Competition, Corporate Governance and Performance

--Evidence from Chinese Stock Exchange

Niu Jianbo Li ShengnanResearch Center of Corporate Governa

nce, 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 aren’t 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. What’s the reason?

Great disputes about the fundamental factor of Chinese innovation

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So there are severe theoretical disputes. What’s 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 what’s 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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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,1986 ； Schmidt,1997 ） .

1. competition and corporate performance

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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 Schumpeter’s theory ， if market power is the preliminary condition, competition perhaps has negative impact on firm performance （ Aghion and Howitt ， 1977 ） .

Charfstein （ 1988 ） thinks that Hart’s 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 Hart’s: 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 aren’t 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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(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).

2. Corporate governance and performance

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The empirical results of impact of ownership concentration and performance aren’t 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 (19

90), Claessens and Djankov （ 1999 ）、 Sun Yongxiang and Huang Zuhui （ 1999 ） , Song Min et al. （ 2004 ）

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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 performance ： negative ， Bhagat and Black （ 1999 ）； positive ， Shao Shaomin et al. （ 2004 ）； Rosenstein and Wyatt （ 1990 、 1997 ）。

（ 2 ） Board of director and performance 　

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Compensation and performance ： positive ， 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 ）

（ 3 ） executive governance and performance

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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.

3. Competition and corporate governance ：complements or substitutes

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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 isn’t substitute relation between competition and governance

Chen Xiao and Jiangdong （ 2000 ） imply a substituted relation. Shi Donghui （ 2003 ） find a complementary relation.

Empirical tests

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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. What’s 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 firm’s 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).

itit

itjitititititit

EXECUTIVEDIRECTOROWNERSHIP

RENTCORGOVRENTklyy

)(*

15143211

，，

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Variable symbol Variable meaning

Productit Income of main business of i company in t year

Kit Net amount of fixed asset of i company in t year

Employit Total employee number of i company in t year acted as the labor input index

Rentit Rent of main business of i company in t year

Con20 it Dummy variable ,if ra_top1it<20%,1,otherwise,0

Con2050 it Dummy variable ,if 20%<=ra_top1it<50%,1,otherwise,0

Con50 it Dummy variable ,if 50%<=ra_top1it,1,otherwise,0

num_dirit Total number of directors of i company in t year

ra_outdirit Ratio of outside directors to total number of director of i company in t year

ra_nopaydirit Ratio of non-payable directors to total number of director of i company in t year

ra_mit Ratio of stock held by executives of i company in t year

ra_tmit Ratio of stock held by total manager of i company in t year

yearsalit Total yearly salary of i company in t year

Symbol and meanings of variables

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Model (I) (II) (III) (IV) (V) (VI)0.7389***(0.0789)

0.7018***(0.0770)

-0.0253(0.0392)

0.7059***(0.0771)

0.7451***(0.0795)

0.7114***(0.0766)

-0.9436***(0.0767)

-0.9155***(0.0751)

0.0773*(0.0402)

-0.9142***(0.0750)

-0.9441*** (0.0771)

-0.9173***(0.0745)

-0.3701***(0.0570)

-0.3432***(0.0561)

-0.0682**(0.0323)

-0.3511***(0.0560)

-0.3791*** (0.0579)

-0.3322***(0.0554)

-0.1627(0.2409)

-0.1940(0.2361)

-0.2276*(0.1327)

-0.1877(0.2365)

-0.1569 (0.2423)

0.4130*(0.2454)

con20it － 0.1561(0.1760)

0.1174(0.1776)

－ －

con50it － 0.3755***(0.0826)

0.3350***(0.0736)

－ －

con2050it － － － -0.3570***(0.0805)

-0.6810***(0.0998)

S0.0000

(0.0000)

*con20it － － -0.4491(0.5426)

－ －

*con50it － － -1.1566***(0.2507)

－ －

*con2050it － － － － 1.3989***(0.2615)

*S0.0000

(0.0000)

Constant.0261484(0.0299)

0.0289(0.0293)

0.0715***(0.0163)

0.0300(0.0293)

0.0273 (0.0301)

0.0340(0.0291)

Wald （ df ） 245.87(4) 268.82(6) 2097.80(10) 268.00(5) 244.13(6) 290.02(6)

Sargan （ P ） 6.07(0.2991)

7.14(0.2107)

6.35(0.2737)

7.03(0.2187)

6.21(0.6827)

7.69(0.1744)

Second-order correlation of residuals(P)

0.5678 0.5486 0.8511 0.5563 0.5866 0.5241

)1( tiy

)1( tik

)1( til

)1(Re tint

)1(Re tint

)1(Re tint

)1(Re tint

)1(Re tint

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model (VII) (VIII) (IX) (X)0.7051***(0.0770)

0.7041***(0.0769)

0.6965***(0.0757)

0.6947***(0.0756)

-0.8909***(0.0746)

-0.8922 ***(0.0746)

-0.8873***(0.0734)

-0.8868***(0.0733)

-0.3561***(0.0557)

-0.3585***(0.0558)

-0.3324***(0.0546)

-0.3336***(0.0547)

－ -0.1964(0.2346)

－ -0.1254(0.2423)

num_dirit0.0176**(0.0315)

0.0175(0.0314)

0.0412(0.0314)

0.0422(0.0314)

num_dir_sqit0.0036

(0.0017)0.0036**(0.0017)

0.0038**(0.0017)

0.0038**(0.0017)

ra_outdirit0.7785***(0.2270)

0.7831***(0.2269)

1.3526***(0.3617)

1.3630***(0.3607)

ra_nopaydirit-0.0071(0.1087)

-0.0026(0.1087)

-0.8359***(0.1722)

-0.8361***(0.1721)

*num_dirit － － -0.1325***(0.0397)

-0.1379***(0.0407)

*ra_ outdirit － － -2.9355**(1.3432)

-2.9751**(1.3393)

*ra_nopaydirit － － 3.5141***(0.5926)

3.5183***(0.5925)

Constant-0.0132(0.0305)

-0.0135(0.0305)

-0.0004(0.0299)

-0.0006(0.0299)

Wald （ df ） 287.81(7) 288.20(8) 338.55(10) 338.93 (11)

Sargan （ P ） 1.89(0.8644)

1.86(0.8681)

1.58(0.9040)

1.56(0.9055)

Second-order correlation of residuals(P)

0.4012 0.4065 0.3648 0.3625

)1( tiy

)1( tik

)1( til

)1(Re tint

)1(Re tint

)1(Re tint

)1(Re tint

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Model (XI) (XII) (XIII) (XIV)0.6061***(0.0995)

0.6209***(0.0992)

0.6078***(0.0991)

0.5874***(0.0978)

-0.6940 ***(0.0925)

-0.6772 ***(0.0911)

-0.6653 ***(0.0908)

-0.6654 ***(0.0907)

-0.3906***(0.0723)

-0.3574***(0.0714)

-0.3543***(0.0708)

-0.3711***(0.0707)

－ 1.7243 ***(0.3740)

1.2360 ***(0.3895)

－

lnyearsal it0.6302 ***

(0.0563)0.6607 ***

(0.0562)0.6890 ***

(0.0569)0.6849 ***

(0.0568)

ra_m it-29.2447(25.5512)

-32.8912(25.3260)

77.5617(128.5866)

84.9191(128.4652)

ra_tm it38.9298

(39.4250)45.5969

(39.0795)-123.5667 (217.5437)

-139.5568(217.3293)

*lnyearsal it － － -0.0724 ***(0.0244)

-0.1070 ***(0.0233)

*ra_m it － － -336.4634(395.5823)

-355.3948(395.2341)

*ra_tm it － － 521.5522(659.3816)

561.1605(658.7902)

Constant-0.0315(0.0482)

-0.0480(0.0480)

-0.0468(0.0475)

-0.0369(0.0472)

Wald （ df ） 243.88(6) 261.72(7) 270.08(10) 266.18(9)

Sargan （ P ） 0.90(0.9699)

0.9237(0.9237)

2.03(0.8444)

1.93(0.8592)

Second-order correlation of residuals(P)

0.5147 0.6315 0.6246 0.6024

)1( tiy

)1( tik

)1( til

)1(Re tint

)1(Re tint

)1(Re tint

)1(Re tint

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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!