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Institutional Causes of Corporate Finance and Governance in Asia
Joseph P.H. Fan(http://ihome.cuhk.edu.hk/~b109671/index.html)
Professor, School of Accountancy and Department of FinanceDeputy Director, Center for Institutions and Governance
(http://www.baf.cuhk.edu.hk/research/cig/)The Chinese University of Hong Kong
Prepared for the 2005 AAA Meeting, San Francisco
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Outline
Research framework Asia’s institutional environments How rent seeking affects corporate
behaviors Conclusions
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A Top-down Framework
Country InstitutionsThe legal system (the court and the law)
The government (regulations, public sector governance)The society (religion, ideology, custom, social norm)
MarketsProduct, labor, manager, raw material, financial capital
FirmsFirm boundary (vertical integration, diversification)
Ownership and control structuresGovernance structures
(accounting, boards of directors,executive compensation, reputation mechanisms)
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Asia’s Business Environments
Incomplete or weakly enforced laws and property rights
Government regulations / interventions in market activities
Corruption problems in a few economies Crony capitalism: some governments allocate
business privileges by connections rather than by the market rule
Relationship-based transactions, Confucianism, low trust society
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Property Rights Protection in Asia(Source: Property Rights Index, Heritage Foundation, 2001)
0
0.5
1
1.5
2
2.5
3
3.5
4
Economy
ChinaTaiwanHong KongIndonesiaJapanKorea (South)MalaysiaPhilippinesSingaporeThailandUnited StateUnited Kingdom
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Protection of Property Rights across China’s Different Regions
HighMiddleLow Missing
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Corruption in Asian Economies(Source: Transparency International: mean Corruption Perception Index 1992-2000)
0
1
2
3
4
5
6
7
8
9
Economy
ChinaTaiwanHong KongIndonesiaJapanKorea (South)MalaysiaPhilippinesSingaporeThailandUnited StateUnited Kingdom
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Rent Seeking and Corporate Behaviors
The quality of public sector governance is of the first order importance in shaping the behavior of Asia’s corporate sector
However, it is often ignored in corporate sector debates in Asia and around the world
In the following we present our research progress on the roles of rent seeking in Stock valuation Corporate finance Governance and professionalism Corporate transparency Organizational structure
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I. Low Stock Valuation
Asian share investors are subject to expropriation by politicians and/or managers
Investors not able to fully enforce their property rights results in low valuation of shares
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Price Protection by Minority Shareholders in AsiaClaessens, Djankov, Fan, Lang (2002)
Company Valuation and the Difference between Control and Ownership
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
0% 1-5% 6-10% 11-15% 16-20% 21-25% 26-30% 31-35% 36-40%
Control Minus Ownership
Mea
n M
arke
t-to
-bo
ok
Val
ue
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Chinese companies’ post-IPO stock return performance (CAR) distinguished by whether CEOs are politically connected (Fan and Wong, 2005)
-45.00%
-40.00%
-35.00%
-30.00%
-25.00%
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
Months after IPO
Ret
urn
mean of firms whose CEOsare potically connected
mean of firms whose CEOsare not potically connected
Cumulative market-adjusted compound stock returns
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Firm Behavior II: High Financial Leverage
Companies in Asia rely on debt much more than equity to finance their investment
Moreover, they rely on short-term debt, even when they engage in long-term investment
Banks, not capital markets, are the primary sources of funds for firms in Asia and other developing countries
Why are these? Owners’ desire to maintain control More fundamentally caused by
institutional factors
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Cross Country Pattern of Corporate leverage (Fan, Titman, Twite, 2004)
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
Kor
ea, R
ep.
Tha
iland
Indo
nesi
a
Indi
a
Bra
zil
Phili
ppin
es
Chi
na
Aus
tria
Paki
stan
Ital
y
Port
ugal
Japa
n
Finl
and
Den
mar
k
Switz
erla
nd
Bel
gium
Fran
ce
Hon
g K
ong,
Chi
na
Can
ada
Mex
ico
Irel
and
Peru
Tai
wan
New
Zea
land
Spai
n
Chi
le
Sing
apor
e
Mal
aysi
a
Net
herl
ands
Ger
man
y
Swed
en
Nor
way
Uni
ted
Stat
es
Aus
tral
ia
Uni
ted
Kin
gdom Isra
el
Tur
key
Sout
h A
fric
a
Gre
ece
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Cross Country Pattern of Corporate Debt Maturity (Fan, Titman, Twite, 2004)
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
Can
ada
Swed
en
New
Zea
land
Uni
ted
Stat
es
Aus
tral
ia
Nor
way
Finl
and
Irel
and
Switz
erla
nd
Mex
ico
Den
mar
k
Indi
a
Net
herl
ands
Sout
h A
fric
a
Chi
le
Port
ugal
Bra
zil
Fran
ce
Bel
gium
Uni
ted
Kin
gdom
Ger
man
y
Phili
ppin
es
Isra
el
Japa
n
Spai
n
Aus
tria
Kor
ea, R
ep.
Hon
g K
ong,
Chi
na
Ital
y
Paki
stan
Peru
Tai
wan
Tur
key
Indo
nesi
a
Mal
aysi
a
Tha
iland
Sing
apor
e
Chi
na
Gre
ece
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Rent seeking and Corporate Finance
In a corrupted country, the government is a weak enforcer (or even a violator) of property rights, and debt (bank loans) provide better protection than equity
Politicians/bureaucrats channel funds to their favored firms through banks they control
We are investigating the effects of government officers corrpution on corporate finance in China (Fan, Rui, Zhao, in progress)
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Mean Leverage - Total Debt/Assets(Briber+Related and Unrelated Firms)
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
-3 -2 -1 0 1 2 3
Years around Event
Briber+Related Firms
Unrelated Firms
Corruption and Firm Leverage in China(Fan, Rui, Zhau, in progress)
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Mean Long Term Debt/Assets (Briber+Related and Unrelated Firms)
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.1
-3 -2 -1 0 1 2 3
Year around Event
Briber+Related Firms
Unrelated Firms
Corruption and Long-term Debt Financing in China (Fan, Rui, Zhau, in progress)
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Mean Maturity - Long Term Debt/Total Debt (Briber+Related and Unrelated Firms)
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
-3 -2 -1 0 1 2 3
Year around Event
Briber+Related Firms
Unrelated Firms
Corruption and Corporate Debt Maturity in China (Fan, Rui, Zhau, in progress)
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Firm Behavior III: Boards of directors are weak in governance: the case of China (Chen, Fan, Wong, 2004)
Board size 9.22 (range 5 to 19)Manager directors 34%Largest shareholder 53%Minority shareholders 0%Politicians 32%
Central govt 4%Local govt 19%Others 9%
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Firm Behavior III: Low Director Professionalism in China (Chen, Fan, Wong, 2004)
Directors from unaffiliated firms (outside experts) 18%Accountants, lawyers, finance experts 5%Academics 14%Woman directors 5%Age 47Education Between Junior
college and university
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Corruption and board professionalismShougang Group in ChinaPercentage of Directors that Are Professionals –
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Corruption CaseCorruption Case
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Firm Behavior IV: Opaqueness
Why are Asian companies opaque? Complex organizational and ownership
structures Covering up: difficulties of putting investors’
interests before family interest Relationship-based business dealings, rent
seeking, or even corruption Prevent predation and expropriation
(sometimes by governments) in weak property rights systems
If these institutional constraints cannot be relieved, it would be difficult to improve corporate transparency even with new accounting standards, laws, and regulations
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Opacity Premium in Asia Source: PricewaterhouseCoopers
0
2
4
6
8
10
12
14
Economy
ChinaTaiwanHong KongIndonesiaJapanKorea (South)SingaporeThailand
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Corruption in Asian Economies(Source: Transparency International: mean Corruption Perception Index 1992-2000)
0
1
2
3
4
5
6
7
8
9
Economy
ChinaTaiwanHong KongIndonesiaJapanKorea (South)SingaporeThailand
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Firm Behavior V:Complex Organizational Structures
Business group A corporate organization where a number of
firms are linked through stock-pyramids and cross-ownership
Groups are the dominant form of corporate organizations in Asia. About 70 percent of publicly traded companies in Asia are group affiliated (Claessens, Fan, Lang, 2005)
Diversification Asian companies are known for extensive
diversification of their businesses (Claessens, Fan, Lang, 2004)
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Figure 1: Organization Framework of Fusun Group
20%
Iron&
Steel 25 % (2)
Commerce
Medicine
24.53%
Estate
10% 10%22%
5%
11.95%(2)
10%
58%
95%
13.53%
90.3%
20%
90%
1.94%
10%
49 % (2)
15.04% (2)
26.04 % (1)
70.95%
11.36%8.81%
%
43.33%(2)
30%
3.77%
30%
67.12%
36.03 %(1)
48 % (2)
20%
21%
Shanghai Guangxin Technology Development Co. Ltd.
Shanghai Fusun High Technology (Group) Co. Ltd.
NISC (600282)
FORTE(HK2337)YYTM
(600655)
53.92%
Nanjing Iron &Steel United Co.,Ltd.
Shanghai Fusun Pharmaceutical Development Co. Ltd.
Shanghai Fusun I.T. Development Co. Ltd. (Subsidiary)
LRGF(600285)
Tianjin Pharmaceutical Holdings, Ltd.
TJPC(600488)
中国医药控股有限公司 .
ACCORD PHARM (000028)
Shanghai Friendship-Fusun (holding) Co. Ltd.
SFGIC(600827) Tangshan
Jianlong Steel Co. Ltd.
Lianhua Supermarket(HK0980)
Fusun Pharm(600196)
Zhaojin Mining Co. Ltd.
JianMin Pharm
(600976)
Shanghai Fusun High Technology Co. Ltd.
Shanghai Fusun
Business Investment Co. Ltd.
Liang XinjunGUO Guangchang
Wang Qunbin Fan Wei
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Number of business lines of listed companies in China (2003)
0%
10%
20%
30%
1 2 3 4 5 6 7 ≥ 8
经营业务数
公司
比例
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Chinese Corporate Pyramids(Fan, Wong, Zhang, 2005)
Number Number of of
PyramidaPyramidal Layers l Layers
Local Government-Local Government-controlled Firmscontrolled Firms
Entrepreneur-Entrepreneur-controlled Firmscontrolled Firms
NNPercentage(%Percentage(%
))NN Percentage(%)Percentage(%)
11 190 190 25.17 25.17 11 1.59 1.59
22 468 468 61.99 61.99 41 41 65.08 65.08
33 88 88 11.66 11.66 18 18 28.57 28.57
>=4>=4 9 9 1.19 1.19 3 3 4.76 4.76
TotalTotal 755 755 100.00 100.00 6363 100.00 100.00
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Why are diversification and group affiliation popular in Asia?
Creating internal factor markets to circumvent external markets subject to distortions and high transaction costs.
These factor markets include financial capital, labor, raw materials and product markets.
The distortions are caused by regulations, taxations, or weak legal protections.
Risk reduction through cross-subsidization Agency problem
Diversification and group formation could be means for controlling owners to expropriate outside investors
Rent seeking can be more important than professionalism when competing in weak institutional environments
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Conclusions
Asian companies’ behaviors are fundamentally shape by their institutional environments
Focusing only on firm level factors is not enough
Top-down approach that examines the interactions between firms and institutions will be fruitful
What should be the focus of corporate sector reforms? No firm-level quick fix please No more new laws and regulations cut-and-pasted
from formula books Focusing on institutional factors, such as fighting
corruption, will more likely payoff