Do Chinese Institutional Investors Help Improve Firm Performance?

On September 10th, 2011, Posted by author

Last modified: October 26, 2015

The Chinese equity market is only two decades old and still at the first stage. The Chinese stock market is beset with problems when compared to the Western stock markets. Data from the World Bank show

that the aggregate shares owned by the government are more than 50% of the total market shares: state-owned shares – 59%, the tradable shares and legal person shares – 40% of which the individual legal person shares are a mere 5%. This suggests that Chinese government still controls the firm performance according to its political advantages. Profit maximization, which is the main basis of business, is not possible because the state owns the shares for generating employment and social stability and does not interested in profits.

Thus, because of the Chinese ownership structure, its stock market is in a quandary when trying to manage diverse principal-agent issues. Also, the growth of corporate governance in China is thwarted by investors with a large number of shares who have the dominant voting power, and individual investor’s voice is drowned out. Voting power that is scattered among smaller investors may be unsuccessful in restraining the managers’ benefits that are ultimately depreciative to the investors’ rights.

Some scholars argue that although the over-concentration of shares with a single entity is harmful to corporate governance, the other extreme of over-dispersed ownership would also be detrimental as the principal-agent problem only shifts focus from large investors vs. small investors to investors vs. managers. The principal-agent problem is not solved in both conditions. The way out of this problem seems to be dependable on increasing the voting power of the institutional investors, seeing that such an increase in stakes would moderate the agency problem in either of the extreme situations (Zhang Yingjie, 2004). However, different institutional investors with diverse reasons for investing may also not be able to enhance firm performance because of their non-profit maximizing objective. This could be the explanation for the lack of change in the stock price even though the Chinese institutional investors are gradually more active at the stock market.

Pressure-resistant groups of institutional investors like the social security funds are forbidden by the Chinese financial institutional system to get involved in the firms’ business, so such funds do not have the control of firm performance either.  The inadequate power of the owners and the principal-agent problem between managers and owners or between large investors and small investors are persisting issues blocking firm performance. Irregular information acts as an inducement to the institutional investors with private information to speculate and sequester profit from other shareholders. Thus, it is evident that an increase of institutional investors does not lead to an improvement of firm performance or its value in the Chinese scenario, as monitoring of firm performance by Chinese institutional investors is a far cry.

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