Does Ownership Affect Performance: Evidence from China

Does Ownership Affect Performance: Evidence from China
BAI Jun
Shihezi University, China,832000; Zhongnian University of Economics and Law, China,.
Abstract This paper investigates the relationship between firm performance and corporate governance
in China. Firm performance is measured by two accounting measures (ROA and ROE) and a market
measure (Stock Return), while corporate governance is determined based on ownership structure and
concentration. The paper reports the results of an empirical study of a sample of firms listed on the
Shanghai and Shenzhen stock exchanges in 2004. The results indicate that not only ownership
concentration has explanatory power but ownership structure does matter also. The implications of the
findings are then deliberate in the context of the current enterprise reform process in China.
Keywords ownership structure, ownership concentration, firm performance, China
1.Introduction
Ownership is a central and distinctive theme in the corporate governance literature. Many researchers
have examined the effectiveness of corporate governance mechanisms using data from the developed
economies such as the U.S. and the U.K.. China is an interesting country to study because of its
enormous business potential and its transformation from a command system to a market economy. This
transition is being accelerated by the accession of China to the World Trade Organization. China has an
embryonic corporate governance system that makes use of the concept adopted in industrialized nations
at the preliminary development stage. Whether these governance mechanisms are appropriate for China
at this stage is open to question. The share ownership structure is far different in China compared with
that in the west, which presents unique challenges for corporate governance practice as well as for
corporate governance studies. A major distinctive feature of China’s economic landscape is that, despite
moves towards a market economy, the government sector still has strong influence over the corporate
sector, which is likely to be the case in the foreseeable future as well.
This study examines whether ownership causes firm performance to differ at the individual firm level by
using data of public companies listed on China’s stock market. It investigates the following issues: (1)
the relationship between ownership structure and firm performance; and (2) the relationship between
ownership concentration and firm performance.
2. Literature
Ownership is a much debated topic and many researchers have investigated the relationship between
firm performance and ownership structure and that between firm performance and ownership
concentration.
Since at least the 1930s, with the works of Berle and Means(1932) and Coase(1937), economists have
been interested in the relationship between ownership and firm performance. Earlier studies focus on the
direct relationship between ownership and firm performance but the finding are mixed. Cubbin and
Leech (1983) find a positive relationship between ownership concentration and profitability, while
Demsetz’s (1983) equilibrium theory suggests that there is no relationship between ownership and firm
performance. This is further supported by Demsetz and Lehn (1985), which shows that the fraction of
shares owned by the five largest shareholders is not correlated with accounting profitability rate.
Heracleous (2001) concludes that previous studies have failed to find any convincing connection
between the ‘best practices’ in ownership structure and organization performance.
Approaches to investigating the association between ownership and performance vary and alternative
views exist to offer different explanations. Amihud and Lev (1999) employ agency theory to explain the
relationship among ownership structure and diversification; Lane et al. (1999) on the hand, adopt a
strategic management perspective to explain the same relationship and they reach a different conclusion.
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A number of recent studies take a contingent view of the firm. They have investigated the mutual
relationships among corporate governance mechanisms and the relationship between these mechanisms
and firm performance. Such research argues that examining governance mechanisms in an isolated
context is not effective. For example, Coles et al. (2001) argue that firms have the ability to choose
among different governance mechanisms and firms are able to create an appropriate structure given the
environment in which they operate.
3. Hypotheses
I assume that corporate performance, ownership structure, and corporate governance are interrelated.
There is a trade-off between ownership patterns and governance control factors to achieve an optimal
structure that reduces agency cost and increases firm value.
Ownership Concentration
High ownership has been advocated as a way to reduce agency costs and improve performance,
although there are also arguments that very high ownership leads to so-called entrenchment where
agency costs increase. The efficient monitoring hypothesis argues that large shareholders have an
incentive to monitor, and are sufficiently informed to take up monitoring roles. In contrast, the strategic
alliance hypothesis suggests that it is more effective for large shareholders to cooperate with the board
on many issues.
To reconcile the above two hypotheses, I propose that there is a non-linear relationship between
ownership concentration and firm performance.” As ownership concentration increases from the lowest
level of zero concentration, firm performance increases gradually. After ownership concentration
reaches a certain level, firm performance commences to decrease as the fraction of the largest
shareholder increase.
I measure ownership concentration by CR as the percentage of shares owned by the largest shareholder
in a firm and by Z as the percentage of shares owned by largest shareholder divided by the sum of
percentage of shares owned by second to fifth largest shareholders.
Ownership structure
In addition to concentration, the impact of ownership structure on performance will also be examined. In
China, the ownership of listed firms consists of state shares, legal person shares, and public individuals’
shares.
A distinct characteristic of China’s listed firms is the large shareholding retained by the government.
Government ownership tends to emphasize political objectives rather than economic efficiency, and
have failed to confront the emerging competition from non-state enterprises. However, active
government intervention may be necessary in the absence of any shareholder control, when managerial
autonomy expands. It is impossible to oversee managerial activities without government intervention at
this early stage of corporate governance evolution.
In general, institutional shareholders are associated with higher performance. China does not have
extensive institutional investors of the type seen in the U.K., but China does have legal person shares
held in large blocks by organizations who may be deemed to be independent of government and who act
to maximize wealth. Because these legal person shareholders have large ownership positions and have
resources to analyze firms, they have potential to force firms to reduce agency costs and improve
performance.
I assume that the relationship between large shareholders and firm performance depends on who the
large shareholders are. I therefore propose that concentration of ownership in legal person shareholders
is associated with better performance than ownership concentrated by the government owners.
According to who is the largest shareholder, four groups are identified. They are Ide-state, Ide-legal,
Ide-public and Ide-foreign.
4. Model
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Given the interdependencies between the ownership structure and firm performance and that between
ownership concentration and firm performance discussed above, I estimate the following regression
models to examine their relationships.
Pi = α + βX i + γIde i + δYi + ξ i
2
where Pi is a measure of firm performance; Xi is a 3×1 vector of variables containing CRi, CRi and Zi,
with CRi being the percent of the largest shareholder and Zi being the ratio of the percentage of the
largest shareholder to the cumulative percentage of the second, third, forth, and fifth largest shareholders,
of the ith firm; β is a 1×3 vector of coefficients mapping Xi; Idei is a 3×1 vector of ownership identity
dummies of the largest shareholder of the ith firm; γ is a 1×3 vector of coefficients mapping Idei; Yi is an
n×1 vector of control variables; δ is a 1×n vector of coefficients mapping Yi; and ξi is the residual.
The ownership identity dummy variables are used to distinguish the effect on firm performance of
ownership concentration when the largest shareholder is the state (Ide-state), the legal person (Ide-legal),
general public individual investors (Ide-public) and foreign investors (Ide-foreign). Using Ide-state as a
benchmark, Ide-legali is equal to 1 if the largest shareholder of the ith firm is a legal person, 0 otherwise;
Ide-publici is 1 if the largest shareholder of the ith firm is individual investors, 0 otherwise; and Ide-legali
is 1 if the largest shareholder of the ith firm is a legal person, 0 otherwise.
The control variables include firm size, leverage, area, and industry dummies.
Firm Size: Firm size is a moderating variable in the determination of the relation between ownership and
performance. In particular, the proxies for agency costs are likely to be smaller for large firms. Note that
large firms are politically more important in China and hence they may be more subject to government
influence and monitoring. The government has a greater incentive to protect and assist large firms due to
social matters, such as protecting employment. Size may therefore have an impact on performance in
Chinese firms.
Leverage: The agency literature suggests that debt can be useful in reducing agency conflicts. Therefore
leverage can be an alternative to institutional ownership in monitoring agency cost.
Area: Economic development, living expenses, and average wage costs in the east coastal cities and
areas are much higher than in the interior of China, especially west of China. These differences in
economic development will affect operating and administrative costs. Three dummy variables are coded
A-east, A-middle and A-west if the firm is located in east, middle, and west of China.
Industry: To cater for differences in competitive environments and differences in financial ratios across
industries, I introduce twelve industry dummy variables. They are IND1 to IND12.
I use two accounting measures (ROA and ROE) and a market measure (Stock Return) for firm
performance. Accounting measures and market measures are the two primary measures of firm
performance and so I include them, one at a time, in the regression model to compare their predictive
abilities. The first measure is more dependent on and more under the control of managers, and
maximizing profitability is the goal or target that the CEO strives for. Problems with accounting
measures include the encouragement of a short term or myopic outlook at the expense of longer-term
profitability, and the manipulation of accounting numbers by managers. The market measure, stock
return, represents the benefits to stockholders. One characteristic of stock return is that they are harder to
manipulate than earnings and they ostensibly measure longer-term profitability of the firm. One
drawback of stock returns is that share prices are subject to the vagaries of the stock market and to
changes in the macro-environment including interest rates, inflation, and exchange rates. Nevertheless,
these factors are outside the control of managers.
5. Sample Characteristics
In order to test the research hypotheses developed above, my analysis uses a panel data of all nonfinancial corporations that were listed on the stock exchanges of Shanghai and Shenzhen in 2004. The
analysis is based on information from annual reports and the data are obtained from the CMSAR
Database. To be consistent with other studies, I exclude those companies that are ST Special
（
500
）
Treatment , PT(Particular Transfer), and IPO(Initial Public Offering) in 2004. The sample consists of
1111 companies.
Table 1 provides the summary statistics of the list of variables.
Table 1. Variable Definitions and Selected Statistics (Dummy variables are not included but available if
enquired.)
Selected Statistics
Variables
Definitions
Max
Mean
Max
Stadev
CR
percent of the largest shareholder
85
40.29344
0.26
16.9303
Z
the ratio of the percent of largest
shareholders to the total percent of the
339.4
16.35897
0.305905
37.40519
second, third, forth, and fifth largest
shareholders
ROA
the ratio of asset
0.313807
0.019348
-0.61295
0.072638
ROE
the ratio of equity
0.750155
0.037135
-5.02019
0.262608
Return
market return (stock return)
0.795989
-0.14542
-1.65415
0.282273
Debt/Asset
the ratio of debt to asset
1.191336
0.509847
0.008143
0.177593
Asset
the total asset
4.25E+11
3.07E+09
0.431605
1.41E+10
Performance statistics of the firms shows that, the mean ROA is 2.21%, while the mean market return
1.00%. It is interesting to note that on average, the market returns are negative whatever in different
group, while ROAs are almost positive except for IND10 & Ide-public groups. The accounting measures
are better. In contrast, however, stock returns are poorer. Accounting returns and stock returns give very
different indicators of performance for a number of reasons. One is that stock returns are forward
looking and incorporate investors’ expectations for the future; in contrast, ROA is a historical number.
Such is the potential risk of Chinese companies that stock prices often give a more pessimistic picture of
a firm’s financial standing than does ROA.
The statistics also indicate that on average, west group has the best performance measured by either
ROA or market return.
For the ownership identity, the Ide-state group (companies whose largest shareholder is GOV) has
highest ownership concentration, which is 44.86%. Meanwhile, this group’s performance is a little bit
better than other groups.
6. Empirical Results
The following discussion outlines the key findings. The regression results of the equation are shown in
Table 2.
Independent
Variables
Table 2 Regression Results
Dependent Variable: ROA
Dependent Variable: ROE
Beta
(Constant)
CR
CR2
Z
Ide-legal
Ide-public
Ide-foreign
Debt/Asset
Asset
IND1
IND2
IND3
IND4
IND5
-.410
.693
-.198
1.033
-.145
-.016
-.366
.046
-.178
-.095
-.373
-.121
-.188
T
7.469***
-2.766***
4.520***
-5.988***
1.681*
-1.247
-.128
-13.416***
1.705*
-1.342
-.768
-.491
-.621
-1.558
Beta
-.107
.267
-.126
1.095
-.065
.037
-.290
.046
-.206
-.043
-0905
-.099
-.066
501
t
4.082***
-.677
1.639*
-3.603***
1.675*
-.522
.278
-9.995***
1.593*
-1.461*
-.327
-1.122
-.479
-.515
Dependent Variable: Market
Return
Beta
T
-.819
-.142
-.891
.245
1.463
-.115
-3.147***
.253
.413
-.153
-1.076
.092
.647
-.056
-1.885*
-.007
-.206
-.185
-1.240
-.007
-.055
-1.065
-1.291
.107
.467
.022
.176
IND6
-.159
-.825
-.173
-.844
IND7
-.170
-.733
-.205
-.831
IND8
-.281
-1.314
-.286
-1.258
IND9
-.120
-.690
-.146
-.790
IND10
-.296
-2.035**
-.189
-1.217
IND11
.034
.443
.037
.457
IND12
.015
.056
.100
.342
A-middle
.658
1.563*
.764
1.705*
A-west
.380
.818
.337
.682
N
1111
1111
Adj.R2
.203
.099
F-Ratio
13.875***
6.544***
*,**,*** refer to 10%,5% and 1% levels of significance, respectively.
.060
.077
-.241
-.087
.332
.017
-.204
.254
.730
1111
.006
1.291
.290
.254
-1.006
-.441
2.038**
.171
-.700
.528
1.439
The regressions based on the equation are estimated at two levels: using two accounting measures (ROA
and ROE) and a market measure (stock return) for firm performance. However, the results are different.
Generally, the regression Results using accounting measure for performance are more significant than
using market measure. It is interesting to ask why different proxies for firm performance (accounting
and market measure) produce different relationships with ownership concentration and ownership
structure. One explanation, as I stated, is that while ROA and ROE measure the past and current
performance of the firm, market return, in addition that, captures the expected future performance of
firm. Consequently, rapidly growing firms might have large market return with relatively smaller
accounting performance measures, vice versa. This is one of reasons that result in substantial differences
between the impact of concentration and structure on ROA & ROE and stock return. A second
explanation or implication is that the efficiency of capital market in China is wake-form. The relevance
of stock market in determining firm value is very miniscule in China’s stock market, in the sense that
there is no contemporaneous association between stock return and the market value of firm.
In generally, we can see from table 2 that firm performance is correlated with ownership concentration
and ownership structure, which confirm my expectation.
In particular, I find that the impact of Z is negative and significant at one percent level on both
accounting measures (ROA and ROE) and market measure (stock RETURN). The effect of CR is
negative and significant at one per cent level on ROA, while CR2 is positive and significant at one per
cent level on ROA. That also largely confirms the expectation that there is a non-linear relationship
between ownership concentration and firm performance.
Surprisingly, I find that debt-to-asset ratio is negative and significant at one percent on both ROA and
ROE rather than positive and significant. The reason might be that the role of debt as a controlling
mechanism is different in China as compared with the developed economies. The four largest
commercial banks are mainly agents of the state, and their lending policy is driven by government
policy. Banks as outside monitors do not exercise strong discipline on China’s state-owned enterprise.
Otherwise, corporate debt levels are comparatively higher in China than in developed economies.
Furthermore, I find that large-size firms are more likely to achieve better performance as indicated by
the positive and significant of Asset. This might be due to competition effects, whereby the market
power of large-size firms enables them to outperform small-size firms in China.
Surprisingly, the IND dummy coefficients are not significant except IND10 is negative and significant
at five percent level on ROA while it is positive and significant at five percent level on stock return,
suggesting that firm performance is not affected by different industry.
After controlling for firm size, industry and debt dummies, I find legal ownership concentration has a
positive and significant impact on ROA and ROE at ten percent level. Surprisingly, I fail to find any
significant impact of either public ownership concentration or foreign ownership concentration on firm
performance.
A-middle (Firms in middle area in China) has positive impact on firm performance, significant with
both ROA and ROE at the ten percent level.
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The results, however, still support my previous exception in that ownership structure and ownership
concentration have a significant with firm performance.
7. Conclusion
Using a sample of 1111firms listed in China in 2004, the paper studied the determinants of ownership
structure and concentration, and the effect of this and other aspects of ownership structure on firm
performance. The following conclusion and policy recommendations could be summed up from the
analysis:
(1)Ownership concentration in China seems significant with firm performance. And there is a non-linear
relationship between ownership concentration and firm performance. I would expect that there is an
optimal amount of concentration to maximize firm performance.
(2)Z ( the ratio of the percent of largest shareholders to the total percent of the second, third, forth, and
fifth large shareholders) has a negative and significant impact on firm performance, from which one
implication is that the largest shareholders are so much more powerful than other shareholders that they
tend to do the entrenchment behaviour in China’s companies. I contend that institutional investors are
long term investors with significant incentives to monitor largest shareholders. So institution investor
should be encouraged or improved and to be strong enough to monitor the largest one.
The trade-off between the largest shareholders and second or other shareholders leads to an appropriate
ownership structure in the firm, and this enhances firm value.
(3)As far as identity of owners is concerned, I find no evidence that state shareholding is more effective
in enhancing firm performance. In the Chinese context, governmental influence is significant. As
government has either the overall dominance as the major shareholder or to exercise the ultimate
influence of other shareholders controlling the firm; the state shareholder would not be a positive and
significant factor in firm performance. However, I argue that private ownership is neither a necessary
nor a sufficient condition for superior performance in current context of China. There are much debates
going on in China as to reduce the government shareholding in the listed firms. Following this, as I
pointed out, I argue that China’s government should encourage, or even mandate, better and improve
institutional investor first.
(4)Large-size firms have higher profitability and performance measures than other firms. This could be
the result of favourable advantages seized by monopoly power, not advantages gained through more
efficiency. As a result, efforts that aim at better corporate practices should be coupled with reforms of
product markets, competition policy, and the overall operating environment for firms.
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The author can be contacted from e-mail : [email protected]
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