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Procedía - Social and Behavioral Sciences 129 (2014) 39 - 45
ICIMTR 2013
International Conference on Innovation, Management and Technology Research, Malaysia, 22 - 23 September, 2013
Corporate governance: A literature review with a focus
on the technology firms
Chin Fei Goh,a*, Amran Rasli,b Saif-Ur-Rehman Khana
aFaculty of Management, Universiti Teknologi Malaysia, 81300 Skudai, Malaysia
Abstract
Corporate governance is often regarded as a main driver of firm performance. However, previous studies often discover contradicting findings about the causal effect of corporate governance mechanisms on firm performance. In this paper, corporate governance literature will be reviewed with a focus on technology industry. Our paper shows that contemporary literature may overlook the industry and institutional context of technology firms. We propose that a fine-grained empirical setting is important in future research. In particular, the countervailing effect of high information asymmetries in high ownership concentration context may require more attention. Lastly, future studies of technology industries in emerging economies can be focused on the potential interaction effect between corporate governance mechanisms and firm investment.
©2014The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license (http://creativecommons.Org/licenses/by-nc-nd/3.0/).
Selectionand peer-review under responsibility of Universiti Malaysia Kelantan
Keywords: Corporate governance; technology industry; institutional context; research and development
Introduction
In general, firm performance of traditional and technology firms are affected by the varying economic cycles. However, unlike traditional firms, technology firms can be thought as unique business entities.
* Corresponding author. Tel.: +6-07-5531800; fax: +6-07-5566911. E-mail address: cfgoh2@live.utm.my.
1877-0428 © 2014 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license
(http://creativecommons.Org/licenses/by-nc-nd/3.0/).
Selection and peer-review under responsibility of Universiti Malaysia Kelantan
doi: 10.1016/j.sbspro.2014.03.645
That is, firm performance of technology firms is driven by human capital component while technology firms also face great uncertainties to sustain successive market-centric technological innovation effectively in the long run (Wu et al., 2005). Specifically, there are two kinds of uncertainties in high-tech industry: (i) continuous yet rapid technology advancement, and (ii) high volatility of technological product demands but low visibility of future trends. These challenges are more prominent in technology industries compared to traditional industries such as agribusiness, trading and service industries. Stated differently, the survival of the technology firms is dependent upon firm's decisionmaking in response to rapid changing external environment. Undoubtedly, management capacity is an important value driver in the technology firm (Prahalad and Hamel, 1990).
Interestingly, many empirical studies have used broad samples across industries in corporate governance research. However, a study by Cui (2002) shows that using broad-based sample across industries will mask the specific characteristics in R&D intensive industries when investigating the relationship between ownership structure and firm performance. In other words, the studies used industry definition as dichotomous variable(s) to incorporate unobserved industry effect(s) in empirical models may overlook industry effect on emerged corporate governance mechanisms. In a similar vain, Le et al. (2006) also point out that the impact of corporate governance mechanisms differs across industries. Thus, this paper intends to shed some lights on the potential research agendas about corporate governance in technology firms.
2. Corporate Governance in Technology Firms
2.1. Why corporate governance of technologyfirms is unique?
Resource-based view suggests that firm's R&D investment is essentially relying on the managerial foresights to create strategic assets, which in turn establish competitive advantage (Barney, 1991). However, the great uncertainties in technology firms have caused high levels of information asymmetry between insiders and outside shareholders, particularly in terms of R&D investment. This can be explained by the fact that R&D investment is incomparable and unique to each firm for following reasons. First, productivity of R&D investment is ambiguous to outsiders. In contrast, the economic significance of physical asset investment can be evaluated clearly, for example, outsiders can estimate the productivity of a newly opened store based on industry (or historical) data. Second, R&D investment is difficult to be evaluated accurately because it is classified as expenses in the financial statement. On the contrary, physical and financial assets can be evaluated based on the accounting fair value or market value. As a result, insiders possess significant information advantages in technology firms relative to outsiders.
Similar arguments also can be detected from empirical studies that shows high information asymmetry becomes the determinant of rent-seeking behavior of insiders in technology industries. Recent study by Ahuja et al. (2005) show that in the United States, insiders capitalize on the information advantages in stock tradings because they have adequate information to foresee the impact of R&D investment on firm performance. In addition, a study by Aboody and Lev (2000) discovered that trading gains of insiders in R&D intensive industries are significantly higher than other industries in the United States. To re-iterate, the nature of technology industry creates a high information barrier to outsiders, whereas insiders often have timely and accurate information about R&D investment.
2.2. Corporate governance of technology firms in Anglo-Saxon economies
The diffused ownership structure of large firms in Anglo-Saxon countries is known as the root cause of agency conflicts in the firm (Porta et al., 1999). In relation to this, portfolio theory suggests that investors may diversify their portfolio to reduce the systematic risks. Thus, the diversified investors may not interested in firm's monitoring activities (Fama, 1980). In addition, Shleifer and Vishny (1986) posit that dispersed ownership context provides insufficient incentive for minority shareholders to assume the monitoring role on firm management. The dispersed ownership structure, therefore, tends to generate free-rider problem among minority shareholders.
Moreover, agency theory posits that information asymmetry exacerbates agency conflicts in the firms. Thus, it is reasonable to believe that agency conflicts in technology firms are more severe compared to other industries.
With regard to technology firms in Anglo-Saxon economies, there are three widely adopted firm-level governance mechanisms, which are executive compensation scheme, managerial shareholdings and board independence (Beatty and Zajac, 1994). First, Eisenhardt (1989) describes that principals can use outcome-based compensation contracts if the agent's behavior are difficult to be measured. The rationale is that when measurability of agent behavior is ambiguous, incentive-based contracts can be utilized to align agent's behavior with the desirable outcome. To illustrate, task programmability of management in technology firms is difficult to be observed especially in building intangible assets. Thus, the incentive-based contracts can be utilized to alter risk taking by agents through a combination type of compensation schemes such as fixed payment and incentive-based payment systems. These arguments are supported by a study by He and Wang (2009), who discovered that incentive-based compensation packages for executives positively moderate the relationship between R&D investment and firm value of manufacturing firms in the United States.
Second, Fama and Jensen (1983) suggest that agency conflicts in the firms can be alleviated by changing agents' risk bearing profile. That is, residual claimants of firm's net cash flows (e.g., common stocks) can be given to the agents. As such, the interest of agents is aligned because they also become the principal of the firm. In line with such arguments, prior studies in technology industries (Le et al., 2006; He and Wang, 2009) found that managerial ownership leads to higher stock returns of firms. Le et al. (2006) concluded that managerial ownership is an efficient instrument to align interests between company executives and shareholders.
Third, board of directors can play a direct role to monitor and discipline management (Fama, 1980). However, the problem arises when executive directors have strong control over the board, which allow them to expropriate shareholders and creditors (Fama, 1980). Thus, outside directors, who are commonly viewed as independent directors, are more likely to scrutinize firm decision-making. In the case of technology firms, prior empirical evidences have shown monitoring role of the board is ambiguous with respect to firm performance (Kor, 2006; He and Wang, 2009). For example, He and Wang (2009) discovered a non-significant relationship between the independent board and firm performance for 736 manufacturing firms in the United States. Likewise, Kor (2006) discovered that a higher percentage of outside directors are not necessarily to be an effective governance mechanism for technology firm in terms of R&D spending. Kor (2006) concluded that while monitoring by independent board is beneficial to firm performance, however, high monitoring cost of the board may outweigh the benefits. Interestingly, Zajac and Westphal (1994) provide an alternative explanation that suggests independent directors in technology industries may not have sufficient capability to monitor management because they could not understand complicated corporate strategies and R&D activities.
Apart from firm-level corporate governance mechanisms, the monitoring by large shareholders and institutional investors is also the focal point in Anglo-Saxon economies. Shleifer and Vishny (1986) suggest that large shareholders are effective to monitor firm's management and possess the ability to initiate firm takeovers to protect their investment in the firms. This can be seen by the fact that large shareholders are more willing to take over the firm when their stake of shareholdings is larger. In addition, institutional investors are also regarded as professional investors who can monitor the management (Le et al. 2006). A study by Le et al. (2006) show that institutional investors have a positive effect on stock returns of technology firms in the United States. In other words, institutional investors are an effective government mechanism in technology firms. Likewise, another study by Kor (2006) shows that the presence of institutional investors in ownership structure can mitigate underinvestment problems of 77 newly listed technology firms in the United States.
2.3. Corporate governance of technology firms in Asia
Unlike Anglo-Saxon context, corporate ownership structure around the globe generally exhibits high levels of ownership concentrations (Porta et al., 1999). In East Asia, the concentration of wealth is prevalent and concentrated on families and governments (Claessens et al., 1999). For example, Malaysia and Singapore governments appear to be controlling shareholders on about 20% of publicly listed firms in each country. On the other hand, Indonesia and Thailand governments also have a significant ownership in corporate sectors. Stated differently, families and government have strong control over the public listed firms in East Asia.
High levels of ownership concentrations bring about unique corporate governance problems in Asia. Claessens and Fan (2002) explain that high ownership concentration makes the agency conflicts between management and shareholder less relevant in East Asia. As a matter of fact, many family-controlled firms have no real separation between ownership interests and control, which denotes that they are also the insiders in the firms (Peng and Jiang, 2010). In turn, divergence of interests between controlling shareholders and other shareholders become the main concern in East Asia. This is also known as principal-to-principal conflicts. In addition, family-controlled firms often utilize pyramid structures and cross-holdings in firm controls, and result in deviation of control and cash-flow rights for family controlling shareholders (Porta et al., 1999). Thus, family controlling shareholders have strong incentive to transfer the wealth from minority shareholder to them. In relation to this, Claessens et al. (2002) discovered that deviation of cash-flow and control rights of controlling shareholders produce a negative impact on firm value based on a sample of 1301 East Asian firms in 1996, which is the evidence of expropriation of minority shareholders.
Notably, state-controlled companies in South East Asia, such as Malaysia, Singapore and Philippines, generally exhibits separation of ownership and management (Claessens et al., 2000). While state ownership is regarded as an unique corporate governance mechanism in the Asia context (Ramírez and Tan, 2004, Ang and Ding, 2006), the controlling power gives government officials the rights to appoint directors on the board of directors and indirectly control firm management. Thus, profit-maximization may become a secondary objective in the firms because many Asian governments utilize state-controlled firms as the proxies to implement socioeconomic projects. Furthermore, Woidtke (2002) suggests that state ownership may not to be an effective governance mechanism because government per se is the agent of citizens.
The diverse institutional development background in Asia countries cause the corporate governance issue unique in each country (Peng and Jiang, 2010). Specifically, the corporate governance instruments used in technology firms vary across countries in Asia. In Korea, Choi (2012a) investigated the effectiveness of ownership concentration and institutional investors as governance mechanisms for 301 high-tech firms between 2002 and 2003. His findings show that ownership concentration is ineffective to monitor and influence the manager's behavior in R&D investment. In terms of ownership structure, the presence of institutional and foreign investors positively improve technological innovation performance of high-tech firms, whereas the opposite results is found for insider ownership and state ownership. Another study in Malaysia shows that family and managerial ownership have a negative impact on the performance of intellectual capital for technology firms listed on the MESDAQ market (Saleh et al.,
2009). Interestingly, the study also shows that the government and foreign ownership produce nonsignificant impact on building firm's intellectual capital.
2.4. Corporate governance and business strategies
Recent corporate governance literature has recommended that multi-theoretical perspectives is important to extend the limited explanation by agency theory when studying the effect of corporate governance mechanisms on firm performance in technology industries (He and Wang 2009; Boyd et al.,2011; Choi et al. 2012a). Specifically, Cui and Mak (2002) suggest that high-tech industries may require different governance mechanisms due to high information asymmetry.
Our review shows that resource-based view is gaining popularity in corporate governance literature. Resource-based view posits that R&D spending is the main value driver of technology firms. Strategical management literature also shows that R&D spending positively affects the stock performance of manufacturing firms. In this regard, resource-based view becomes a competing theoretical framework for explaining corporate governance in technology industries. Till to date, several empirical studies have employed corporate strategy perspective and agency theory to investigate corporate governance mechanisms in technology industries in Anglo-Saxon economies (Kor, 2006, He and Wang, 2009, Choi et al., 2012a). These empirical studies mainly focus on two lines of research.
The first line of research emphasizes on the role of institutional investors on firm investment (Le et
2006; He and Wang 2009). For example, the study by Le et al. (2006) in the United States shows that the institutional ownership positively moderate the relationship between R&D spending and stock performance. By contrast, He and Wang (2009) found that outside large shareholders negatively moderate the relationship between R&D spending and firm value. These results suggest that the type of large shareholders may be important to influence management's investment decisions.
The second line of research attempts to examine the interaction effect between internal corporate governance mechanisms (i.e., independent board and CEO duality) and firm's R&D spending on firm performance (Le et al., 2006, He and Wang, 2009). On the one hand, He and Wang (2009) discovered that CEO duality positively moderate R&D spending on firm value (Tobin's Q). On the other hand, Le et al. (2006) found that independent board has a positive moderating effect on the relationship between R&D spending and firm performance. These results suggest CEO duality (i.e., less board independence) and board independence (i.e., measured by proportion of independent directors on the board) positively moderate the relationship between firm R&D investment on firm performance. It is important to note that the. board's monitoring effect is likely to be compromised because CEO duality structures gives high level of power concentration on CEOs. Thus, one question that needs to be asked is whether the balance of power on the board of directors is beneficial in firm strategic decision.
3. Conclusion
In conclusion, there is an increasing awareness that institutional context is unique, and this may lead to inconclusive empirical evidence regarding corporate governance mechanisms across countries (Fraser et al., 2006; Christensen et al.; 2010, Choi et al., 2012b). Previous studies have attempted to examine the relationship between ownership concentration and firm performance in Asia, and show that expropriation of minority shareholders is a prevalent phenomenon across industries during financial crisis. With regard to technology firms, higher information asymmetry may aggravate expropriation of minority shareholders by controlling shareholders. Thus far, however, little attention is given to the expropriation issue in technology firms. In addition, our review shows empirical studies about the effect of corporate governance mechanisms on firm decision-making in technology firms have mainly focused in the context of advanced economies. There is a lack of similar studies on emerging economies.
Our paper reveals four important research agendas in the corporate governance literature. First, the tradeoff of between the incentive effect of ownership concentration and potential expropriation of minority shareholders in technology industries is an important issue to be studied. Second, there is limited direct examination on how information asymmetries can reduce the effectiveness of corporate governance mechanisms in technology industries. Third, we are still unclear about the function of ownership and board structure on R&D investment policy for technology firms in emerging economies. Fourth, the moderating effect of internal corporate governance mechanisms (i.e., board independence and CEO duality) on the relationship between firm's R&D investment decision and firm performance is still ambiguous.
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