Going (More) Public: Ownership Reform among Chinese...
Transcript of Going (More) Public: Ownership Reform among Chinese...
Going (More) Public: Ownership Reform among Chinese Firms
Heather A. Haveman University of California, Berkeley, Department of Sociology
410 Barrows Hall Berkeley, CA 94720-1980
email [email protected] tel 510-642-3495
Charles Calomiris Columbia University, Graduate School of Business
601 Uris Hall, 3022 Broadway New York, NY 10027-6902 email [email protected]
tel 212-854-8748
Yongxiang Wang Columbia University, Graduate School of Business
Uris Hall, 3022 Broadway New York, NY 10027-6902
email [email protected]
10 March, 2008
We are grateful to three anonymous reviewers for their insightful comments. We also thank Doug Guthrie for helpful comments, and Zhichao Fang, Feihu Long, Rong Xu, and Kui Zeng for informative discussions about details of the ownership reform plan and for providing some of the data we analyzed here. The third author would also like to thank the Center for International Business Education and Research (CIBER) at the Columbia Business School for financial support.
Going (More) Public: Ownership Reform among Chinese Firms
Abstract
During the past two years, Chinese joint-stock companies have been converting non-tradable stock
held by the state and state-controlled institutions, which constitute almost two-thirds of all stock in
Chinese firms, into stock that can trade on local exchanges. This ownership reform reduces direct
state control over industrial enterprises. It also greatly increases the supply of stock, which threatens
to depress stock prices because there is no corresponding increase in demand. For this reform to
succeed, holders of tradable stock must be compensated for the expected stock-price depreciation.
The most common form of compensation consists of stock grants. Despite huge differences in
stock-price returns, stock-price volatility, and the number of non-tradable shares, most Chinese
firms set compensatory grants at about the same level: three shares for every ten shares of
outstanding tradable stock. Our analysis demonstrates that, net of coercion from state owners, most
of this surprising isomorphism is due to imitation of other firms. Interestingly, we find little direct
evidence of normative isomorphism due to professional advisors.
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Over the past three decades, China has moved gradually from state socialism toward market
capitalism. This transition has involved many different reform events, but all are centered on two
aspects of political economy (Walder, 1995; Naughton, 1995, 2007; Chow, 2007). First, ownership
of productive enterprises has slowly shifted away from central state control toward a combination of
local state and private control, and institutions that create and safeguard property rights have been
developed to foster private ownership. Second, economic transactions have increasingly been
conducted through markets rather than through central planning and redistributive efforts
co-ordinated by national, provincial, and local state offices.
One of the most notable stages in this gradual economic transition involves selling
ownership shares of industrial enterprises that can be traded freely among individual and
institutional investors. By July 2007, over 1,200 formerly state-owned enterprises had conducted
initial public offerings of stock, becoming publicly-held and publicly-traded companies. But until
very recently, these firms were only partially publicly-held and publicly-traded, as most of their stock
was held by the state itself or by state-owned or state-controlled institutions, and this stock traded
only through auctions or negotiations involving other state-owned or state-controlled entities, not
on stock exchanges. On April 29, 2005, the China Securities Regulatory Commission (CSRC) – the
Chinese equivalent to the U.S. Securities and Exchange Commission – announced a plan by which
non-tradable shares could be converted into shares that could be traded on stock exchanges. In
other words, publicly-traded Chinese firms would become more public.
This news was welcome as a concrete step toward a less state-owned and more market-based
economy, which state officials and economic analysts alike hoped would eliminate conflicts of
interest between owners of tradable and non-tradable shares, reduce stock-price volatility and raise
stock prices, and motivate the continued development of effective corporate governance systems
(Inoue, 2005; Wang and Chen, 2006; Chow, 2007). But this news was also greeted with dismay, for
it presented shareholders with a problem: unless managed carefully, a flood of new shares would
depress the prices of tradable shares. Anticipating this problem, the CSRC required that reform be
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done in increments and allowed the owners of tradable shares to be compensated for losses
anticipated to be incurred when stock prices fell. The form and amount of compensation offered to
the owners of tradable shares was left open to negotiation between the two groups of owners.
Our analysis focuses on this most recent step in China’s transition toward market capitalism.
We are interested in solving an empirical puzzle: Why do most Chinese firms offer around the same amount
of compensation to holders of tradable shares? Asset-pricing models from finance predict that the amount
of compensation offered should vary greatly, depending on the number of non-tradable shares
outstanding, the volatility of the focal firm’s stock price, and the correlation between its stock-return
volatility and market return (Kahl, Liu, and Longstaff, 2003; Wu and Wang, 2005). Even though
these three factors varied greatly across firms, the vast majority of Chinese firms compensated
tradable shareholders with grants of about three new shares of stock for every ten shares of tradable
stock held before reform.
In explaining this regularity, we contribute to sociological research on China’s transition
toward a decentralized, market-based, and privately-owned economy. Many observers of China
would expect to see strong coercive pressures emanating from the state because the state has long
controlled political, cultural, and economic familial life in China, and because the state is the largest
owner of many publicly-traded firms (Guthrie, 1997; Green, 2003; Guthrie, Xiao, and Wang, 2007).
But we show that net of state coercion, imitation is the strongest predictor of Chinese firms’
compensation ratios. Our analysis suggests that, at least with respect to some of China’s most
market-focused enterprises, state control over the economy has waned and Chinese firms are
coming to resemble their Western counterparts by attending to the actions of other firms as much
as, if not more than, the demands of the state. These findings dovetail with the argument that the
state’s monitoring and sanctioning capacity has declined due to the shift from a centrally-planned
economy to a market-mediated one (Walder, 1994), and with studies showing that dependence on
the state for guidance and funding has declined as external advisors (such as lawyers and investment
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bankers) and external sources of funding (such as commercial banks, the stock market, and foreign
investors) have developed (Walder, 1994; Keister, 2004).
We also contribute to the study of organizations as economic institutions by bringing issues
of agency into institutional analysis, which responds to longstanding complaints that institutionalist
analyses generally lack a theory of action (Stinchcombe, 1997; see also Perrow, 1985; Abbott, 1992).
We do this by considering the often-conflicting interests of different parties to negotiations over
ownership reform: holders of non-tradable shares (both state and private-sector institutions),
holders of tradable shares, the agents of state and non-state owners, and the managers of publicly-
traded firms. Our analysis is an advance on previous efforts to introduce agency into institutional
analysis because it is based on a well-developed model: economic agency theory. In marrying
institutional and agency ideas, we strive to distinguish between coercive, normative, and mimetic
isomorphic forces (DiMaggio and Powell, 1983), which have often been conflated in previous
research (Mizruchi and Fein, 1999).
We proceed as follows. Since most sociologists are unfamiliar with the Chinese economy, in
particular with how Chinese enterprises are privatized, we begin by describing this process and
detailing the legal institutions that underpin the Chinese political-economic transition. We then map
this evolving empirical terrain onto ideas from sociological theory, and develop hypotheses to
predict how much compensation holders of tradable shares should receive. Next, we describe our
data sources and measures, and explain how we test our hypotheses. After presenting the results of
our empirical analyses, we conclude by considering the implications of our study for sociological
accounts of firm behavior, in particular, explanations of China’s transition toward a market economy
with substantial private ownership of industrial enterprises.
Background: Taking Chinese Enterprises Public
Starting in 1979, the central government of the People’s Republic of China ceded managerial
control of productive enterprises to provincial, municipal, township, and village governments,
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thereby creating myriad state-owned enterprises (SOEs). In addition, the central government
created a “dual-track” system that sent more tax revenues directly to local governments. This kept
SOEs oriented toward the central government’s economic plan, but also gave them incentives to
generate extra income by selling in local markets anything they produced above the plan. Thus,
from 1979 to the mid 1990s, China adopted some aspects of a market economy while continuing to
operate a planned economy (see Naughton [1995, 2007] for more details). By the mid 1990s, the
market component of China’s economy had outstripped the planned component.
This gradual two-dimensional shift – away from central state ownership of productive
enterprises toward local state and private ownership, and away from planned and co-ordinated state
management of the economy toward market-mediated transactions – was bolstered by the aggressive
creation of a rule-of-law infrastructure in the 1980s and 1990s (Guthrie and Wang, 2006; Guthrie et
al., 2007)1. Perhaps the most important regulation is the Company Law, which was passed in 1994
and which codified the process of converting SOEs into corporations. It encouraged enterprises to
standardize governance structures and develop procedures to limit political intervention in
enterprise decision making. This law marked a fundamental shift in the organization of China’s
economy, as it allowed Chinese firms to become legal entities independent of the state, as limited-
liability joint-stock companies [gufen youxian gongsi], whose stocks trade on domestic and foreign stock
exchanges. The Securities Law, which took effect July 1999, further codified the legal basis for the
standardized operation of joint-stock companies.
As a result of these reforms, over 1,200 SOEs floated initial public offerings of stock (IPOs)
and become publicly-traded joint-stock companies. The privatization of SOEs was facilitated by the
opening of the Shanghai and Shenzhen stock exchanges in 1990 and 1991, respectively. The
number of IPOs rose from eight in 1990, the first year data are available, to 1,483 in 2006, while the
number and value of shares issued in IPOs soared from 0.048 billion shares valued at 0.081 billion
1 For a review of legal developments in China, see the special issue of the China Quarterly published September 2007.
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RMB (renminbi, or Chinese yuan) in 1990 to 130.1 billion shares valued at 681.4 billion RMB in 2006
(GTA, 2007).
In the process of going public, entire SOEs may be privatized. Alternatively, single plants or
groups of plants, often the best-performing ones, may be spun out of SOEs. In either case, SOEs
first apply to their local State Assets Administration Bureau for permission to have their assets
appraised. After permission is granted, SOEs choose a certified public assessor or accountant, who
calculates the enterprise’s value. The Bureau conducts further analysis, considering the enterprise’s
health, its industrial sector, and the state’s interests. The final valuation amount is divided into state
shares [guojia gu], which represent investments by the state in the creation, expansion, or upgrading
of the enterprise. State shares are valued at 1 RMB each and held by State-owned Assets
Supervision Administration Commissions or by SOEs that are wholly owned by the state.
New joint-stock companies can raise additional capital by offering three kinds of shares to
three kinds of investors. Institutional shares [faren gu], which are also known as legal-person shares,
are dividend-earning shares offered to domestic institutions such as other joint-stock companies that
have at least one non-state owner and domestic non-bank financial institutions (pension and mutual
funds). Trading in institutional shares is highly restricted; they can be purchased through negotiation
or auction and such trades require the approval of the local government and the exchange on which
the firm is listed (Green, 2003: 119, 144); most are held by state-owned or state-controlled
institutions, although an increasing fraction are held by private-owned or private-controlled firms
(Green, 2003). Individual shares [geren gu], which are also called A shares, are sold to domestic
(mainland Chinese) investors, mostly individuals and a few domestic institutions. These are
dividend-earning and fully negotiable. Foreign shares have been offered since late 1991 to attract
indirect foreign investment; they come in several flavors. B shares are sold to foreign individuals
and institutions, and are traded on the mainland Chinese stock exchanges in a market that is separate
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from the A-share market.2 On the Shanghai Stock Exchange, B shares are denominated in U.S.
dollars; on the Shenzhen Stock Exchange, they are denominated in Hong Kong dollars. H, N, S, J,
and L shares are traded on the Hong Kong, New York, Singapore, Tokyo, and London exchanges,
respectively, and denominated in local currency.
The People’s Bank decides how many of each kind of shares can be offered. In accordance
with the gradual pace of China’s economic transition, the state has generally required that the
majority of shares in publicly-traded firms be held by institutions that are wholly state-owned. In
this way, the state retained majority ownership and therefore control over most ostensibly public
firms (Chow, 2007; Guthrie et al., 2007).3 As of year-end 2005, non-tradable shares constituted 62%
of shares outstanding in publicly-traded firms; 71% of those were held directly by the state
(Naughton, 2007: 470). In addition, many of the non-tradable legal-person shares (27% of shares
outstanding) were held by state-controlled institutions.4 Notwithstanding this concentration of
shares in the hands of the state, there is great variation across firms in the allocation of shares.
Among the 1,325 firms listed on the Shanghai and Shenzhen Stock Exchanges between 1995 and
2004, state shares ranged from zero to 85% of total shares outstanding (the mean was 39%), legal-
person shares ranged from zero to 80% (mean 21%), tradable A shares ranged from 9% to 91%
(mean 37%), and foreign shares ranged from zero to 62% (mean 4%) (Eun and Huang, 2007: 458).
Initial offering prices for tradable shares are based on the People’s Bank’s estimates of the
company’s future earnings and its assets, and are set to produce price/earnings ratios approximating
international standards. Because of the extraordinary demand for shareholding in China, tradable
2 Until recently, it was illegal for non-mainland Chinese to buy and sell A shares; in December 2002, foreign investors were given limited rights to trade in A shares under the Qualified Foreign Institutional Investor system. And until recently, mainland Chinese could not invest in B shares or trade in international markets; as of March 2001, they could buy and sell B shares, but only by using legal foreign-currency accounts. 3 In addition, former SOEs are still mostly state-run after they go public. The previous enterprise manager and party secretary are typically reappointed as a publicly-traded company’s new chief executive officer and chairman of its board of directors (Chow, 2007). 4 Just how much of this 27% is state-controlled is difficult to estimate, since there are often several layers of ownership. For instance, one state-owned or state-controlled organization may have a controlling interest in an ostensibly non-state-owned organization, which in turn holds shares in a publicly-traded firm.
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share prices rise quickly after IPO. The upshot is that prices of tradable shares may be an order of
magnitude higher than the prices of non-tradable state shares (Hertz, 1998; Green, 2003).
This system of split ownership (part state, part non-state; part tradable, part non-tradable)
was put in place to enable SOEs to raise capital and to allow the government to maintain control of
selected enterprises through majority ownership. But this system created several interrelated
problems (Green, 2003; Wang and Chen, 2006; Feinerman, 2007). Most obviously, there is an
inherent conflict of interest between holders of tradable and non-tradable shares. When the state is
a controlling shareholder, political priorities (maintaining employment levels, providing social
welfare benefits like housing and child care, and controlling sensitive industries) may displace profit-
seeking. Moreover, controlling shareholders, whether state or non-state, can manipulate firms’
accounts by carrying out transactions with affiliated companies to siphon off assets and profits.
Because tradable shareholders are usually in the minority, they have virtually no say in corporate
governance. And because the vast majority of shares are not traded, the stock market is thin and so
vulnerable to fraud and manipulation.
Going More Public: Converting Non-tradable Shares to Tradable Shares
After the domestic stock exchanges were established, Chinese officials struggled with the
issue of how to get non-tradable shares into circulation. Doing so was expected to force publicly-
traded firms to become more efficient and less vulnerable to fraud, and to make it easier to raise
additional capital in the stock market (Chow, 2007). Alas, early reforms failed utterly. In 1992,
when officials suggested that institutional shares be allowed to trade on the domestic stock markets,
prices of tradable shares dropped because supply was expected to swamp demand. The same thing
happened in 1999 when officials announced that state-owned shares of two firms would be made
tradable. On June 12, 2001, the CSRC announced the Tentative Measure for Decreasing State Shareholding,
which was intended to accelerate privatization by requiring the conversion of some non-tradable
shares (10% of total shares outstanding) to tradable status at the tradable-share price. Although only
17 firms participated in this reform, the stock markets plunged 30% in three months. As a result,
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this reform was cancelled four months after it was announced. Due to this aborted reform and to
expectations that other reforms might be in the offing, as well as to the generally poor performance
of listed companies and the discovery of widespread fraud, the stock-market crash continued for
four years. By 2005, market capitalization had declined by over 50%.
The reform on which we focus was unveiled on April 29, 2005, when the CSRC released the
Directive on Problems in Trying to Solve the Split-Share Structure of Listed Companies, which announced that
non-tradable shares would be converted into tradable shares starting in May. Learning from past
mistakes, the CSRC structured the reform to increase the chances that this time reform would
succeed (Wang and Chen, 2006). To begin, reform was to be rolled out in stages. Four firms were
to serve as a pilot project; after their ownership reform was completed, 42 large firms, which
together accounted for 10% of the overall domestic stock-market valuation, were to undertake
reform; only after they finished would other listed firms proceed with reform.5 The reform plan
mandated a one-year lock-up period for holders of formerly non-tradable stock. After the lock-up
period expired, state bureaus and other institutions that held more than 5% of outstanding shares
could sell no more than 5% in the first 12 months and no more than 10% in the first 24 months.
This was intended both to reduce the volume of shares that would enter the market and to signal the
state’s intention to retain sizeable ownership stakes in many firms.
Two features of this reform plan were crucial to its success. First, firms had to obtain
approval from at least two-thirds of non-tradable shareholders and two-thirds of tradable
shareholders. This required a serious negotiation, mediated by the board of directors and
investment banks. Second, the CSRC encouraged non-tradable shareholders to compensate tradable
shareholders for the losses the latter expected to incur. Because tradable share prices would be
diluted when non-tradable shares converted, tradable shareholders needed to be compensated to
5 This is typical of Chinese economic reforms, where the state reveals its policy through the actions of “model” firms, whose experience often prompts adjustments in the reform process before it is applied more generally. In Chinese, this is called mo zhe shi tou guo he, or “crossing the river by feeling the stones.” The phrase was used by Deng Xiaoping to mean that there is no suitable model for reform, so you have to advance step by step and reassess your route after each step.
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persuade them to allow the conversion and to assure investors that their ownership rights would be
upheld.
The CSRC did not specify how firms should compensate tradable shareholders; it left the
details to be negotiated (Inoue, 2005; Wang and Chen, 2006). The Directive of April 29 stated that
“…the companies selected to take part in the experiment decide for themselves how they will sell
their non-tradable shares” (CSRC, 2005a). Guidance notes released by the CSRC on August 23
reiterated this point by declaring the CSRC’s aim was “independent decision-making with respect to
specific share reform scheme to suit circumstances” (CSRC, 2005b). At a press conference held
September 4, when guidelines for the third reform wave were promulgated, the CSRC reinforced
this stance, stating that “the principle approach and operating principle for the Reform” was
“flexible decision-making to suit different circumstances under centralized coordination” (CSRC,
2005c). It is no surprise that legal scholars concluded:
The implemented reform is essentially a privatized bargaining process between the non-tradable and tradable shareholders. The market-based and private bargaining elements of the reform have been repeatedly emphasized in the relevant guidelines and regulations (Wang and Chen, 2006: 341).
Ownership reform begins with a vote by non-tradable shareholders; a two-thirds majority is
required to initiate the reform process. After drawing up and announcing a plan, the board of
directors announces the date of shareholders’ meetings to vote on the plan, and all trading in the
firm’s stock is halted. During negotiations with both tradable and non-tradable shareholders, the
plan may be revised. After the plan is finalized, it is announced to the public and trading is resumed.
Trading is suspended a second time before the shareholders meet and vote on the plan. There are
two separate and independent meetings: one for non-tradable shareholders, the other for tradable
shareholders. For a reform plan to pass, it must be approved by the holders of two-thirds of non-
tradable shares participating in their shareholders’ meeting and by the holders of two-thirds of
tradable shares participating their shareholders’ meeting. If the plan passes in both meetings, the
firm announces the result the next day and the stock begins to trade again.
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This reform effort was hugely successful: 1,250 firms listed on the Shanghai and Shenzhen
Stock Exchanges, a full 84.3% of the total, had undertaken ownership reform by July 18, 2007.
Moreover, starting in late 2005, the domestic stock markets’ capitalization levels surged. The
Shanghai Composite Index increased by 211% over the calendar year 2006, while the Shenzhen
Composite Index rose by 197% over the same period.
The Empirical Puzzle: Isomorphism in Compensation for Owners of Tradable Shares
The first firms to convert non-tradable shares into tradable shares were Sany Heavy Industry
[San Yi Chong Gong], Shanghai Zi Jiang Enterprise [Zi Jiang Qi Yi], and Hebei Jinnui Energy
Resources [Jin Niu Neng Yuan], which announced reform plans in June 2005. (The fourth firm,
Tsinghua Tongfang, failed in its initial attempt at ownership reform because fewer than two-thirds
of the holders of tradable shares approved the plan.) All three successful firms chose to offer extra
equity to tradable shareholders. Their compensation ratios – the number of new shares offered
relative to the number of existing shares – were set at 0.35, 0.25, and 0.30, respectively. The next
month, the second batch of 42 companies announced reforms; their average compensation ratio was
0.33. Of the 1,250 firms that reformed their ownership between May 2005 and July 18, 2007, 87%
(1,086) compensated tradable shareholders through transfers of stock from non-tradable
shareholders. The other 13% used other means of levelling the playing field: offering call or put
warrants to tradable shareholders, guaranteeing stock buy-backs for tradable shareholders at pre-set
prices, or cancelling a fraction of non-tradable shares before conversion. Figure 1, which plots the
cumulative distribution function for compensation ratios among the 1,086 firms that chose this
option, shows that most firms set compensation ratios close to 0.30 (the mean and median are 0.300
and 0.306, respectively) and that the distribution is quite compact (the 25th and 75th percentiles are
0.264 and 0.347, respectively).
[Figure 1 about here]
Such clear isomorphism is surprising because the CSRC did not specify how firms should
compensate tradable shareholders; instead, it merely made general provisions for compensation and
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left the details to be negotiated (Inoue, 2005; CSRC 2005a, 2005b, 2005c; Wang and Chen, 2006).
Moreover, models of asset pricing predict great variation in compensation ratios, depending on the
fraction of shares that are at risk of converting to tradable status, the volatility of the firm’s stock
price, and the correlation between stock-return volatility and market return (Kahl et al., 2003; Wu
and Wang, 2005). Why, then, do most firms set their compensation ratio at about the same level –
three new shares for every ten? Our goal is to explain this remarkable level of similarity in behavior.
Or, to put it another way, we seek to explain what causes firms to deviate from this standard. We
begin by focusing on how political coercion operated through the actions of the Chinese state. We
conclude with an assessment of norm-guided behavior and imitation.
Theory: Setting Compensation Ratios
As communities of organizations evolve, a variety of forces, such as interorganizational
power relations, the state and professions, and competition, promote organizational isomorphism –
similarity in structure or behavior (DiMaggio and Powell, 1983). Being isomorphic with prevailing
notions of structure or behavior brings organizations legitimacy, which in turn improves access to
resources and acceptance, and thus contributes to organizational survival (Meyer and Rowan, 1977).
Organizations become isomorphic in three ways (DiMaggio and Powell, 1983). Coercion works
through organizations on which the focal organization is dependent and through cultural
expectations of the societies in which organizations operate. State institutions like the laws and
administrative guidelines that constitute the basic rules governing transactions are exemplary agents
of coercive isomorphic pressures. Norms works through “expert” sources of information about the
nature of fields, values (what is important and good), and expectations (how things should be done).
Professions and collective actors like industry associations are major sources of normative
isomorphic pressures. Imitation works through observation of others and stems from responses to
uncertainty. Copying others, in particular similar others that are perceived to be more successful and
legitimate, is an efficient solution to ambiguous causes and unclear solutions: when in doubt, do
what highly successful (and therefore highly legitimate) organizations do.
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This model has typically been used to explain the behavior of organizations in Western
capitalist economies. But it offers great promise to explain the behavior of organizations in other
settings, including Asian societies undergoing economic and political transitions, as a few examples
make clear. Westney’s (1987) analysis of the transfer of Western organizational structures in Meiji-
era Japan revealed coercive, normative, and mimetic effects, tempered by the fact that the
organizations she studied adapted Western structures to fit their own culture. More germane to our
study is Guthrie’s (1997) analysis of Shanghai firms in the mid 1990s. Their creation of Western-
style bureaucratic structures – written rules and job descriptions, formal grievance procedures and
mediation committees, and formal hiring procedures and promotion tests – was driven by all three
of the isomorphic processes identified by DiMaggio and Powell (1983): state mandates, normative
pressures from foreign investors, and economic uncertainty, which prompted imitation of other,
“market-savvy” Chinese firms. Similar to Westney, Guthrie found that Chinese managers did not
blindly imitate Western firms; instead, they tailored the logics underpinning Western structures to
their own political and economic situation.
Many scholars have complained that institutionalist accounts of organizations, including
DiMaggio and Powell’s (1983) model of isomorphism, ignore the “guts” of institutions: the people
whose interests are at stake when institutions diffuses across fields (Stinchcombe, 1997; see also
Perrow, 1985; Abbott, 1992). There have been some attempts to incorporate a theory of action into
this model of isomorphism (e.g., Dobbin, et al., 1993; Fligstein, 1996), but those attempts are limited
because their thinking about action and agency is limited to the particular phenomena under study
(e.g., the roles played by personnel managers in developing affirmative-action policies for employing
organizations or the interests of corporate managers in market stability). To infuse this very general
institutional model with a general theory of action, we draw on the highly coherent theory of agency
derived primarily from economics (Jensen and Meckling, 1976; Fama, 1980).
Briefly, agency theory focuses on relationships between principals and agents (for an
engaging review, see Shapiro [2005]). Principals hire agents to perform services and delegate
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decision-making authority to those agents; for instance, owners shareholders hire executives to run
corporations, and corporate executives hire professional investment banks to advise them on
financial transaction. There are often conflicts between principals and agents, for two reasons.
First, agents’ interests are often not identical to those of principals; for example, principals want
executives to maximize their firm’s share price, both in the short run and in the long run, while
executives want to maximize their compensation, which may depend only on short-run share-price
performance. Second, principals and agents have different information; in particular, principals
cannot know precisely how hard agents are working, or even whether agents are working at the right
tasks. The upshot is that agents are often prone to doing things that principals don’t want them to
do. To prevent this, principals try to set up reward and monitoring systems so as to align agents’
interests more closely with those of principals, or to make it harder for agents to do the wrong thing
or do too little of the right thing.
Like the model of institutional isomorphism, the model of principal/agent conflict is a
general one. But it, too, has great power to explain the behavior of organizations in China and other
countries that are undergoing economic and political transitions. For example, Lin, Cai, and Li
(1998) argued that the separation of ownership and control causes Chinese industrial enterprises to
suffer from the same agency problems as those of Western corporations. Similarly, Walder (1995)
demonstrated that the varying ability of state institutions to monitor the enterprises they own
(strongest at the local level and weakest at the central state level) accounts for differences in
enterprise performance.
Because of its evident importance in Chinese society, our analysis begins by discussing the
state’s coercive power. We then consider normative and mimetic factors in succession. For all three
isomorphic processes, we first conduct a traditional, agency-free institutional analysis, and then
renalyze the situation considering the interests, motivations, and abilities of all relevant actors.
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The Coercive Power of the Chinese State
The most obvious explanation for similarity of behavior among Chinese firms – or any other
collection of Chinese actors, for that matter – is state coercion. The state strictly governs all aspects
of political, cultural, and economic life in China. Indeed, China has since 1978 earned a Polity IV
score of -7 on a scale ranging from +10, which denotes full democracy, to -10, which denotes full
autocracy (http://www.cidcm.umd.edu/polity/country_reports/Chn1.htm). State policy can be
changed at any time with little or no input from the public. Sudden policy shifts are excellent
natural-experimental stimuli, since seldom can anyone predict what policies will be announced. This
contrasts sharply with most Western countries, where government action is generally preceded by
public debate and so can be easily anticipated.
Coercion by the state as regulator. For publicly-traded Chinese firms, the CSRC is a powerful
coercive actor. Publicly-traded firms must get approval from the CSRC for any significant financial
decisions, such as equity offerings and mergers, while private firms must get approval from the
CSRC to be listed on domestic or foreign stock exchanges and so become publicly-traded. It is clear
that publicly-traded firms were coerced into reforming their ownership by the CSRC. On May 30,
2005, the CSRC and the central State-owned Assets Supervision Administration Commission jointly
issued a statement stressing how important the ownership reform program was and stating that all
those involved should give it their support. In addition, the CSRC offered companies that reformed
their ownership structures priority when they sought to raise new capital by borrowing from state-
controlled banks or floating new equity issues. The coercive actions of the CSRC can explain why
almost all publicly-traded companies in China have launched ownership reforms, but not why they
settled on such similar compensation ratios. The law of 2005 explicitly requires that each firm
determine on its own how it would compensate holders of tradable shares. Not only does the CSRC
place no restriction on the amount or form of compensation, it actively encourages firms to design
compensation schemes appropriate for their particular situations (Inoue, 2005; CSRC, 2005a, 2005b,
2005c). This flexibility was built into the reform to avoid past mistakes. An article published in the
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China Securities Journal (Wang, 2003), the most influential business paper in China, concluded that the
failed reform of 2001, “…teaches us a big lesson, that is, government and regulatory agencies cannot
simply set a uniform plan for thousands of public firms to solve this [non-tradable shares] issue.”
Interviews with Chinese investment bankers indicate that this sentiment is widespread. Therefore,
the great isomorphism that we see in compensation ratios was clearly not due to general coercion by
the CSRC. To explain this, we must look to how state coercion plays out within firms, specifically,
through the state’s presence as an owner.
Coercion by the state as owner. Unlike firms in the U.S., the state has a large presence in publicly-
traded Chinese firms: most shares are held by state-owned agencies, and all of these shares are non-
tradable. Thus, the state enters directly into the negotiation between the non-tradable and tradable
shareholders over the compensation the former should offer the latter. The interests of the two
groups are opposed: all non-tradable shareholders, including the state, prefer to offer little or no
compensation to tradable shareholders, while tradable shareholders prefer to be offered a lot of
compensation. A super-majority of both groups must be satisfied if the reform is to proceed.
The tug of war that ownership reform unleashes is a game played in a fog. This reform is
highly uncertain because, as explained above, earlier ownership reforms failed. Moreover, the
property rights of tradable shareholders are recent social inventions, and so not well understood,
much less accepted as permanent (Putterman, 1995; Oi and Walder, 1999). The situation is
exacerbated by the fact that this reform involves complex financial-economic calculations. To
determine the appropriate level of compensation, one must calculate how much non-tradable shares
would increase in value and how much tradable shares would drop in value if the ownership reform
were to pass. Although the windfall gains accruing to non-tradable shareholders can be calculated
using a method developed by Wu and Wang (2005), which is a variant of Kahl et al.’s (2003) asset-
pricing model, the losses accruing to tradable shareholders cannot be calculated because no asset-
pricing model has been developed.
16
In sum, because of the great uncertainty surrounding this reform, no-one knows what
compensation is optimal or fair. This makes compensation schemes observable but not easily verifiable:
observable because they are divulged, not verifiable because their truth-claims cannot be checked
without a great deal of time and effort (Bolton and Dewatripont, 2005). The inability to verify
compensation schemes arises from the fact that there is no clear and precise benchmark. The only
outcome owners can verify is whether or not reform passes. The upshot is that the negotiation
between the two ownership groups offers many opportunities for manipulation.
The question of which ownership group wins the tug of war depends, in large part, on a
third party: the executives of publicly-traded firms. Executives prefer to offer more compensation
than non-tradable shareholders because it is in executives’ interests for this reform to succeed. If it
does, executives and their firms will be viewed favourably by the CSRC, and their firms will be
eligible for preferential terms on loans and future equity offerings. The probability of reform
succeeding, which hinges on a two-thirds majority vote by tradable shareholders, increases with the
amount of compensation offered. The tendency of managers to offer high levels of compensation
to ensure success is accentuated by the fact that managers, like owners, do not know how much
compensation is optimal or fair; managers know only that more compensation makes acceptance by
tradable shareholders more likely. Agents can be held accountable by principals only for verifiable
outcomes, not for unverifiable outcomes (Bolton and Dewatripont, 2005); this means that managers
can be held accountable only for the success or failure of reform attempts, not for the compensation
schemes they suggest to owners.
One of the strongest players in this three-way tug of war is the controlling shareholder.
Some firms are controlled by the state, while others are controlled by non-state institutions, such as
other pension funds, mutual funds, joint-stock companies, and foreign firms. With respect to the
compensation offered to holders of tradable shares, private-sector holders of non-tradable shares
have the same preference as the state, but less power to coerce executives. When the state is the
controlling shareholder, the state will be more successful at pushing executives to offer less
17
compensation than would a private-sector controlling shareholder, because the state is a stronger
coercive force. Accordingly, we propose that when the state is the controlling shareholder, the state
has the leverage to win the tug of war:
Hypothesis 1a: Firms controlled by state owners will set lower compensation ratios than firms controlled by private-sector institutions.
There is reason, however, to believe that this hypothesis is wrong, due to the different
capacities of state and non-state owners to monitor executives, and to agency problems within the
state itself. Starting in 2003, the state’s ownership interests have been handled by central and local
State-owned Assets Supervision Administration Commissions (SASACs), which monitor the
operations of the firms owned by the state, appoint directors, approve major operating decisions,
and report on performance and revenues to government bureaus. SASACs were created to separate
the government’s functions as owner of state assets from its function as public manager of society as
a whole and to reduce the diversion of assets from publicly-traded firms into the hands of managers
and their cronies (Naughton, 2007: 316). SASACs are fiduciaries of the state bureaus that own
SOEs, township and village enterprises (TVEs), and former SOEs and TVEs that have been
transformed into corporations. The central SASAC represents the State Council’s interests; local
SASACs represent provincial, municipal, township, and village governments. SASACs also control
state-owned asset management companies (Naughton, 2007).
SASACs are analogous to institutional investors like pension or mutual funds, as each is set
up to manage a portfolio of assets (Guthrie et al., 2007). Because each SASAC represents the state’s
ownership interests in many firms (for example, the central SASAC originally oversaw 196 firms),
SASACs have limited ability to monitor any single firm (Sun and Tong, 2003). The central SASAC’s
control of the firms it monitors is particularly limited because multiple layers of holding companies
own stakes in publicly-traded firms; it is the highest level of holding companies, rather than the
central SASAC, that actually controls firms (Naughton, 2007: 317-318). In contrast, the typical non-
state owner is a large shareholder in only a few firms, so non-state owners of legal-person shares are
18
both more able and more motivated to monitor and coerce enterprise management than are
SASACs (Xu and Wang, 1999).
Non-state owners are also generally more competent to monitor enterprise management
than are SASACs. Non-state owners have more expertise than SASACs because many legal-person
shareholders have close business ties to publicly-traded firms: many firms were carved out of non-
state legal-person shareholders, and many legal-person ownership stakes were created through debt-
equity swaps (Qi, Wu, and Zhang, 2000). Such close business ties facilitate monitoring managers.
Moreover, all SASACs are beset by internal agency problems (Wang and Chen, 2006; Chow,
2007). SASAC employees generally hold short-term appointments (a few years at most) and their
performance is evaluated annually or at the end of their appointment. Therefore, SASAC employees
are motivated to pursue short-term goals at the expense of the long-term health of the firms they
oversee. SASAC employees have been told repeatedly that ownership reform is important, and that
high-ranking state officials want it to succeed. Therefore, SASAC employees may be tempted to
jump on the reform bandwagon and accept high levels of compensation to ensure that tradable
shareholders vote for reform, even though such actions run counter to the interests of the state
owners they are supposed to safeguard. The tendency of SASAC employees to offer more
compensation than state owners prefer is enhanced by the fact that SASAC employees do not
personally foot the bill – the state owners do.
Given these three facts – (i) SASAC employees’ attention is scattered across many firms
while the attention of non-state owners is concentrated on one or a few firms, (i) non-state owners
are more competent to monitor the firms they own than state owners, and (iii) the interests of
SASAC employees are not aligned with those of the state – the coercive power of the state may be
less than that of non-state owners. If so, firms controlled by the state should offer more
compensation to tradable shareholders than firms controlled by non-state owners. This logic yields
the following hypothesis, which is directly opposite to hypothesis 1a:
Hypothesis 1b: Firms controlled by state owners will set higher compensation ratios than firms controlled by private-sector institutions.
19
Conflict or co-operation between non-tradable shareholders? As the owner of publicly-traded firms,
the Chinese state is not a monolithic entity; instead, it is hydra-headed (cf. Adams, 1996; Kiser, 1999).
The policy of decentralization carried out since 1978 drove decision making about most industrial
enterprises down to the provincial and local levels. Subsequent corporatization and privatization
efforts led to a situation in which most state ownership stakes are in the hands of provincial and
local governments (Putterman, 1995). Because the state consists of many different entities, we must
consider not just the overall coercive power of the state, but also whether the many state owners of
a publicly-traded firm act in concert or clash. There is great variation across firms in the extent to
which state ownership is concentrated in the hands of a few parties, and therefore there is great
variation in the extent to which the state is a cohesive, much less monolithic, coercive force.
The issue of owner cohesion extends beyond state owners to all non-tradable shareholders.
As explained above, these owners must negotiate among themselves and agree on a compensation
scheme to offer tradable shareholders.6 Concentrated ownership of non-tradable shares can have
two opposing effects on the compensation scheme they negotiate. On the one hand, the more
concentrated ownership of non-tradable shares is, the stronger is non-traadable shareholders’
bargaining power vis-à-vis tradable shareholders. This happens because greater ownership
concentration means fewer owners have a say in setting the compensation ratio, which reduces free-
rider problems (Darley and Latané, 1968; Jensen and Meckling, 1976). The smaller the free-rider
problem among non-tradable shareholders, the more likely the outcome of the negotiation is to
reflect the preferences of non-tradable shareholders rather than those of tradable shareholders, and
the lower the compensation the two groups will agree on. Therefore, we propose:
6 The non-state owners of non-tradable shares are often closely tied to the state in two ways. First, legal-person shares are often transferred from the state to the private sector through negotiations to which only firms with close state ties have access (Calomiris, Fisman, and Wang, 2008). Second, some shares labelled non-state legal-person shares are actually state-owned due to inconsistencies in the Chinese stock-ownership classification system (Green, 2003: 15). For example, when a state-controlled firm establishes a subsidiary that purchases non-tradable shares through negotiation with a state owner, those shares are usually labelled legal-person shares. But they are still owned by a state-controlled firm, albeit indirectly. Thus, even when many non-tradable shares are held by non-state owners, the state has great oercive power.
20
Hypothesis 2a: The more concentrated ownership of non-tradable shares is, the lower the compensation ratio.
But the effect of concentrated ownership of non-tradable shares may run in the opposite
direction because the interests of non-tradable shareholders are not identical. Large non-tradable
shareholders have a particularly strong incentive to reform their firm’s ownership because they have
the most, in absolute terms, to gain from increases in the value in their share holdings due to
removing trading restrictions.7 The more concentrated ownership of non-tradable shares is, the
more controlling non-tradable shareholders can dominate the decision-making process, and the
easier it is for them to offer a high level of compensation to ensure approval by the holders of
tradable shares. This leads us to predict:
Hypothesis 2b: The more concentrated ownership of non-tradable shares is, the higher the compensation ratio.
Owners of tradable shares. Publicly-traded Chinese firms face a second source of coercive
pressure when they contemplate reforming their ownership structures: tradable shareholders must
agree to the reform proposal, or it will fail. When non-tradable shareholders negotiate among each
other to determine how much to offer tradable shareholders, they are likely to take into account
tradable shareholders’ expectations about compensation. The lower those expectations are, the less
compensation they will offer. The distribution of ownership among tradable shareholders
determines how much compensation they can demand. The more widely distributed shareholding
is, the more free-rider problems limit tradables shareholders’ ability to agree on and demand a high
level of compensation (Darley and Latané, 1968; Jensen and Meckling, 1976). Conversely, the more
concentrated shareholding is, the easier it is for tradable shareholders to band together and demand
a high level of compensation. Thus we predict:
Hypothesis 3a: The more concentrated ownership among tradable shareholders is, the higher the compensation ratio.
Ownership among tradable shares is often highly concentrated when mutual funds own large
stakes. This introduces a new player to our tug of war, mutual-fund managers. These agents may
7 We thank Mr. Kui Zeng of CITIC Securities, a leading securities firm in China, for pointing out this factor.
21
have different interests from their principals, mutual-fund investors. Specifically, non-tradable
shareholders can make side-payments to mutual-fund managers to persuade them to accept, on
behalf of their investors, less compensation than they would otherwise demand. Such bribery is
likely because compensation schemes are not verifiable outcomes, which means that investors
cannot hold mutual-fund managers accountable for whatever compensation is finally offered.
Discussions with managers at two leading investment banks in China, Mr. Zhichao Fang of CITIC
Securities and Mr. Feihu Long of Guosen Securities, confirmed that such side-payments do occur.
Therefore, if ownership concentration among tradable shares is due to mutual funds holding large
blocks of shares, then high concentration may result in low compensation ratios, since it is quite easy
for mutual-fund managers to be bribed by non-tradable shareholders. Accordingly, we predict:
Hypothesis 3b: The more concentrated ownership among tradable shareholders is, the lower the compensation ratio.
Normative Isomorphism
For publicly-traded firms in China, as in many other countries, one of the most salient
sources of professional norms is investment banks, which counsel corporations about offerings of
equity and debt, mergers and acquisitions, joint ventures, etc., and which manage complex financial
transactions. Investment banks are likely to exert strong pressure on Chinese firms because
investment bankers have more experience with market economies than do Chinese managers. For
their part, investment bankers look to their own past experience to determine what works well.
Therefore, investment banks are likely to advise Chinese firms to set compensation ratios close to
the values set by their previous clients, and Chinese firms are likely to accept this advice.
Accordingly, we predict:
Hypothesis 4a: The higher the mean compensation ratio set by other firms that used the same investment bank, the higher the compensation ratio set by the focal firm.
Any relationship we find between the focal firm’s compensation ratio and the compensation
ratios set by the other clients of its investment bank might be due to spurious causation (Haunschild,
22
1994). Some unobserved factor may influence all investment banks or all Chinese firms; for
instance, there may be some generalized understanding of appropriate behavior that is shared by all
Chinese firms, including those served by other investment banks. Such a generalized norm may be
due to the fact that in addition to looking at its own past experience, each investment bank looks at
the actions other investment banks, especially the most prestigious. Interviews with investment
bankers in China confirmed this tendency: they stated that they usually read reports from top
investment banks, such as the China International Capital Corporation (CICC), a joint venture
between the China Construction Bank and Morgan Stanley, and from some foreign investment
banks, but they rarely paid attention to what the smaller and less-prestigious investment banks did.
The actions of other investment banks are likely to be salient normative forces because most
of the investment banks advising Chinese firms on ownership reform are small. Some prestigious
investment banks advised only a handful of firms; for example, CICC advised four firms. Interviews
with Chinese investment bankers revealed that income from this activity is quite small, especially in
later stages of this reform, when many small investment banks obtained permission from the CSRC
to participate in this reform. One person we interviewed, who wished to remain anonymous, said:
In the very beginning, when only a handful of investment banks were allowed to advise the firms on setting a proper compensation plan, typically an investment bank would earn 4,000,000 RMB. But when more securities firms got licenses to participate in this reform, consulting frees dropped sharply, in some cases to 400,000 RMB, which barely covers banks’ consulting costs. Faced with this situation, many top investment banks withdrew from this market, leaving a lot of unknown securities firms… Some prestigious investment banks, like _______, participated not for the current small profit; instead, they did so because they wanted to maintain their relationships with publicly-traded firms.
Small investment banks, who have shallower pools of talent and less experience than large
investment banks, face great uncertainty about what compensation is appropriate. This uncertainty
prompts them to imitate what other investment banks do to avoid an awkward situation: they don’t
know how to help their clients. For this reason, we propose:
Hypothesis 4b: The higher the mean compensation ratio set by set by other investment banks for their client firms, the higher the compensation ratio set by the focal firm.
23
When we consider agency problems that may crop up with investment banks, our
expectations change dramatically. Investment banks often act as the agents of managers, not as
agents of owners, because it is managers, not owners, who are responsible for hiring them. As
explained above, many Chinese investment banks are quite small – indeed, much smaller than the
firms they are hired to advise, especially in the third reform wave. This reduces the likelihood that
investment banks exert much normative influence on executives. Instead, executives may exert
considerable influence on investment banks, pushing banks to suggest compensation schemes that
match executives’ preferences. In other words, investment banks may not be normative influences:
they may be “beards” for CEO preferences. This possibility is supported by a banker in a small
Chinese investment bank, who wishes to remain anonymous:
Ours is not a big investment bank, as you may know. Our main task is to communicate between the firm (the CEO) and the non-tradable shareholders. When we actually made a presentation about what compensation ratio the firm should set, it turned out we were shadows of the firm. You must know “Shuanghuang” show? 8 Then you see what I mean, right? Those CEOs really think that they can manage everything by themselves and that they are the real controllers of their firms who can decide on everything… Why do they hire us? Oh, do you think the tradable shareholders would believe that compensation ratio is fair and acceptable if they are told that the CEO sets it? After all, we’re called financial intermediaries.
This indicates that investment banks may play limited roles in determining compensation schemes,
other than by facilitating communication between the two ownership groups. We expect that
agency problems may eliminate any normative influence of investment banks. Thus we propose:
Hypothesis 4c: Net of the effect of ownership structure, there will be no effect of investment banks on the focal firm’s compensation ratio.
Mimetic Isomorphism
Indiscriminant imitation: everyone is a target. For publicly-traded Chinese firms, ownership
reform was a very uncertain proposition because, as explained above, several earlier reforms failed
8 Shuanghuang is a traditional Chinese show in which one player stands before the audience on the stage and another player hides behind the stage. The audience perceives that the first player is “talking,” but actually the second player is. The first player is just moving his mouth to make audience think he is doing the talking.
24
and the rights of tradable shareholders were recent social inventions. Faced with great uncertainty,
firms contemplating ownership reform will look for clues about what to do in the actions of other
firms that have gone through this reform (DiMaggio and Powell, 1983). Thus we propose:
Hypothesis 5a: The higher the mean compensation ratio set by other firms that previously reformed their ownership, the higher the compensation ratio set by the focal firm.
Targeted imitation of role-equivalent and cohesive firms. A careful reading of DiMaggio and Powell
(1983: 148) reveals that imitation in the face of uncertainty is not indiscriminant; instead, it will be
seen primarily within sets of organizations that play similar roles or that are tied directly to each
other. We consider both imitation targets in turn. Firms attend to the actions of other firms in their
industry because they are role equivalents, which means that firms in the same industry are involved
in similar types of exchange relations, although not necessarily with the exact same exchange
partners (Winship and Mandel, 1983; Winship, 1988). Strategic decisionmaking uses cognitive
categories that executives construct as they label and make sense of the competitive environment
(Daft and Weick, 1984; Porac and Thomas, 1990). Executives attend to the actions of organizations
in their own industry more than other industries because the segregating mechanisms (Hannan and
Freeman, 1989: 45-65) that create and maintain industry boundaries also serve to focus their
attention. Moreover, organizations in the same category as the focal organization, such as those in
the same industry, will be viewed as more important competitors than organizations outside this
category; therefore, firms in the same industry will be monitored more closely than firms in other
industries (Porac and Thomas, 1990: 232-234). Thus, competitive boundaries and competitive
scanning are narrowly focused by industry. For these reasons we predict:
Hypothesis 5b: The higher the mean compensation ratio set by firms in the same industry that previously reformed their ownership, the higher the compensation ratio set by the focal firm.
Industry is not the only boundary salient to decision-making attention; location also matters.
Executives can more easily observe the actions of nearby organizations than those of far-away
organizations. Region is especially relevant when we study firms in China, which covers a vast
25
terrain – a landmass that is 2% larger than the U.S., with mountains that fence regions off from one
another. This rugged terrain has long engendered strong regional cultures and hampered the
creation of a national culture. To the extent that executives’ cognitive strategic maps are congruent
with regional boundaries, they will tend to downplay, even ignore, the actions of organizations in
other regions, and will tend to focus only on the actions of organizations in the same region. For
this reason, we expect:
Hypothesis 5c: The higher the mean compensation ratio set by firms in the same province that previously reformed their ownership, the higher the compensation ratio set by the focal firm.
Now consider imitation of organizations that are directly connected to the focal firm.
Director interlocks are important sources of information for Chinese firms, just as they are for
western ones (Useem, 1984; Haunschild, 1994). Expensive decisions like what compensation to
offer ordinary shareholders during ownership reform are discussed at board meetings. According to
CSRC guidelines, non-tradable shareholders entrust boards of directors to oversee reform, for
instance by hiring investment banks as professional advisors. Board of directors typically discuss all
issues related to ownership reform, including what compensation ratio should be offered tradable
shareholders. Conversations with directors of other firms that have succeeded at this complex and
uncertain reform will offer directors vivid examples that are likely to influence their own decisions
and actions. Indeed, such vivid, case-based information is more influential than pallid, abstract
statistics (Nisbett and Ross, 1980). Therefore, we predict that the compensation ratios previously
set by firms with which the focal firm is interlocked will influence decision makers in the focal firm:
Hypothesis 5d: The higher the mean compensation ratio set by firms with which the focal firm is interlocked, the higher the compensation ratio set by the focal firm.
The influence of peer-group organizations and interlock partners may be more intense in
situations of great uncertainty (DiMaggio and Powell, 1983; Haunschild, 1994). When faced with
uncertainty, organizations economize on search costs (Cyert and March, 1963 [1992]) and imitate the
actions of other organizations, substituting institutional rules for technical ones (Meyer, Scott, and
Deal, 1983). When there is uncertainty about what to do, decision makers should be more likely to
26
attend to information gained from salient others, such as other firms in the same industry, the same
region, and those with which they are interlocked. Accordingly, we propose:
Hypothesis 5e: The impact of imitation targets will be stronger when uncertainty is greater.
Considering agency issues does not change any of our predictions about mimetic
isomorphism. Instead, it merely changes our interpretation of any findings of mimetic isomorphism.
Specifically, incorporating ideas about agency problems leads us to presume that executives, non-
tradable shareholders, and tradable shareholders alike all justify their preferences for low or high
levels of compensation by using salient role models.
Research Design
To test the hypotheses developed above, we gathered and analyzed data on all conversion
plans developed by publicly-traded Chinese firms between June 12, 2005, when the first successful
conversion plan was announced, and July 18, 2007. Our unit of analysis is the firm.
Data and Measures
Our main sources of data are the Guo Tai An Information Technology Company (GTA,
also called CSMAR) and Wind Information Corporation. GTA is a for-profit enterprise based in
Hong Kong that has developed databases on the Chinese banking industry, stock market, and
economy for international academic and industry researchers. Wind is a Shanghai-based provider of
financial data used by most investment banks in China. Because these two companies provide
similar information about publicly-traded firms in China, we were able to cross-check their databases
for consistency and completeness, which is always a concern when dealing with data on China. The
GTA Ownership Restructuring database covers the period up to the end of 2006, while the WIND
database covers the period up to July 18, 2007. Our reading of detailed ownership reform plans of
over 400 firms indicates that Wind provides a more precise record of compensation ratios than
GTA. Also, GTA records only those non-tradable shareholders who own 5% or more of a firm’s
27
stock, while Wind provides data on all non-tradable shareholders. Accordingly, we gathered data on
compensation ratios, details of reform plans, the reform’s completion date (if successful), director
names, investment bank names, ownership of all non-tradable shareholders, province, and industry
from Wind; we gathered data on assets, financial performance, beta, and the ownership stakes of the
ten largest tradable shareholders from GTA.
Measuring the dependent variable. Our dependent variable is the compensation ratio, the ratio of
shares granted to shares held before ownership reform. For instance, if an investor held ten shares
of tradable stock and received three shares of tradable stock, the compensation ratio would be 3:10,
or 0.30. A few plans (5% of the 87%) also included grants of cash; for these, we translated cash into
shares using the closing stock price the day before the reform plan was announced.
Measuring independent variables. We created a binary indicator to measure coercion due to state
ownership, specifically, whether the firm under study is controlled by the state or the private sector.
This variable was set equal to one when the controlling shareholder listed in the firm’s annual
shareholders’ report was a government entity and zero otherwise. Starting in 2004, each listed firm
is required to disclosure its ultimate controlling shareholder in its annual report. We downloaded
annual reports filed the year before each firm undertook ownership reform from the Shanghai and
Shenzhen Stock Exchange websites (www.sse.com.cn and www.szse.com.cn).
Dummy variables are rather crude indicators of differences between firms. To compensate
for this limitation, we created a second, more nuanced, measure of state control: the percentage of
non-tradable shares that are owned by the state, either as state shares [guojia gu] or as state-owned
legal-person shares [faren gu].
Next, we assessed cohesion among non-tradable shareholders. We measured the concentration of
ownership of non-tradable shares using the Hirschman-Herfindahl index:
( )∑=
=n
iimm yNT ionConcentrat
1
2 ,
28
where yim is the fraction of the non-tradable shares in firm m owned by the ith holder of non-tradable
shares. When this index is high, ownership of non-tradable shares is concentrated; when this index
is low, ownership of non-tradable shares is dispersed.
For coercive pressure due to the bargaining power of tradable shareholders, we again used the
Hirschman-Herfindahl index, this time to measure concentration among the top ten tradable
shareholders:
( )∑=
=n
iimm yT ionConcentrat
1
2 ,
where yim now represents the fraction of the tradable shares in firm m held by the ith tradable
shareholder. As before, when this index is high, ownership is concentrated; when it is low,
ownership is dispersed.
To measure normative isomorphic pressures from investment banks we used the mean
compensation ratio set by other Chinese firms that were advised by the same investment bank and the
mean compensation ratio set the by clients of other investment banks. Note that the only client firms
whose compensation ratios were included in these measures were those that finished reforming their
ownership structures before the focal firm began to reform its own. To be sensitive to the fact that
the actions of top-ranked investment banks matter more than the actions of other investment banks,
we weighted data for investment banks ranked higher than the focal firm at 0.7 and weighted data
for lower-ranked banks at 0.3. We took investment-bank rankings from the Securities Association
of China (www.sac.net.cn). We used the 2006 rankings, which were based on net profits per worker,
and which captures investment banks’ operating efficiency and creative ability. Because rankings do
not change much from year to year, a static measure for 2006 is reasonably accurate.
Most previous studies of mimetic isomorphism have focused on the diffusion of particular types
of practices or structures; for instance, the spread of civil-service reform among American cities
(Tolbert and Zucker, 1983) or the adoption of the multidivisional structure by large American
corporations (Fligstein, 1985). Because the outcomes under study were binary (0,1) variables,
previous studies have counted the number of organizations within some reference group that
29
previously adopted the practice or structure in question. But our dependent variable, the ratio of
new share grants to outstanding shares, is continuous. A firm contemplating ownership reform can
set its compensation ratio at an infinite number of levels: 0.301, 0.3011, 0.30111, etc. Given the
nature of our dependent variable, we took a different approach and measured the mean
compensation ratio set by firms in a reference group. The mean of any distribution captures its
central tendency, what the “typical” firm in the reference group did.
We considered four different reference groups. First, we assessed untargeted mimesis by
including in the reference group all firms that had previously set compensation ratios. Second, we
restricted the reference group to firms in the same industry as the focal firm, and then to firms
headquartered in the same province as the focal firm, thereby capturing mimesis through role
equivalence. Finally, we restricted the reference group to the set of firms with which the focal firm
is interlocked, thereby capturing mimesis through cohesion. The first firm in each reference group to
undertake ownership reform – or the first group of firms, if multiple firms announced ownership
reform on the same day – has no reference group. Those pioneering firms drop out of our analysis
when we include the reference-group variables. Because some firms have no director interlocks,
they drop out of the analysis when we include the director-interlock reference-group variable.
Measuring the moderator: uncertainty. Recall that we expect uncertainty to accentuate the effect
of several independent variables. Uncertainty derives from the actions of other firms whose actions
are relevant to the firm under study, so we used the standard deviation of the compensation ratio
within the four reference groups, which measures within-group disagreement. The greater the
standard deviation, the greater the disagreement, and therefore the greater the uncertainty around
what is “right” or “normal” with regard to ownership reform.9 These measures are specific to each
9 Another potential measure of uncertainty is a time clock. As time passes and more firms reform their ownership structures, uncertainty diminishes because firms learn from each other’s successes and failures. But this measure is unsuitable because the timing of ownership reform was correlated with the complexity of ownership structure (firms that issued B or H or N shares, as well as A shares, reformed ownership later than firms that issued only A shares) and financial performance (troubled firms were the laggards in the reform process).
30
firm: all reference groups were based on firms that had already reformed their ownership structures,
which depended on the timing of the focal firm’s ownership reform, its industry, and its location.
We created interaction terms by multiplying uncertainty and the reference-group average.
Such interaction terms are often highly correlated with their components. High correlations
between variables in regression models cause multicollinearity, which can cause computational errors
when using standard statistical software (Jaccard, Turrisi, and Wan, 1990). Moreover, coefficients
on collinear variables are poorly estimated, so small measurement or sampling errors can have large
effects on coefficients. To avoid these problems, we subtracted both factors in an interaction from
their sample means before multiplying them together to create a mean-centered interaction (see
Cohen, 1978; Cronbach, 1987).
Measuring control variables. Our statistical models include for several factors that are not of
central interest to us, but that nonetheless might influence compensation ratios. First, we controlled
for firm size, in terms of market value, measured just before reform began. The shares of large firms
are more likely to trade often and in large quantities in the domestic exchanges than the shares of
small firms. Therefore, tradable shareholders in large firms will be less affected by the sale of
formerly non-tradable shares on the domestic exchanges than will tradable shareholders in small
firms (cf. Field and Hanka, 2001; Brav and Gompers, 2003). Therefore, tradable shareholders in
large firms are likely to demand less compensation for ownership reform than tradable shareholders
in small firms.
We also controlled for the focal firm’s overall stock-price performance, using the mean return
on the stock over the twelve months before ownership reform began. The higher the stock return,
the more tradable shareholders have already benefitted from the run-up in the stock price and the
less potential there is for future increases in stock price. So the higher the stock return, the less
incentive non-tradable shareholders have to initiate ownership reform, and the less compensation
they are likely to offer to tradable shareholders. We gathered data on stock returns from Sinofin, a
database created by the Center for China Economy Research at Peking University, which offered a
31
more convenient way to gather daily stock-return data than GTA. This widely used financial-market
database is devised to conform to the standards of the well-known database from the University of
Chicago’s Center for Research in Securities Prices.
We controlled for three variables that finance theory (Kahl et al., 2003; Wu and Wang, 2005)
predicts will affect compensation ratios. First, we controlled for stock-price volatility using the standard
deviation of the focal firm’s stock prices over the twelve-month period before that firm’s
ownership-reform process began.10 For this measure, the year under study was idiosyncratic to each
firm and was determined by the date on which the firm undertook ownership reform. The more
volatile stock returns are, the lower the implied value of non-tradable shares is (controlling, of
course, for the level of past stock returns) and the more removing trading restrictions increases their
value. The more volatile stock returns are and the larger potential windfalls for non-tradable
shareholders are, the more compensation they are willing to offer tradable shareholders. Our
second financial control is the beta of the asset-pricing model. We measured beta over the twelve
months before the focal firm’s ownership-reform process began. By a similar logic to that used
above, the higher beta is, the higher the implied value of non-tradable shares is, and the less their
holders benefit from lifting trading restrictions; therefore, the less they will compensate tradable
shareholders. Our third financial control is the ratio of non-tradable to tradable shares, which was
measured on the day before the focal firm’s ownership-reform process began. The higher the ratio
of non-tradable to tradable shares, the more removing trading restrictions will flood the market and
the more tradable shareholders can expect to suffer losses. The higher the ratio of non-tradable to
tradable shares, therefore, the more non-tradable shareholders must compensate tradable
shareholders to get the latter group to agree to the proposed reform.
10 Some firms in our analysis were recently listed and so lacked a full year’s track record; others were long-established but illiquid in that their stocks did not trade at all in the year before they undertook ownership reform. For both categories of firms, we lack the data needed to calculate stock-price volatility and beta. These firms dropped out of the analysis whenever we included these variables as regressors.
32
Methods of Analysis
Our data are cross-sectional and our dependent variable is continuous, so we estimate linear
regression models. These firms vary greatly in size and financial performance, so we correct for
heteroskedasticity.
Results
Table 1 presents descriptive statistics on all variables used in our analysis.
[Table 1 about here]
Table 2 presents the results of our multivariate analysis. Models are built step-wise, by
adding one variable at a time to a baseline model that contains control variables. This table is split
into two parts: Table 2a contains Models 1 to 7; Table 2b, models 8 to 12.
[Tables 2a and 2b about here]
Control variables. Model 1 shows that three control variables have the expected effects. Firms
with larger market capitalization levels and firms with better financial performance (as measured by
returns to stock price) set lower compensation ratios than smaller and poorer-performing firms,
while firms with higher ratios of non-tradable to tradable shares set higher compensation ratios.
The two other controls do not behave as predicted by finance theory. Stock-price volatility has the
expected positive effect, but this effect is generally non-significant. The effect beta is unexpectedly
positive, but generally not statistically significant. These results indicate that finance theory doesn’t
do a very good job of explaining the behavior of Chinese publicly-traded firms. This is not entirely
surprising, as it is much more difficult for tradable shareholders to understand and act on complex
asset-pricing models than it is for investors in Western economies. Western investors have a well-
developed appreciation of investment banks’ expertise and economic models of supply and demand,
but Chinese investors do not. The directors of Chinese firms cannot simply write letters to their
tradable shareholders and suggest that the compensation ratios they are being offered are “fair”
because they are based on the advice of investment banks that rigorously used asset-pricing models.
33
Model 2 adds the dummy variable indicating whether the firm is ultimately controlled by the
state. The coefficient is positive and statistically significant, which supports hypothesis 1b and fails
to support hypothesis 1a. Model 3 substitutes the more-nuanced measure of state control, the
percentage of shares owned by state shareholders. Again, we see a positive and statistically
significant effect, which again supports hypothesis 1b and fails to support hypothesis 1a. Together,
these results indicate that problems within the organizations that act as agents for state owners – the
central and local SASACs – attenuate the ability of state owners to coerce the managers of publicly-
traded firms to act in the state’s interests and against the interests of tradable shareholders. Model 4
includes both state-coercion proxies together. These variables are highly correlated (r=.60), so it is
not surprising that the effect of the dummy (the coarser measure) is rendered non-significant.
Model 5 drops the now-non-significant state-control dummy and adds ownership
concentration among non-tradable shares. The coefficient on this variable is negative and
statistically significant. This result supports hypothesis 2a and fails to support hypothesis 2b. It
indicates that the more ownership is concentrated among a few state agencies, the more bargaining
power state owners have vis-à-vis tradable shareholders.
Model 6 adds ownership concentration among tradable shares, to assess the coercive power
of that ownership group. We see a negative and statistically significant effect, which supports
hypothesis 3b and fails to support hypothesis 3a. This indicates severe agency problems among
tradable shareholders, most likely due to mutual-fund managers. Recall that ownership
concentration among tradable shares is often due to the fact that mutual funds own large stakes. If
so, then high concentration results in low compensation ratios because mutual-fund managers are
offered side payments (bribes) by non-tradable shareholders to do their bidding, rather than the
bidding of mutual-fund investors.
Model 7 tests for normative isomorphic pressures from investment banks by adding the
mean compensation ratio set by other firms advised by the same investment bank as the focal firm,
and the mean compensation ratio set by firms advised by other investment banks. The effects of
34
both variables are positive and statistically significant. These results support hypotheses 4a and 4b,
and fail to support hypothesis 4c. Taken together, these results suggest that when investment banks
advise Chinese firms, they look at both their own prior practices and at the practices of other
investment banks, especially more prestigious ones. (Recall that we gave banks ranked higher than
the focal firm a weight of 0.7 and banks ranked lower than the focal firm a weight of 0.3.) This
result is not surprising, given that many investment banks advising Chinese firms are small and
inexperienced.
Models 8 through 12, which are shown in Table 2b, add variables to capture the effects of
reference groups that might serve as bases for imitation: all firms that have previously undergone
ownership reform, firms in the same industry as the focal firm, firms in the same province as the
focal firm, and firms interlocked with the focal firm. In Model 8, the parameter estimates on three
groups (all firms, firms in the same industry, and firms in the same province) are statistically
significant (using one-tailed t tests, which is appropriate for directional hypotheses). The estimate
on the fourth group (interlocked firms) is non-significant. These results support hypotheses 5a
through 5c and fail to support hypothesis 5d. We conclude that Chinese firms attend to the actions
of all firms, as well as the actions of firms in their industry and region; however, after taking into
account these imitation targets, Chinese firms do not attend to the actions of interlock partners. In
other words, untargeted imitation and imitation of role-equivalent organizations trump imitation of
directly tied organizations. Note that the coefficient on the reference group encompassing all firms
is much larger than the coefficients on the more-restricted reference groups: eight times as large as
the same-industry effect and five times as large as the same-province effect.
The coefficients on the variables capturing the normative influence of investment banks
become close to zero and non-significant. This suggests that for Chinese firms, the power of role
models trumped any normative power that investment banks may have had. This conclusion is
bolstered by interviews with Chinese investment bankers, who told us that when they present
research in the course of advising Chinese managers about ownership reform, the most common
35
index of “reasonable” behavior they use is the average compensation ratio set by other firms that
have undergone ownership reform. For example, an internal consulting report written by the
prominent investment bank CICC highlights the average compensation ratio set by other firms.
Model 9 drops the normative variables and the interlock reference group. In this model, the
effect of the unrestricted reference group, of firms in the same industry, and of firms in the same
province are all significant using two-tailed tests, while the effect of interlock partners remains non-
significant.
Models 10 through 12 test for the moderating effect of uncertainty, using the three reference
groups that had significant main effects in Models 8 and 9. In all three models, the main effects of
the reference groups remain positive and statistically significant, the main effect of uncertainty
(which is measured relative to each reference group) is negative and statistically significant, and the
interaction effects are positive and statistically significant. These results support hypothesis 5e. In
results not shown here to save space, we estimated a similar model for the interlock reference group
and found a non-significant interaction, which fails to support hypothesis 5e. In other results not
shown here to save space, we included all three interaction effects in one model. Alas, high
correlations rendered many coefficients non-significant.
Robustness checks. We conducted several ancillary analyses to assess the robustness of these
results. First, we used an alternative measure of financial performance – earnings per share instead
of the stock return. Second, we used the natural logarithm of size. Third, we measured size using
assets instead of market capitalization. In all three alternative analyses, the results were very similar
to those shown here. Fourth, we experimented with other weights for high- and low-ranked
investment banks, which we originally weighted at 0.70 and 0.30, respectively. Our results are robust
to weights of 0.8:0.2 and 0.6:0.4. Fifth, we checked whether our results were driven by a few
extreme observations by deleting observations on firms whose compensation ratio was outside the
[5%, 95%] interval. Our results are robust to this trimming of the sample, which is to be expected,
as deleting a few extreme observations only makes the compensation ratios more similar than before.
36
A total of 75 firms (7%) have only one non-tradable shareholder, which means their non-
tradable share concentration index was 1.0. When we dropped these unusual firms from the sample,
all variables, including the concentration of non-tradable shares, had the effects of approximately the
same magnitude with approximately the same level of statistical significance.
One of our control variables – the ratio of non-tradable to tradable shares – is highly
skewed, with a mean of 2.17 and a small number of very, very large values (maximum 27.5). We
investigated the sensitivity of our results to outliers by dropping all 59 firms where this variable was
one standard deviation above the mean (4.23). In this subset of observations, all variables had
effects in the same direction and with the similar values and significance levels. The effect of the
ratio of non-tradable to tradable shares was much larger than in the results shown here, which
demonstrates that including the outliers obscured the true power of this factor.
The impact of other firms’ behavior: Coercion, norms, or mimesis? So far, we have assumed that
coercive pressure comes from owners, normative pressure comes from professional advisors, and
mimetic influences are instantiated in reference groups. But Mizruchi and Fein (1999) argued that
coercive and normative pressures can also come from reference groups. As they explained, research
that uses a binary dependent variable, which includes almost all research on mimesis, cannot
distinguish among imitation of, coercion from, or norms from reference groups. Because we have a
continuous dependent variable, we can draw this distinction. If Chinese firms were coerced by their
peers or if they viewed the behavior of their peers as a culturally valued norm, we would expect
them to set compensation ratios at least as high as, if not higher than, their peers’ average. After all,
if a firm tried to set its compensation ratio lower than its peers’ average and if the holders of
tradable shares noticed, they might refuse the proposed offer, which could be interpreted as coercive
or normative. In the aggregate, if Chinese firms are coerced by their peers’ behavior or if they
valorize that behavior, the distribution of compensation ratios should be centered on some point
above the average of the salient reference group. But if Chinese firms simply imitated the behavior
of other firms because they didn’t know what else to do, if they didn’t valorize that behavior and
37
didn’t feel pressure to conform to it, we would expect them to set compensation ratios neither
consistently higher nor lower than their peers’ average, but rather about the same. Such behavior
would, in the aggregate, yield a distribution centered on the average of the salient reference group.
To test predictions about coercion by or imitation of reference groups, we performed
Wilcoxon rank tests on a simple statistic: the compensation ratio set by the focal firm minus the
mean compensation ratio of its reference group. We focused on the three reference groups that had
significant effects on compensation ratios in Model 13 of Table 2b. Table 3 shows the results of this
analysis. For all three reference groups, the compensation ratio set by the focal firm is more likely to
be lower than the group mean that it is to be higher than the group mean. These results fail to
support the interpretation of similarity of behavior as being coerced or normative. Based on this
analysis, we conclude that firms are not coerced by their peers, nor do they interpret their peers’
behavior as instantiating cultural values; instead, they imitate them as a way out of great uncertainty.
[Table 3 about here]
To continue probing the issue of coercion or norms vs. imitation, we conducted a
multivariate analysis of the variable analyzed in Table 3, the difference between the focal firm’s
compensation ratio and its reference group’s average compensation ratio, to investigate how the
bargaining power of different shareholders affects whether the focal firm’s compensation ratio is
above or below its reference-group mean. We are specifically concerned with testing two
predictions that were supported in our original analysis, shown in Table 2a. Extending the logic
behind hypothesis 1b, we expect that because the agents of state owners (SASAC employees)
monitor many firms while non-state owners concentrate on one or a few firms, because non-state
owners are more competent to monitor the firms they own than state owners, and because the
interests of SASAC employees are not aligned with those of the state, firms controlled by state
owners should set higher compensation ratios, relative to their peers, than firms controlled by non-
state owners. Extending the logic of hypothesis 3b, we expect that because concentration of
ownership of tradable shares is often due to mutual funds owning large stakes, and because non-
38
tradable shareholders can make side-payments to mutual-fund managers to persuade them to accept
less compensation than they would otherwise demand, then the more concentrated ownership is, the
more likely it is that firms set compensation ratios lower than their peer groups.
The results of this ancillary analysis are shown in Table 4, which examines the three peer
groups that had significant effect on compensation ratios in Model 14 of Table 2b. The results are
consistent across the three specifications. Better-performing firms (those with larger market
capitalization and stock-price returns) set lower compensation ratios than their peers in all three
groups, which suggests that better-performing firms can resist peer pressure. In addition, firms with
higher fractions of non-tradable shares, which are more likely to see demand for tradable shares
swamped by excess supply if reform passes, set higher compensation ratios than their peers. Firms
with more state ownership set compensation ratios higher than their peers, which supports the
extension of hypothesis 1b. Concentrated ownership tradable shares reduces compensation ratios
relative to peers, which supports the extension of hypothesis 3b.
[Table 4 about here]
Discussion and Conclusion
In this paper, we explained a curious empirical regularity: publicly-traded Chinese firms
undergoing ownership reform tended to compensate their tradable shareholders in the same way
(with new grants of shares) and at about the same level (three new shares for every ten existing
shares). As expected, we found that the state is a powerful coercive force. But we also discovered
that the behavior of other firms – role models – have strong effects. Moreover, we found that
predictions based on analysis that ignored issues of agency were incorrect; only when we took the
interests of principals (both kinds of owners, state and non-state) and many different agents
(employees of the SASACs that oversee publicly-traded firms, managers of the publicly-traded firms
themselves, employees of the non-state holders of non-tradable shares, and managers of the mutual
funds that hold many tradable shares) were we able to explain Chinese firms’ compensation ratios.
39
Finally, because our analysis focused on a continuous (rather than discrete) outcome, we were able
to clearly separate mimetic effects from coercive and normative ones (cf. Mizruchi and Fein, 1999).
Coercive effects. Although the Chinese state (specifically, the CSRC) coerced firms into
undertaking ownership reform, it did not force them to compensate tradable shareholders for their
expected losses, and did it not force them to set compensation at any particular level. Instead, the
CSRC pushed each firm to determine, by negotiation between non-tradable and tradable
shareholders, an outcome that was appropriate for its own circumstances. Coercion by the state did
operate through an internal, firm-specific channel: through state ownership of non-tradable shares,
which constituted over two-thirds of shares in publicly-traded Chinese firms. But this coercion took
an unexpected turn, due to agency problems within state owners. Specifically, when the state owned
a large fraction of shares, compensation ratios were high, which indicates that state owners of non-
tradable shares are less able than non-state owners to monitor managers to make sure they act in the
interests of non-tradable shareholders.
One concern is that coercion may work through channels other than state ownership; for
example, through pressure on investment banks to advise their clients to act in ways that conform to
state preferences. But we showed that the effects of investment banks disappeared after we took into
account the impact of imitation targets, possibly due to agency problems with investment banks
(they are beholden to the executives who hire them rather than to shareholders). So even if
investment banks are a channel of state coercion, our results indicate this channel is not powerful.
Finally, state officials on corporate boards may be an alternative channel of coercive
influence, one that is not taken into consideration in our analysis. State officials sit on corporate
boards in China for two main reasons: either the central, provincial, or local government controls a
firm, usually by being its largest shareholder, or a firm controlled by individuals or non-state
corporations brings state officials onto its board in order to form a political connection, as insurance
against unexpected political shocks or other state intervention (Calomiris, Fisman, and Wang, 2008).
To the extent that state ownership is highly correlated with the appearance of state officials on the
40
board, our measure of state ownership captures this channel of state influence. Alternatively, the
presence of state officials on corporate boards may not reflect pressure from the state, but rather
firms’ attempts to manage their dependence on unpredictable state action by co-opting state officials
(Pfeffer, 1972).
Normative effects. We demonstrated that mimetic isomorphic effects overshadowed normative
ones. Evidence that Chinese firms followed the path taken by other firms advised by the same
investment bank was wiped out when we controlled for the actions of imitation targets. We also
described, with the limited information available to us, the evolution of the role played by
investment banks, which shows how actors, actions, and meanings changed over time.
Mimetic effects. We found evidence of three distinct imitation targets – all firms, firms in the
same industry as the focal firm, and firms in the same region as the focal firm. These findings
suggest that great uncertainty drove firms to imitate the actions of others, rather than to follow the
advice of investment banks. We found that imitation of all reference groups was more pronounced
when uncertainty was great.
While our integrated theoretical framework gives us a new angle to examine the social life
using augmented new institutional theory, and while our empirical results offers some useful hints
about how institutional isomorphism plays out among publicly-traded Chinese firms, we are also left
with several new puzzles and problems. Theoretically, we have a lot of work to do to fully integrate
agency theory into institutional analysis. Empirically, the complex ownership structure of Chinese
firms – cross-shareholding and multiple-layer business groups – make it difficult to precisely
measure the influence of different interest groups: the state, non-state institutions, and individual
investors (Guthrie, et al., 2007). Untangling interests is a formidable task since detailed information
on holders of non-tradable shares of Chinese firms is simply not available.
41
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Figure 1: The Distribution of Compensation Ratios Set by Chinese Firms, May 2005 – July 2007
di
Note: This figure summarizes data from Wind Information on all 1,086 publicly-traded Chinese firms that reformed their ownership structure and compensated the holders of tradable shares with grants of new tradable shares between May 1, 2005 and July 18, 2007. This group constituted 87% of firms undertaking ownership reform. For plans that included cash compensation (5% of the 1,086), we translated cash into an equivalent number of shares using the closing stock price the day before the reform plan was announced. Each point represents one firm’s compensation ratio. For instance, the arrow points to the modal firm, whose compensation ratio was 0.306, meaning that holder of tradable shares were granted 3.06 shares for every 10 shares they held before reform.
47 Table 1: Descriptive Statistics
Variable 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Mean .300 .713 34.6 .600 .006 .317 .314 .318 .316 .315 .311 .069 2.85 -.0015 .022 1.03 2.18 Standard deviation .079 .453 26.8 .274 .030 .031 .030 .012 .032 .027 .049 .007 12.1 .0022 .048 .204 2.06 Minimum .020 0 0 .049 .000 .100 0 .300 .100 .200 .100 0 .272 -.06 .0075 .075 .268 Maximum .700 1 85.0 1.00 .786 .500 .375 .364 .474 .500 .594 .089 370 .011 .053 1.57 27.3 # observations 1086 1086 1086 1086 1086 1017 1086 1085 1014 1055 821 1086 1077 1077 1076 1086 10851 Compensation ratio 2 Controlling shareholder dummy .215 3 % State-owned shares .303 .642 4 Concentration[NT shares] .028 .028 .431 5 Concentration[T shares] -.105 .028 .026 .029 6 Mean CR[same IB] .055 -.022 .024 .133 .041 7 Mean CR[other IBs] .076 -.025 -.018 .035 .013 .083 8 Mean CR[all firms] .165 -.050 -.008 .121 -.022 .382 .417 9 Mean CR[same industry] .152 -.010 .007 .005 -.009 .135 .043 .304 10 Mean CR[same province] .152 -.022 -.031 .043 -.033 .171 .225 .398 .154 11 Mean CR[interlocked firms] .064 .027 .025 .057 -.041 .070 .110 .192 .142 .166 12 Uncertainty: Std Dev(CR[all firms]) -.175 -.043 -.087 -.178 .028 -.276 -.329 -.771 -.234 -.313 -.184 13 Market capitalization/109 -.007 .062 .105 .075 -.002 -.042 .018 -.009 -.090 .031 -.001 -.003 14 Mean stock-price return -.171 .040 .074 .095 .078 .105 .065 .193 -.055 .059 .060 -.201 .064 15 Stock price volatility .148 -.028 -.057 -.093 .066 -.055 -.028 -.060 .098 -.033 .030 .108 -.107 -.353 16 Beta .166 -.018 .016 -.042 -.047 .021 -.019 .038 .156 .037 .036 .012 .018 -.407 .575 17 # NT shares/# T shares .324 .110 .183 .056 -.023 .049 .019 .032 .005 .081 -.005 -.051 .432 .024 -.001 -.012
Note: This table is based on 1,086 observations on ownership reform plans by publicly-traded Chinese firms between June 2005, when the first plan was announced, and July 18, 2007. All of these plans offered compensation in the form of stock or stock plus cash. We converted cash grants into stock equivalents. Mean CR[ ] refers to the mean compensation ratio set by the reference group named in the square brackets. NT and T stand for non-tradable and tradable shares, respectively. To save space, we show only uncertainty based on all firms.
48
Table 2a: Linear Regression Analysis of Compensation Ratios
(1) (2) (3) (4) (5) (6) (7) Market capitalization/1012 -1.07*** -1.09*** -1.09*** -1.09*** -1.07*** -1.06*** -1.01*** (-5.26) (-4.97) (-4.83) (-4.84) (-4.7) (-4.72) (-4.64) Mean stock-price return -5.39** -5.45** -6.01*** -6.05*** -5.94*** -5.45** -8.12*** (-2.88) (-2.88) (-3.24) (-3.27) (-3.21) (-2.95) (-4.40) Stock price volatility .746 .932 1.23* 1.23* 1.13 1.35* .839 (1.24) (1.52) (2.03) (2.04) (1.89) (2.25) (1.46) Beta .031* .030* .022 .023 .021 .017 .022 (2.06) (1.96) (1.48) (1.45) (1.5) (1.19) (1.47) #NT shares/# T shares .015*** .014*** .013*** .013*** .013*** .013*** .013*** (6.06) (5.93) (5.69) (5.67) (5.66) (5.65) (5.51) Controlling shareholder dummy .023*** -.004 (4.20) (-.049) % State-owned shares/103 .637*** .679*** .741*** .745*** .847*** (7.35) (5.84) (7.30) (7.34) (8.05) Concentration[NT shares] -.021* -.021* -.026** (-2.40) (-2.36) (-2.88) Concentration[T shares] -.244*** -.237*** (-5.89) (-5.67) Mean CR[same IB] .218*** (3.25) Mean CR[other IBs] .412*** (3.38) # Observations 1075 1075 1075 1075 1075 1075 1008 R2 0.15 0.16 0.19 0.19 0.19 0.20 0.24
Notes: This table presents ordinary-least-squares regressions. Robust t-statistics are in parentheses below parameter estimates. * indicates p<.05, ** p<.01 and ***p<.001, two-tailed t tests. Coefficients on the constant are omitted to save space.
49 Table 2b: Linear Regression Analysis of Compensation Ratios
(8) (9) (10) (11) (12)Market capitalization/1012 -.911*** -.916*** -.997*** -1.04*** -1.04***
(-3.31) (-3.82) (-3.65) (-4.46) (-4.56)Mean stock-price return -10.82*** -10.47*** -9.67*** -6.86*** -7.27***
(-4.98) (-4.98) (-5.10) (-3.61) (-3.89)Stock price volatility 1.22 1.03 1.40* 1.30* 1.12*
(1.82) (1.59) (2.37) (2.14) (1.96)Beta .015 .010 .007 .011 .019
(0.86) (1.11) (0.49) (0.70) (1.27)#NT shares/# T shares .012*** .012*** .013*** .012*** .013***
(4.90) (4.96) (5.40) (5.44) (5.44)% State-owned shares/103 1.08*** .961*** .789*** .818*** .813***
(8.84) (6.48) (6.83) (6.16) (6.26)Concentration[NT shares] -.037*** -.037*** -.032*** -.026** -.026**
(-3.53) (-3.58) (-3.67) (-2.74) (-2.84)Concentration[T shares] -.206*** -.204*** -.216*** -.232*** -.218***
(-.564) (-5.85) (-5.27) (-6.58) (-5.42)Mean CR[same investment bank] -.061
(-0.52)Mean CR[other investment banks] .049
(0.28)Mean CR[all firms] 1.59*** 1.50*** 1.27***
(3.64) (4.83) (5.83)Mean CR[same industry] .185 .186* .382***
(1.92) (2.07) (4.71)Mean CR[same province] .308** .293* .465***
(2.60) (2.54) (5.26)Mean CR[interlocked firms] .028 .042
(0.57) (0.88) Uncertainty[reference group] -1.03* -.232** -.114
(-2.56) (-2.70) (-1.31)Mean CR[reference group]*Uncertainty[reference group] 71.5*** 4.80* 4.47*
(3.76) (2.19) (2.17)# Observations 764 789 1074 1005 1044R2 0.31 0.31 0.27 0.25 0.24
Notes: This table presents ordinary-least-squares regressions. Robust t-statistics are in parentheses below parameter estimates. * indicates p<.05, ** p<.01 and ***p<.001, two-tailed t tests. Coefficients on the constant are omitted to save space.
50
Table 3: Testing For Coercion:
The Difference Between the Focal Firm’s Compensation Ratio
and the Peer Group’s Average Compensation Ratio
(1) (2) (3)
Peer Group All Firms Firms in the Same Industry Firms in the Same Province
# Observations # Observations # Observations
Difference Positive 471 (43%) 451 (44%) 465 (44%)
Difference Negative 614 (57%) 559 (55%) 590 (56%)
Difference = 0 0 4 0
Total Sample Size 1,085 1,014 1,055
Wilcoxon Test
median difference = 0
vs.
median difference > 0
Pr(#positive ≥ 471) =
Binomial(n = 1085, x ≥ 471, p = 0.5) =
1.0000
Pr(#positive ≥ 451) =
Binomial(n = 1,014, x ≥ 451, p = 0.5) =
0.9997
Pr(#positive ≥ 465) =
Binomial(n = 1,055, x ≥ 465, p = 0.5) =
0.9999
Wilcoxon Test
median difference = 0
vs.
median difference < 0
Pr(#negative ≥ 614) =
Binomial(n = 1,085, x ≥ 614, p = 0.5) =
0.0000
Pr(#negative ≥ 559) =
Binomial(n = 1,010, x ≥ 559, p = 0.5) =
0.0004
Pr(#negative ≥ 590) =
Binomial(n = 1,055, x ≥ 590, p = 0.5) =
0.0001
Conclusion Focal-firm CR < Mean CR[all firms] Focal-firm CR < Mean CR[same industry] Focal-firm CR < Mean CR[same province]
51
Table 4: Linear Regression Analysis of the Difference
Between the Focal Firm’s Compensation Ratio and its Reference-Group Average Compensation Ratio
(1) (2) (3) All Firms Firms in the Same Industry Firms in the Same Province
Market capitalization/1012 -1.03*** -.789*** -.997*** (-4.25) (-3.29) (-4.45)
Mean stock-price return -7.73*** -6.91*** -8.34*** (-4.22) (-3.45) (-4.29)
Stock price volatility 1.27* 1.20 1.16* (2.17) (1.85) (2.02)
Beta .014 -.003 .017 (1.00) (-0.20) (1.14)
#NT shares/# T shares .013*** .012*** .012*** (5.56) (5.12) (5.26)
% State-owned shares/103 7.97*** .866*** .859*** (8.12) (8.03) (8.35)
Concentration[NT shares] -.027** -.026** -.030*** (-3.10) (-2.74) (3.34)
Concentration[T shares] -.230*** -.236*** -.216*** (-5.56) (-7.05) (-4.89)
# Observations 1074 1005 1044 R2 0.22 0.19 0.21
Notes: This table presents ordinary-least-squares regressions. Robust t-statistics are in parentheses below parameter estimates. * indicates p<.05, ** p<.01 and ***p<.001, two-tailed t tests. Coefficients on the constant are omitted to save space.