LITERATURE REVIEW

3.1. I

D

F

P

Until recently, most research on the impact of independent director is empirical, and the results are mixed (Becht et al. 2003 p.31). While some research in US find that companies with higher percentage of independent director are more likely to dismiss the poorly performed CEO (Weisbach 1988 cited in Becht et al. 2003 p.31-32), and have higher appointment announcement date equity abnormal returns (Rosenstein and Wyatt 1990 cited in Becht et al. 2003 p.32), other research find that board compositions are unrelated to firm performance (Hermalin and Weisbach 2003).

Regarding international corporate governance literatures, early Japanese evidence shows that appointment of independent director from bank to non-financial companies stabilize and modestly improve firm performances, measured by stock returns, operating performance and sales growth (Kaplan and Minton 1994). In European countries, the role of the board of director is usually not prescribed in law, as Europeans do not consider shareholder wealth maximization as the paramount goal of a corporation (Wymeersch 1998 cited in Denis and McConnell 2003 p.6).

Nevertheless, starting from the Code of Best Practice in UK in year 1992, European countries have begun to embrace the idea of board composition appropriateness (Denis and McConnell 2003 p.7). The evidences in UK are mixed as well. While the result of Dahya et al. (2002 cited in Denis and McConnell 2003 p.7) shows that the independent director is associated with higher management turnover following poor performance, Frank et al. (2001 cited in Denis and McConnell 2003 p.7) find that in poor performing firms, independent director impedes discipline of poorly-performing managers.

In terms of emerging market, Korea instituted outside director after Asian financial crisis under the command of International Monetary Fund (IMF), requiring all the public-listed firm to have at least 25 percent of the board comprising of outside directors, and the empirical result shows that the valuation effect of outside director is strongly positive (Choi et al. 2007). China instituted outside director in 2001 after several corporate governance scandals, yet the empirical result shows that outside directors only have positive impact on sales growth but little impact on financial performance measured by return on equity (Peng 2004 and Clarke 2006).

3.2. D

B

F

P

Blockholder utilizes its influence on management to make decisions that increase overall shareholders’ welfare and is a candidate solution to mitigate the agency problem (Denis and McConnell 2003). Among them, institutional investor is becoming increasingly prominent for its sophisticated and active investing style (Gillan and Starks 2000). Literatures of institutional investor are inconclusive.

Although Hartzell and Starks (2003 cited in Gillan 2006) approve the impact of concentrated institutional ownership in moderating executive compensation, others argue that interest conflictions (Woidtke 2002 cited in Gillan 2006) and business ties (Davis and Kim in press cited in Gillan 2006) compromise the monitoring role of institutional investors. In Asia, Mitton (2002) acknowledges the positive effect of outside blockholder on firm’s performance immunity against financial distress.

Korean evidence are inconclusive, while Chang and Hong (2000) find that group-affiliated firms are benefit from group member through resources sharing, Choi

et al. (2007) find that domestic institutional investors such as Chaebol or family

performance.

3.3. F

B

F

P

Starting from the end of year 2003, the regulation of Qualified Foreign Institutional Investor (QFII) and investment amount ceiling for foreign institutions are abolished (United Group Daily News 2003). As the equity markets are increasingly globalizing and integrating, foreign institutions start to play an important role in the Taiwanese equity market, and empirical studies start to pay attention to their differently investment objectives and decision-making horizons (Filatotchev et al. 2005). Most research acknowledge their contributions to firm performance, with their more experienced monitoring ability (Thomsen and Pedersen 2000), more abundant international financial resources (Taylor 1990), and more professional strategic expertise (Tihanyi et al. 2003). Evidence in Korea shows that foreign investor has significant positive valuation effect (Choi et al. 2007). Evidence in Taiwan also confirms that foreign bank investment is significant positive associated with firm performance measured by return on capital and market to book ratios (Filatotchev et

al. 2005).

3.4. S

L

F

P

Shareholding leverage is embodied in two forms: one is the deviation of control rights away from cash flow rights, and the other is the pledge ratio. La Porta et al. (cited in Claessens et al. 2000) initiate the discussion of ultimate control, and find that ownership and controlling rights can be separated to the benefit of incumbents. When control rights bring about private benefits that have value beyond the cash flow rights, incumbents have incentives to hold excess control rights than cash flow rights, by cross holdings, design of superior-voting shares, and pyramid structure (Denis and

McConnell 2003 p.16). Bebchuk e al. (2000) argue that deviation of control rights away from cash flow rights creates large agency cost. Therefore, investor protection appears to improve with the concentration of cash flow rights, but decreases as the controlling shareholders acquire more control rights in excess of their cash flow rights (Durnev and Kim 2005). An empirically research across 18 emerging countries has demonstrated this viewpoint, discovering that accumulation of control rights in excess of cash flow rights is generally value-reducing for a company (Lins 2003 cited in Denis and McConnell p.18). In East Asia, Classens et al. (2000) find that the deviation of control rights and cash flow rights is especially pronounced in family-controlled firms in Korea, Singapore and Taiwan, while less common in Japan.

In Western Europe, Faccio and Lang (2002) only find significant discrepancy of control rights and cash flow rights in Switzerland, Norway, and Italy.

In terms of pledge ratio, pledging for loans effectively reduces the funds required for shareholding, resulting in personal credit expansion and over-investment (Lee and Yeh 2004). In Korea, Joh (2003) finds that before the financial crisis, firms with higher disparity of control rights and cash flow rights are associated with lower profitability, especially in public-listed firms. Evidence in Taiwan shows that pledge ratio has better explanatory ability than discrepancy of control rights and cash flow rights when it comes to abnormal equity returns (Chen 2003). Yeh et al. (2003) suggest that Classens et al. (2000) underestimate the control right of the controlling shareholder in Taiwan due to the insufficient disclosure of ultimate control. Yeh et al.

(2003) recalculate the discrepancy of control rights and pledge ratio during 1997-1998 in Taiwan, and find that these two measurements are negatively associated with firm value. Further, Lee and Yeh (2004) find that these two measurements are associated with higher possibilities of financial distress.

3.5. B

I

Some previous studies investigate how blockholder interacts with other conditions.

Regarding the interaction between takeover mechanism, Grossmand and Hart (1980 cited in Becht et al. 2003 p.24) find that blockholder facilitates the implement of takeover activities; and Cremers and Nair (2005) prove that the other way around relationship is true. In terms of the interaction between market liquidity, Hirschman (1970 cited in Becht et al. 2003 p.25) suggests that blockholder can not be relied upon once the market has abundant liquidity and the blockholder has the option to sell the stake rather than to intervene. This explains the reason why in US market blockholder has less incentive to monitor management than many other emerging countries (Mayer 1988, Black 1990, Coffee 1991, Roe 1994 and Bhide 1993 cited in Becht et al.

2003 p.25). To summarize, blockholder mechanism is complementary to anti-takeover mechanism and relies on the incentive rooted in the illiquid secondary market to function well.

3.6. A

R

, V

C

G

remers and Nair (2005), whose methodology is adopted in this thesis, examine how governance mechanisms interact in being associated with equity abnormal returns, yet this these investigates how governance mechanisms interact in being associated with firm valuation. Regarding abnormal return, Gompers et al. (2003) find intriguing evidence and conjecture that investors are surprised by the higher-than-expected agency costs resulted from weaker corporate governance, and hence firm with weak governance has significantly negative equity abnormal returns and vice versa.

However, Core et al. (2006) detect analysts forecasting errors and earning announcement date abnormal returns as measurements of the accuracy of investor

resulted from different corporate governance practices between companies beforehand.

Furthermore, after either extending the sample period to year 2000-2003 or excluding the technology firms from the original sample period, the significant relationship between equity abnormal returns and corporate governance found by Gompers et al.

(2003) fades out. Consequently, Core et al. (2006) conclude that rather than the expectation effect, the abnormal returns to shareholder rights are caused by the larger

“new economy pricing puzzle” of the late 1990s.

In terms of valuation and corporate governance, LaPorta et al. (1998) argue that greater investor protection increases investors’ willingness to provide financing and lead to a lower cost of capital and a higher firm valuation. An empirical study cross 14 emerging market also finds that better corporate governance is significantly correlated with better firm performance and valuation (Klapper and Love 2004). In single country empirical studies, the positive valuation effect of corporate governance, including outside blockholder, foreign institution, and outside director, is also found in China (Bai et al. 2004) and Korea (Black et al. 2006).