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Secondly, also arising from the dominating state ownership and control, the top management (such as, chair of BOD, CEO and other senior managers) of Chinese listed firms are appointed by the government. Also, government assigns supervisors to the supervisory board of the firm to perform oversight functions. According to Lin (2001), the top management (including supervisors) are usually former government officials (for example, their status in the firm is bench marked to the government hierarchy) and their appointments are often made based on political rather than economic considerations. Furthermore, the remuneration for top management provides weak economic incentives as it is not determined by the market.12 There appears to be little or no correlation between the money incomes of senior management and company profitability, and between senior management incomes and company size. For example, there do not exist management bonus schemes in China. As a result, China has not established a market for professional managers. The governance and remuneration systems have not provided sufficient incentives for management to perform. This perhaps explains why there exist a negative relation between state shareholding and company performance, as revealed by past research on this issue (e.g., Xu and Wang, 1999; Chen, 2001) and why the performance of listed firms as a whole has worsened after listing (Lin, 2001).
Thirdly, as the majority shares of listed firms (both state and legal person shares) are not tradable in the market, the main shareholding structure of a firm cannot be altered through market activities and the management are largely unexposed to the equity market disciplines and control mechanisms. As a result, the company management would be indifferent to the fluctuations in share prices, which diminishes the desires of management to manipulate financial results.
Overall, the predominance of state ownership and control of listed firms, the lack of incentives in the remuneration system for management and the absence of a managerial market have resulted in a situation where the top management of the state controlled firms have little motivation (and necessity) to engage themselves in manipulating the financial condition of their firms. Furthermore, as the top management of the state controlled firms are usually former government officials and still retain their official status (many of them are also the Communist Party officials), they are subject to the government and the Party (instead of market) disciplines. Had they committed financial statement fraud, which may directly benefit some groups of individuals (but unlikely themselves) at the expense of others, they themselves would likely be punished by the government and the Party disciplinary systems or even the legal system.13 A cost and benefit analysis tells us that the top management of the state controlled firms would not benefit significantly from committing financial statement fraud while they might have to bear the cost, if the fraud were detected. This perhaps explains why a higher state shareholding in the listed firms relates to a lower likelihood of management-perpetrated fraud.
Another finding of this study is that high legal person shareholding would lead to a low likelihood of corporate fraud. Although legal person shareholding has the same result as state shareholding, the explanations should differ. Legal person shares are held by domestic institutions, which mainly consist of profit oriented organisations (although some of them are ultimately owned or controlled by state), such as, Chinese Trust and Investment Corporations, securities companies, collective enterprises, Sino-Foreign enterprises or private enterprises. According to Chen (2001), these institutions have stronger incentives to pursue profits than government or government agencies, which may not have clear economic objectives. The positive (negative) effect of domestic institutional shareholding (state shareholding) on performance has been confirmed by empirical evidence of prior research (e.g., Xu and Wang, 1999; Chen, 2001). For the same argument, these institutions should have stronger incentives than state shareholders to pursue good corporate governance and to monitor management of listed firms so that the interests of theirs and management are better aligned. The finding of this study with respect to institutional shareholding is also consistent with that of Sharma’s (2004) in a western context.
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