Economical science/ 6. Marketing and mmanagement.

Yarmak Timofiy

National University of Food Technologies

FIRM PERFORMANCE IN CHINA

Logit models of CEO turnover are estimated using comprehensive financial and accounting data on China’s firms, augmented by unique data on CEO turnover, ownership structure and board characteristics,. We find consistently for all performance measures including both stock return and various accounting measures that: overall, CEO turnover is significantly and inversely related to firm performance though the magnitude of the relationship is modest; CEO turnover-performance link is stronger when the percentage of company shares owned by the largest shareholder is larger. Furthermore, insofar as stock performance is concerned, turnover-performance link is found to be weaker for listed firms still controlled by the state; the appointment of independent directors enhances turnover-performance link; the listing suspension mechanism, i.e., the ST designation, adopted by China’s securities regulatory agency appears to be effective in improving turnover-performance tie; and listed firms with CEOs holding additional positions in the controlling shareholders have weaker turnover-performance link. Consistent with the “law and finance” approach to corporate governance and the literature on economic transition, our findings suggest that any fundamental improvement in China’s corporate governance will require a broad program that encompasses not only privatization but also laws and their effective implementation to provide better protection for investors.

Executive turnover and its link to firm performance have been the focus of a large and growing literature since they provide a crucial measure of how effective a firm solves the two sets of principal-agent problems it faces: diverging interests between top management and shareholders, which may result in managerial entrenchment; and diverging interests between the controlling shareholders and the minority shareholders, which may lead to the expropriation of the latter by the former or “tunneling,” as referred to in the literature. Specifically, tying the personal fortune of top executives to the performance of the firm aligns the interests of the shareholders and those of the management. It also breaks up the “insider” alliance between the controlling shareholder and the management and therefore helps protect the interests of outside investors (or minority shareholders). As such, executive turnover-performance sensitivities can serve as an important indicator of how well the corporate governance system functions.

In this paper it is studied such link of executive turnover to firm performance in Chinese listed firms and provide the first systematic evidence on the turnover-performance sensitivities of Chinese top executives. By now a large literature has been developed on executive turnover, mostly on U.S. firms and increasingly on firms in other industrialized countries as well. There is, however, relatively limited evidence on developing and transitional economies. In particular, no turnover-performance sensitivity estimate is available for China, which is presently the largest In particular, no turnover-performance sensitivity estimate is available for China, which is presently the largest transition economy in the world. By early 2004, China’s stock market has emerged as the eighth largest in the world with close to 1,300 listed firms and market capitalization of over $550 billions. By focusing on China’s listed firms, our paper therefore attempts to fill possibly the greatest gap in the large and growing literature on executive turnover.

Perhaps more importantly, China is an ideal case for a study of internal corporate governance including CEO turnover for at least two reasons. Firstly, the internal disciplinary mechanism that determines CEO turnover is particularly important due to the lack of effective markets for corporate control in China. In addition, both types of agency problem are acute in China due to the poorly defined property right and weak investor protection (resulting in part from the legacy of the command economy). Volpin regards Italy as an ideal case for a study of top executive turnover in the absence of strong investor protection.

Specifically, using 1998 to 2002 financial and accounting data on China’s listed firms, augmented by unique data on CEO turnover, ownership structure and board characteristics, we find consistently for all performance measures including both stock return and various accounting measures that: overall, CEO turnover is significantly (statistically) and inversely related to firm performance though the magnitude of the relationship is modest; perhaps more importantly CEO turnover-performance link is stronger when the percentage of company shares owned by the largest shareholder is larger. In addition, insofar as stock performance is concerned, the link between firm performance and CEO turnover is found to be stronger for privately-controlled listed firms than for state-controlled listed firms; the appointment of independent directors enhances the link between firm performance and CEO turnover; the listing suspension mechanism, i.e., the ST designation, adopted by China’s securities regulatory agency appears to be effective in improving the link between firm performance and turnover; and listed firms with CEOs who also hold positions in the controlling shareholders have weaker link of CEO turnover to performance.

References:

1. Bai, Chong-En and et. al. A Multitask Theory of State Enterprise Reform. / Journal of Comparative Economics, 2000 - 28(4) - 716-38 pp.

2. Brunello Giorgio; Graziano Clara and Parigi Bruno M. CEO Turnover in Insider-Dominated Boards: The Italian Case / Journal of Banking and Finance, 2003 - 27(6) - 1027-51 pp.

3. Kato Takao, Long Cheryl CEO Turnover, Firm Performance and Enterprise Reform in China: Evidence from New Micro Data / IZA DP No. 1914 [Electronic resource]: Access mode: http://ftp.iza.org/dp1914.pdf