Beatson: Foreign Investment, Corporate Governance & Performance in the Chinese Listed A Share Companies

ABSTRACT:

We present a novel lens on the presence and impact of qualified foreign institutional investors (QFII) in the top shareholdings of the non-financial domestically listed Chinese ‘A’ share firms. Unlike prior cross sectional studies which use only annual data, this research runs a robust panel fixed effects model employing quarterly data, thereby capturing the presence of a foreign investor in these firms for the first time and with greater precision, since relying on Q4 shareholdings would be misleading due to changes in ownership configurations intra annum. The initial results suggest that the presence of a QFII as a top shareholder in these companies is associated with their better performance, using both Tobin’s Q and ROA as the performance measures. We control for internal/external corporate governance mechanisms of Bai et al. (2003), ultimate ownership variables as suggested by Chen et al. (2009), foreign legal person shares, a proxy for international affiliations and a number of time variant firm characteristics (e.g. size, leverage, age etc). The exhaustive specification was reduced using principal component analysis and meted with similar results.

Economically, the coefficient of impact on the market measure is the more significant, while the effect of having a QFII in top shareholdings on both is empirically significant. Previously, studies have often ignored the potential for reverse causality beyond using lagged regressors. This is problematic. Therefore, we follow up with a 2SLS instrumental variables model to further mitigate this potential and surprisingly find the empirical relationship holds. Contrary to the only work on QFIIs and governance post-implementation, the findings from our models suggest that in spite of their very low percentage holdings, we can tentatively interpret the presence of a QFII top shareholder could have acted to augment performance over and above existing corporate governance mechanisms.

Therefore, foreign investors could contribute towards the mitigation of agency problems in non-financial Chinese listed companies. Our interpretation is that the effect of a QFII in top shareholdings results in herding behaviour by the market more broadly, but that there may also be a managerial impact. Following up with twenty five interviews with industry practitioners, we found thematic evidence to suggest the interactions foreign investors insist upon with management in their invested companies could lend them a ‘foreign ownership leverage’ – an influence whereby their voting rights are incommensurate to their influence. Moreover, we identify an indirect governance mechanism by which even passive foreign investors could pressure Chinese management who do not want to see their share price and reputation erode, i.e. exiting the trade in addition to the ability to spread the bad news about the company’s governance issues – thus adding to pressure sensitive and insensitive/resistant categories of institutional investors with a third passive-reactive category.

 

Available for download here.

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