Severe Agency Problems Research Articles

Better safe than sorry? The effect of asymmetric cost management on firm resilience in manufacturing firms

PurposeGlobal business practices show that during periods of demand volatility, manufacturing firms often engage in asymmetric cost management (ACM), a behavior in which costs increase faster than they decrease when demand decreases by the same amount. However, whether managing asymmetric costs will enhance or impede firm resilience remains an open question. We aim to investigate the impact of ACM on firm resilience and its boundary conditions.Design/methodology/approachUsing unbalanced panel data of 2,273 Chinese manufacturing listed companies from 2002 to 2021, we conduct an empirical analysis using a double fixed effects model.FindingsOur findings reveal that ACM has a negative effect on firm resilience. This suggests that in coping with external environmental fluctuations, ACM fails to fulfill its expected role effectively. Instead, it manifests as a severe agency problem affecting firm resilience. Further, we find that managerial myopia and digitalization diminish the negative effect, while customer instability exacerbates it.Originality/valueThis study contributes to the literature on the organizational resilience of manufacturing firms by providing an in-depth understanding of cost management and emphasizing the need to consider agency issues carefully when managing asymmetric costs.

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.

ESG divergence and corporate strategic green patenting

Based on a sample of Chinese A-share listed companies from 2010 to 2020, we find that ESG divergence motivates companies to engage in green innovation patent applications, but such behavior is more strategic than genuine quality improvement. Following thorough robustness checks, this conclusion remains unchanged. We find that among large-scale enterprises, those with more government subsidies, and those with more severe agency problems, ESG divergence leads to more apparent green innovation behaviors aimed at increasing the quantity and reducing quality. Moreover, we observe that ESG investors magnify the relationship between ESG analysis and strategic patenting.

Multiple large shareholders and audit fees: Demand‐side evidence from China

AbstractThis paper provides evidence on the role of multiple large shareholders (MLSs) in the determination of audit pricing from a new demand‐side perspective, rather than the typical supply‐side perspective. We find that for Chinese A‐share listed firms, the presence of MLS is associated with significantly higher audit fees. The results are robust after we address endogeneity concerns and use auditor choice as an alternative proxy to capture demand for auditing. Further tests show that audit fees increase with the number and relative power of noncontrolling large shareholders. The positive impact of MLS on audit fees is more pronounced for state‐owned enterprises (SOE) than in family‐owned enterprises. Moreover, this positive impact of MLS is more pronounced for SOEs with foreign blockholders and non‐SOEs with independent institutional blockholders. This positive impact is also more pronounced for firms with higher information asymmetry, severe agency problems and higher litigation risk. Overall, our results provide consistent evidence that firms with MLS are likely to demand high‐quality auditing, leading to higher audit fees.

Tax aggressiveness under concentrated ownership: The importance of long-term institutional investors

Using a sample of 1,707 firm-year observations for the period 2010–2019 based on the Warsaw Stock Exchange, we reveal the positive relation between corporate tax aggressiveness and long-term institutional ownership. Controlling for a “normal level” of tax avoidance within the industry and firm size we provide evidence that tax aggressiveness increases with the increase of shareholdings of independent long-term institutional investors, domestic long-term institutional investors, and long-term institutional investors holding relatively large stakes. This relation holds for firms prone to severe agency problems, such as family firms. Our results thus suggest that ownership structure affects corporate tax avoidance, in line with the agency perspective of corporate tax aggressiveness.

Business Strategy and M&A Transactions

This paper establishes the relation between the target’s business strategy and M&A transactions. We find that acquirers purchasing an innovation-oriented firm (prospector) experience significantly lower announcement returns and worse long-run operating performance than when they purchase an efficiency-oriented firm (defender). The effect is more pronounced for the acquirer with severe agency problems. Further analysis finds that synergies can be obtained from combining business strategies. We also show that acquirers respond to the presence of a prospector target by using stock payment in their offers.

Do suppliers value clients’ ESG profiles? Evidence from Chinese firms

We investigate whether suppliers value their clients' ESG profiles in China, the largest emerging market featuring low ESG awareness and severe agency problems. We find a robust and negative impact of Chinese firms' ESG scores on their access to trade credit. The 2SLS regression results based on the instrumental variable indicate that the impact is casual. Additionally, the impact is more pronounced for firms with higher agency costs, greater information asymmetry, worse financial performance, and larger ex-ante default risk. These results suggest that suppliers in China view clients' ESG engagement as costly investments caused by agency problems. Finally, we highlight the economic importance of ESG's negative impact on trade credit by showing that trade credit access helps Chinese firms decrease debt costs, increase trade credit provision to downstream firms, and promote R&D inputs.

How Does Environmental Tax Influence the Scale and Efficiency of Green Investment among China’s Heavily Polluting Enterprises?

This paper investigates the impact of environmental tax on corporate green investment behavior using archival data from China’s A-share-listed companies. We took advantage of the quasi-natural experiment based on China’s environmental “fee-to-tax” reform and employed the difference-in-differences (DID) method. This study goes beyond the existing studies by integrating the scale of green investment with the financial circumstances of the firms to comprehensively assess the effectiveness of green investment. Using the refined Richardson residual econometric model, we accurately measured the green investment efficiency, expanding the policy evaluation of the environmental fee-to-tax transition beyond the investment scale to include efficiency. Our findings indicated that the environmental tax promotes green investment, especially among state-owned firms, firms with fewer financial constraints, and those operating in regions with weaker environmental governance. However, we discovered a trade-off between the growth in the green investment scale and the efficiency of such investments, suggesting a decrease in efficiency due to the tax. Further investigation revealed that corporate agency issues contributed to the heterogeneity in the impact of the environmental tax on green investment efficiency, with firms facing severe agency problems and experiencing more misuse of green investment. This implied that addressing agency issues could alleviate the distortionary effects of the environmental tax on green investment efficiency.

Short-sale constraints and firm investment efficiency: Evidence from a natural experiment

We examine the causal effect of relaxing short-sale constraints on firm investment efficiency using the experiment of the SEC Regulation SHO pilot program. Using a difference-in-differences approach, we find significant treatment effects of the pilot program on mitigating both underinvestment and overinvestment during the pilot period. These treatment effects disappear after the end of the pilot program. The effect on mitigating underinvestment is stronger for firms with severe financial constraints before the pilot period. The pilot program mitigates underinvestment and alleviates financing constraints more for pilot firms that experienced greater improvement in price efficiency after the pilot program began. The effect of the pilot program on mitigating overinvestment is more pronounced for firms with weaker governance and firms with more severe agency problems before the pilot period. These results suggest that relaxing short-sale constraints mitigates underinvestment through the external financing channel by improving price efficiency that alleviate financial constraints; and mitigates overinvestment through the managerial incentive channel by strengthening the disciplinary role of short sellers that enhances managers’ incentives to take correct actions.

Are firms doing good also doing well?—The CSR advertising‐analogous effect

AbstractThis paper provides a theoretical framework and empirical support for an examination of corporate financial performance (CFP) from the perspective of an effect that is analogous to corporate social responsibility (CSR) advertising. We propose that not all companies are capable of “doing well by doing good.” Through an analytic model, we identify three key elements for determining a company's CSR advertising‐analogous effect on CFP: the incremental margin (gross profit rate), the sales–CSR elasticity and sales demand in the market (market share). By re‐examining the equivocal relationship between CSR and CFP based on a sample of publicly held US companies from 1991 to 2018, we document that companies in the best position to undertake CSR activities (with gross profit rates, sales–CSR elasticities and market shares above the industry medians) have a superior advertising‐analogous effect to other companies. Moreover, our empirical results show that companies in the best position to undertake CSR activities face less severe agency problems when they conduct more CSR activities than other companies. Finally, in a test of whether regular advertising expenditures and CSR devotion could jointly enhance current CFP, the results show that the positive joint effect is more pronounced for companies in the best position to undertake CSR activities than for other companies.

Individual investors’ dividend tax reform and investment efficiency

This paper examines the effect of individual investors' dividend tax on corporate investment efficiency. Investment efficiency is closely related to increases in firm value and investor wealth, but the effect of tax incentive on investment efficiency is relatively unknown. By introducing plausibly exogenous dividend tax reform (DTR) for individual investors in China, we find that reducing dividend tax for individual investors significantly improves corporate investment efficiency. From the perspective of individual investor supervision, we find that the effect is particularly pronounced for firms with severe agency problems and inadequate supervision. Furthermore, evidence from firm innovation shows that DTR increases the attention on the firm's long-term development. Finally, we find that DTR reduces the level of investment but promotes the financialization of firms, implying that DTR primarily encourages firms to increase investment in high-return projects. Overall, our findings suggest that taxation can be used as an incentive to encourage individual shareholders to take on a supervisory role and thus improve the efficiency of resource allocation.

R&D expenditures and CEO compensation policy: The effect of corporate control and market competition on managerial opportunism

AbstractChina and Taiwan (so‐called Greater China) are representative of two of the fastest‐growing economies in the Pacific Rim region. This study uses Taiwanese high‐tech firms as sample and explores whether boards of directors attempt to avoid opportunistic reductions in research and development (R&D) investments by CEOs. This study considers a scenario in which high‐tech firms face a small earnings decline or a small loss but their CEOs could opportunistically cut R&D investments to improve financial results. The focus of this study is to examine how corporate control (whether or not a firm is controlled by a family) and market competition affect the relationship between R&D investments and CEO compensation schemes. Overall, we find that the stock‐based incentive compensation is more effective than the cash compensation in deterring managerial opportunism. In non‐family firms, we find there exists a positive significant relationship between changes in R&D expenditures and changes in CEO stock‐based compensation when a firm is faced with a small earnings decline or a small loss. Specifically, compared to family firms, the boards of directors of non‐family firms face more severe agency problems (as a result of the separation of ownership and control) and therefore tend to significantly adjust the incentive components in CEO compensation schemes to deter managerial opportunism. Regarding the effect of market competition, we find that incentives to adjust compensation plan to remove CEOs from opportunistically reducing discretionary R&D investments are greater in firms facing more intense market competition.

Exploitation or Exploration? Managerial Myopia, Economic Policy Uncertainty and Ambidextrous Innovation Investment

In today’s increasingly competitive international environment, original technology innovation has become essential for enhancing enterprises’ sustainability. As key innovation needs constant exploration rather than growing leaps and bounds, it is often ignored by managers who focus on short-term performance. Taking the data of publicly listed Chinese companies from 2010 to 2020 as a sample, this paper put forward the relation between managerial myopia and ambidextrous innovation investment on the basis of a empirical approach combining machine learning technology. Results revealed that managerial myopia has different effects on the ambidextrous innovation investment of enterprises. Specifically, the study finds a significant negative association between managerial myopia and exploratory innovation investment, while there is no significant relationship with regard to exploitative innovation investment. Further study showed that the negative influence is weakened by economic policy uncertainty and stronger in companies with more severe agency problems. By shedding light on the way that managerial myopia affects enterprises’ ambidextrous innovation investment, this research contributes to the literature on the impact of managerial myopia, offering key insights into how to cultivate the core competitiveness of enterprises and ensure their sustainable development.

Auditor choice and audit fees through the lens of agency theory: evidence from Chinese family firms

PurposeFrom an agency perspective, the authors investigate whether family ownership and control configurations are systematically associated with a firm's choice of auditor and audit fees. Agency theory is an economic theory that purposes the existence of a contract between two parties, principals and agents. Auditor choice and audit fees by family firms provide interesting insights given the unique nature of the agency problems faced by such firms.Design/methodology/approachThe authors employ Big-4 auditors (PWC, KPMG, E&Y and Deloitte) as a proxy for high quality auditor (Big N) for the auditor choice model. For the audit fee model, the dependent variable is the natural logarithm of audit fees (LnAF). The authors use two measures for family firm as explanatory variables: (1) a dummy variable (FAM_Control), which equals one if the firm is classified as a family firm and (2) FAM_Ownership, which is an indicator variable with a value of one if a firm has family members who hold CEO position, occupy board seats, or hold at least 10% of the firm's equity. Data of Chinese listed firms from 2011 to 2021 are used. The authors adopt the Heckman (1979) two-stage model to mitigate the potential endogeneity issue involved in the selection of Big-N auditors.FindingsThe findings suggest that compared with non-family firms, Chinese family firms have a less tendency to employ Big-4 auditors due to less severe agency problems between owners and managers. Additionally, Chinese family firms sustain higher audit fees than non-family firms. Similar to the prior literature, however, Chinese family firms audited by Big-4 auditors incur lower audit fees than family firms audited by non-Big-4 auditors in this study. In contrast to young-family firms, old-family firms are less likely to pick top-tier auditors and sustain lower audit fees. Consistent and robust results are found from endogeneity tests and sensitivity analyses.Originality/valueThe empirical evidence provides a unique insight, for accounting practitioners, policymakers, family owners and other capital market participants concerning the diverse effects of various family ownership and control features on selecting high-quality auditors and audit fees. This study advances the understanding, showing that a lower demand for audit quality occurs in Chinese family firms as they encounter less severe Type I agency problems. However, the more severe Type II agency problems in Chinese family firms sustain higher audit fees due to higher audit risk and greater audit effort.

Multiple large shareholders and auditor choice: evidence from China

PurposeThis study aims to examine whether a firm's demand for high-quality auditors is influenced by multiple large shareholders (MLS). As one type of ownership structure, MLS have gained popularity in China recently and have different types of large shareholders, including large institutional shareholder, large foreign shareholder and large state shareholder. The authors also examine whether different types of MLS have heterogeneous impacts on appointing high-quality auditors.Design/methodology/approachWith a sample of 27,131 firm-year observations from Chinese public companies from 2003 to 2018, the authors use multivariate regressions to examine the effect of MLS on auditor choice. Heckman two-stage analysis, a firm fixed effects model, propensity score matching and difference-in-differences test are used as robustness checks.FindingsThis paper finds that the presence and power of MLS increase the likelihood of appointing high-quality auditors. With regard to the types of MLS, large institutional shareholders and foreign shareholders have significant positive effects on appointing high-quality auditors, while the presence of state-owned large shareholders has no effect on auditor choice. Further analyses reveal that the positive effect of MLS on high-quality auditor choice is more pronounced in firms with severe agency problems and information asymmetry. Taken together, these results suggest that MLS play a monitoring role by demanding high-quality auditors.Originality/valueThis paper contributes to the literature on the determinants of auditor choice. While prior studies primarily focus on the impact of concentrated ownership structure, corporate governance and the pressure from stakeholders on auditor choice, this paper complements the literature by providing evidence from the heterogeneous effects of different types MLS. This paper also extends the literature on the consequences of MLS from the perspective of auditor choice.

I Feel Your Pain: The Effect of Regulator as a Minority Shareholder on Merger and Acquisition Performance

We examine the effect of a regulator‐led advocate for minority shareholders on merger and acquisition (M&A) performance in China. In recent years, the China Securities Regulatory Commission established the China Securities Investor Services Center (CSISC), which began its ownership of 100 shares of public firms in 2016. The CSISC advocates for the interests of minority shareholders proactively. Focusing on abnormal stock returns in M&A announcements, we find that acquirers that have the CSISC as a shareholder (CSISC acquirers) exhibit higher positive abnormal stock returns than non‐CSISC acquirers. Cross‐sectional analysis suggests that the core results are mainly driven by firms with severe agency problems and weak external/internal monitoring, and those not controlled by the state. In addition, we find that CSISC acquirers have better long‐term performance and encounter more M&A failures than non‐CSISC acquirers. Our findings indicate that although the CSISC only holds 100 shares of listed companies, it plays an effective role in monitoring and driving firms to make appropriate M&A decisions.

Product market competition and the value of corporate cash: An agency theory explanation

In this paper, we document the effect of product market competition on cash value and provide evidence supporting the agency discount mechanism. Using the regulation-induced IPO suspensions in China as shocks to product market competition, we find that reduced competition threat, induced by competitors' IPO delay, decreases incumbent firms' value of cash reserve. The effect of IPO suspension on cash holding is more pronounced for companies with severe agency problems and loose governance mechanisms but not statistically different across high and low predation threats. Furthermore, we show that the marginal value of cash increases when IPO restarts, and our baseline results hold in both a large sample and a matched sample of firms. Our paper contributes to the literature by providing the plausibly causal effect of product market competition on cash value and an explanation from the perspective of competition's disciplinary role in mitigating managers' slack.

The disciplinary role of product market competition on cash holding

This paper provides evidence supporting the disciplinary role of product market competition on cash holding. We use the regulation-induced IPO suspensions in China as shocks to product market competition. With a generalized difference-in-difference design, we find that reduced competition threat induced by rivals' IPO suspension increases incumbent companies' cash level by 1.0 percentage points. The effect of IPO suspension on cash holding is weakened when the product market is highly competitive before suspensions and more pronounced for companies with severe agency problems and loose governance mechanisms. Furthermore, we document that the marginal value of cash reduces during IPO suspension, and companies' cash level decreases when IPO restarts. Our paper contributes to the literature by providing the plausibly causal effect of product market competition on cash holding and an agency explanation from the perspective of competition's disciplinary role in mitigating managers' slack.

Innovation Input and Firm Value: Based on the Moderating Effect of Internal Control

Using the data of Chinese A-share listed firms with non-zero innovation investment between 2007 and 2017, this paper links the value relevance of innovation investment with internal control from the perspective of operating performance and market value, respectively. This paper empirically verifies that internal control significantly increases the value relevance of innovation input, that is, the better the internal control, the more innovation investment contributes to the operating performance and market value of a firm. Then, based on the potential mechanisms of alleviating agency problems and conducting better risk management, further investigation in this paper also indicates that internal control’s moderating effect on the value relevance of innovation input is more prominent for firms with relatively more severe agency problems and for expensed R&D expenditure which represents the part of innovation investment with higher uncertainty.

The value of fiduciary duties: Evidence from en bloc sales in Singapore

This paper examines the impact of fiduciary duties on collective asset sales in the case of owners acting as delegates for other owners, thereby potentially inducing conflicts of interests. Our identification strategy exploits a unique legal shock in Singapore, which established fiduciary duties in those transactions in the real estate market known colloquially as en bloc sales. The imposition of fiduciary duties caused the price premium of units sold via en bloc sales to increase over units ineligible for en bloc sale, as well as over units that, although eligible for en bloc sale, are sold individually. In addition, this valuation effect is stronger for projects with especially severe agency problems as proxied by high ownership turnover. This legal reform also affects the general private housing market beyond the en bloc premium: findings show that residential owners are increasingly willing to participate and reduce condominium turnover. Finally, we find that the stock price of public real estate developers responded positively to the legal reform, which indicates a possible overall positive welfare effect. Our study highlights the importance of judicial oversight for addressing agency conflicts in non-consensual asset-sale mechanisms.