governance structures should guarantee the strategic guidance of the company, the effectual monitoring of management by the board, and the board’s accountability to the company and the shareholders (Yan-Leung et al 2010). The board is supposed to reduce the problems of agency conflicts if it does play well its role of monitoring and controlling management. For Chinese companies, such boards in addition to supervisory boards that work in conflict allow for the mismanagement of companies. Analysis in the data acquired showed that board structure in the company had the influence of impacting the company by having a working board associated with better performance. Board structure in the sense that the directors were independent and well knowledgeable would work towards the well being of the company and the reverse is true.

4.5.4 Debt structure

            Companies that have their debt either largely owned by an individual entity or is by several entities and is either long-term or short-term have differing corporate governance practices. In our analysis, management tended not to act accordingly and by design supported by other stakeholders if a long-term debt was majorly owned and controlled by a single entity that has influence over the corporate governance structures. As shown in the data analyzed, such an influence translated in the company having efficiency problems equivalent or in tandem with the debt structuring.

4.5.5 Information disclosure

            All investments decisions made on a firm by various shareholders are dependent upon the information provided and are available from such a company. It is therefore imperative that information disclosure falls under the gambit of corporate governance structures to offer truthful, concise information on the workings of a company. This is done by management and is oversighted and approved by the board and supervisory board in the case of Chinese firms. The degree of the information released in terms of quality yields a glimpse on the agency conflict and information asymmetry within the firm. As a result, the corporate governance framework should guarantee that timely and accurate information revelation is prepared on all material matters regarding the company, including the financial situation, performance, ownership, and governance of the company (Yan-Leung et al 2010). Our data revealed this had a bearing on governance efficiency as it highlights the workings within a company. Any company that had its information disclosures satisfying regulatory requirements and shareholders were satisfied seemed to be working well on the bourse. Therefore, information disclosures that were of a positive contribution were of good bearing on corporate governance efficiency.

4.5.6 Conclusion

            The research had the intention of establishing the factors that had a bearing on the efficiency of corporate governance that the Chinese companies listed on the Shanghai and Shenzhen stock exchanges experienced. From the data collected and analyzed, some insights were offered towards these objectives. It can be seen that the research offered a new understanding on the intricate relationships of some factors and corporate governance structures and how efficient these structures are efficient. The next chapter will draw conclusions from this study and show if this research met its objectives.

Chapter Five: Conclusion and Recommendations

5.1 Conclusion

            The previous chapters of this paper have established the place of corporate governance in the well being of companies. This research aimed to explore the concept and measures of corporate governance, and factors affecting the efficiency of corporate governance; to build and test a research model of the factors affecting the efficiency of corporate governance and to make practical suggestions to the corporate governance of Chinese listed companies. To make this possible, Chinese companies listed on the Shenzhen and Shanghai stock exchanges’ were identified as the target sample. A number of techniques and measures were used to come with the requisite data and then analyzed. The study utilized a quantitative methodology that employed data analysis through Excel and SPSS in order to offer insights. Looking at the results achieved it is imperative to gauge and see if the objectives of this research were met.

The data that was acquired covering 37 companies listed on the Shanghai and Shenzhen stock exchanges offered information on the factors affecting corporate efficiency under investigation. The study had limited itself to four factors; ownership structure, structure of the board, debt structure and information disclosure practiced by companies. Considering the analysis of data based on the sample created, there was a relationship between the factors identified and the corporate governance efficiency in these companies. There was a connection between the factors and corporate governance. The research model created and employed showed that when the board structure was largely independent and had well oversight authority and functions the company performed well. In the case of the ownership structure, that affected the board composition, the more diverse the shareholding the better was the corporate governance structures as they sought to ensure all stakeholders were brought on board. Debt structure had the ability to influence the corporate governance in accordance with the power the debt obligation placed the debtors over the company. Finally, companies that practiced good information disclosures were in themselves having good corporate governance structures that ensured the information was forthcoming.

The author therefore cannot overemphasize the important insights the research was able to achieve. The existing literature on the factors under study showed that although they all played a role on governance, the relationship itself was not well established. The Chinese stock market has unique characteristics that make it a little bit more difficult to understand due to the influence of the state through intermediaries. It is hope that this research was able to overcome these challenges.

5.2 Limitations

            This study encountered severe difficulties in obtaining data and such, the data available to the researcher was not as required. Although the study did the best it could with what was available, it is considered not comprehensive enough to make generalizations that can be applied to all companies except the manufacturing sector from what it was drawn from that majorly had SOE which operate under controlled environments.

5.3 Recommendations

            Having just highlighted the limitation the study encountered, it is the view of the researcher that further studies should be undertaken over the topic. The sample used was very small considering the number of Chinese manufacturing companies and the eminence they have in the Chinese economy. The 37 companies under study cannot be said to be comprehensive or representative. Also, the quantitative research should be further developed probably with more information being able to be sourced from independent sources. This should be geared towards offering insight in an environment that seems to have many aspects controlled.

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