Under the contractual form of FMC in China, fund investors are not shareholders of FMC, which is different from the corporate form of mutual fund in the U.S. where fund investors are fund shareholders. A conflict of interests arises between FMC and fund investors as fund fees are the major income source for FMC which reduced fund returns for investors. Lack of direct representation for fund investors coupled with conflict of interests between FMC and fund investors gives rise to complex governance issues in Chinese FMC. The board of directors is placed as the key internal governance mechanism to protect the interests of fund investors. The first major research question of this thesis is therefore to examine how board effectiveness may be enhanced under highly concentrated ownership in China’s FMC where the controlling shareholder usually has a dominant position.
Given the situation of a misalignment of interests between fund investors and FMC, FMC performance is a key to attract fund investors and protect their interests. Therefore, two major research questions are formulated to be tested empirically in this study:
How may specific internal corporate governance mechanisms impact on board effectiveness in Chinese FMC? (Chapter 7)
How does the overall quality of FMC corporate governance affect FMC performance? What are the relationships between specific internal governance mechanisms and FMC performance? (Chapter 8)
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Internal corporate governance mechanisms including shareholder profile and characteristics, board structure and characteristics, size of supervisory board and the presence of remuneration committee are applied to investigate the relationship between corporate governance and board effectiveness and FMC financial performance. Corporate governance rating is applied to examine the relationship between quality of FMC corporate governance and FMC performance.
With prevalent concentrated ownership in Chinese FMC, most of the board members especially the position of CEO or chairman are more likely to be appointed by the controlling shareholders. The question therefore arises whether these insiders could represent the interests of fund investors rather than FMC shareholders especially when there is a conflict of interests between fund investors and FMC shareholders. The controlling shareholder in China’s fund industry is, in most cases, ultimately the state, but the state’s dual role as owner and regulator raises another problem of how to motivate and monitor government appointed insiders to maximise the interests of fund investors in selecting, disciplining, and motivating senior management.
The role of board independence in mutual fund in the West has received heightened attention. But in China where there is a lack of qualified independent directors, their role as well as their independence has been questioned all the time. Therefore, whether independent directors could perform their assigned functions to represent the interests of investors in fund industry is poorly documented by empirical evidence and worthwhile to investigate.
Given the complex and intense corporate governance issues in Chinese FMC, how to improve FMC board effectiveness and increase FMC performance is critically important in China, and a better understanding of what makes governance mechanisms’ effective is vital to addressing some major governance issues faced by the burgeoning fund industry in China. This study contributes to the literature by examining how governance mechanisms matter in the development of an effective and well-functioning board in FMC.
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CHAPTER 6
METHODOLOGY
6.1 Introduction
To investigate the relationship between internal governance mechanisms and board effectiveness as well as FMC performance, this chapter describes the data set and discuss the methodology used in this thesis. Four estimation models employed in this study are discussed: pooled ordinary least square (OLS) estimation, random effect (RM) specification, Bootstrap method, and Generalized Method of Moments (GMM).
6.2
Sample
Our sample comprises 288 firm-year observations covering 58 FMC over 5 years from 2006 to 2010 (Table 20). Our sample FMC own more than 98% of all open-end funds (OEF) funds, managing more than 95% of AUM in fund industry (WIND database) and accounting for 58 of the 61 FMC in China. We exclude three newly established FMC between 2008 to 2010 to eliminate the young FMC in the sample as a three-year track record is generally considered necessary for performance assessment. We further exclude CEF because of their relatively small size and difference in operations and fund management style from OEF. We use the year of 2006 as the start point because OEF only started in China in 2001 and there has been a lack of comprehensive data and specific regulations prior to 2006. Indeed, ‘China’s Fund Law’ as the major regulation for the fund industry only came into effect in 2004.
Article 29, Section 4 of CSRC’s‘Operation and management procedures to securities investment funds’ defines several types of funds. It defines that equity funds as a fund with more than 60% of its AUM invested in stocks; bond funds will have more than 80% of its AUM invested in bonds; funds investing only in money market is defined as money market funds; mixed funds include investments in stocks, bonds and/ or money market and are not within the above three definitions; others include represent non-fixed income funds.
6.3 Data Sources
Data are collected from three primary data sources. First is the WIND database, which provides information on fund performance, fund flows and fund characteristics such as
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fund/FMC AUM, total fund fees, and fund investment objectives. The second data source is the fund prospectus. It offers useful information on FMC governance including the identity and composition of shareholders, board characteristics, and other governance information. When fund prospectus does not provide full information about governance, we check fund’s financial report. “Jian An Jin Xin Database” is the third data source for this study, where we collect fund performance data including fund’s continuous monthly returns, Jensen’s alpha and M2PF.
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Table 20: Summary Description of Sample Data on China’s Fund Industry2005 2006 2007 2008 2009 2010 Fund type Fund s No AU M (b) % of Total AUM Funds No AUM (b) % of Total AUM Fund s No AUM (b) % of Total AUM Fund s No AUM (b) % of Total AUM Fund s No AUM (b) % of Total AUM Funds No AUM (b) % of Total AUM Equity 61 52 12% 104 293.18 36% 127 1570.68 48% 308 695.47 37% 308 1325.21 49% 327 1281.64 53% Bond 13 24 5% 20 17.40 2% 29 63.50 2% 147 191.09 10% 98 82.51 3% 155 141.11 6% Mixed 86 116 26% 110 291.94 36% 122 1176.52 36% 165 542.02 29% 165 793.18 30% 167 741.45 31% Money Market 30 187 42% 49 79.49 10% 51 111.05 3% 69 350.07 18% 69 259.53 10% 69 153.28 6% Others* 28 70 16% 30 133.81 16% 36 330.39 10% 85 129.44 7% 85 217.69 8% 36 98.70 4% Total 218 449 100% 313 815.82 100% 365 3252.12 100% 509 1900.21 100% 725 2678.12 100% 754 2426.03 100% Sample
Funds No Not in the sample 292 763.61 93.60% 358 3128.75 96.20% 478 1797.47 96.42% 672 2551.90 95.29% 691 2333.79 96.59%
FMC No 47 56 58 60 61 63
Sample
FMC No Not in the sample 56 58 58 58 58
Notes: We exclude from our sample three newly established FMC between 2008 to 2010 to eliminate the young FMC in the sample as a three year track record is generally considered necessary for performance assessment. Others* include balanced funds, preservation funds, QDII funds and closed end funds. We further exclude CEF and passive index funds because of their relatively small size and different of operations and fund management style from OEF. We use “Plot Box” to identify outliers and replace them using mean-value.