Joseph P. H. Fan

Disentangling the Incentive and Entrenchment Effects of Large Shareholdings

This article disentangles the incentive and entrenchment effects of large ownership. Using data for 1,301 publicly traded corporations in eight East Asian economies, we find that firm value increases with the cash-flow ownership of the largest shareholder, consistent with a positive incentive effect. But firm value falls when the control rights of the largest shareholder exceed its cash-flow ownership, consistent with an entrenchment effect. Given that concentrated corporate ownership is predominant in most countries, these findings have relevance for corporate governance across the world.

Do External Auditors Perform a Corporate Governance Role in Emerging Markets? Evidence from East Asia

In emerging markets, the concentration of corporate ownership has created agency conflicts between controlling owners and minority shareholders. Conventional corporate control mechanisms such as boards of directors and takeovers are typically weak in containing the agency problem. This study examines whether external independent auditors could be employed as monitors and as bonding mechanisms to alleviate the agency conflict. Using a broad sample of firms from eight East Asian economies, we document that firms are more likely to employ Big Five auditors when they are more subject to the agency problem imbedded in their ultimate ownership structure. One possible reason that this documented relation between auditor choice and the agency problem is more evident than the inconsistent results using U.S. and U.K. data is that alternative governance mechanisms are limited in East Asia. In addition, among East Asian auditees subject to the agency problem, Big Five auditors charge a higher fee and set a lower audit modification threshold while non-Big Five auditors do not. Taken together, the evidence suggests that Big Five auditors in emerging markets do have a corporate governance role.

An International Comparison of Capital Structure and Debt Maturity Choices

This study examines the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries. We find that a countrys legal and tax system, the level of corruption and the preferences of capital suppliers explain a significant portion of the variation in leverage and debt maturity ratios. Our evidence indicate that firms in countries that are viewed as more corrupt tend to use less equity and more debt, especially short-term debt, while firms operating within legal systems that provide better protection for financial claimants tend to have capital structures with more equity, and relatively more long-term debt. In addition, the existence of an explicit bankruptcy code and/or deposit insurance is associated with higher leverage and more long-term debt. We also find that firms tend to use more debt in countries where there is a greater tax gain from leverage, while firms in countries with larger government bond markets have lower leverage, suggesting that government bonds tend to crowd out corporate debt. Countries with more extensive defined benefit pension funds have higher debt ratios and longer debt maturities, whereas those with more extensive defined contribution fund activities have lower debt ratios. In addition, debt ratios are lower in countries that limit the bond holdings of pension funds. Finally, we do not find a significant association between financing choices and the size of the insurance industry.

The Measurement of Relatedness: An Application to Corporate Diversification

Employing commodity flow data from input-output (IO) tables, we construct two IO-based measures to capture interindustry and intersegment vertical relatedness and complementarity. At the industry level, we demonstrate that the new IO-based measures outperform traditional measures based on Standard Industry Classification (SIC) codes. At the firm level, we report that firms increase their degree of vertical relatedness and complementarity over time. The increasing pattern is robust; it is not sensitive to accounting changes in segment definition, different weighting methods, and different IO data employed. As an application, we examine the valuation effects of relatedness in the context of corporate diversification. Copyright 2000 by University of Chicago Press.

On the Patterns and Wealth Effects of Vertical Mergers

We use industry commodity flows information to measure vertical relations in completed mergers from 1962 to 1996. Almost one-third of the mergers display vertical relatedness. Vertical merger activity is more intensive in the 1980s and 1990s and less so in the 1960s and the 1970s. Vertical mergers generate positive wealth effects that are significantly larger than those for diversifying mergers; the wealth effects in vertical mergers are comparable to those in pure horizontal mergers.

Public governance and corporate finance: Evidence from corruption cases

Cross-sectional research finds that corporate financing choices are not only affected by firm and industry factors, but also by country institutional factors. This study focuses on the roles of public governance in firm financing patterns. To conduct a natural experiment that avoids endogeneity, we identify 23 corruption scandals involving high-level government bureaucrats in China and a set of publicly traded companies whose senior managers bribed bureaucrats or were connected with bureaucrats through previous job affiliations. We report a significant decline in the leverage and debt maturity ratios of these firms relative to those of other unconnected firms after the arrest of the corrupt bureaucrat in question. These relations persist even if we only focus on the connected firms that were not directly involved in the corruption cases. The relative decline in firm leverage is associated with negative stock price effects. We also examine the possibility that rent seekers are efficient firms and that corruption does not thus result in capital misallocation, but fail to find evidence to substantiate this postulation. Journal of Comparative Economics 36 (3) (2008) 343-364.

The Value of Marriage to Family Firms

This paper presents the first empirical evidence showing that the marriage of a member of the controlling family adds value to public corporations. The results, based on a uniquely comprehensive data set from Thailand, show that the family firm’s stock price increases when the partner is from either a prominent business or a political family. Abnormal returns tend to be higher for firms whose operation depends on extensive networks. In contrast, marriages to ordinary citizens are not associated with any abnormal returns. These findings are generally supportive of the value of networks in general and marriage in particular.

Does 'Good Government' Draw Foreign Capital? Explaining China's Exceptional Foreign Direct Investment Inflow

China is now the worlds largest destination of foreign direct investment (FDI), despite assessments highlighting its institutional deficiencies. But this FDI inflow corresponds closely to predicted FDI flows into China from a model that predicts FDI inflow based on government quality indicators and controls and is estimated across a sample of other weak-institution countries. The only real discrepancy is that, if government quality is measured by constraints on executive power, China receives somewhat more FDI than the model predicts. This might reflect an underestimation of the strength of these constraints in China, a unique institutional setting for FDI operations, FDI based on expected future institutional improvements, or a unique Chinese model of development. The authors conclude that Ockhams razor disfavors the last. They also note that FDI may be elevated because Chinese institutions protect foreign firms better than domestic ones.

Vertical Integration, Institutional Determinants and Impact: Evidence from China

Where legal systems and market forces enforce contracts inadequately, vertical integration can circumvent these transaction difficulties. But, such environments often also feature highly interventionist government, and even corruption. Vertical integration might then enhance returns to political rent-seeking aimed at securing and extending market power. Thus, where political rent seeking is minimal, vertical integration should add to firm value and economy performance; but where political rent seeking is substantial, firm value might rise as economy performance decays. China offers a suitable background for empirical examination of these issues because her legal and market institutions are generally weak, but nonetheless exhibit substantial province-level variation. Vertical integration is more common where legal institutions are weaker and where regional governments are of lower quality or more interventionist. In such provinces, firms led by insiders with political connections are more likely to be vertically integrated. Vertical integration is negatively associated with firm value if the top corporate insider is politically connected, but weakly positively associated with public share valuations if the politically connected firm is independently audited. Finally, provinces whose vertical integrated firms tend to have politically unconnected CEOs exhibit elevated per capita GDP growth, while provinces whose vertically integrated firms tend to have political insiders as CEOs exhibit depressed per capita GDP growth.

Does 'Good Government' Draw Foreign Capital? Explaining China's Exceptional FDI Inflow

China is now the worlds largest destination of FDI, despite assessments highlighting its institutional deficiencies. But this FDI inflow corresponds closely to predicted FDI flows into China from a model that predicts FDI inflow based on government quality indicators and controls and is estimated across a sample of other weak-institution countries. The only real discrepancy is that, if government quality is measured by constraints on executive power, China receives somewhat more FDI than the model predicts. This might reflect an underestimation of the strength of these constraints in China, a unique institutional setting for FDI operations, FDI based on expected future institutional improvements, or a unique Chinese model of development. We conclude that Ockhams razor disfavors the last. We also note that, FDI may be elevated because Chinese institutions protected foreign firms better than domestic ones.