Independent Directors In China: Role And Mechanism

The separation of ownership and control causes agency problems in many modern firms.Independent directors,who are often more objective than other board members,play an important role in corporate governance.Regulators around the world have introduced various policies,such as Cadbury Report and Sarbanes-Oxley Act,to encourage the adoption of an independent director system.In 2001,the China Securities Regulatory Commission(CSRC)issued the Guideline for Establishment of Independent Director System in Listed Companies.In this dissertation,I study independent directors in China,with a particular emphasis on role and mechanism.My dissertation consists of three parts.The first part analyzes voting behavior,specifically the dissention behavior of independent directors.I show that the dissention of independent directors can significantly increase a firm's value.Dissention occurs when a firm is punished by regulatory authorities or faces potential financial difficulties.Also,dissention is closely related to the incidence of agency problem.Overall,the evidence suggests that independent directors take actions to protect firm and minority shareholders.In addition,when pay-for-performance sensitivity or turnover-for-performance sensitivity is low,independent directors veto poor decisions of the board and engage in activism.The second part investigates the effect of individual concerns on the voting behavior of independent directors.I focus on four individual factors including career concern,compensation concern,reputation concern and term concern.The results suggest that an independent director with a longer career horizon,who is better compensated,who starts the term earlier than the board chairman,or with less board seats in other firms is more likely to vote dissention.The last part of my dissertation examines heterogeneity in independent directors.To examine the effect of firm ownership structure on the behavior of independent directors,I categorize firms based on the nature of their controlling shareholders.Overall,I find that independent directors across different types of firms increase the firm's value and take action when a firm faces trouble,when it performs expropriation at the expense of minority shareholders,or when the board makes poor decisions.There is heterogeneity in the effect of individual concerns on voting behavior.Only the compensation concern holds for both types of firms.My dissertation contributes to the literature in three perspectives.First,I collect and construct a dataset of board voting details and use the dissention decision of independent directors as a measure of their effectiveness and quality of the board.The most popular measure in extant literature is the board independence ratio,which does not reflect the actual decision-making process of the board,and thus may lead to an endogeneity problem.I study independent directors through their dissention behavior,which is a valuable form of passive monitoring and a proxy for their diligence.Voting behavior has been widely studied in both theoretical models and experimental tests,and my work complements this strand of literature by providing empirical evidence.Second,I examine whether or not independent directors effectively protect firm and minority shareholders,and help board make better decisions.Prior studies focus on how independent directors directly increase a firm's productivity and profitability.Most indicators measuring a firm's operation change slowly over time and are not able to reflect the efforts of independent directors in a timely manner.However,it is much easier to observe and quantify independent directors' dissention behavior at a given time.While it is widely believed that independent directors do not function well in China,my analysis shows that independent directors actively engage in monitoring management and increase a firm's value.This finding suggests that the stereotype of independent directors in China may be false.Third,my dissertation discusses the effect of ownership structure on the behavior of independent directors.Countries throughout the world have various institutional conditions.In China,nearly half of the firms have government or its affiliates as their controlling shareholders.My dissertation adds to the strand of literature by studying the effect of firm ownership structure on directors.The heterogeneity of independent directors across different types of firms has rich policy implications.In addition,I extend the research design by taking the unique institutional background of China into account.