1. Governance Role of Different Types of State-Share Holders: Evidence from China ’ s Listed Companies By Jiwei Wang Ph.D. Candidate 16 JUNE 2003

2. Outline Brief summary Motivation: why is the topic import? Literature review Type of state-share holders and firm performance Type of state-share holders and top management turnover Conclusions

3. Brief summary of this thesis Difference from existing literature: this thesis focuses on the identity of state-share holders rather than the state shareholding per se. Classification of state-share holders: –bureaucratic state-share holder (BSH) –corporate state-share holder (CSH) Main tests: effects of types of state-share holders on –Firm performance –Monitoring of top management Results: CSHs play better than BSHs and no worse than non-state shareholders.

4. Shanghai Bureau of Finance 8.26% The largest one Shanghai Pudong Development Bank Co. Ltd. Bureaucratic State-Share Holder Example of state-share holder

5. TCL International Holdings TCL Industrial Holdings 51.82% TCL Holdings 100% Huizhou City Municipal Government …… Corporate State-Share Holder Example of state-share holder (cont.)

6. Why the types of shareholders important? Effectiveness of privatization depends on the existence of the institutional underpinnings of capitalism (Nellis, 1999). Delay privatization and use “better management contracts” to make state-share holders act like private owners in the absence of institutions (Stiglitz, 1999)

7. Chinese approach: –Under gradual privatization strategy, Chinese government maintains a large portion of state-owned shares in listed companies (Table 1). –The government delegates various types of state-share holders to control this portion of state-owned shares. The success of this approach depends on the effective governance role of these different types of state-share holders in China’s listed companies. 19931994199519961997199819992000 32.48%32.34%31.83%33.81%36.51%37.65%38.93%38.54% Why the types of shareholders important?

8. Literature review Political and managerial perspectives Political perspective: government interference –Government intervention would be detrimental if it is not a social welfare maximizing government. (Sappington and Stiglitz, 1987). –Rational individual politicians have their own goals, such as maximizing their political base. (Shleifer and Vishny, 1994). –The interference of government and individual politicians would also lead to distortion of manager’s investment decision and result in suboptimal investment. (Laffont and Tirole, 1993). Detrimental role of state shareholdings:

9. Managerial perspective: agency cost –Principal-Agent problems arise when there is separation of ownership and control (voluminous literature). –“absence of principal” causes higher degree of principal- agent problems for state ownership. –Thus state shareholders have less incentive to remove non- performing top management. Literature review (cont.) Detrimental role of state shareholdings:

10. State ownership and firm performance in China –Weakly negative correlation: the detrimental role of state ownership (Xu and Wang, 1999, Chen, Firth, and Rui (2003), and Sun and Tong, 2003). –U-shaped relationship: grabbing (detrimental) and helping (supportive) role of state ownership (Tian, 2001). –Inverted U-shaped relationship: nonlinear positively correlated (Sun, Tong, and Tong, 2002) –They do not differentiate the type of state-share holders Literature review (cont.)

11. Top management turnover in China –Chairperson is fired for poorly performing: Firth, Fung, and Rui (2002) examine the determinants of chairperson turnover in China’s listed companies and find that performance based on accounting data is a key determinant of forced chairperson turnover. –They do not examine the effect of the type of state- share holders on the sensitivity between the likelihood of chairperson turnover and poor firm performance. Literature review (cont.)

12. Classification of state-share holders Classification basis: degree of government intervention Five types of state-share holders are classified as BSHs: –Central government ministries and commissions –National industrial companies –Local government bureaus –Local state assets management bureaus –Local state assets operating companies All other types of state-share holders are CSHs: mostly they are SOEs. Three groups of shareholders: –BSHs, CSHs, non-state (holder of legal-person shares)

13. Main prediction: BSHs play worse than CSHs. –Higher degree of government intervention will be more detrimental to firm performance –In addition, CSHs have better incentive contract than BSHs (World Bank, 1997), which makes CSHs behave more like market-oriented entities than BSHs. Hypotheses: –H1a: performance of firms with BSHs < that of other type of firms –H1b: performance of firms with CSHs < that of firms without state-owned shares Type of shareholders and firm performance

14. Dependent variable: firm performance –Both accounting and market performance measures (CROAI and MARET) Independent variable: type of shareholders –STATED, BURD, BLARGE Control variables (Caves and Barton, 1990): –Organizational factors: SIZE, LISTAGE –Capital intensity: TANGIBLE –Dynamic disturbances: INTRY, SALESG –Government and regulatory policies: LEVERAGE –Ownership concentration: HERF (Demsetz and Lehn, 1985) –Other control variables: EXCHANGE, INST%, and Year Dummies Type of shareholders and firm performance

15. Data source : Genius, TEJ, and CSRC Sample : firms issued A shares (RMB denominated) and listed in Shanghai or Shenzhen stock exchanges for at least one year from 1994 through 2000, excluding firms in banking and financial industry. It includes 918 listed companies and 3725 firm-year observations. (Table 4) Outlier: I trim the top and bottom 0.5% of the sample, which results in a total sample of 900 firms with 3468 firm-year observations.

16. CROAI Eq. (1)Eq. (2)Eq. (3)Eq. (4) STATED -0.0036 (-1.24) 0.0008 (0.27) 0.0020 (0.67) BURD *STATED -0.0104 (-4.23)*** -0.0106 (-4.05)*** BLARGE *STATED -0.0169 (-6.20)*** Types of shareholders and firm performance Regression of performance (CROAI and MARET) on Shareholder Dummies and other controls (Table 7) Strong Evidence: BSHs play worse than others and CSHs do not play worse than non-state shareholders.

17. A more direct indication of governance role of shareholders: monitoring of top management. Managerial perspective predicts that state- share holders have less incentive to monitor top management. Types of shareholders and management turnover

18. H2a: correlation of probability of top management turnover and prior firm performance < 0. H2b: sensitivity of top management turnover to poor firm performance in firms with state- owned shares < that in firms without state- owned shares. Types of shareholders and management turnover

19. Different types of state-share holders have different incentives to monitor managers. H2c: the sensitivity in firms with BSHs < that in other types of firms. H2d: the sensitivity in firms with CSHs < that in firms without state-owned shares. Types of shareholders and management turnover

20. Top management turnover sample (Table 9) –Hand-collected turnover sample from announcements –Delete non-forced turnover, such as: Retirements and healthy reasons Promotions Illegal operations Large shareholder changed Control sample –Firms listed for at least one year and not experienced any management changes from 1994 to 1998 Total sample: 327 turnovers representing 270 firms; 502 non-turnovers representing 239 firms Types of shareholders and management turnover

21. Dependent variable: management turnover –TURNOVER Independent variable: firm performance –Accounting and market performance measures (ROAI, MARETI) Control variables, such as: –Firm size (SIZE): Huson et al. (2001) –Tenure (TENURE): Goyal and Park (2001) –Ownership concentration (HERF) –Board size (BSIZE): Jensen (1993) –Management age (CEOAGE): Goyal and Park (2001) –Year dummies Types of shareholders and management turnover

22. Eq. (7)Eq. (8)Eq. (9)Eq. (10) ROAI-9.0808 (<.0001) -13.4428 (<.0001) -16.9348 (<.0001) -14.5715 (<.0001) STATED * ROAI6.5628 (0.0484) BURD * ROAI15.0384 (<.0001) 12.7330 (0.0001) CORPD * ROAI-5.2539 (0.2468) Management is fired for poor performance Types of shareholders and management turnover Logit analysis: Table 12

23. Eq. (7)Eq. (8)Eq. (9)Eq. (10) ROAI-9.0808 (<.0001) -13.4428 (<.0001) -16.9348 (<.0001) -14.5715 (<.0001) STATED * ROAI6.5628 (0.0484) BURD * ROAI15.0384 (<.0001) 12.7330 (0.0001) CORPD * ROAI-5.2539 (0.2468) CSHs play no worse than non-state shareholders Only BSHs reduce the sensitivity Analysis of turnover probability (Table 12)

24. Conclusions Results: Different types of state-share holders play different governance roles in China’s listed companies. Firm performance is determined by the incentive of state-share holders, rather than state ownership per se. Implications: –State-owned shares held by BSHs in China’s listed companies should be released first. –For transitional economies without institutional underpinnings of capitalism, introduction of “corporate state-share holders” acting like “private owners” could be considered.

25. Governance Role of Different Types of State-Share Holders: Evidence from China ’ s Listed Companies Thank you very much!