Corporate governance systems and ownership structures : implications for corporate performance - evidence from Hong Kong

Abstract

Corporate governance is an important variable that can serve to enhance firm performance. This dissertation focuses on a key corporate governance variable, that of managerial ownership. While Jensen and Meckling's (1976) "convergence of interest" hypothesis suggests that increases in managerial ownership can enhance firm performance, Fama and Jensen (1983) and La Porta et al. (1999) argue that at high levels of managerial ownership there are "entrenchment effects" (that is, managers will pursue their own interests). Although there are mixed results, the UK and US literature in general suggests that the relationship between managerial ownership and firm performance is non-linear in nature and conforms to a cubic relationship corresponding to "alignment-entrenchment-alignment" (that is, alignment at low levels of managerial ownership, followed by entrenchment at intermediate levels of managerial ownership and alignment once again at high levels of managerial ownership). It is doubtful whether this relationship is the same under different corporate ownership structures. Claessens et al. (2000) document the fact that most of the firms in the East-Asian region are characterised by a concentrated form of family-controlled ownership, in contrast to the diffuse form of ownership in the UK and the US. Hong Kong is a prime example of an economy dominated by a family-controlled ownership structure. The thesis contributes to the academic literature on corporate governance by its examination of the relationship between managerial ownership and corporate performance III Hong Kong. Based on the regression results of 1406 firm-year observations of Hong Kong listed companies from 1995 to 1998, it is found that under the family-dominated ownership structure in Hong Kong, there is a non-linear relationship between managerial ownership and firm performance which corresponds to a pattern of "entrenchment-alignment-entrenchment". This is in contrast to the pattern ("alignment-entrenchment-alignment") found in the UK by Short and Keasey (1999) and in the US by Morck et al. (1988). While the finding of a non-linear relationship between managerial ownership and firm performance in this study supports both the "convergence of interest" hypothesis over certain ranges of managerial ownership and "entrenchment effects" over other ranges of managerial ownership, the discovery of a pattern which is opposite to that found in UK and US studies indicates that managerial ownership affects firm performance in a different way in Hong Kong. In Hong Kong, the convergence of interest effect only dominates the entrenchment effect in the intermediate range of managerial ownership, leading to the conclusion that a policy of providing management with larger amounts of equity within this intermediate range of managerial ownership should enhance firm performance. In contrast, increasing managerial share ownership in cases where the existing level of managerial share ownership is either low or high will have the effect of reducing firm value. The design of an optimal managerial compensation strategy for Hong Kong firms thus has to take account of the existing level of managerial share ownership. In contrast to the finding of other studies, the results reported in this study show that board structure variables (board size, board composition and directors' remuneration) are not significantly related to firm performance. An explanation for this may be found in the different character of the board in Hong Kong. For example, the number of independent non-executive directors in Hong Kong is low and they are very often not truly independent, while the remuneration of directors is typically not subject to review by any board committees. If these aspects of Hong Kong board structures can be successfully reformed then corporate performance should be enhanced, in line with the results reported from other countries. The data concernmg managerial ownership and performance was partitioned in accordance with the East-Asian financial crisis, which began in late 1997. The findings from this further empirical analysis suggest that the macro-economic conditions in existence before and after the crisis affect the nature of the relationship between managerial ownership and firm performance. It is found that the convergence effect is stronger in the "prosperous years" prior to the crisis, as shown by the wider alignment range from the regression results based on the data before the East-Asian financial crisis (1995-1997). The entrenchment effect is, however, more prominent during the "difficult years" as indicated by the narrower range of alignment in the regression results based on the data for the year after the crisis (1998). The importance of corporate governance in Hong Kong was brought into sharp prominence by the East-Asian financial crisis. Weaknesses in corporate governance regimes have been widely identified as an important factor leading to the fast downturn in economies within the whole East-Asian region. Enhancing corporate governance practices is thus important for corporate recovery and growth. Various international organizations, professional bodies, regulators and academics have spent a great deal of effort over the past six years in a wide range of activities to enhance corporate governance practices in the region, and these are reviewed in the thesis. Due to the different cultural backgrounds and ownership structures in different countries, it can be argued that there is no single "best" corporate governance system. A secondary aim of this thesis is the evaluation of the corporate governance initiatives of various international organizations and the identification of areas for improvement and for reform in Hong Kong. Specific policy recommendations are made for the structural improvement of the corporate governance regime in Hong Kong.