Competition, Corporate Governance and Performance Evidence from Chinese Stock Exchange

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Competition, Corporate Governance and
Performance --Evidence from Chinese
Stock Exchange

• Niu Jianbo Li Shengnan
• Research Center of Corporate Governance,
• Nankai University, China

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Introduction

• In China, there are mainly three viewpoints about
  the innovation of state-owned enterprises.
• First, some scholars claim that the stock
  innovation and privatization are the most
  important channels (Zhang Weiying, 1996),
  improving corporate governance is the foundation
  (Li Weian, 2001)
• secondly, competition is regarded as more
  important method to improve corporate performance
  than corporate governance. Increasing competition
  is the strategic center in the initial stage (Lin
  Yifu,1997)
• the third view try to combine former two kinds
  of theories, namely beyond property theory. This
  theory figures that we should not only implement
  the ownership innovation, but also boost
  competition. Both of them are important to
  improving performance (Liu Shaojia, Li Ji, 1998).

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Puzzles from Chinese Enterprises Practice

• Ownership change, competition and corporate
  governance arent solely effective for innovation
  of state-owned enterprise.
• Practices show that competition can contribute to
  the high performance in some industries, but not
  other industries. Whats the reason?
• Great disputes about the fundamental factor of
  Chinese innovation

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• So there are severe theoretical disputes.
  Whats more, there is greater difference in the
  results of empirical analysis, some of which are
  disappointing.
• Current researches mainly focused on the
  influence of single factor on performance and
  scarcely found the significant relation. Then
  whats the matter? The reason perhaps is that
  former research ignored the interactions between
  competition and corporate governance, complements
  or substitutes.

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• To our knowledge, there are no other
  empirical studies on the interaction of product
  market competition and corporate governance for
  China. In this paper we use the data of Shanghai
  and Shenzhen stock exchange in China to analyze
  the interaction between product market
  competition and corporate governance.

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Literature Review
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1. competition and corporate performance

• On the whole, the influence of competition to
  performance is uncertain.
• Positive impact
• According to traditional economic theory,
  competition can make product price equal to
  marginal cost and bring the optimization of
  resource allocation. In the long run, competition
  can stimulate the survival of more efficient
  companies.
• Competition may also affect performance and
  foster efficiency by improving managerial
  incentives ( Holmstrom,1982 Hart,1983 Nalebuff
  and Stiglitz ,1983 Shleifer and
  Vishny,1986Schmidt,1997).

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Negative impact

• Nickell(1996)believes that there are neither
  theoretical foundation for the common view that
  competition can improve performance, nor strict
  empirical tests.
• According to Schumpeters theory,if market power
  is the preliminary condition, competition perhaps
  has negative impact on firm performance(Aghion
  and Howitt,1977).
• Charfstein(1988)thinks that Harts conclusion
  depends on the degree of managerial risk
  aversion. So he designs a model that is similar
  to Hart model. But executive has different
  utility function. The result is contrary to
  Harts increased product market competition
  leads to more slack.
• In the context of transitional economies,
  competition perhaps has an extra influence on
  performance. On the downside, as analyzed by
  Blanchard and Kremer(1997), competition may
  worsen corporate performance during the
  disorganization phase.

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• On the whole, there arent consistent conclusions
  about the influence of market competition on
  performance in theory.
• According to the empirical researches,
  Caves(1992), Green and Mayes(1991), Blundell et
  al.(1995) and Nickell(1996) found that strong
  competition is positively related to higher
  productivity or productivity growth.
  Klette(1999)concluded through research about the
  Norway companies that price-cost margins(the
  index used as market competition) is negative to
  the scale economy and productivity. Januszewski
  et al.(2002), Grosfeld and Tressel(2002), Shi
  Donghui(2003)found positive relation between
  competition and performance through the research
  in Germany, Poland, and China.

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2. Corporate governance and performance

• (1) Ownership structure and firm performance
• Some theoretical models suggest that the impact
  of ownership concentration on performance may be
  more ambiguous than initially expected.
• First,if concentrated ownership provides
  incentives to monitor,it also reduces the
  manager initiative or incentives to acquire
  information (Aghion and Tirole,1997).
• Secondly,dispersed ownership implies higher
  liquidity of stocks,which,in turn, improves the
  informational role of the stock market(Holmstr6m
  and Tirole,1993).
• Third,concentrated ownership is costly for large
  shareholders because it limits diversification
  and reduces owners tolerance towards risk
  (Demsetz and Lehn,1985).

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• The empirical results of impact of ownership
  concentration and performance arent conclusive.
  
• Positive relation Demsetz and Leah(1985)Negative
  relation Nickell et al.(1997)? Bianco and
  Casavola(1999)
• Irrelative Leech and Leahy(1991)
• Non-linear relation McConnell and Servaes
  (1990), Claessens and Djankov(1999)?Sun Yongxiang
  and Huang Zuhui(1999), Song Min et al.(2004)

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(2)Board of director and performance

• Irrelative relation between board constitution
  and firm performance Baysinger and
  Butler(1985),Hermalin and Weisbach(1991)? Agrawal
  and Knoeber(1996),Klein(1998) ?Ferris(2003)
• Board size and performance negative,Sun
  Yongxiang and Zhangrong(2000) Non-linear
  relation ,Yu Dongzhi and Chi Guohua(2004),reverse
  U shape
• Independence and performancenegative, Bhagat and
  Black(1999)positive,Shao Shaomin et al.
  (2004)Rosenstein and Wyatt(1990?1997)?

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(3)executive governance and performance

• Compensation and performancepositive,Murphy
  (1985)Mehran (1995)?Hall and Liebman(1998)?Li
  Weian and Niu Jianbo 2004) irrelative,Jensen
  andd Murphy (1990),Wei Gang(2000 , 2002 )?Li
  Zengquan(2000)
• Shareholding and performance positive,Jensen and
  Murphy (1990) ? Hall and Liebman(1998)? Oswald
  and Jahera(1991)?Liu Guoliang et al.(2000), Liu
  Shanmin(2003)?Zhou Jianbo and Sun Jusheng(2003)
  irrelative,Yu Dongzhi(2002)? Wei Gang(2002) ?Hu
  Ming(2003)

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3. Competition and corporate governancecomplement
s or substitutes

• Theoretical viewpoint
• Aghion and Howitt (1997)and Aghion et
  al.(1999)propose a model in which competition
  appears as a substitute for good corporate
  governance (measured by financial Pressure)at the
  firm level.
• On the contrary,Holmström and Milgrom (1994)
  analyze initiative and various incentive
  mechanisms as complementary in a multitask
  Principal-agent framework.

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Empirical tests

• Nickell et al. (1997) found that both competition
  in product markets and financial pressure can
  substitute for internal control.
• Nickell and Nicolitsas (1999) found that an
  increase in financial pressure has a large
  negative effect on employment while it has a
  small positive effect on productivity.
• Januszewski et al.(2002)find complementary effect
  between competition and strong ultimate owner to
  productivity through the research of Germany
  companies.
• Grosfeld and Tressel(2002) conclude similar
  result, that is, product market competition has
  significant impact on productivity in companies
  whose ownership structure is more disperse or
  more concentrated.
• Hu et al.(2004) find that there isnt substitute
  relation between competition and governance
• Chen Xiao and Jiangdong(2000)imply a substituted
  relation.
• Shi Donghui(2003) find a complementary relation.

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Our appraisal

• In above limited research papers they
  regard ownership structure (identity of
  controlling shareholder, ownership concentration
  and the multiple largest shareholders) as
  corporate governance and extend the conclusion
  deriving from ownership structure analyses to
  corporate governance. This is obviously exiting
  great bias and underestimates the influence of
  corporate governance on firm performance.

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• We follow Nickell et al. (1997) research
  method and analyze the impact of production
  market competition and corporate governance on
  Chinese manufacture listed companies. We measure
  governance from ownership structure, structure of
  director board and executive incentive aspects.
  Comparing to current research, such as Cable
  (1985), Edwards and Nibler (2000) and Shi
  Donghui(2003),we control the endogenous problem
  of market competition and corporate governance.
  Whats more, we also control the unobservable
  heteroskedasticity. For example, companies that
  have higher productivity may have special
  ownership structure. Fixed effect model should be
  able to control this initial variance.

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Empirical model

• We present an empirical model of
  productivity growth derived from the firms
  production function. This model is augmented with
  a set of variables that capture the influence of
  product market competition and corporate
  governance on productivity growth. This approach
  follows Nickell (1996) and Nickell et al. (1997).

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Symbol and meanings of variables
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Empirical result

• There is complementary effect between competition
  and relative disperse and relative concentrated
  ownership structure. Market competition can
  further improve firm performance in companies
  which ownership is relative dispersed and highly
  concentrated. But competition and median
  concentrated ownership are substitutes for firm
  performance. That is, bad ownership structure
  tampers with effect of market competition on
  performance because of the big dispatch between
  control rights and cash flow rights.
• Market competition and director governance (size
  of director board, ratio of outside directors and
  ratio of non-payable directors) are complements.
• Executive governance (annual salary and ratio of
  shareholding held by executive) are complementary
  to product market competition.

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Thanks for Your Attention!
Any comments, welcome!