The preference for a fellow townsman in investment decisions: Identification or selfishness?

Abstract

As a kind of nepotism, the phenomenon of a “preference for a fellow townsman” exists throughout the world capital market and is particularly prominent in Asian countries, where business relationships are often based on personal relationships. This paper takes China as representative of Asian countries and explores the preference for a fellow townsman as the CEO and board chairman in investment decisions. In addition to examining the identification hypothesis, we propose using the selfishness hypothesis and study the effectiveness of transmission of the agency mechanism. We conclude that at enterprises in the same hometown as the CEO and chairman, investment efficiency is lower, investment performance is worse, and the form of this inefficient investment is overinvestment. This shows that selfishness hypothesis is more suitable for explaining the fellow townsman preference leading to overinvestment than the identification hypothesis. The two mechanisms (internal communication mechanism and external supervision mechanism) that influence the agency motivation indicate that the greater the demographic differences between the CEO and chairman and the higher the corporate governance level, the more that overinvestment by enterprises caused by preference for a fellow townsman is inhibited. In this paper, identification hypothesis and selfishness hypothesis in the relationship between the CEO and chairman in corporate governance are unified into the integrated analysis framework of agency cost, which enriches and expands the connotation of agency theory and the relevant research on agency problems with Asian characteristics.