This thesis examines the necessity of multiple governance mechanism design. The research process can be separated into three parts: the first part confirms the effectiveness of each governance mechanism; the second part distinguishes whether incremental governance mechanism adds more value or not. The third part examines if the governance mechanism interaction depends on firm characteristics.
The first part clarifies which governance mechanism is effective in eliminating the agency problem and thus augmenting firm valuation. The preliminary regression shows that firms with higher percentage shareholding by institutional investors, either domestic or foreign, are associated with higher market valuation premium, implying that institutional investors, based on superior professional know-how and abundant incentive, play important roles in monitoring the incumbents and effectively increase firm value in Taiwan. Furthermore, the regression results also show that firm with qualified independent director arrangement are associated with higher market valuation premium, implying that independent director is also a vigorous governance mechanism in monitoring the incumbents and increasing firm value. Meanwhile, the valuation effect of discrepancy of control rights and pledge ratio are not significant in the regression results. The reason why the stock market do not giver premium value to firms for temperance in discrepancy of control rights and pledge ratio might results from the specific business background in Taiwan that cross-holding, pyramid shareholding structure and pledge ratio are commonly utilized even in many first-tier companies such as Foxconn, Formosa Plastic Group and China Trust (United Group Daily News 2006). In addition, both functions, i.e. less discrepancy of control rights or less pledge ratio, are merely passive governance mechanisms that reduce incumbents’ incentive to seek private benefits, instead of active monitoring
mechanism to prohibit them. Last but not least, the reason why the result contradicts to that of Yeh et al. (2003) might result from the different economic conditions in the two sample periods. As the discrepancy of control rights mostly appears in the best and the worst firms like a “M distribution”, the Asia financial crisis in the late 90’s has washed out most of the worst firms and thus the negative relationship between the discrepancy of control right and firm value is not so significant later on. In conclusion, in Taiwanese market, independent director and blockholder might be the definitive governance mechanisms in firm valuation. The results of graphic analysis also correspond to this result, showing that better board independence and higher percentage of blockholder shareholding, either domestic or foreign, contribute incremental premium on firm value given other things being equal. A clear trend of increasing value can be seen for firms with either better board independence or higher blockholder shareholding from the graphs.
The second part tries to find out whether two joint governance mechanisms performs better in eliminating agency problem than single governance mechanism.
The results of graphic analysis show that the highest percentage of blockholder shareholding combining with qualified board independence are associated with higher market valuation than either highest percentage of blockholder shareholding or qualified board independence in isolation. It denotes that both blockholder and independent director are valued higher when coexisting with each other than functions alone. The results indicate that market may view multiple governance mechanisms as better shareholding protection mechanism and give it higher premium. The regression shows that when considering independent director and domestic blockholder, the substitution effect outweighs the complement effect in valuation; it is the more sophisticated governance mechanism that matters to the firm valuation. When
regarding independent director and foreign blockholder, the complementary effect outweighs the substitution effect in valuation; it is the more coexisting level that matters to the firm valuation. It indicates that the market views independent director and domestic blockholder as substitutes and only gives premium value to the highest level of either of them. On the other hand, market views independent director and foreign blockholder as complements and only give premium value to the extent in which both governance mechanisms coexist. The reason why the governance effect of independent director substitutes the effect of domestic blockholder while complements the effect of foreign blockholder might be rooted in the time horizon of the incentives. As foreign blockholder prefers short-term investment, it tends to monitor management by the short-term performance. In contrast, domestic blockholder prefers relatively long-term investment, so it tends to monitor management by the long-term performance. Independent directors are induced by the
“reputation incentive.” As reputation can not be built in a short period of time, independent directors also tend to monitor management by the long-term performance so that they can gain and maintain long-term prestige. Therefore the monitoring effect of independent directors overlaps the effect of domestic blockholder while complements the effect of foreign blockholder.
The third part examines whether the interaction between governance mechanisms are specific in firms with certain characteristics. The results show that the substitution effect between independent director and domestic blockholder is especially significant in large or high-leveraged firms, and the complement effect between independent director and foreign blockholder is especially significant in small or low-leveraged firms. Regarding the size factor, it perhaps is due to the reason that large firms can attract more attention of institutional investors and can recruit more competent
independent director in an independent director market with excess demand, while small firms are inferior in attracting the attention of blockholder and find it more difficult to recruit prestigious independent director, thus the governance mechanism quality of large firms tend to be stronger and can function well independently and the governance mechanism quality of small firms tend to be weaker and can not function well without the facilitating of the other mechanism. In terms of the leverage factor, in high-leveraged firms the free cash flow is constrained which serves as a self-enforcing function to prevent management appropriation (Grossman and Hart 1982, Jensen, 1986, 1993 cited in Gillan 2005). Accordingly, the agency problem in firms with high leverage is less serious and hence independent dependent and domestic blockholder can substitute each other and function well in isolation. Contrarily, the agency problem in low-leveraged firms are severer and hence independent director and foreign blockholder can not function well along; instead, they need the complement of each other.
To conclude, while in large or high-leveraged firms the design of an optimal governance mechanism should avoid overlapping problem and should focus on refining single governance mechanism, in small or low-leveraged firms the design of an optimal governance mechanism should diversify to multiple governance mechanisms and hence enable them to facilitate each other.