Institutional Causes of Corporate Finance and Governance in Asia Joseph P.H. Fan (b109671/index.html) Professor, School of Accountancy.

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

Joseph Fan Institutions

Outline

Research framework Asia’s institutional environments How rent seeking affects corporate

behaviors Conclusions


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)


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


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


Protection of Property Rights across China’s Different Regions

HighMiddleLow Missing


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


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


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


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


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


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


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


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


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)


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)


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


Unrelated Firms

Corruption and Long-term Debt Financing in China (Fan, Rui, Zhau, in progress)


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


Unrelated Firms

Corruption and Corporate Debt Maturity in China (Fan, Rui, Zhau, in progress)


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%


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


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


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


Opacity Premium in Asia Source: PricewaterhouseCoopers

0

2

4

6

8

10

12

14

Economy

ChinaTaiwanHong KongIndonesiaJapanKorea (South)SingaporeThailand


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


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)


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


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


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


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


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

Institutional Causes of Corporate Finance and Governance in Asia Joseph P.H. Fan (b109671/index.html) Professor, School of Accountancy.

Documents

asia joseph

high slide

san francisco slide

corruption cases

roles of rent seeking

property rights index

governance http

corporate sector debates