The Governance Mechanisms Of Corporate Misconducts

Listed companies are an important subject in capital market.Improving corporate governance has always been an important part of the top-level design of the capital market.In recent years,the frequent occurrence of corporate misconduct cases in the securities market has not only severely hit the confidence of investors,but also greatly damaged the capital market efficiency,and reduced the role of financial market in resource allocation function.Therefore,it is of great theoretical significance and practical value to study the governance mechanism for reducing corporate misconducts and preventing financial risks,guiding the capital market to serve the real economy and allocate resources effectively.Existing literature in corporate governance studied the effect of internal and the external governance mechanism respectively,but neglecting the connection between internal and external governance mechanism.This paper studies internal and external governance mechanisms for disciplining corporate misconducts which is fundamentally caused by information asymmetry and conflicts of interest between the principal and the agent.To assess the importance of studying governance mechanism for corporate misconduct,this paper first examines the direct economic impact and indirect contagion effects of corporate misconduct.This paper finds that corporate misconduct could reduce the profitability and increase agency costs,which damages the interests of the shareholders;And it could also reduce stock price efficiency and increase the stock crash risk,which infringes the legitimate rights and interests of investors.Besides,such misconduct risk could spread to equity related firms,hindering the function of financial market in resource allocation.Since the 19 th National Congress of the Communist Party of China,“Serving the real economy,preventing financial risks,and deepening financial reform” has always been the primary goal for the supervisory authority,and the regulators have enhanced supervision on corporate misconduct behaviors.However,due to the weak investor protection and the low level of administrative penalties,various types of misconduct behaviors keep occurring and show an increasing trend in recent years.Therefore,it is very necessary and important to study the governance mechanism for corporate misconduct.Based on the internal and external governance mechanism,this paper examines the role of incentive-based compensation system,the financial information intermediary,and the short selling mechanism based on the levels of manager,monitor and investor correspondingly under the settings of information asymmetry and mitigating conflicts of interest.Using the data of Chinese A-share listed companies from 2010 to 2019,this paper finds: the monetary compensation to performance sensitivity and the equity compensation to performance sensitivity could effectively mitigate the agency problem,thereby improving corporate governance and reduce corporate misconduct;analyst focus and short selling could play external governance effect in corporate misconduct through promoting the design of performance based compensation design.For each governance mechanism,the findings are as follows:From the perspective of coordinating conflicts of interest,compensation contract is the link of the interests between shareholders and managers.This paper first examines the role of compensation incentive in corporate misconduct,and then investigate how the compensation incentive works.This paper finds that the greater sensitivity of executive monetary compensation to operating performance or the higher sensitivity of executive equity compensation to stock price performance,the lower the probability of corporate misconduct;this is because the performance-based compensation incentive contracts can promote the interest alignment between shareholders and managers and reduce agency costs,thereby improving corporate governance and reducing corporate misconduct.Besides,as there is marked difference between state owned enterprises(SOEs)and non-state-owned enterprises(non-SOEs),the governance effect of managerial incentive mechanism is more pronounced in non-SOEs.Therefore,the compensation incentive system is an effective internal governance mechanism in corporate misconduct.From the perspective of alleviating information asymmetry,this paper investigates the effect of the financial information intermediaries,i.e.,securities analysts on corporate misconduct,and find that analyst focus could significantly reduce corporate misconduct through the information production channel.This is because analyst have advantage in information obtaining and analyzing,and providing high-quality information to the market through research reports,which reduce the information asymmetry in the company.Such information intermediary role of security analysts promotes the design of compensation incentive and improves the sensitivity of both executive monetary compensation to operating performance and executive equity compensation to stock performance,thereby reducing corporate misconduct.Further evidence shows that the disciplining effect of analyst focus is through affecting managerial incentive instead of affecting shareholders' behaviors.Furthermore,the governance effect of analyst focus comes from the information production channel rather than the widespread market attention channel.Therefore,analysts play an effective external governance role in corporate misconduct.From the perspective of negative information expressing channel,this paper studies the external disciplining effect of short selling in corporate misconduct.Using the quasi-natural experiment of short selling pilot and distributed expansion program since March 31,2010,this paper first finds that after relaxing short selling constraints investors can actively participate in corporate governance through “voting with their feet” and significantly discipline corporate misconduct behaviors.This paper then explores the internal channel through which short selling works and find that short sellers are informed as they can discern and attack the negative information of the firm which improve the stock price efficiency,such potential short selling pressure promotes shareholders to increase the managerial alignment with firms and thereby reducing corporate misconduct.Besides,since the shareholders in SOEs do not care about stock price as much as non-SOEs,the disciplining effect of short selling is significant in nonSOEs but non-significant in SOEs.Furthermore,the disciplining role of short selling in corporate misconduct is more significant when firm faces equity pledge risk and financing constraint.Overall,this paper documents the economic consequences of corporate misconduct and the governance mechanisms from the levels of manager,monitor and investor.The findings of this paper can shed some light on the study of internal and external corporate governance mechanisms and the interconnectedness.This paper also contributes to the identification of misconduct risks,the supervision of corporate misconduct,the optimization of corporate governance mechanism design,thus promoting the effective role of financial market in resource allocation.