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Are directors with foreign experience better monitors? Evidence from investment efficiency

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Abstract

Using Chinese listed firms from 2008 to 2018, we find that directors with foreign experience alleviate both overinvestment and underinvestment, hence improve firms’ investment efficiency. The source of efficiency lies in better governance, which arises from the transfer of values and cognition, and advanced management practices across countries as well as greater independence as these directors with foreign experience have fewer local ties. Better governance helps mitigate agency problems and information asymmetry and relax firms’ financial constraints. Supporting this argument, we find that directors with foreign experience are associated with lower controlling shareholders’ tunneling transactions and lower investment—cash flow sensitivity. We further find that the impact of directors’ foreign experience on investment efficiency is more pronounced at firms with weaker corporate governance, less transparent information environment, higher financial constraints, and when foreign experience is gained in countries with better investor protection, superior management practices, better rule of law, and less corruption. Our finding is robust to alternative variable measurements and tests for endogeneity. Overall, this paper highlights the important monitoring role of directors with foreign experience, which promotes firm investment efficiency through various governance channels.

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Notes

  1. Currently, most Chinese companies listed and traded on the Shanghai Stock Exchange (SHSE) and Shenzhen Stock Exchange (SZSE) issue two classes of shares: A and B shares. A shares are domestic shares quoted in Chinese currency (RMB) and are restricted to domestic investors and qualified foreign institutional investors (QFIIs). B shares are foreign shares quoted in foreign currencies (U.S. dollars for Shanghai B shares and Hong Kong dollars for Shenzhen B shares). Until February 2001, B shares were available only to foreign investors. B-share companies might be more likely to employ directors with foreign experience and have different investment policies. To avoid the influence of B shares on our research question, our sample covers only A shares.

  2. CSMAR divides all listed firm into four categories based on their equity nature, including, state-owned enterprises, private enterprises, foreign-owned enterprises and other. Foreign-owned enterprises are those established in China with capital invested by foreign investors, including joint ventures, cooperative enterprises and wholly foreign-owned enterprises, excluding the branches of foreign enterprises or other economic organizations in China. We exclude firms labelled as “Foreign-owned Enterprise” and “Other”. Our sample contains only state-owned firms and private firms.

  3. ST (special treatment) stocks are stocks with abnormal financial conditions. *ST stocks fail to comply with certain rules imposed by the exchange during the period of being labeled as ST. These stocks are typically in financial difficulty.

  4. This measurement is equivalent to capital expenditure (COMPUSTAT Item 128#) used by U.S.-based studies.

  5. This test is motivated by the fact that in the Chinese context, Tobin’s Q may be an imperfect measure of investment opportunities.

  6. We also use the industry-fixed effect, and our main conclusion does not change. The results are available upon request.

  7. Because \(Leverage\) and \(Cash\) are used to construct \(Over\,\,Firm\), they are omitted from Eq. (2).

  8. In this paper, the KZ index is calculated as: \(-9.352\times \left(Cash\,\,Flow/K\right)+\left(0.483\times TQ\right)+4.634\times Leverage-29.912\times \left(Dividends/K\right)-3.079\times \left(Cash/K\right)\).

  9. This measurement is equivalent to capital expenditure (COMPUSTAT Item 128#) used in U.S.-based studies.

  10. Thanks for the reviewer’s suggestion of identifying individual firms with changes in board members with foreign experience and use evidence from change analyses to provide stronger evidence. However, to employ this identification approach, we need firstly to identify individual firms with changes in board members with foreign experience and then compare the difference in investment efficiency of treated firm pre- and post-event. As shown in Eq. (1) in the main text, we measure firm’s investment efficiency as the sensitivity of investment expenditure to investment opportunities, which is the coefficient estimate obtained by regressing firm investment expenditure on investment opportunities. Therefore, to measure the investment efficiency of a firm that experiences a change event, we need sufficient number of observations for this specific firm both before and after the changes to make the regression analysis in Eq. (1) meaningful. That is, all firms must have sufficient number of observations during the pre- and post-event periods. However, constrained by our panel data set with data availability fixed to the period of 2008-2018, and some changes occur in the earlier years of the sample period, while others occur in the latter years, estimating investment efficiency for all firms with unequal number of observations (before and after the event) is statistically not feasible. Therefore, we are unable to conduct the change analyses as the reviewer suggested in our empirical framework.

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Authors and Affiliations

  1. School of Accounting, Chongqing University of Technology, Chongqing, China

    Xueman Xiang

  2. School of Business, University of Dayton, Dayton, OH, USA

    Carl R. Chen

  3. Business School, University of Edinburgh, Edinburgh, UK

    Yue Liu

  4. The Institute of Management Science, Lahore, Pakistan

    Azhar Mughal

  5. Institute of Chinese Financial Studies, Southwestern University of Finance and Economics, Chengdu, China

    Qizhi Tao

  6. William J. Hoben Professor of Finance, Department of Economics and Finance, University of Dayton, Dayton, OH, 45469, USA

    Carl R. Chen

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  1. Xueman Xiang
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  2. Carl R. Chen
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  3. Yue Liu
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  4. Azhar Mughal
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  5. Qizhi Tao
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Appendices

Appendix 1

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Table 13 Definition of variables
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Appendix 2

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Table 14 Correlation matrix
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Xiang, X., Chen, C.R., Liu, Y. et al. Are directors with foreign experience better monitors? Evidence from investment efficiency. Rev Quant Finan Acc 62, 799–840 (2024). https://doi.org/10.1007/s11156-023-01221-9

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