External Monitoring Mechanisms Research Articles

Information acquisition or just going through the motions? Institutional investors' site visits and green innovation

AbstractThe importance of green innovation in global sustainable development is increasingly recognized. Literature has documented that enhancing external oversight can improve green innovation performance. However, few studies systematically investigate the relationship between external supervisory behavior and green innovation. This study employs a game‐theoretic model to examine the relationship between institutional investors' site visits (SVs) and green innovation. Using a unique dataset covering SVs from 2012 to 2021, empirical findings reveal that institutional investors' SVs are dramatically favorable to green innovation performance, particularly among stress‐resistant institutional investors. More broadly, SVs by institutional investors with higher shareholdings and stronger reputations exhibit a substantial response to green innovation. Similarly, institutional investors' SVs significantly boost the green innovation of firms with inadequate environmental disclosure. Additional analysis documents that the quality improvement of green innovation significantly increases after institutional investors conduct more than three SVs in a calendar year. This study proposes that policymakers should improve the institutional environment for site visits, and enterprises can strategically involve institutional investors to enhance external monitoring mechanisms. The theoretical and practical implications of this contribute to boosting green innovation capabilities.

Before thrive, first survive: The impact of controlling shareholder pledging on corporate ESG performance

This paper investigates the impact of controlling shareholder pledging on corporate environmental, social, and governance (ESG) performance. Using data from Chinese listed firms, we show that controlling shareholder pledging significantly weakens firms' ESG performance and that this effect is robust to endogeneity and the choice of ESG metrics and controlling shareholder pledging measures. In addition, we show that the main channel through which ESG performance deteriorates for firms with controlling shareholder pledging is the risk of losing control. The adverse impact of controlling shareholder pledging on ESG is much less when control rights are not at risk. On the other hand, limited resources (e.g. tunnelling and financial constraints) contribute little to the impact. Our further analyses demonstrate that internal monitoring mechanisms can mitigate the negative impact of controlling shareholder pledging on corporate ESG performance, but external monitoring mechanisms cannot.

Comparative Review Of The Practices Of Sole Proprietorship Company Supervision Mechanism

A sole proprietorship is a unique form of Limited Liability Company (Perseroan Terbatas) which has a legal status under Indonesian law. The aspect of supervision is important as a consequence of the rights and obligations carried out by the sole proprietorship. This study aims to examine the comparison of the supervisory mechanism of sole proprietorship in Indonesia with the European Union, China, Germany, France, and the United Kingdom. This study uses normative research methodology. The results of the study show that, first, the supervisory mechanism in a sole proprietorship company and a limited liability company has a significant difference in the internal control in which the sole proprietorship is lacking, while the limited liability company has effective internal control by a General Meeting of Shareholders forum. In addition, the form of supervision on individual companies is less different than the form of supervision on Limited Liability Company. This difference is due to the initial purpose of establishing a sole proprietorship in Indonesia which is intended to provide ease of doing business, hence the supervision aspect is not taken into account too much. Second, the comparison of individual monitoring mechanisms in the European Union, China, Germany, France, and the United Kingdom with the Indonesian practice generally has similarities in that each country does not have an effective internal control mechanism. However, each country provides an external monitoring mechanism for individual companies with different forms of implementation. The unavailability of internal control is caused by the requirements for the establishment of a company that can be established by one person. Hence, it does not allow for effective internal control. As for the availability of an external supervisory mechanism for the company as a consequence of implementing the principles of Good Corporate Governance to prevent misuse of individual companies.

Party direct control and corporate fraud: Evidence from China

This study examines the impact of the involvement of Party committees of the Communist Party of China in the decision-making process of state-owned enterprises (SOEs) in China on fraudulent activities. Based on a sample of 1180 listed SOEs covering the period 2004–2019, we present empirical evidence of a negative relationship between Party direct control and the likelihood of corporate fraud, mainly driven by the effect of Party participation in the board of directors. Additional evidence suggests that Party direct control raises the anticipated costs associated with fraud by facilitating the exposure of fraudulent activities and enhancing the likelihood of CEO dismissal upon the detection of wrongdoing. Furthermore, we observe that the negative association between party direct control and corporate fraud is weakened in firms with robust external monitoring mechanisms and significant levels of state ownership. Additionally, our findings reveal that the deterrent effect of Party direct control on corporate fraud is enhanced following the implementation of the 2015 “Discussion Precedence” reform, which bestowed Party committee members with increased decision-making authority in SOEs.

Directors’ and officers’ liability insurance and corporate cash holdings: From principal–principal perspective

AbstractThis study examines the effect of directors’ and officers’ liability insurance (D&O insurance) on corporate cash holdings in China. We propose a collusion theory in which D&O insurance can exacerbate the conflicts of interest between controlling and minority shareholders by shielding directors and officers from shareholder litigation in emerging countries. Consistent with our expectation, we find that insured firms tend to have high cash holdings that are appropriated by both controlling shareholders and directors/officers rather than being invested or paid to shareholders. Moreover, the positive relationship between D&O insurance and cash holdings is more pronounced in firms with high litigation risks, whereas the effect is attenuated in firms with political connections, strong external monitoring mechanisms and strong controlling shareholder power. Compared with uninsured firms, the market discounts the value of cash holdings for insured firms.

Boardroom backscratching and stock price crash risk

AbstractWe empirically capture boardroom backscratching, or cronyism, as when a firm's Chief Executive Officer (CEO) and directors concurrently receive excessive remuneration. We argue that boardroom backscratching can inhibit a board's constructive criticism and monitoring, resulting in a greater likelihood of bad news hoarding. Using 14,104 US firm‐year observations spanning 1999–2020, we document a significant positive relationship between boardroom backscratching and stock price crash risk. In additional analyses, we show that boardroom backscratching firms produce less readable annual reports and engage in greater upward real earnings management as channels for concealing bad news. We also find that external monitoring mechanisms weaken the positive association between boardroom backscratching and stock price crash risk. Our main findings withstand several endogeneity tests including propensity score matching, entropy balancing, difference‐in‐differences analysis using firms’ commencement of boardroom backscratching and CEO turnover event analysis. Our study offers insights to securities regulators and policymakers to revisit the notion of board independence, develop relevant market oversight and revise director and executive remuneration disclosure requirements so as to mitigate adverse stock market performance associated with boardroom backscratching.

Corporate governance of weak stakeholders: Minority investors and investment efficiency

This study explores the impact of minority shareholders' participation in governance on corporate investment efficiency. The study focuses on the effects of online voting rules in China, utilizing data from firms listed on the Shenzhen Stock Exchange between 2011 to 2017. Employing a quasi-natural experiment with the difference-in-differences model, the results reveal that online voting by minority investors increases corporate investment efficiency. This conclusion is verified using a series of robustness tests and endogeneity adjustments. Furthermore, the findings indicate that the impact of minority investors' online voting is more evident in firms with less internal governance and weaker external monitoring mechanisms. Additionally, minority investor participation in governance increases corporate investment efficiency by increasing information transparency and the quality of internal control. Online voting encourages the organization's management to make more favorable decisions and assure the steady growth of the business.

How do auditor attributes affect bank earnings management? Evidence from Africa

PurposeThis paper aims to examine the impact of the auditor's characteristics on bank's earnings management (EM) through loan loss provisions (LLP) for African banks.Design/methodology/approachThis study is based on 360 bank-year observations from 14 African countries for the period 2011–2016, discretionary LLP is used as proxy for EM. Panel regressions have been conducted.FindingsThe authors' findings reveal that auditor's industry specialization and tenure exert a negative and significant influence on the extent of LLP-based EM. The results also show that total fees paid to the banks' auditors are positively related to the extent of EM. In a further analysis, the authors find that industry specialist auditors are more effective in reducing the incoming-increasing. Similarly, the positive relationship previously found between EM and total fees still holds only for income-increasing. Moreover, auditor tenure negatively impacts both income-increasing and income-decreasing EM. As for auditor change, results reveal differential effect on EM.Originality/valueThe current research extends prior literature and provides an understanding of an important external monitoring mechanism, the external audit, within African banks. To the best of the authors' knowledge, there is a paucity of cross-country studies that has addressed the influence of auditors' attributes on banks' EM in Africa.

When a gift resembles a trojan horse: CEO stock gift and stock price crash risk

This study presents a new interpretation of executives’ stock gifts as an agency cost of managerial bad news hoarding. In a sample of US firms, we document a higher stock price crash risk associated with CEO stock gifts. This evidence suggests that stock gifting could be an exit for opportunistic managers to dispose of their unwanted shares and avoid wealth losses when they can no longer withhold negative information about their firm. Further analyses confirm our proposition by showing that the association between stock gifts and crash risk is stronger for CEOs most concerned about their career and personal wealth, which are the two critical motives of managerial bad news hoarding. Finally, we find that more transparent information environments and external monitoring mechanisms, but not an internal governance system, can alleviate the agency problem embedded in CEO stock gifts.

Economic policy uncertainty and default risk: Evidence from China

Against the backdrop of high leverage and indebtedness worldwide, the prevention of corporate default and systemic financial risk has received growing attention from academics and practitioners. Using a sample of Chinese A-share listed firms on the Shanghai and Shenzhen stock exchanges from 2010 to 2019, this study empirically examines the impact of economic policy uncertainty on default risk and its underlying mechanism. We find that economic policy uncertainty significantly increases default risk. This finding remains valid after a series of endogeneity and robustness tests, including instrumental variable methods. The results of the mechanism test show that good corporate operational capabilities, a high level of corporate internal governance, and effective external monitoring mechanisms can mitigate the impact of the economic policy uncertainty on default risk. This study enriches the research on economic policy uncertainty and default risk while also providing new insights to curb the further rise of corporate default risk from an external macro perspective.

External Monitoring Mechanism and Financial Reporting Quality Tunnelling from REM Perspective in Listed non-financial Firms Nigeria

External Monitoring Mechanism and Financial Reporting Quality Tunnelling from REM Perspective in Listed non-financial Firms Nigeria

Do foreign institutional investors influence corporate climate change disclosure quality? International evidence

AbstractResearch Question/IssueWe examine the association between foreign institutional ownership and climate change disclosure quality from 2006 to 2018 across 34 countries. We find that firms with a higher level of foreign institutional ownership demonstrate better quality climate change disclosures, whereas domestic institutional ownership has immaterial impacts on such disclosures. We utilize a difference‐in‐differences (DiD) analysis using a firm's addition to the Morgan Stanley Capital International (MSCI) index as an exogenous shock to control for endogeneity. Our findings are robust to various other endogeneity controls. We also establish evidence on an indirect effect of climate change disclosure quality in mediating the positive association between foreign institutional investors and firm valuation.Research Findings/InsightsWe find that the positive association between foreign institutional ownership and climate change disclosure quality is more pronounced for (1) firms domiciled in stakeholder‐orientated countries, (2) firms domiciled in countries that adopt emission trading schemes, and (3) firms with a greater level of information asymmetry. Additionally, our results are more robust when foreign investors are domiciled in countries that care more about the environment.Theoretical/Academic ImplicationsOur study contributes to climate change disclosures, corporate governance, and international business literature by showing that foreign rather than domestic institutional investors contribute to improved corporate climate change disclosure quality in their portfolio firms.Practitioner/Policy ImplicationsOur study urges regulators to increase their market oversight, especially in firms with less foreign institutional ownership. This is required because such firms are prone to exhibiting poorer accountability for their climate risk management practices, and their disclosures are bereft of effective external monitoring mechanisms.

Wirecard scandal. A commentary on the biggest accounting fraud in Germany’s post-war history

Purpose The purpose of this paper is to illustrate how the Wirecard scandal has highlighted the need for further reforms in Germany and Europe, exposing institutional and market oversight weaknesses, particularly in terms of market integrity and investor protection. Design/methodology/approach To provide a comprehensive picture of the situation, this paper is based only on relevant studies, which focus on the topic of interest, namely, the context of the Wirecard collapse in June 2020. It also examines how internal and external governance and monitoring mechanisms failed to uncover major fraud within the German payments group earlier. Findings This study shows that this is by no means an isolated or unpredictable incident, and the allegations of accounting fraud had been known for several years, thanks to warnings from the Financial Times. In addition, the paper reviews the serious shortcomings revealed in the Wambach report. The report provided private details of the Wirecard audit and documents on the relationship between Wirecard management and the auditor. All of this can serve as a reference point for institutional and market oversight architecture in Germany and Europe and pave the way for future research. Originality/value The paper contributes to the literature by highlighting the implications of the Wirecard scandal and the lessons that can be learned from what was one of Germany’s biggest corporate scandals especially at a time when many are already affected by the impact of COVID-19 on the entire financial services industry.

Adjustment speed of capital structure: A literature survey of empirical research

We synthesize empirical studies on the determinants of the heterogeneity in the adjustment speed (speed of adjustment; SOA) of capital structure. These determinants are categorized into six groups, namely, (1) firm-specific characteristics, (2) financial reporting and managerial incentives, (3) corporate governance, (4) informal institutions, (5) financial market attributes and (6) economy-wide attributes. From this analysis, we perceive important potential research questions linked to identifying channels associated with the costs and frictions explaining SOA heterogeneity, including financial reporting quality aspects, firm internal and external monitoring mechanisms and institutional and cultural elements. Interesting avenues for future research also include considering SOA dynamics for comparable cross-country samples and the investigation of the subsequent consequences of capital structure adjustments. JEL Classification: G30, G32, G34, M41

The impact of idiosyncratic risk on corporate financialisation——Evidence from China

Using the quarterly data of non-financial companies listed on China's A-share market from 2007 to 2019, this paper examines the relationship between the idiosyncratic risk formed based on the secondary market exchanges and the corporate financialization from the perspective of a market feedback effect. The empirical results show that idiosyncratic risk has a significant impact on the allocation of financial assets of non-financial enterprises, which is one of the motivating factors for the financialization of non-financial enterprises. Compared with SOEs, large enterprises and non-manufacturing enterprises; private enterprises, small and medium-sized enterprises, and manufacturing enterprises will allocate more financial assets when idiosyncratic risk increases. Mechanism analysis shows that managers risk aversion and financing constraints increase the impact of idiosyncratic risk on financial asset allocation while strengthening the external monitoring mechanism of institutional investors has the opposite effect. The research findings of this paper help to understand whether secondary financial markets affect the financial investment decisions of real firms in transition economies, and also have implications for how to govern the “transition from real to virtual” of real enterprises in China.

Uncertainty of uncertainty and accounting conservatism

We investigate the impact of uncertainty of uncertainty (UOU) on corporate accounting conservatism, finding a positive association. Mechanism analysis suggests that under UOU, creditor demands for real information drives shifts toward accounting conservatism. Further analysis shows that the impact of UOU is more salient in non-SOEs, and firms with weak external monitoring mechanisms. Our study highlights that under uncertainty about levels of uncertainty, contract demand plays a significant role in corporate governance.

Does social media coverage deter firms from withholding bad news? Evidence from stock price crash risk

Using a comprehensive dataset for listed companies between 2010 and 2020, we document that social media coverage can reduce managers' incentives and capabilities to withhold bad news (i.e., reduce stock price crash risk). The results remain robust in the test of solving endogenous problems. Compared with other external governance mechanisms (other media sources, external auditors, financial analysts, and institutional shareholders), social media coverage plays a complementary role in reducing stock price crash risk when there is increased monitoring by other external monitoring mechanisms. Additional tests show that social media coverage reduces crash risk when managers have greater incentives to hoard bad news.

Ethical commitment, institutional investors and financial performance: Malaysian evidence

AbstractThis study investigates whether institutional investors moderate the relationship between ethical commitment and financial performance amongst Malaysian companies. Through the role of institutional investors, the external monitoring mechanism is expected to reduce the cost associated with the agency problem amongst Malaysian companies, as shown by the lack of ethical practises. Using data from 429 publicly listed companies on the Main Board of Bursa Malaysia from 2012 to 2021, the results show that companies with higher ETHICS have better financial performance than companies with lower ETHICS. However, the findings on the moderating effect of institutional investors cannot be proven. By separating the sample based on pre‐MCCG 2017, institutional investors were found to have an association between ETHICS and performance, but no evidence was found during the period post‐MCCG 2017. This study adds to the perspective of agency theory in the academic literature, of which companies can create values by being committed to higher ethical practises. Results on the moderating effect of institutional investors provide perspective on external monitoring mechanisms in the Malaysian market because they are found to have a monitoring role in enhancing corporate performance. However, such a role decreases after the introduction of MCCG 2017. This study provides insights for Malaysian regulators on the necessity to keep promoting ethical practises and transparency amongst companies to achieve the goals of the National Anti‐Corruption Plan 2019–2023. The ethical practises, however, are not limited to listed companies, and regulators should also consider monitoring the institutions within the capital market.

Performance Feedback and Strategic Change: The Effects of Analyst Coverage and Forecast Dispersion

This study employs the behavioral theory of the firm and the attention-based view to examine the connection between performance feedback and strategic change in the external monitoring mechanism extracted from stock analysts. Based on a sample of Taiwanese electronic firms from 2001 to 2020, we first found that firms tend to search for alternative strategic options when facing below-aspiration performance. Next, analyst coverage and forecast dispersion, as sources for revising the attention structure of decision-makers, become the contingencies for explaining this connection. However, we also found that firms avoid strategic change when experiencing above-aspiration performance and the contingent roles become neutralized in this scenario.

EARNING MANAGEMENT: THE EFFECT OF FINANCIAL STABILITY, EXTERNAL MONITORING MECHANISM, OPPORTUNISTIC BEHAVIOR, AND INEFFECTIVE MONITORING

This study aims to determine the effect of financial stability as measured by changes in assets (ACHANGE), external monitoring mechanism (DAR) and opportunistic behavior (FCF) on earnings management. The addition of the ineffective monitoring variable as measured by the proportion of independent commissioners (BDOUT) is intended to determine whether this variable is able to moderate the effect of each variable. The research sample used is the financial data of companies belonging to the non-cyclical consumer sector. Observations were made for 2016-2020 accounting period based on purposive sampling method. The data that has been collected is then processed by using an application namely SPSS version 25. Based on the test, it was found that financial stability and external monitoring mechanisms have a positive effect on earnings management, opportunistic behavior has a negative effect and ineffective monitoring cannot be a moderating variable.