The issue of corporate governance has experienced a long time development from early principal-agency theory (Jensen and Meckling, 1976) and entrenchment theory (Jensen and Ruback, 1983). Corporate governance is a mechanism which alleviates the conflict interest between managers and shareholders. Denis and McConnel (2003) characterized governance mechanism as internal or external to the firm. They indicate the effectiveness of corporate governance in a firm is enhanced by
both of internal and external mechanism. The internal governance mechanisms of primary interest are the board of directors and the equity ownership structure of the firm (Denis and McConnell, 2003). On the other side, takeover market is a major source of external control (Huson, Parrino and Starks, 2001).
Another feature is top management turnovers. According to Kang and Shivdasani (1995) top executive succession events provide a natural setting to examine the functioning of governance mechanisms because the decision to remove top managers is both extreme and highly visible. Besides, the mechanism of managerial replacement protects shareholders rights from management exploitation.
For example, Lausten (2002) finds the threat of turnover ensures CEO acts in the interest of the shareholders in Danish firms.
Several aspects surrounding top management replacement and corporate governance have been documented in years, yet most of the articles focus on firm performance assessment. As Kaplan (1994a, b) state, the relationship between manager turnovers and firm performance is a good way to appraise the viability of a firm’s governance system. The evidence generally indicates that manager turnovers and firm performance are negatively related (Denis and Denis, 1995; Graziano and Parigi, 2003; Kaplan and Minton, 2006). Aivazian, Ge, Qiu (2004) present the firm performance was significantly and negatively related to manager demotion in Chinese
state-owned enterprises.
While a negative relation between firm performance and the likelihood of CEO turnovers has been well documented, there is relatively little evidence about how turnover decisions are made. Some evidence suggests that turnover decisions are affected by board composition (Weisbach, 1988) and CEO stock ownership (Salancik and Pfeffer, 1980; Allen, 1981; Denis and Denis, 1995), but many other factors that affect these decisions have not been examined, for instance, the role of institutional investors.
The institutional investors have long been regard as large shareholders in the firm with better information advantages and stronger incentives to undertake monitoring activities (Shleifer and Vishny, 1986; Huddart, 1993). Gillan and Starks (2000) indicate that institutional investors with large debt or equity positions in a company have been motivated to actively participate in the company's strategic direction. Although large institutional investors can be very effective in solving agency problems in theory, empirical research provide ambiguous evidence for successful changes in corporate decisions. On the other hand, it is also costly. Such monitoring requires independent sources of information concerning managerial actions and there are also potential liquidity costs (Kahn and Winton, 1998; Maug, 1998; and Noe, 2002) and free-rider problems with other shareholders (Grossman and
Hart, 1980). In addition, governance characteristics can determine how effectively managers are monitored and howmuch influence a shareholder can exert (Parrino et al., 2003). For example, CEOs who are members of a firm’s founding family tend to control relatively large blocks of stock either directly or indirectly. This type of control makes it more difficult to remove such CEOs (Morck et al., 1989; Parrino, 1997).
Thus, there is another theory of voting with their feet (Parrino et al., 2003), often termed as “Wall Street Rule”. They believe selling of shares may be the most common action taken by institutional investors to voice their opinions considering the cost of direct involvement. Despite the passive nature of institutional selling, such selling behavior seems to be another alternative of monitoring activities. For example, because the amount holdings institutions hold, a shift in ownership structure is likely to have a meaningful impact on corporate decisions (Parrino et al., 2003). Brickley et al. (1988) report evidence that some shareholders are pressure-sensitive due to business relationships with the company.
Hirschman (1970) terms “voice behavior” as the use of ownership power to change the company’s actions, “exit” implies voting with your feet, and “loyalty”
implies remaining quiet and not selling. The possibility that exit by a large shareholder can have positive impact on the firm is also discussed in Gopalan (2005).
In fact, the financial logic tends to favor exit behavior, that is, the institutional investors does not want to be stuck in corporate governance bodies, but wants to be free to make reallocations in the portfolio at any time (Hellman, 2005). Similarly,
Palmiter (2002) suggests that large shareholders may be able to affect managerial decisions through the “threat (actual or implied) of selling their holdings and driving down the price of the targeted company.” Some studies even claim the “wall street
walk” can be regard as another form of shareholder activism.
The principal aim of this paper is to examine the potential passive role of institutional investors under concentrated ownership by observing changes in shareholdings around top management turnovers and its impact on the issue of corporate governance. Considering dominant individual investors, concentrated family control, and possible cross-holding scenario in Taiwan listed corporations, the main hypothesis tested is whether institutional investors tend to sell their shares prior forced top management turnovers because they believe concentrated corporate structure make direct actions (i.e., trying to influence corporate decisions) too costly (H1). To further explore the intention under institutional selling, the forced turnover samples are recategorized as outside succession or inside succession due to the possibility that outside successors are better able to change the direction of a firm (Parrino, 1997). If institutional investors intend to influence corporate decisions with
selling actions prior to top management replacements, they shall repurchase their shares for the fulfilled purpose after the turnovers (H2). Finally, this paper examines whether intended institutional selling prior top management turnovers can result in better corporate governance in terms of board efficiency (H3).