The Role of Institutional Investors in Chinese Corporate Governance

In much of the literature, there are arguments about whether institutional investors are able to take part in corporate governance and improve corporate performance. A large number of studies suggest that institutional investors play a positive role in corporate governance. The rationale is that due to the high cost of monitoring, only large shareholders such as institutional investors can achieve sufficient benefits from it.¹ Shleifer and Vishny observe that institutional investors by virtue of their large stockholdings have greater incentive to monitor corporate performance since they have greater expected benefits of monitoring.² McConnell and Servaes, and Del Guercio and Hawkins have found that corporate monitoring by institutional investors can result in managers focusing more on corporate performance and less on opportunistic or self-serving behaviour.³ Some researchers find that institutional investors are helpful to corporate governance and firm valuation.⁴ McConnell and Servaes find that the percentage of institutional ownership is positively related to a firm's Tobin's Q (ratio of market value to book value of a firm).⁵ Del Guercio and Hawkins also find a positive relation between institutional ownership and various measures of firm performance.⁶

Another line of research suggests that institutional investors are not only short of essential professional skills, but are also easily puzzled by the "free-rider" problem, so are not able to monitor corporate management efficiently. Some analysts have argued that the absence of appropriate incentives and "free-rider" problems hinder institutional activism.⁷ Others have observed that institutional activism has negligible impact on the performance of the companies. They allege that institutional investors, due to their responsibility, select only financially healthy firms in which to invest. Thus, they play only a passive role in corporate governance.⁸

Since 1998, institutional investors have been holding more and more shares and become a major force in Chinese capital markets. However, it is still unknown whether institutional investors participate in corporate governance or not. Most of the Chinese research suggests that institutional investors play only a passive role in corporate governance,⁹ though recently, some researchers have found that institutional investors play an active role in monitoring the performance of the companies. However, they are not able to give the causality.¹⁰ Therefore the purpose of this article is to clarify whether institutional investors take part in corporate governance in China.

Hypotheses

Institutional Investors and Corporate Performance

Compared with the controlling shareholders, institutional investors in China have difficulty controlling listed companies due to their small holding proportion. As investment portfolio experts, institutional investors seek financially healthy firms in order to pursue short-term profits. They generally do not participate in or pay much attention to corporate governance. Most institutional investors are blockholders, i.e., they cannot easily sell their shares in a short time and suffer serious losses if they simply "vote with their feet". They must be concerned about the company's long-term value growth. The more shares they hold, the more influence they can exert on the company and more voice they can have. With more shares of a listed company, they have more incentive to take part in corporate governance and monitor the company management in order to improve corporate performance. Hence,

Hypothesis 1a: Institutional ownership has a positive relationship with firm performance.

Hypothesis 1b: Institutional investors can improve corporate governance.

Institutional Investors and Corporate Governance

CEO Duality

There are arguments about Chief Executive Officer (CEO) duality in the theory and empirical studies. In theory, some researchers consider that the CEO position should be separate from the board chairman position because the duality will lead to lower board independence, reduction in board monitoring effectiveness and CEO entrenchment.¹¹ Li et al. prove that institutional ownership is negatively and significantly associated with CEO duality,¹² while other researchers believe that CEO duality will strengthen definite leadership, achieve unity of command and avoid conflict between the CEO and board chairman.¹³ Simon and Kar Shun Wong find that voluntary information disclosure in the CEO duality company is lower than that in...