Corporate Governance & Accounting Research in Asia and China

1. Corporate Governance & Accounting Research in Asia and China T.J. Wong CUHK

2. Outline • Research approach • Top-down not bottom-up • Unique institutional settings in Asia • Key institutional factors of China • Sample projects • Center for Institutions and Governance

3. Bottom-up Approach Two common problems • Replicate a US topic - not taking into consideration the difference institutions • Document a “unique” phenomenon but not being able to explain it with good theories

4. Top-down Approach • Identify key institutional factors that shape organization and incentives • These factors include property rules, government’s role in economy, market and legal development • These factors also shape the corporate governance, accounting and corporate policies • Apply common theories or analytical frameworks -- only institutions are different

5. Institutions of East Asia • Political economy • Close ties between government and business • Rent seeking society • Legal systems • Poor protection of property rights • Private enforcement of contracts • Weak protection of outside shareholders • Culture and social norm • Low trust society • Relationship-based transactions • Family firms

6. Sample studies • Fan and Wong (2002, JAE) • Institutions: concentrated ownership  stock pyramids  divergence of cash flow and voting rights through pyramiding  expropriation incentives / rent seeking  less transparent • Fan and Wong (2005, JAR) • Divergence of cash flow and voting rights  hire B4 auditors • More prevalent among issuing firms; reduce cost of capital

7. China’s Institutional Setting Economic in transition  Govt vs. Market • Capital markets (state vs. market) • IPO, rights offerings and delisting controlled by govt (quota system; ROE targets) • State banks – related lending • Government not market plays a big role • Majority ownership by the state • partial privatization (minority shares) of SOEs • direct (SAMB) and indirect (parent SOE) government majority ownership • Government shares cannot to be sold easily • Incentive issues: soft budget constraints; SOE pursuing non-economic goals

8. Institutional setting (cont’d) • Control (mgmt vs. state) • 1992, central govt granted SOEs 14 rights, mainly operating rights • Rights not given: M&A, disposal of assets, appointment of chairman and CEO • Boards and management filled with govt bureaucrats; not professional • Incentives issue: government interventions; double agency of management • Economy is decentralized • Local governments own SOEs and have production and fiscal autonomy • Listed SOE can bring resources and political capital to local govt • Weak legal systems and undeveloped markets • Poorly developed legal system and markets, more government interventions • Institutions vary across provinces in China, which allows x-sectional comparisons across regions

9. Different Organization Structures SAMB SAMB Private SAM Co. Listed Firm Parent SOE Listed Firm Listed Firm

10. Market Institutions Protection for property rights High Low Middle Missing

11. Market Institutions of Different Regions Source: Fan and Wong, 2003 (Economic Science Press)

12. Rough Sketch of the Framework Institutions Firm organization Government Corporate governance Role of accounting and corporate policies

13. Some Studies • Political influence and accounting quality • Board structures; pyramids; corruption as measures of political influence • How institutional factors determine auditor choice in China • Chinese firms do not hire quality auditors. Why? • Corporate governance role of accounting? Used by controlling owner to monitor management? When? How?

14. State Ownership, Institutional Environment and Auditor Choice: Evidence from China Wang Qian, TJ Wong CUHK Xia Lijun SUFE

15. Chinese Firms Choose Poor Quality Auditors • Market share of Top 10 auditors (based on market shares) declined from 47% in 93 to 24% in 03 • But Top 10 auditors are found to have better quality • Compared to non-state firms, SOEs tend to choose local auditors (from same region) that are small • What causes Chinese SOEs not to choose good quality auditors? • Fundamental questions: what determine Chinese firms choice of auditors?

16. Institutional Constraints • Government ownership • Easier access to capital (equity and debt) - less need to reduce information asymmetry • Soft budget constraint - less need for insurance • Government influence over auditors • Small local auditors lose independence - help clients to meet government targets • Mainly related to local government SOEs • Poor market and legal systems • Weak monitoring against lack of independence

17. Results • SOEs vs. non-state firms • Local SOEs more likely to hire small local auditors • Regions with less market development and more government intervention • Local SOEs hire even more small local auditors • Are small local firms compromising independence? • They issue fewer qualified opinions • They are more lenient towards SOEs from same region

18. Future Directions • Ask more fundamental questions with good data • Role of accounting and corporate policies in Asian / Chinese listed firms • Organization economics – firm governance, agency issues and contracts  role of accounting corporate policies • Transition economics – state ownership or intervention that creates distortion  role of accounting and corporate policies • Identify other key constraints that shape CG and accounting

21. Website address http://www.baf.cuhk.edu.hk/research/cig/