The Role of Financial Institutions in the Corporate Governance of Listed Chinese Companies*
| Published date | 01 December 2009 |
| Author | Joe Hong Zou,Rongli Yuan,Jason Zezhong Xiao,Nikolaos Milonas |
| Date | 01 December 2009 |
| DOI | http://doi.org/10.1111/j.1467-8551.2008.00602.x |
The Role of Financial Institutions in the
Corporate Governance of Listed Chinese
Companies
Rongli Yuan, Jason Zezhong Xiao,
1
Nikolaos Milonas
2
and
Joe Hong Zou
3
School of Business, Renmin University of China, Beijing, China,
1
Cardiff Business School, Cardiff University,
Cardiff, UK,
2
University of Athens, Athens, Greece, and
3
Department of Economics and Finance, City
University of Hong Kong, Hong Kong, China
Corresponding author email: xiao@cardiff.ac.uk
This paper explores the role of Chinese financial institutions in the corporate
governance of listed companies through interviews with both senior managers of
financial institutions and board directors of listed companies. Our results show that,
while most securities companies are passive investors, a good proportion of the active
mutual funds help their portfolio companies prepare financial forecasts, standardize
their operations, raise external funds, strengthen their company image in the capital
markets, and sometimes intervene in corporate issues. This limited role can be
attributed to a number of factors specific to the Chinese context including highly
concentrated state ownership, an immature regulatory environment, inadequate
transparency and disclosure of financial information, and weak corporate governance
within financial institutions themselves. It could also be affected by several other factors
that are considered to cause institutional passivity in developed countries such as
conflicts of interest, monitoring costs and lack of expertise.
Introduction
A substantial regulatory effort has recently been
made in China to accord financial institutions an
important role in improving corporate governance
and stabilizing the stock market. For example,
in 2000 the government made a strategic decision
to devote major efforts to developing financial
institutions (China Securities Regulatory Com-
mission, 2000). It encouraged financial institu-
tions, especially mutual funds and securities
companies, to invest in listed companies so that
they can monitor corporate management and
counter opportunistic behaviours of individual
investors. In this context, mutual funds and
securities companies have experienced an unpre-
cedented growth. As at the end of 2003 when this
study was undertaken, there were 133 securities
companies and 54 closed-end and 41 open-end
mutual funds.
The recent law and finance literature highlights
that a central agency problem in a setting like
China with poor corporate governance and weak
investor protection is the expropriation of min-
ority shareholders by controlling shareholders
(e.g. Bai et al., 2004; La Porta et al., 2000; Sun
We are grateful to Zhiliang Li, Xiaodong Liao,
Qiaohong Ma, Aixiang Pan, Bin Wang, Xiuxiang Wang,
Zhihua Xie, Youhong Yang and Dewu Zheng for their
valuable assistance in arranging the interviews on which
this paper is based. We thank the 30 interviewees for
providing their valuable responses and cooperation. We
acknowledge financial support from the Chinese Ac-
counting, Finance and Business Research Unit at
Cardiff University. Finally, we appreciate the useful
comments provided by Roy Chandler.
British Journal of Management, Vol. 20, 562–580 (2009)
DOI: 10.1111/j.1467-8551.2008.00602.x
r2008 British Academy of Management. Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford
OX4 2DQ, UK and 350 Main Street, Malden, MA, 02148, USA.
and Tong, 2003; Wei, Xie and Zhang, 2005).
Indeed, Xiao, Dahya and Lin (2004) report that
there are widespread corporate malpractices in
China (e.g. illegal insider trading, market manip-
ulation and corporate reporting frauds) that are
detrimental to minority shareholders. Acting as
an intermediary in pooling the investment of
various individuals, mutual funds can help
strengthen the bargaining power of minority
shareholders in the corporate governance process
of their investee companies (Belev, 2003). This
helps explain why regulators in China are keen to
develop the role of financial institutions in
improving corporate governance and stabilizing
stock markets.
Unfortunately, the role of financial institutions
in China so far has attracted little academic
attention, partly because financial institutions
are not perceived to play any significant role in
corporate governance (Gen, 2002). However, the
literature offers no empirical evidence to support
such a perception. Indeed, financial institutions’
recent attempts to intervene in corporate govern-
ance issues suggest that some of them are exercis-
ing an important role in protecting the rights of
minority shareholders. Thus, it is important to
empirically reassess their current role in corpo-
rate governance and the effectiveness of the
recent regulatory efforts. This study represents a
first attempt towards filling a gap in the litera-
ture. If empirical evidence suggests that finan-
cial institutions play a certain role in corporate
governance, then this would be an indication that
the regulatory efforts have achieved some mea-
sure of success and such efforts should probably
be extended. If the evidence confirms prior
perceptions that financial institutions play little
or no role in corporate governance, then it would
be useful to identify the reasons why this is the
case and ways to overcome the difficulties.
To explore the role of financial institutions
in the governance of listed Chinese companies,
we interviewed both senior managers of financial
institutions and directors of listed companies.
From their perspectives, we are able to provide
balanced and comprehensive evidence on the
participation and role of financial institutions in
corporate governance. The interview evidence
indicates that most securities companies are
passive investors, while some active mutual funds
attempt to get involved in the governance of their
portfolio firms. This finding suggests that the
regulatory efforts in promoting the development
of mutual funds seem to have generated positive,
albeit limited, impacts on corporate governance.
This paper also indicates that this limited role can
be attributed to a number of factors. Some of the
factors are consistent with the arguments put
forward by studies undertaken in other econo-
mies. These include conflicts of interest with
investee companies, high monitoring costs and
lack of expertise. Others appear to be specific to
the Chinese context, e.g. high concentration of
state ownership, immature regulatory environ-
ment, inadequate disclosure of financial informa-
tion, and weak corporate governance within
financial institutions themselves.
The remainder of this paper is structured as
follows. The next section reviews the literature
and the Chinese institutional background and
presents our research questions. A description of
the research method and the sample used is
presented in the following section. The interview
data are analysed next, and finally the conclu-
sions and policy recommendations are presented
in the last section.
Literature review, institutional
background and research questions
Agency problem and two views on the role of
financial institutions
Traditionally, agency theory assumes that own-
ership of a firm is well diversified among share-
holders, and managers of the firm have control
over it. So the traditional agency problem derives
from the conflicts between shareholders and
managers (Jensen and Meckling, 1976). Jensen
(1986, 1989) argues that managers can expropriate
shareholders by diverting corporate resources for
perquisites and empire building. Indeed, managers
have incentives to consume excessive salaries and
perquisites and to pursue politics that protect
them against job termination at the expense of
those of shareholders. Such behaviour may be
shielded from shareholders’ detection, due to
adverse selection or moral hazard (Rasmusen,
1989).
However, in firms with controlling share-
holders (like many Chinese companies), another
kind of agency problem derives from the conflicts
between minority shareholders and controlling
shareholders (Shleifer and Vishny, 1997). Such
Governance Role of Financial Institutions in Listed Chinese Companies 563
r2008 British Academy of Management.
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