In the theoretical section, we predict that the effectiveness of corporate governance increases with the severity of credit crunch shock. We test the moderating role of
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heterogeneous credit crunch shock by introducing the interaction between corporate governance and external finance dependence. With a firm depending more on external finance, it is exposed to severer credit crunch shock during the crisis. Therefore, we expect that corporate governance would be more effective in improving firm performance with a firm depending more on external finance.
The estimation results are reported in column 1 of Table 3.4. The coefficient estimate of external finance dependence (Dependence) is -7.957, which indicates the firms that depend more on external finance are exposed to severer credit crunch shock during the crisis. The coefficient estimate of interaction between control-ownership disparity (Voting rights / Cash
flow rights) and external finance dependence (Dependence) is -0.484, which is statistically
significant at the 5% level. It suggests that, with a firm being exposed to severer credit crunch shock, separation of voting rights and cash flow rights is more likely to induce controlling shareholders’ expropriation behavior. Hence the negative association between control-ownership disparity and crisis period stock return is stronger.
The coefficient estimates of interactions between external finance dependence
(Dependence) and corporate governance mechanisms (i.e., Block shareholding, board
independence, and big four auditing) are positive, and they are statistically significant at the 1%
or 5% level. The positive coefficients imply that the effectiveness of corporate governance increases with the severity of credit crunch shock, which is consistent with our prediction. When a firm relies more on external finance and hence is exposed to severer credit crunch shock, corporate governance is more effective in deterring expropriation and improving firm performance.
The above findings can also partially explain why corporate governance mechanisms do not show significant influence on crisis period stock return in column1 of Table 3.3. Since different firms could heterogeneously suffer from credit crunch shock during the crisis,
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controlling shareholders’ expropriation incentive vary across firms. For the firms that suffer less from the crisis, corporate governance could not significantly improve firm performance. Therefore, we cannot observe significant coefficient estimates if we do not differentiate a firm’s exposure to the credit crunch shock.
[Insert Table 3.4 about here]
We also predict that controlling shareholders’ cash flow rights play an important role in the effectiveness of corporate governance. When a controlling shareholder holds more cash flow rights of a listed firm, the controlling shareholder’s payoff is more likely to be influenced by adverse shock. Therefore, the controlling shareholder has higher expropriation incentive, and hence the moderating role of heterogeneous credit crunch shock on the effectiveness of corporate governance is stronger.
We do subsample analysis by partitioning the total sample based on controlling shareholders’ cash flow rights. The results are reported in column 2 and 3 of Table 3.4. When a controlling shareholder’s cash flow rights are greater than 50%, the coefficient estimate of interaction between control-ownership disparity (Voting rights / Cash flow rights) and external finance dependence (Dependence) is -56.43, which is statistically significant at the 10% level. In contrast, the corresponding coefficient estimate is not statistically significant when a controlling shareholder’s cash flow rights are less than 50%. The above findings suggest that, when a controlling shareholder holds higher cash flow rights, heterogeneous credit crunch shock more likely to induce controlling shareholders’ expropriation and hence moderate the effectiveness of corporate governance.
Corporate governance variables also show similar pattern across subsamples. In the higher cash flow rights subsample, the coefficient estimates of Block shareholding ×
Dependence and Board independence × Dependence are 68.47 and 39.42, respectively. Both
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estimate of Block shareholding × Dependence is not statistically significant in the lower cash flow rights subsample. The coefficient estimate of Block shareholding × Dependence is statistically significant in the lower cash flow rights subsample, but the magnitude is much smaller. The exception is the coefficient estimate of Big four auditing × Dependence, which is only statistically significant in the lower cash flow rights subsample.
It is worth to note that, the exact threshold of cash flow rights for subsamples is difficult to determine solely based on the theoretical model. To check robustness, we employ the cash flow rights of 45%, 35%, and 25% as alternative threshold points for subsamples. The results are reported in Table 3.5. In general, the coefficient estimates of interaction between corporate governance and external finance dependence are statistically significant in the higher cash flow rights subsamples (i.e., even columns). Whereas, the coefficient estimates in the lower cash flow rights subsample (i.e., odd columns) are either statistically insignificant or much smaller in magnitude.
We further use Chow test to compare the coefficient estimates across subsamples. All theχ2statistics are significantly different from zero with the p-value of 0.00. It indicates that
the coefficient estimates of higher cash flow rights subsample are significantly different from that of lower cash flow rights subsample. The above finding is consistent with our prediction, and it indicates that cash flow rights affect controlling shareholders’ expropriation incentive and hence impact the effectiveness of corporate governance under the heterogeneous credit crunch shock.
[Insert Table 3.5 about here]
Overall, our findings suggest that heterogeneous adverse shock could moderate the effectiveness of corporate governance. With a firm being exposed to severer credit crunch shock, corporate governance is more effective in deterring expropriation and improving firm performance. It could potentially explain why previous literature documents mixed findings
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on the effectiveness of corporate governance. Since different firms could be heterogeneously influenced by an adverse shock, it is difficult to examine the effectiveness of corporate governance if neglecting firms’ heterogeneous exposure to the shock.