External Governance Mechanisms Research Articles

Managerial Ability and ESG Risks: The Moderating Effect of Internal Control Quality

The 2017 COSO framework highlights the increasing need to incorporate environmental, social, and governance (ESG) considerations into firms’ internal control and risk management practices. Top managers play a crucial role in risk management and control. However, it remains unclear whether managerial ability affects ESG risk management. This study investigates the relationship between firms’ ESG risk exposure and managerial ability, and examines whether the quality of internal control (ICQ) influences this relationship. Based on panel data from Chinese listed firms between 2008 and 2022, we found that firms led by more capable managers have lower overall ESG risk exposure, including reduced environmental, social, and governance risks. Furthermore, our findings indicate that higher ICQ strengthens the association between managerial ability and ESG risks. Specifically, an analysis of the five internal control components showed that the mechanisms through which ICQ influences this relationship involve enhancing control environments, risk assessment, control activities, and information and communication channels. Further analysis indicated that the moderating effect of ICQ on the relationship between managerial ability and ESG risks is influenced by management power and the effectiveness of external governance mechanisms.

Corporate culture and shareholder litigation rights: evidence from a quasi-natural experiment and textual analysis

PurposeTaking advantage of an innovative measure of corporate culture obtained from advanced machine learning and textual analysis, we investigate how corporate culture is influenced by shareholder litigation rights, which are widely recognized as a crucial external governance mechanism. The innovative measure of corporate culture is based on a textual analysis of over 200,000 earnings call transcripts.Design/methodology/approachTo mitigate endogeneity and thus demonstrate causality, we exploit a quasi-natural experiment based on the staggered passage of universal demand laws, which reduce shareholder litigation rights. The enactment of state-level legislation is likely exogenous to individual firms’ characteristics as it is beyond the control of any given firm. Following the literature, we employ a difference-in-difference analysis, supplemented by several robustness checks, i.e. propensity score matching and entropy balancing.FindingsOur difference-in-difference estimates show that an exogenous reduction in shareholder litigation rights weakens corporate culture considerably. Specifically, corporate culture is 12.74–14.41% weaker after the implementation of universal demand laws. Our results corroborate the hypothesis that a decline in litigation risk exacerbates agency problems, discouraging self-interested managers from taking actions that enhance shareholder value in the long run, such as cultivating a strong corporate culture.Originality/valueOur study is the first to explore how corporate culture is affected by shareholder litigation risk, which constitutes a vital external governance mechanism. Moreover, we utilize an innovative measure of corporate culture based on sophisticated textual analysis. Finally, we employ a quasi-natural experiment based on an exogenous shock, making it more likely that our conclusion reflects a causal influence rather than merely a correlation.

Digital tax enforcement and shadow banking of non-financial firms: Evidence from China's Golden Tax Project III

Digital tax enforcement (DTE) is an important external monitoring and governance mechanism for firms. We leverage the pilot of China's Golden Tax Project III as a natural experiment of DTE to investigate its impact on non-financial firms’ shadow banking. Using a sample of Chinese firms from 2007 to 2022, we document that DTE restrains shadow banking activities of non-financial firms by improving corporate transparency and mitigating agency problems. Additional analyses suggest that the effect is more salient for firms in regions with weak financial supervision, low-quality media monitoring, low-quality auditor, or weak internal control.

Multiple large shareholders and pay-performance sensitivity: Evidence from China

This study investigates whether and how multiple large shareholders affect pay-performance sensitivity. Our findings suggest that multiple large shareholders can enhance pay-performance sensitivity by improving the efficacy of compensation committees and reducing inefficient investments. Further analysis reveals that this positive governance effect is more pronounced in firms with more severe agency problems, weaker external governance mechanisms, and higher accounting comparability. We also find that the impact of multiple large shareholders on pay-performance sensitivity is more significant in state-owned enterprises, where corporate governance is often deficient due to government’ multifaceted objectives and limited oversight of managers. Overall, this study contributes to existing literature by enriching the research on ownership structure and pay-performance sensitivity, and offering new insights into the governance dynamics associated with multiple large shareholders within the context of compensation contracting.

IFRS Convergence and Accounting Quality

Purpose: This study aims to empirically prove the impacts of IFRS convergence on the quality of information. Methods: This study used non-finance companies listed on the Indonesian Stock Exchange as research samples. The total number of samples consisted of 181 companies with a total of 2,511 observations. The research hypotheses were examined using multiple linear regression. Findings: This study indicates that the implementation of IFRS convergence in Indonesia does not guarantee improvements in information quality. Therefore, strict regulation and good governance are needed to support the implementation of IFRS convergence. Limitation: The research samples were limited to Indonesian non-finance companies. Practical Implications: Company managers need to enforce regulations and strengthen internal and external governance mechanisms to improve the quality of information. Originality/Value: This study examines accounting quality using data from longer periods, precisely four years before the full adoption (2008-2011) and ten years after the full adoption (2012-2021).

Information disclosure, product market competition and payout policy

The extant literature studying the impact of information asymmetry and agency problems on corporate payouts found that a lower level of information asymmetry and agency problems contributes to higher corporate payouts. However, it is unclear through which corporate governance mechanisms would information asymmetry and agency problems be reduced, thereby affecting payout policies. In this paper, we examine how information disclosure, an internal corporate governance mechanism that reduces information asymmetry, and product market competition, an external corporate governance mechanism that mitigates agency problems, affect payout policies. Using a unique information rating scheme as a measure of information disclosure for Taiwanese public firms from 2005 to 2014 and the timeliness of financial reports as an alternative measure of information disclosure for Taiwanese public firms from 2005 to 2022, we examine the interactive effects of information disclosure and product market competition on payout policy. We find that information disclosure and product market competition positively affect firms' decisions to distribute dividends and repurchase shares. In particular, information disclosure increases dividend payouts only for firms in competitive industries. Our results suggest that governance mechanisms for information disclosure are more effective for firms in competitive industries.

Corporate takeover susceptibility and classification shifting

PurposeThis paper examines the effect of firms’ takeover susceptibility on the manipulation of financial statements through classification shifting.Design/methodology/approachThe paper applies ordinary least squares regression (OLS) with fixed effects analyses to a sample of United States listed firms over the period 1992–2014. We use takeover index as a proxy for takeover susceptibility of firms, with high values representing higher takeover susceptibility and lower values representing lower takeover susceptibility.FindingsThe study finds that firms engage in classification shifting through core expenses, suggesting that takeover threats reduce the incentive to manage earnings through classification shifting. We also find that takeover susceptibility improves the monitoring mechanism for firms with low profitability because these firms have greater incentives to engage in classification shifting. Finally, we find that the Sarbanes–Oxley Act strengthens the monitoring mechanism influenced by takeover threats. Overall, the results provide evidence of the important role of takeover susceptibility in mitigating classification shifting. Our results are robust to a battery of sensitivity tests.Practical implicationsThe results emphasise the disciplinary role of the legal environment around corporate takeovers. The study suggests that policymakers and regulators should be cognisant of antitakeover laws which may increase agency conflicts between managers and shareholders and promote managerial self-seeking behaviours such as classification shifting.Originality/valueThe paper highlights the important role of takeover threats as an external governance mechanism to mitigate classification shifting which is detrimental to investors’ value. From prior literature, this study is the first to provide evidence of the effect of takeover threats on classification shifting.

Strategic responses to hostile takeover threats: Empirical evidence on enhancing corporate social engagement

AbstractUnderstanding the dynamics between external corporate governance mechanisms and social engagement offers insights into how corporate strategies towards social capital are shaped. We explore the impact of hostile takeover threats on corporate social engagement by utilizing a measure of takeover vulnerability. This allows for a detailed examination of how exposure to takeover threats influences firms' engagement in social engagement initiatives. Our analysis reveals a positive and causal relation between the degree of takeover threats and the level of social commitments in firms, suggesting that the presence of hostile takeover threats enhances corporate social responsibility as a means of external governance and reduces agency costs. The findings support the hypothesis that the threat of hostile takeovers prompts firms to invest more in social commitments, potentially as a strategic defense mechanism.

Do analysts play a monitoring role? Evidence from exogenous changes in litigation risk

AbstractThis paper examines whether securities litigation and sell‐side equity analysts play a substitutive versus complementary role as an external governance mechanism. We expect the 1999 ruling on the stricter interpretation of the Private Securities Litigation Reform Act to make it easier for firms headquartered in the Ninth Circuit to defend against securities class actions filed by shareholders, resulting in weaker protection from a litigation channel and stronger demand for analyst activity. Using a difference‐in‐differences research design, we find that analyst coverage increases as litigation risk decreases in the Ninth Circuit firms. Moreover, we find that analyst earnings forecast accuracy increases for firms in the Ninth Circuit following the ruling, consistent with analysts exerting greater efforts to perform their monitoring role. In cross‐sectional tests, we find that the substitution relation between litigation risk and analyst research is more pronounced in firms with a high level of ex‐ante litigation risk. We conduct extensive robustness tests, including another legal event exogenously increasing the risk of litigation, to gain confidence in our interpretations. We contribute to the literature by documenting causal evidence that analysts have greater incentives to provide meaningful equity research as gatekeepers in times of weaker investor protection by securities litigation.

On the measurement of corporate governance and its impact on bank profitability and credit risk: The case of Tunisian listed banks

AbstractThis paper explores the influence of corporate governance on the profitability and credit risk of a sample of listed banks in Tunisia. The methodology involves two main steps. Firstly, principal component analysis is employed to construct a novel governance index, assessing the quality of both internal and external bank governance. This index takes into account the degree of compliance and application of directives and laws mandated by the Tunisian Central Bank regarding banking governance. In the second step, panel data analysis is conducted to scrutinize the impact of internal and external governance mechanisms on the profitability and risk of Tunisian banks. The results reveal that as the governance index increases, the profitability of banks improves in terms of return on assets and stock market performance. Additionally, a higher governance index is correlated with a reduction in credit risks, as indicated by lower instances of non‐performing loans and an increased rate of coverage for classified debts. To enhance the robustness of our results, we calculate a standard governance score based on existing empirical literature. Furthermore, to account for potential endogeneity, we employ the two‐step system generalized method of moments.

Is managerial myopia detrimental to corporate ESG performance?

This study explores the nexus between managerial myopia and corporate Environmental, Social, and Governance (ESG) performance within the framework of China's A-share listed companies from 2010 to 2020. We provide a novel insight into how the temporal orientation of managerial decision-making significantly impacts ESG outcomes, highlighting the adverse effects of a short-term focus on sustainable corporate development. Using a robust dataset, we delineate the mechanisms through which managerial myopia undermines ESG performance, specifically in green innovation and corporate information disclosure quality. Further, it examines the efficacy of external governance mechanisms, such as the increased liquidity of stocks and the engagement of Big 4 accounting firms, as mitigating factors. The paper's methodology combines advanced regression analysis with propensity score matching to validate the causal relationship between managerial myopia and ESG performance, controlling for potential endogeneity and selection bias. The findings suggest that managerial myopia indeed poses a significant challenge to achieving high ESG standards, with implications for both policymakers and corporate governance practices. This study contributes to the broader discourse on corporate sustainability by linking managerial cognitive traits to ESG performance, with a specific focus on the Chinese market, thereby enriching the understanding of ESG dynamics in emerging economies.

Pension funding gaps: do mandated external governance mechanisms matter?

PurposeThis study aims to examine whether and how the experience of specialized external governance mechanisms mandated by the Employee Retirement Income Security Act of 1974 – the actuary and auditor – affect pension plan funding.Design/methodology/approachThis study uses data from annual pension plan regulatory reports (Form 5500), Form 10-K filings, Form DEF 14A filings (company proxy statements) and publicly available data sources. The hand-collected data include information related to the pension plan’s actuary and auditor and various pension plan data disclosed in the company’s financial statement footnotes.FindingsThe author finds that more experienced actuaries and auditors are associated with better funded pension plans, especially when the company has higher financial risk or lower board independence. Additional analyses indicate that companies with more experienced actuaries and pension plan auditors are more likely to make higher annual pension plan contributions and hold fewer Level 3 fair value assets.Originality/valueThe dearth of pension plan governance research generally focuses on whether and how internal governance mechanisms affect pension plan funding. To the best of the author’s knowledge, this is the first empirical study of the relationship between external pension plan governance mechanisms and pension plan funding.

The moderating role of duality split on the relationship between CEO narcissism and earnings management

PurposeThe purpose of this study is to examine the moderating effect of an exogenous corporate governance shock that curbs Chief Executive Officers’ (CEOs) power on the relationship between CEO narcissism and earnings management practices.Design/methodology/approachThe authors performed a quasi-experiment using a differences-in-differences approach to examine Brazil’s duality split regulatory change on 101 Brazilian public firms during the period 2010–2022.FindingsThe main findings indicate that the introduction of duality split curtails the positive influence of CEO narcissism on earnings management, suggesting that this corporate governance regulation may act as a complementary corporate governance mechanism in mitigating the negative consequences of powerful narcissistic CEOs. Further robustness checks indicate that the results remain consistent after using entropy balancing and alternative measures of CEO narcissism.Practical implicationsIn emerging markets, where governance systems are frequently perceived as less than optimal, policymakers and regulatory authorities can draw insights from this enforcement to shape governance systems, reducing CEO power and, consequently, improving the quality of financial reporting.Originality/valueTo the best of the authors’ knowledge, this is the first study to examine whether a duality split mitigates the influence of CEO narcissism on earnings management. Thus, this study contributes to the corporate governance literature that calls for research on the effectiveness of external corporate governance mechanisms in emerging markets as well as the CEO narcissism literature that calls for research on moderating factors that could curtail negative consequences of narcissistic CEO behavior.

Can common institutional ownership inhibit the formation of zombie firms? Evidence from China

The survival of zombie firms severely crowds out healthy corporate investment and employment growth, eventually undermining economic growth potential. Hence, how to properly address the problem of corporate zombification is an essential part of achieving high‐quality economic development in China. In recent years, the phenomenon of common institutional ownership has become increasingly widespread in the capital markets and has a significant impact on the strategic decisions of companies. There are currently two views on the corporate governance role of common institutional ownership: the synergistic governance effect and the collusive fraud effect. Using data from Chinese‐listed firms from 2009 to 2021, this paper finds that common institutional ownership can significantly inhibit the formation of zombie firms. The higher the degree of their linkage and the greater the shareholding, the more pronounced the synergistic effect. The findings remained valid after considering the endogeneity issue and conducting robustness tests. Furthermore, the mechanism test suggests that common institutional ownership inhibits the formation of zombie firms by improving internal control quality and reducing agency costs. This paper contributes to the study of how to inhibit the formation of zombie firms by identifying common institutional ownership from the perspective of external governance mechanisms. In addition, this paper enriches the research on the economic consequences of common institutional ownership. Finally, various practical implications for policymakers may be realised, which may help curb the trend of corporate zombification through equity‐based instruments.

Internal corporate governance and cash holdings: the role of external governance mechanism

Internal corporate governance and cash holdings: the role of external governance mechanism

The effect of CEO's compensation in driving corporate ESG greenwashing: Evidence from China.

This study examines the relationship between CEO compensation schemes and ESG greenwashing behavior in Chinese listed firms during the period 2013-2022. We find that a CEO's cash (equity) compensation has a significantly positive (negative) correlation with corporate ESG greenwashing behavior. From mechanism analysis, consistent with the agency problem view, firms engage in more severe ESG greenwashing behavior under a higher proportion of cash in the CEO compensation structure. Such distortion behavior is mitigated by higher internal control quality in firms having an equity incentive for their CEO under the convergence of interest viewpoint. Additional analysis reveals that corporates audited by large accounting firms and those with more media coverage exacerbate the positive correlation between CEO cash compensation and ESG greenwashing behavior, while government environmental regulations reinforce the inhibitory effect of CEO equity compensation on ESG greenwashing. Our results imply that different CEO compensation schemes can have opposite effects on limiting firms' ESG greenwashing behavior in the Chinese context. Furthermore, we highlight that the question of form over substance principle to certain external governance mechanisms, leading CEO to exacerbate impression management of ESG disclosure.

Governance and competitiveness evaluation of China's financial asset management corporations.

With the development of non-performing assets market and the requirement of maintaining national financial security and stability, asset management corporations (AMC) have set up in recent years, facing the dilemma of governance reform and competitiveness improvement. This paper puts forward the Governance-Performance-Competitiveness theory of asset management corporations, and constructs the comprehensive competitiveness evaluation index system of based on internal and external governance mechanisms, and studies the factors and degrees of internal and external governance affecting competitiveness by combining principal component analysis method and grey correlation analysis method. The empirical results show that the asset scale and profitability of asset management corporations directly determine their competitiveness level to a large extent, and the correlation between external governance mechanism and competitiveness is stronger than that of internal governance mechanism. Clustering and grouping are conducted based on the size of competitiveness, and China's local asset management corporation system presents a diamond structure. China's local financial asset management corporations should strengthen the top-level design of internal governance, attach importance to external governance, expand and strengthen the asset scale, and carry out full-chains business while implementing a differentiated development model to achieve sustainable development when adhering to the principal business of non-performing assets.

Board competence and green innovation—Does external governance matter?

AbstractPrevious research examining the link between board attributes and ecological strategies such as green innovation has primarily focused on structural board attributes, yielding mixed findings. Moreover, the critical contextual grounds that shape the relationship between board attributes and green innovation have often been overlooked, leading to potential biases in empirical investigations. Considering that competence drives outstanding performance, we developed a unique measure of board competence that represents the board's intrinsic ability to perform in corporate strategies. Drawing on a holistic perspective of agency, resource dependence, and stakeholder theories, we posit a strong relationship between board competence and green innovation. Furthermore, we contend that this association is moderated by external governance mechanisms, namely audit quality, media coverage, and imitative pressure. Through our analysis of publicly traded Chinese companies, we found compelling evidence to support our assertions. These findings have important implications for policymakers, practitioners, and managers.

Attracting institutional investments to emerging markets: The case of Turkiye

AbstractUnderstanding institutional investors' investment criteria in emerging markets is essential because they typically make large investments without control rights or protection of the rule of law. This study undertakes an investment criteria investigation of institutional investors in Turkiye. The sample covers real and financial sector companies to investigate sectoral differences in Borsa Istanbul‐listed firms for 2010–2021. Using a panel data approach, we show that the presence of growth options, generous payout policy, attractive firm valuation, and quality of the external governance mechanisms are important factors in attracting institutional investors by real sector firms. Only a large firm size and the quality of the external governance mechanisms arise as important factors for financial sector firms. Moreover, institutional holdings positively impact the percentage shares of institutional investors during crisis periods among real sector firms, whereas they do not affect financial sector firms. Real‐sector and financial‐sector firms can use our findings to increase institutional ownership. Our results have important implications for institutional investors, individual investors, and market regulators to demand critical corporate governance practices.

Tax enforcement and investment efficiency–Based on the China's “VAT reform”

The impact of tax enforcement on corporate financial accounting behavior has been widely concerned as an external governance mechanism. Based on the background of China's “VAT reform” pilot program in multiple provinces, this paper uses DiD method to test the impact of tax enforcement on corporate investment. We found that the "VAT reform" has suppressed inefficient investment behavior, which is mainly manifested in suppressing the excessive investment behavior of firms. This effect is more significant in regions with insufficient tax collection capacity, economically underdeveloped western regions, and private firms in China. Further research found that tax enforcement mainly improves the investment efficiency of firms by improving the corporate information environment and restraining the level of earnings management; the "Golden Tax III Project" promotes the improvement of tax enforcement technology and further improves the investment efficiency. The research results show that the changes in tax enforcement by China's "VAT reform" can improve the corporate information environment and play a corresponding governance role, thereby enhancing the efficiency of investment and promoting the efficiency of resource allocation.