Moderating Effects of Board and Managerial Incentive on ... Krishnamurti Chandrasekar.pdf · Dr. Krishnamurti Chandrasekar, ... investment and firm performance .However, there have

The Journal of International Management Studies, Volume 7 Number 1, April, 2012 41

Moderating Effects of Board and Managerial Incentive on the

Relationship between R&D Investment and Firm Performance-

Evidence from Listed Manufacturing Firms in China

Dr. Haiyun Ren, Associate professor of College of Economics and Management,

Northwest A&F University, China

Dr. Krishnamurti Chandrasekar, Professor of School of Management, New York Institute of Technology,

New York, USA

Dr. Bin Li, School of Finance and Economics, Xi'an Jiao tong University, China

ABSTRACT

Several studies based on US and UK data have tested the moderating effects of corporate governance on R&D

investment and firm performance .However, there have been no investigations for China, in part because of data

unavailability and the complicated analysis involved. In this paper we take a first step towards filling this gap using a

hand collected R&D data of Chinese listed manufacturing firms. We demonstrated how board of director and

managerial ownership influence the relationship between R&D and firm performance. Based on Chinese listed

manufacturing firm’s data, we examine the moderating effects of board of directors and managerial stock ownership on

the relationship between R&D spending and firm performance by hierarchical regression and subgroup analysis.

Results show that board size has no moderating effect on the R&D-firm performance relationship, while this

relationship is negatively associated with board stock ownership, frequency of board meeting and managerial stock

ownership.

Keywords: R&D; Firm performance; Board of director; Managerial incentive

INTRODUCTION

The characteristics of R&D activities（high-risk, cross-period income and serious asymmetry information）

induce particularly serious agency problem. Appropriate corporate governance mechanisms can reduce information

asymmetry and control manager's opportunistic behavior, which may influence corporate R&D decision-making

(Jensen and Meckling, 1976). For this reason, both academics and practitioners have paid high attention on the

relationship between corporate governance and R&D activities. The early studies have mainly concerned with the

influence of corporate governance on R&D input and more recently scholars have realized corporate governance not

only affects R&D intensity but also controls managers’ opportunistic behavior causing managers allocate resources

more efficiently, which in turn influences the outcome of R&D project and corporate performance. Thus corporate

governance has been introduced as a moderating variable of R&D input and corporate performance. However, to the

best of our knowledge the more recent studies were mainly based on firm data in the US and UK. So far, there has been

no investigation of Chinese data, in part because of data availability issues. In this paper we take a first step towards

filling the data gap using a hand collected R&D data of Chinese listed manufacturing firms. In the emerging economies,

the concentration of ownership-a common agency solution- would not work because giving more control to an already

powerful controlling shareholders group may further enhance their prospect of expropriation (Dharwadkar et al., 2000).

So, we mainly examine the moderating effect of board and management ownership on the relationship between R&D

and firm performance in this paper. Our empirical results indicate that board size has no moderating effect on the R&D

spending-performance relationship, while board meeting, board stock ownership and managerial stock ownership have

negative association. We draw the conclusion that the boards of Chinese companies probably have a passive role in

corporate governance. Besides, owing to high risk and cross-period income in R&D investment, stock ownership

incentive is not likely to raise R&D expenditure.

The Journal of International Management Studies, Volume 7, Number 1, April, 2012 42

The rest of the paper is organized as follows. In section 2 we develop testable hypotheses. Section 3 describes the

sample and summary statistics. In section 4, we report the empirical findings and provide concluding remarks in Section

5.

HYPOTHESES DEVELOPMENT

The purpose of R&D investment is to improve the firm’s performance. However R&D expenditures per se do not

automatically lead to better firm performance because those expenditures may not be effectively and profitably used.

Firm’s performance depends critically on how effectively and profitably the R&D expenditures are used, rather than the

amount of R&D investment per se1. Agency theory (Jensen and Meckling, 1976; Byrd et al. 1998) propagates that due

to separation in ownership and management, there is non-alignment of interests between principal (owner) and agents

(managers).The separation of ownership and control in large publicly owned firms has induced potential conflicts

between the interests of professional managers and stockholders (Berle and Means, 1932).Stockholders are interested in

maximizing the long-term profitability of a firm and the value of their investments, while manager's objectives when

running a company's business may also include assuring personal wealth, job security, and prestige. Thus the divergence

of manager's and stockholders' objectives may lead to acute conflicts of interest in decision making and implementation

regarding the strategic orientation of the firm. One strategy that is subject to acute manager-stockholder conflict of

interest is the firm's corporate R&D strategy.

The character of R&D activities makes agency costs particularly severe. First, they are inherently risky as they

provide greater variability of outcomes and greater probability of failure despite the best effort of managers (Baysinger

et al., 1991). Second, R&D activities require long-term investments in projects that may have a negative impact on

more immediate performance (Hoskisson et al., 1993). Consequently, risk-averse managers may be reluctant to invest in

risky long-term R&D projects. Third, the extent of information asymmetry associated with R&D is larger than that

associated with tangible (e.g., property, plant, and equipment) and financial investments because of the relative

uniqueness of R&D and the managers may exploit this asymmetry to gain from insider trading (Aboody and Lev, 2000).

Fourth, managers are more likely to hide information in R&D activities (Zenger，1994). As we know R&D project is a

kind of knowledge investment activity, which is comparatively complicated (Jensen et al.，1992）. As insiders,

managers may have the personal knowledge and understand the expected obstacle of R&D projects. If managers

perceive the negative effects of R&D expenditure such as potential risk and loss, then they will refrain from pursuing

R&D investment. They may not even report the issues. On the other hand, even if manager’s own information is

positive about investing in R&D, but in a climate of lack of economic incentives, managers may very well hide the

critical knowledge and technology. Moreover, accounting measurement and reporting rules treat R&D differently from

other physical assets and R&D is immediately expensed in financial statements, so that no information on value and

productivity changes arising from of R&D input is reported to investor (Aboody and Lev, 2000). Together, these

characteristics can stimulate managerial opportunistic behavior; aggravate agency costs through non initiation or failure

of R&D projects and ultimately influencing the firm performance. So, the agency problem in R&D activities not only

influences the input of R&D but also affect the impact of the effects of R&D implementation.

Agency theory predicts that proper corporate governance mechanisms can reduce agency problems and may help

to ensure appropriate level of R&D investment since they curtail managers’ propensity to pursue inefficient strategies

(Jensen and Meckling, 1976). Moreover, proper corporate governance mechanisms can reduce information asymmetry,

supervise the managers, and control managerial opportunistic behavior, thus ensuring that the R&D activities are

performed according to the general understanding of maximizing shareholder interest (Hill and Snell, 1988; Wright et

al., 2002).In sum, corporate governance may affects the R&D input and R&D output . The relationship between R&D

1 Although some studies (e.g. Griliches ,1980, 1985,1986 ; Hall, Mairesse,1995; Wakelin ,2001)based on the C-D production function found R&D

investment had positive effect on firm productivity, the contribution rate is different. Some other studies (e.g. Hirschey ,1982;

Connolly ,Hirschey ,1984; Hirschey ，Weygandt ,1985; Hall ,1993; Johnson ,Pazderka,1993; Lev ,Sougiannis , 1996; Chan, et.al.,2001) examined

the relationship between R&D investment and firm’s market value. However, the conclusions are mixed.


input and firm performance varies according to the corporate governance environment. Thus corporate governance has

been introduced as moderating variable of R&D input and corporate performance naturally. Empirical evidence is

consistent with the R&D-firm performance relation moderated by corporate governance. For example, Chung et

al.(2003) reports that the market valuation of the firm’s capital and R&D investments depends critically on board

composition, but not on institutional holding. With a high proportion of outside directors they find a significant and

positive correlation between firm’s value and both capital and R&D investments. It is worth noting that the results are

for firms that are largely followed by security analysts. In contrast, they find in their empirical study correlations

between firm value and R&D investments are insignificant for firms with less analyst following and /or with a low

proportion of outside directors. They also find that the level of institutional holdings do not have a significant effect on

the market valuation of R&D and capital expenditures. Le et al.(2006) report that institutional investors moderate the

form of the R&D spending-performance relationship and independent outside board members influence the strength of

that relationship. While they find evidence that securities analysts have a direct impact on firm performance it does not

moderate the R&D spending-performance relationship；Hall and Oriani (2006) find that firms controlled by a major

shareholder have a better market valuation of R&D. This means that the R&D spending-performance relationship is

moderated by major shareholder. Chang et al. (2008), Yeh et al. (2008), Chung and Shen (2009) examine the influence

of corporate governance on the wealth effect (Cumulative Abnormal Return) of corporate R&D expenditure. Chang et

al. (2008) finds that stock markets respond more favorably to announcement of an increase in R&D expenditure by

firms with stronger internal governance; Yeh et al. (2008)’s study shows that investors on average respond favorably to

a firm’s R&D announcement and the response is greater for firms with a small and independent board. Chung and Shen

(2009)’s results indicate that firms with better monitoring governance mechanisms experience an abnormal return on

R&D investment.

The existence of the principle-agent problem prevents the proper performance of R&D projects which are

designed to maximize shareholder’s interest. Proper corporate governance can reduce the information asymmetry,

supervise managers, control opportunistic behaviors of managers and ensure the implementation of R&D project in

accordance with shareholder’s interest (Wright et al.2002). Therefore, the relation between R&D investment and firm’s

performance varies with the differences in corporate governance. Methodologically, corporate governance moderates

the relationship between R&D investment and firm performance.

Moderating effects of board

Agency theorists argue that the board, with its legal authority to hire, fire, and compensate top management,

safeguards invested capital and, thus, are an important element of corporate governance (Williamson, 1984).So, its

impact on R&D investment is self-evident. The following review of research is mainly concerned on the effect of board

size and board composition on R&D investment.

Several studies have examined the relationship between board size and R&D investment. Some researchers have

pointed out that large boards have a range of expertise and can bring a diversity of views and experience, increase the

opportunity for a broad geographic representation, and provide extensive director resources for constituting board

committees to deal effectively with complex issues (e.g. Rao and Lee-Sing, 1995). In addition, larger boards are better

for corporate R&D investments because they are harder for a CEO to dominate. In contrast other researchers have

suggested that large boards can be less effective than small ones. When boards become too big, agency problems (such

as director free-riding) increase with the board, and the board becomes more symbolic and less a part of the

management process (Jensen, 1993; Hermalin and Weisbach, 2003).

Wu (2000) has structured similar arguments such as: (i) small board of directors facilitate better communication

among directors, more effective coordination of the directors’ expertise, and speed up action when there is a problem;

and (ii) a limited number of board members preventing a board from developing into a bureaucracy, from dividing into

cliques, and from encouraging passivity at meetings. In the literature we also find the evidence that smaller board size

translates into better firm performance (Yermack, 1996; Eisenberg et al. 1998). Hence it is expected that smaller boards

would facilitate higher R&D intensity strategy of firms that would lead to shareholders’ wealth creation.

In our opinion, the size of the board is not the critical factor related with R&D expenditure. The size of the board


depends on the firm size, business scope, business complexity, nature of the industry, business environment, and many

other exogenous variables. Song et al. (2009) in their empirical result indicates that the size of the board and firm’s

performance have no significant relation and have pointed out that a change of board’s size in cross-section just reflects

the difference in company's operating environment rather than unreasonable use of governance mechanisms. Therefore,

we should place less focus on the size of board which depends on specific business circumstances and cannot be

generalized. We should mainly consider whether a given board plays a real role in influencing R&D expenditure and

how to make the board perform better. The independence and incentive system are critical for better performance of the

board.

Researchers have used as a variable the proportion of outside directors to indicate the independence of board.

Outside directors are expected to represent the interests of shareholders by mitigating agency problems between

management and shareholders (Fama and Jensen, 1983; Subrahmanyam, et.al., 1997). Such consideration may lead one

to conclude that a board's independent outside directors are expected to help promote strategic orientations that benefit

stockholders' wealth, including investment in R&D (Kosnik, 1990; Baysinger et al. 1991). However, Baysinger and

Hoskisson (1990) pointed out that high proportion of outside directors may unexpectedly cause a negative effect on

manager’s strategy-orientation. Outside directors prefer to maintain an open and subjective relationship with top

management, but they simply lack the amount and quality of information upon which such relationships must be based.

For example, outsiders usually serve as directors on several boards. Between managing their own businesses and

serving on multiple boards, outside directors may not be able to "understand each business well enough to be truly

effective"(Patton and Baker, 1987).In addition, inside directors and outside directors obtains information in different

ways. Outside directors obtain business information mainly through financial statements whereas insiders usually

access information by participating in the decision processes. Consequently, outside directors may suffer a comparative

disadvantage, relative to insiders, especially with regard to R&D projects which are of long term duration because of

serious information asymmetry . More likely a moderate proportion of outside directors is conducive for R&D project.

Board, the link between stockholders and managers, not only plays the role of a monitor and as an agent of

stockholders, but also commit managers to operate specific business as principals. This then would lead to exiting the

principal-agent problem between board and shareholders. It is necessary to limit or eliminate the principle-agent

problem between board and shareholders to ensure that the board acts in the interests of stockholders. For this to happen

if directors own a certain proportion of the stock of the company their interests will be more consistent with those of the

shareholders, in turn they will become more competent strategic monitors (Kosnik, 1990). The Risk preference and

degree of effectiveness of directors who own the stock in their company will certainly be different from those directors

whose income are only from cash compensation.

Besides the independence and necessary compensation of the board, spending an adequate amount of time to

carry out directors’ duties is also important for a better performance of the board. Lipton and Lorsch(1992) pointed out

that the most widely shared problem directors have is a lack of time to carry out their duties. They suggest boards

should meet at least bimonthly with each meeting lasting a full day, including committee sessions and other related

activities. In addition, one meeting each year lasting two or three days should be viewed as strategy sessions. Vafeas

(1999) indicated that board activity, measured by the frequency of board meetings, is an important dimension of board

operations. So, if the board meeting is more frequent, there is more time for the directors to carry out their duties which

helps for timely solution to the problems existing in the R&D activities, and ensures successful implement of R&D

project.

Based on the above analysis, we suggest the following hypotheses for testing the moderating effects board may

have on the association of R&D spending and firm performance.

Hypothesis 1. The R&D investment-performance relationship is moderated by independent board director in “inverted

U-shape”.

Hypothesis 2. The R&D investment-performance relationship is positively associated with board ownership.

Hypothesis 3. The R&D investment-performance relationship is positively associated with board meeting frequency.

app:ds:information

app:ds:asymmetry


Moderating effects of managerial incentive

Two major agency problems between managers and shareholders may influence corporate decisions regarding

R&D investment. The first agency problem is goal divergence and risk differential between managers and shareholders.

Goal divergence and risk differential may lead to acute conflicts of interest in corporate decisions, such as R&D

expenditures. R&D investment will reduce net returns on the current balance sheet (Baysinger and Hoskisson, 1989).

Additionally, the payoffs from R&D investment are neither immediate nor certain, and thus increase employment risk

for managers (Alchian and Demsetz, 1972; Wiseman and Gomez-Mejia, 1998). Influenced by concerns regarding

personal wealth and job security, risk-averse managers may be less likely to make R&D expenditures in certain

situations than shareholders, who are concerned with maximizing returns. The second agency problem related to R&D

is hidden information and hidden action confronted by employers (Zenger, 1994). Employees generally have private

knowledge on innovative projects and their expected obstacles; however, they may act passively in reporting or solving

those problems. Furthermore, the efforts that employees put into R&D are often difficult for shareholders to assess and

extremely costly for them to monitor. These hidden information and monitoring problems increase R&D risks and

agency costs, which in turn increase the likelihood of R&D failure.

To solve these agency problems associated with R&D, firms need to control managers by some monitor

mechanism (e.g. ownership structure and board of director) and also build up an incentive alignment mechanism to alter

the risk orientation of managers and induce the desired efforts from employees.

Employee stock ownership is one form of incentive alignment that makes employees become part owners of the

business (Pugh et al., 2000). Through granting stock to managers, the goals of managers become similar to those of

shareholders by further alleviating the agency conflicts associated with manager risk taking propensities. Thus, risk-

averse managers are inclined to undertake risky investments, such as making large expenditures in R&D. Furthermore,

employee stock ownership may transfer partial risk from shareholders to employees. Bearing risk from uncertain

payoffs and a strong probability that R&D will fail, employee-owners are induced to increase their efforts at work and

to unselfishly share their private knowledge and information with the firm. In brief, employee stock ownership could

help reduce agency conflicts between managers and shareholders alleviating agency costs, in turn decreasing R&D risks

while increasing the likelihood of success in R&D. In other words, manager ownership moderates the relationship

between R&D spending and firm performance.

Hypothesis 4. The R&D investment-performance relationship is positively associated with manager ownership.

RESEARCH DESIGN

Data

The data is drawn from Chinese A-share manufacture companies listed in the main board from 2004-2009 that

voluntarily reported R&D expenditure in the financial statements. To avoid any confounding events that could distort

the corporate governance and performance, we excluded those firms which have been listed less than two years until the

selected year. Also, the specially-treated and insolvent companies were deleted. After screening the sample, we get 102

samples in 2004, 119 samples in 2005, 149 samples in 2006, 156 samples in 2007, 150 samples in 2008 and 151

samples in 2009. Since these firms went public in different years and not all of them continued to report R&D through

these six years, the sample data does not include an equal number of observations for each firm. The final data sample

yields a total of 828 firm- year observations. The study gathered the corresponding financial data and corporate

governance data from the CCER database, which is compiled by China Center for Economic Research and Beijing

Xenophon Information Services. Only the mandatory disclosure information is included in this database. In China,

disclosure of annual R&D expenditures is not compulsory. So this database does not provide R&D data. The R&D data

have been hand collected from the financial statements, which are from websites such as

http://www.cs.com.cn,http://www.csrc.gov.cn/pub/newsite/ et al.. Considering the lag effect of decision and R&D

outputs, R&D data lag one year of corporate governance data and firm performance data lag one year of R&D data.

Thus, our data actually cover the period 2003-2010.

http://www.cs.com.cn/

http://www.csrc.gov.cn/pub/newsite/

http://dict.cnki.net/dict_result.aspx?searchword=%e6%bb%9e%e5%90%8e%e6%95%88%e5%ba%94&tjType=sentence&style=&t=lag+effect


Measure

(1) Independent variable and dependent variable

The independent variable in this study is R&D intensity, which is calculated as the level of investments divided

by the firm’s total assets (Chen and Huang, 2006). The measure was adopted because total assets were relatively stable,

while sales could fluctuate significantly. The study’s dependent variable is firm performance measured as the lagged 1-

year return of assets (ROA) using profit from principal operations divided by average net assets.

(2)Moderating variables

The moderating variables include board size, board independence, board ownership, board meeting frequency and

management ownership. Board size is the number of directors sitting on the board at the shareholder meeting date.

Board independence is calculated as the number of independent board members divided by board size. In this study,

board meeting frequency refers to the number of meetings held by the board of directors annually, including written

consent of the board and telephonic meetings. The variable board ownership is measured as shares holding by board of

director dividing by total shares. Also, we define management ownership as shares holding by managers (excluding

supervisors and board of directors) dividing by total shares.

(3) Control variables

To reduce the possibility of model misspecification, we control for additional variables in our empirical model.

Large firms may have more resources for R&D activities, possibly influencing the R&D spending-performance

relationship (Finkelstein and Hambrick, 1989), so we added a proxy for firm size (the natural log form of operating

revenue) as a control variable. As firms with greater financial leverage may outperform less leveraged firm in good

times and under perform in bad times, we included each sample firm’s debt-to-equity ratio.

Analytical method

Following Le et al. (2006), we identified all types of moderating effects of corporate governance on the R&D

spending-performance relationship by hierarchical regression and subgroup analysis methods. We used hierarchical

regression to examine whether corporate governance affects the form of the relationship, and we used subgroup analysis

to examine whether they influenced the strength of the relationship.

Referencing to Sharma et al. (1981)’s research, we illustrate the identifying moderating effect of corporate

governance on the R&D spending-performance relationship in Fig.1.


No Yes

Yes No Yes No

Yes No

Yes No

Figure 1: Identifying Moderating effects of governance mechanisms on the R&D investment -corporate

performance relationship CG is the abbreviation of corporate governance. CP is the abbreviation of corporate performance.

EMPIRICAL RESULTS

Descriptive statistics

Table 1 summarizes the basic descriptive statistics of firm characteristic .Table 2 presents the correlation matrix of

the variables included in our study. It shows that the mean value of R&D intensity is 0.547% which is comparable to the

corresponding figures (0.59%) reported in Liu Yunguo and Liu Wen（2007）and the standard deviation is 0.928%.

This suggests that the R&D intensity of Chinese manufacture listed companies is very low and there are large

differences among firms. Chen and Huang (2006) reported that the average R&D intensity (R&D spending /total assets)

of Taiwan’s IT enterprises reached 2.45% over 1996-2001 period. Hall and Oriani（2006）reported that the average

R&D intensity of firms in the United states, France and Germany over 1989-1998 period were respectively 4.9%, 4.2%

and 4.5%. Compared with these three countries, on average Italian and British firms had a significantly lower R&D

intensity, of 3.3% and 2.9 % respectively but are significantly higher than for Chinese firms.

Table 1: Descriptive statistics of firm characteristic for the sample period 2004-2009

Variables Sample size Min 1st Quartile Median 3st Quartile Max Mean Std. D

ROA (%) 827 -78.430 2.47 7.570 15.17 231.430 7.57 15.834

R&D intensity (%) 827 0.001 0.113 0.291 0.643 11.192 0.547 0.928

Board size 827 3.000 9.000 9.000 11.000 17.000 9.617 1.893

Board shareholding (%) 827 0.000 0.000 0.001 0.010 58.305 0.947 5.919

Independent board director ratio（%) 827 12.500 33.333 33.333 36.364 60.000 35.344 4.653

Management shareholding (%) 827 0.000 0.000 0.002 0.020 26.102 0.269 2.076

Board meeting frequency 827 3.000 6.000 8.000 10.000 36.000 8.288 3.204

Firm size(Log of operation revenue) 827 18.367 20.542 21.226 22.012 25.785 21.330 1.206

LEV(debt-to-equity ratio) 827 0.000 0.608 1.009 1.635 22.200 1.294 1.273

Is CG variable related

to R&D or CP?

CG is a homologize

variable.

Does CG variable interact

significantly with R&D?

Is CG related to

CP?

相关

CG is not moderator

variable.

Do subgroup

analysis.

CG is quasi

moderator variable.

vvariable

CG is a pure

moderator variable

Are subgroups different

with respect to R2?

CG is not a

moderator variable.


Table 2: Correlation matrix of variables variables 1 2 3 4 5 6 7 8

1. ROA (%)

2. R&D intensity (%) 0.081*

3.Board size 0.002 0.066

4.Board ownership(dichotomous variable) 0.011 -0.044 0.03

5.Independent board director ratio（ %) 0.042 -0.015 -0.198** -0.078*

6.Management ownership(dichotomous variable) -0.049 -0.006 -0.11 0.564** 0.017

7.Board meeting frequency -0.022 -0.003 -0.003 -0.061 0.075* 0.009

8.Firm size(Log of operation revenue) 0.149** 0.034 0.242** 0.104** 0.12** 0.112** 0.186**

9.LEV(debt-to-equity ratio) 0.153** -0.085* 0.035 0.044 0.043 -0.022 0.123** 0.035 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Regression results

Table 3-10 present results of the logistic regression analyses .We begin our formal analysis by investigating the

effect of board size on the R&D-performance relation. The results of table3 and table4 show that the R&D-performance

relation is not effected by board size. This result is consistent with our conjectures.

We cannot test Hypotheses 1. It is shown in table 1 that the mean and median of independent board director ratio

are 35.344% and 33.333% respectively and the standard deviation is only 4.653%.This suggests that the independent

board director ratio of most Chinese listed companies (59.61% companies in our sample )just meet with the legal

minimum limit (which is no less than 1/3). So, when we use hierarchical regression method to test the effect of

independent director on the R&D-performance relation, it appears that multicollinearity issue is apparent. Thus, in this

study, we cannot provide the evidence on the importance of independent director in explaining the relationship between

R&D investment and firm performance.

Given that board ownership, board meeting frequency and management ownership were not found to be directly

related to firm performance, nor moderate the form of the R&D spending-performance relationship (per results

presented in Table 5,7and 9), we tested for the possibility that these variables moderate the strength of the relationship.

In order to do so we split the sample at the mean value of board meeting frequency (which was 8.288) and we split the

sample at whether board members holding shares or not. Also, we split the sample at whether managers (except

directors and supervisors) holding shares or not. We then regressed R&D spending along with our control variables on

firm performance for each sub-sample. The regression models are presented in Table 6, 8 and 10. Our results suggest

that board ownership，board meeting frequency and management ownership moderate the strength of the R&D

spending-performance. Interestingly, in contrast with expectations of Hypothesis 2-4 which assumes a positive

relationship between board ownership，board meeting frequency and management ownership and R&D investment-

performance, our empirical results show that the relationship of R&D investment –performance is negatively associated.

Nevertheless, our results provide some evidence on the importance of board and incentive system in explaining

the relationship between R&D investment and firm performance.

Table 3: Hierarchical regression analysis of board size effect on the relationship between R&D investment and

firm performance (N=827)

Variables Model1 Model2 Model3

R&D intensity (%) 0.088 * 0.09** 0.221

Firm size 0.11** 0.119*** 0.119***

LEV(debt-to-equity ratio) 0.130*** 0.129*** 0.129***

Board size

-0.037 -0.019

R&D intensity*Board size

-0.137

F value 12.441*** 9.614*** 7.822***

Adjusted R2 0.040 0.040 0.040 *p<0.05；**p<0.01；***p<0.001（2-tailed）


Table 4: Subgroup analysis of board size’s moderating effect on the relationship between R&D investment and

firm performance

Variables Board size

large small

R&D intensity (%) 0.062 0.084

Firm size 0.103* 0.256***

LEV 0.033 0.007

F Value 2.910* 8.912***

Adj.R2 0.012 0.066

Dif.in R2 0.054

N=492 N=335 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Table 5: Hierarchical regression analysis of board ownership effect on the relationship between R&D

investment and firm performance (N=827)


R&D intensity (%) 0.088 * 0.082* 0.083 *

Firm size 0.11** 0.113** 0.113**

LEV(debt-to-equity ratio) 0.130*** 0.132*** 0.132 ***

Board ownership

0.058 0.064

R&D intensity*Board ownership

-0.01

F value 12.441*** 10.064*** 8.050***


Table 6: Subgroup analysis of board ownership’s moderating effect on the relationship between R&D

investment and firm performance

Variables

Whether board holding shares or not

Yes No

R&D intensity (%) 0.05 0.147**

Firm size 0.121* 0.117**

LEV -0.013 0.047

F Value 2.505 5.315***

Adj.R2 0.01 0.034

Dif.in R2 0.024*

N=455 N=372 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Table7: Hierarchical regression analysis of board meeting frequency’s effect on the relationship between R&D



R&D intensity (%) 0.088 * 0.087* 0.043

Firm size 0.11** 0.120*** 0.119***


Board meeting frequency

-0.061 -0.075

R&D intensity*Board meeting frequency

0.050

F value 12.441*** 10.121*** 8.144***



Table 8: Subgroup analysis of board meeting frequency’s moderating effect

on the relationship between R&D investment and firm performance

Variables Board meeting frequency

high low

R&D intensity (%) 0.063 0.106**

Firm size 0.155** 0.084*

LEV -0.083 0.312***

F Value 3.147* 24.092***

Adj.R2 0.021 0.118

Dif.in R2 0.097*

N=308 N=519 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Table9: Hierarchical regression analysis of management ownership’s effect on the relationship between R&D



R&D intensity (%) 0.088 * 0.083 * 0.084*

Firm size 0.11** 0.111** 0.111


Management ownership 0.035 0.038

R&D intensity*Management ownership -0.004

F value 12.441*** 9.591*** 7.665***


Table 10: Subgroup analysis of management ownership’s moderating effect on the relationship between R&D

investment and firm performance

Variables

Management ownership

Y N

R&D intensity (%) 0.049 0.104**

Firm size 0.221*** 0.109**

LEV -0.158** 0.202***

F Value 4.231** 14.259***

Adj.R2 0.035 0.067

Dif.in R2 0.032*

N=271 N=556 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Robustness Checks

In this section we present robustness checks to test whether our results are sensitive to the alternative choices in

our research design. Because of cross-period income in R&D investment, our result may vary with the duration of lag

and we test the robustness of our results by using two-year lag performance variable. The result of this analysis

indicates that our original findings obtained with one-year lag performance are not sensitive to the duration of lag. Table

10-17(in appendix) present results of robustness test.

DISCUSSION AND CONCLUSION

In this paper we have addressed questions related to the moderating effect of board and managerial incentive on

R&D spending- firm performance relationship. To our knowledge, this is the first in-depth empirical analysis of

influence of corporate governance on R&D-firm performance relationship in China. We have theorized that board of

director and managerial incentive may moderate R&D spending-performance relationship. Our results demonstrate that

board of director and managerial incentive do indeed affect R&D spending-performance. However, some of our

empirical results go contrary to our hypothesis. We found that the independent board director ratio of most of Chinese

listed companies just meet with the legal minimum limit of a third of the total number of board of directors. So we

cannot provide evidence on the independent board directors’ role in R&D investment in this study. Our results show that


board ownership，board meeting frequency and management ownership moderate the strength of the R&D spending-

performance. This indicates that board ownership, board meeting and management ownership have an indirect effect on

the R&D-firm performance relationship. However, these three variables have negative influence on the R&D-

performance relationship which is inconformity with our hypothesis. It is possible that managers of Chinese listed

companies are myopic and stock ownership incentive is not a sole factor required for initiating R&D project.

Traditionally, agency theorists do not differentiate risk differences associated with stock ownership and stock options.

However, behavioral agency theorists argue that stock option pay is fundamentally different from stock ownership in

terms of managerial responses to downside risks (Wiseman and Gomez-Mejia, 1998). More specifically, stock

ownership has a linear relationship with stock price, and a downside risk may discourage executives from risk-taking

decisions. On the other hand, option pay does not result in real and immediate wealth reduction given that the stock

price is dropping. Thus, stock option pay encourages managerial risk-taking behavior. Owing to high risk and cross-

period income in R&D investment, manager’s stock options may well be a more active factor than stock ownership in

initiating R&D investment. The literature provides some empirical evidence for the fact that stock option may facilitate

managerial risk-taking behavior. For instance, Wu and Tu’s (2007) study have found that CEO stock option pay has a

significantly positive effect on R&D spending, while CEO stock ownership has no such effect. Our study provides

additional evidence on Sanders(2001) finding that stock ownership and option pay have different effects on managerial

risk taking. However, we are unable to examine this proposition in this study because few Chinese listed companies

adopt stock option pay for managers.

Inference from our data analysis is that frequency of board meetings is negatively associated with R&D –

performance relationship. This indicates that the frequency of board meeting is relatively high when R&D project has a

poor performance and vice versa. These results provide additional impetus to the findings of Vafeas (1999) which

reported the annual number of board meetings is inversely related to firm value. Also, Tang and Luo (2006), Chen and

Liu (2006) reported that the number of meetings of the board of directors of Chinese companies had a negative

correlation with firm performance. All these results suggest that the board in Chinese companies has a passive role in

corporate governance. Our conclusion supports Jensen (1993)’argument that the role of corporate boards becomes

increasingly more important during crises, when shareholders' interests are in visible danger and as performance

declines, boards are likely to become more active to cope with these problems rather than prevent these problems in

advance.

In this article, we have analyzed the moderating effect of corporate governance on R&D spending-firm

performance relationship based on hitherto unavailable and unstudied data on Chinese listed companies. This study has

provided new and sometimes puzzling evidence which can further stimulate the debate on corporate governance-R&D

investment relationship in China. Even though the evidence is based on a limited number of samples, it represents a first

step into a deeper investigation of the interactions between corporate governance, R&D investment and firm

performance in contexts where the corporate governance regime and investment environment are significantly different

from those of the United States or the United Kingdom.

REFERENCES

Aboody D., & Lev B. (2000), Information Asymmetry,R&D,and Insider Gains, Journal of Finance,55(2),2747-2766.

Alchian A.A., & Demsetz H. (1972), Production, Information Costs, and Economic Organization, American Economic Review, . 62(5),777-795.

Baysinger B.,& Hoskisson R.E. (1989),Diversification Strategy and R&D Intensity in Multiproduct Firms, Academy of Management Journal,

32(2),310-332.

Baysinger B., & Hoskisson R.E.(1990), The Composition of Boards of Directors and Strategic Control: Effects on Corporate Strategy, Academy of

Management Review, 15(1),72-87 .

Baysinger B. D., Kosnik R.D., & Turk T.A.(1991), Effects of Board and Ownership Structure on Corporate R&D Strategy, Academy of Management

Journal,34(1),205-214 .

Berle A.A. ,& Means G. C. (1932), The Modern Corporation and Private Property, New York, Macmillan Publishing Co.

Byrd J., Parrino R., & Pritsch G.(1998),Stockholder-Manager Conflicts and Firm Value, Financial Analysts Journal, 54(3),14-30.


Chang S.C.,Chen S.S.,&Lin C.W.( 2008), The Influence of Corporate Internal Governance on the Wealth Effect of R&D Expenditure Increase, Working paper,

Available at http://scholar.google.com.hk/scholar?hl=zh-

CN&q=The+Influence+of+Corporate+Internal+Governance+on+the+Wealth+Effect+of+R%26D+Expenditure+Increase+Shao-

Chi+Chang&btnG=%E6%90%9C%E7%B4%A2&lr=&as_ylo=&as_vis=0.

Chen H.-L. ,& Huang Y.-S.( 2006), Employee Stock Ownership and Corporate R&D Expenditures：Evidence from Taiwan's Information-Technology

Industry, Asia Pacific Journal of Management, 23( 3),369-384.

Chen J.,& Liu L.(2006), Relationship between the Characters of Board of Directors and Firm Achievements of Listed Company, China Soft Science

Magazine, 11,101-108(in Chinese).

Chung K.,Wright P. ,&Kedia B. (2003), Corporate governance and market valuation of capital and R&D investments, Review of Financial

Economics,12(2),161-172.

Chung K.H.，& Shen C.H.H.( 2009), Corporate Governance and Market Reactions to Capital and R&D Investment Decisions, Working Paper,

Available at http://scholar.google.com.hk/scholar?hl=zh-

CN&as_sdt=0,33&q=Corporate+Governance+and+Market+Reactions+to+Kee+H.+Chung+and+Carl+Hsin-Han+Shen

Dharwadkar R., George G.., & Brandes P. (2000), Privatization in Emerging Economies: An Agency Theory Perspective, The Academy of

Management Review, 25(3), 650-669.

Eisenberg T., Sundgren S., &Wells M. T.(1998), Larger Board Size and Decreasing Firm Value in Small Firms, Journal of Financial Economics,

48(1),35-54.

Fama E.F., & Jensen M.C.(1983), Separation of Ownership and Control, Journal of Law and Economics, 26(2),301-325.

Finkelstein S.,&Hambrick D.C.(1989), Chief Executive Compensation：a Study of the Intersection of Markets of Political Progress, Strategic

Management Journal, 10(2),121-134.

Hall B.H., & Oriani R. (2006), Does the Market Value R&D Investment by European firms? Evidence from a Panel of Manufacturing Firms in France,

Germany, and Italy, International Journal of Industrial Organization, 24(5), 971-993.

Hermalin, B.E., &Weisbach, M.S. (2003), Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature,

Economic Policy Review, Special Issue, 9(1), 7-26.

Hill C.W., & Snell S. (1988), External control, corporate strategy and firm performance in research-intensive industries, Strategic Management

Journal, 9(6), 577-590.

Hoskisson R.E.,Hitt M.A.,Johnson R.A. ,& Moesel D.D. (1993), Construct validity of an objective (entropy),categorical measure of diversification

strategy, Strategic Management Journal, 14(3),215-235.

Jensen M.C. (1993), The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems, Journal of Finance, 48, (4), 831-880.

Jensen M.C., & Meckling W.H.(1976), Theory of the firm: Managerial behavior, agency costs and ownership structure, Journal of Financial

Economics, 3(4),305-360.

Jensen G.R.,Solberg D.P., &Zorn T.S.( 1992), Simultaneous Determination of Insider Ownership, Debt, and Dividend Policies, Journal of Financial

and Quantitative Analysis, 27(2),247-263.

Kosnik R.D. (1990), Effects of Board Demography and Directors' Incentives on Corporate Greenmail Decisions, Academy of Management Journal,

33(1), 129-150.

Le S.A.,Walters B., & Kroll M.( 2006), The Moderating Effects of External Monitors on the Relationship between R&D Spending and Firm

Performance, Journal of Business Research, 59(.2),.278-287.

Liu Y.G., & Liu W. (2007), Top Executive Prefecture and R&D investment, Management World, 1, 128-136 (in Chinese)

Lipton M., & Lorsch J.( 1992), A Modest Proposal for Improved Corporate Governance, Business Lawyer, 48(1),59-77.

Patton A. & Baker J.C. (1987), Why Directors Won’t Rock the Boat, Harvard Business Review, 65(6), 10-18.

Pugh W.N., Oswald S.L., & Jahera Jr J.S. (2000), The effect of ESOP adoptions on corporate performance: are there really performance changes?

Managerial and Decision Economics, 21(5), 167-180.

Rao, P.S., & Lee-Sing, C.R. (1995), Control and Performance: Evidence from the TSE 300, Edited by Dallies, R.J. and Morck, R., Corporate

Decision-Making in Canada, University of Calgary Press, 43-103.

Sanders G.(2001), Behavioral responses of CEOs to stock ownership and stock option pay, Academy of Management Journal , 44(3),477-492.

Sharma S.,Durand R.M, & Gur-Arie O.(1981), Identification and Analysis of Moderator Variables , Journal of Marketing Research, 18(3),.291-300.

Song Z.J., Li Ch.H., & Lu Y.H. (2009), Board of Directors, Product Market Competition and Firm Performance: Theoretical Analysis and Empirical

Research, Journal of Management Review, 21( 9), 120-12. (in Chinese)


Subrahmanyam V.,Rangan N. ,& Rosenstein S.(1997), The Role of outside Directors in Bank Acquisitions, Financial Management,26(3),23-36.

Tang Q. Q.&Luo D. L.(2006), An Empirical Research on the Efficiency and Effectively of Board Directors-In Case of the Shenzhen Market.

Economic Management, 2, 25-37.

Vafeas N.( 1999), Board Meeting Frequency and Firm Performance, Journal of Financial Economics, 53(1),113-142.

Williamson O.E.(1984),The incentive limits of firms: A comparative institutional assessment of bureaucracy,Review of World Economics, 120(4),736-

763.

Wiseman R.M. ,& Gomez-Mejia L.R. (1998), A Behavioral Agency Model of Managerial Risk Taking, Academy of Management Review,23(1),133-

153.

Wright P.,Kroll M.,& Elenkov D.(2002), Acquisition Returns, Increase in Firm Size, and Chief Executive Officer Compensation：the Moderating

Role of Monitoring, Academic Management Journal , 45(2),599-608.

Wu J.F., & Tu R.T.(2007), CEO Stock Option Pay and R&D Spending：A Behavioral Agency Explanation, Journal of Business Research,60(5),482-

492.

Wu Y.L.(2000), Honey, CalPERS Shrunk the Board. Working Paper, June 13. Available at SSRN: http://ssrn.com/abstract=235295 or

doi:10.2139/ssrn.235295.

Yeh Y.H.,Shu P.G., & Su Y.H.(2008), Board Structure, Intra-Industry Competition and R&D Announcement Effect, Working Paper, Available at

http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2008-athens/Su.pdf, pp.1-40.

Yermack D. (1996), Higher Market Valuation of Companies with a Small Board of Directors, Journal of Financial Economics, 40(2), 185-211.

Zenger T.R. (1994), Explaining Organizational Diseconomies of Scale in R&D: Agency Problems and the Allocation of Engineering Talent, Ideas,

and Effort by Firm Size. Management Science, 40(6), 708-729.

APPENDIX

Table 10: Hierarchical regression analysis of board size effect on the relationship between R&D investment and

firm performance (Lag two-year performance) (N=676)


R&D intensity (%) 0.091 * 0.097** 0.332

Firm size 0.197** 0.220*** 0.222***

LEV(debt-to-equity ratio) -0.055 -0.059 -0.06***

Board size

-0.075 -0.061

R&D intensity*Board size

-0.246

F value 10.956*** 9.775*** 8.186***


Table 11: Subgroup analysis of board size’s moderating effect on the relationship between R&D investment and

firm performance(Lag two-year performance)

Variables Board size

large small

R&D intensity (%) 0.052 0.074

Firm size 0.101* 0.252***

LEV -0.047 -0.043

F Value 2.910* 8.912***

Adj.R2 0.013 0.065

Dif.in R2 0.052 N=243 N=433

*p<0.05；**p<0.01；***p<0.001（2-tailed）

http://www.springerlink.com/index/Q12614W41702X373.pdf

http://www.springerlink.com/content/1610-2878/


Table 12: Hierarchical regression analysis of board ownership effect on the relationship between R&D

investment and firm performance (Lag two-year performance) (N=676)


R&D intensity (%) 0.091 * 0.090* 0.133**

Firm size 0.197** 0.198** 0.196**

LEV(debt-to-equity ratio) -0.055 -0.055 -0.056

Board ownership

-0.012 0.020

R&D intensity*Board ownership

-0.077

F value 10.956*** 8.233 *** 7.047***


Table 13: Subgroup analysis of board ownership’s moderating effect on the relationship between R&D

investment and firm performance(Lag two-year performance)

Variables

Whether board holding shares or not

Yes No

R&D intensity (%) 0.024 0.156**

Firm size 0.215 *** 0.179**

LEV -0.010 0.039

F Value 5.596 7.604***

Adj.R2 0.038 0.058

Dif.in R2 0.020*

N=351 N=325 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Table14 Hierarchical regression analysis of board meeting frequency’s effect on the relationship between R&D



R&D intensity (%) 0.091 * 0.090* 0.078

Firm size 0.197** 0.202*** 0.202***


Board meeting frequency

-0.036 -0.039

R&D intensity*Board meeting frequency

0.014

F value 10.956*** 8.436*** 6.742***


Table 15: Subgroup analysis of board meeting frequency’s moderating effect on the relationship between

R&D investment and firm performance(Lag two-year performance)

Variables Board meeting frequency

high low

R&D intensity (%) 0.071 0.103*

Firm size 0.093 0.246 ***

LEV -0.057 -0.046

F Value 1.229 11.03***

Adj.R2 0.003 0.063

Dif.in R2 0.060*

N=230 N=446 *p<0.05；**p<0.01；***p<0.001（2-tailed）


Table 16: Hierarchical regression analysis of management ownership’s effect on the relationship between R&D



R&D intensity (%) 0.091 * 0.089 * 0.115**

Firm size 0.197** 0.204 *** 0.200***


Management ownership -0.076 -0.052

R&D intensity*Management ownership -0.054

F value 10.956*** 9.261*** 7.661***


Table 17: Subgroup analysis of management ownership’s moderating effect on the relationship between R&D

investment and firm performance(Lag two-year performance)

Variables

Management ownership

Y N

R&D intensity (%) 0.028 0.121**

Firm size 0.229*** 0.166***

LEV -0.096 -0.05

F Value 5.089** 7.648***

Adj.R2 0.035 0.070

Dif.in R2 0.035*

N=193 N=483 *p<0.05；**p<0.01；***p<0.001（2-tailed）

Documents

Moderating Effects of Board and Managerial Incentive on ... Krishnamurti Chandrasekar.pdf · Dr. Krishnamurti Chandrasekar, ... investment and firm performance .However, there have