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A survey conducted by Lin (1994) lends empirical support to this argument. The survey concludes that, while corporatisation increased managerial autonomy, corporate governance did not improve, and in a number of instances it deteriorated. As a result, the performance of China’s corporate sector as a whole has worsened. In addition, there is preposition that as the central and local governments are less effective than some other forms of ownership in controlling the management, the likelihood of corporate fraud might increase. However, to date, there has been no study that empirically examines the explicit relationship of the state-owned shares and legal person shares to the likelihood of corporate fraud in the Chinese listed companies. As this relationship is unclear, the following hypotheses are stated in the null form.
Hypothesis 1: There is no relation between the percentage of state-owned shares and the likelihood of corporate fraud in Chinese listed firms.
Hypothesis 2: There is no relation between the percentage of legal person shares and the likelihood of corporate fraud in Chinese listed firms.
Board of Directors Shareholdings
While BOD is a key internal governance mechanism for it plays important roles (e.g., monitoring management), BOD shareholding has been considered to be a factor that influences the board’s capacity in performing a governance role. This is because BOD shareholding links directors’ personal interests to managerial decisions. However, there is no decisive evidence that shows whether BOD shareholding aligns the interests of inside directors more closely with shareholders or managers.
In the case of Chinese firms, observations confirm that board directors (sometimes even supervisory board members) and senior management hold shares in their firms. However, these insider shareholdings are relatively small in percentage terms in the firms with predominant state shareholdings. The key reason for the small insider shareholdings is a provision in the “Standard Opinions on Limited Joint-Stock Companies” (May 1992) which prohibits JSCs from issuing more than 10 percent of stocks as employee shares when they go for a public offering. Subsequently, the “Notice on the Cessation of Employee Share Issuance” (November 1998) promulgated by the CSRC prohibited any issuance of employee shares when a limited JSC makes a public offering. Sizable shareholdings by senior management are seen in only the few truly private sector listed companies where senior managers, who are often also the controlling shareholders, hold sufficiently large shareholdings.
As prior research has provided inconclusive results as to the relation between BOD shareholdings and corporate fraud, and how this relation may turn out among the Chinese firms is not clear, a null hypothesis is formulated.
Hypothesis 3: There is no relation between the percentage of BOD shares and the likelihood of corporate fraud in Chinese listed firms.
Board Structure
Board structure is another key dimension examined in corporate governance. Board structure concerns the independence of directors, chair/CEO duality and, in the case of China, the role of the supervisory board as well.
Fama and Jensen (1983) assert that BOD plays an important role in reducing agency problems and enhancing shareholder wealth. They further argue that the board’s effectiveness depends on the composition of the board (i.e., inside directors vs. outside directors on the board) and advocate that BOD should be controlled by outside directors beholden to the interest of all shareholders and not by insiders who might compromise the interest to the concerns of other managers in the firm (Fama and Jensen, 1983; Himelstein, 1994). In addition, financial press has documented a perceived relation between BOD composition and the occurrence of financial statement fraud (see KPMG, 1997; Association of Certified Fraud Examiners, 1998).
Daily et al. (1999) deployed three widely used measures of board composition, that is, the proportions of inside directors, outside directors, and affiliated directors7 and found that the three groups of directors on the board to have played different roles in relation to corporate governance and played the roles to different levels of effectiveness. Thus, they suggest that future research should match the measurement of board composition with the different roles the three groups of directors play on the board.
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