Journal Pre-proof

Foreign shareholding, corporate governance and firm performance:

Evidence from Chinese companies

Georges Tsafack, Lin Guo

PII: S2214-6350(21)00060-5
DOI: https://doi.org/10.1016/j.jbef.2021.100516
Reference: JBEF 100516

To appear in: Journal of Behavioral and Experimental Finance

Received date : 11 January 2021

Revised date : 19 April 2021
Accepted date : 14 May 2021

Please cite this article as: G. Tsafack and L. Guo, Foreign shareholding, corporate governance and
firm performance: Evidence from Chinese companies. Journal of Behavioral and Experimental
Finance (2021), doi: https://doi.org/10.1016/j.jbef.2021.100516.

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Title Page (with Author Details) Journal Pre-proof

Foreign Shareholding, Corporate Governance and Firm

Performance: Evidence from Chinese Companies

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Georges Tsafack1 Lin Guo
University of Rhode Island Suffolk University, Boston

pro
Abstract

This paper examines how a firm’s corporate governance characteristics and

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institutional environment affect the presence of large foreign shareholding, and
how a firm’s foreign ownership influences its performance. For a sample of listed
Chinese companies, we find that both firm-level governance characteristics and
country-level institutional environment affect the presence and the extent of large
foreign shareholding. We also find an inverted U-shaped relation between a firm’s
foreign ownership and its return on assets, return on equity and Tobin’s q. The
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implied optimal foreign ownership increases when changes in institutional
environment reduce the opportunity for controlling shareholders to extract private
benefits.
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JEL Classification: F390, G30

Keyword: Chinese Market, Foreign Investor, Firm performance, Corporate Governance

1
Georges Tsafack is at the College of Business, University of Rhode Island; email: gtsafack@uri.edu. Lin Guo is at Sawyer
Business School, Suffolk University; email: lguo@suffolk.edu. We are grateful for comments and suggestions from seminar
participants at the Financial Management Association (FMA) in Denver, CO. Any remaining errors are our own.
Manuscript (without Author Details) Journal Pre-proof Click here to view linked References

Foreign Shareholding, Corporate Governance and Firm

Performance: Evidence from Chinese Companies

of
pro
Abstract

This paper examines how a firm’s corporate governance characteristics and

institutional environment affect the presence of large foreign shareholding, and
how a firm’s foreign ownership influences its performance. For a sample of listed
Chinese companies, we find that both firm-level governance characteristics and
re-
country-level institutional environment affect the presence and the extent of large
foreign shareholding. We also find an inverted U-shaped relation between a firm’s
foreign ownership and its return on assets, return on equity and Tobin’s q. The
implied optimal foreign ownership increases when changes in institutional
environment reduce the opportunity for controlling shareholders to extract private
benefits.
lP
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JEL Classification: F300, G30

Keyword: Chinese Market, Foreign Investor, Firm performance, Corporate Governance
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1. Introduction

The role of corporate governance in investors’ portfolio selection has generated growing

interests among investors, corporate managers, regulators and researchers. Existing studies suggest

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that the extraction of private benefits by controlling shareholders may affect investors’ stock

selection decision. In this paper, we focus on a particular type of investors—large foreign

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investors—and examine how a firm’s corporate governance characteristics and institutional

environment are related to the presence of large foreign shareholdings, and how large foreign

ownership affects firm performance.

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The pioneer work of Leuz, Lins and Warnock (2009) suggest that foreign shareholdings

can be explained not only by firm-level differences in corporate governance quality, but also by

country-level differences in disclosure and shareholder protection. Although different countries

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may have different institutional environment in which firms develop their governance practices,

analyzing foreign shareholding within a particular country is especially valuable to understand the

relation between governance characteristics and foreign ownership in general. Despite the
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increasingly important role of China in the global economy and the growing need of Chinese firms

to attract foreign capital to finance their growth, there is no prior study that examines how Chinese

firms’ corporate governance characteristics affect foreign investors’ shareholding decision. The

changing institutional environment and the special characteristics of the ownership and control
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structure of Chinese companies provide us with an excellent setting to examine the role of

corporate governance in determining the foreign shareholdings of companies in emerging markets,

and to shed light on the effect of foreign ownership on firm performance.

Our paper contributes to the literature in the following ways. First, we examine whether

the concern of expropriation by controlling shareholders is an important factor to explain foreign

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shareholding of listed Chinese companies. More broadly, we investigate whether a firm’s

corporate governance characteristics are related to the presence and the extent of large foreign

shareholding. Our results show that the probability of having large foreign shareholders and the

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percentage of foreign shareholding increase when the largest shareholder is more constrained by

other influential investors (i.e., the second to the tenth largest shareholders) from obtaining private

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benefits of control. Bai et al. (2004) argue that the increase in concentration of shares in the hands

of the second to the tenth largest shareholders may more effectively restrain the largest shareholder

from transferring firm resources for private benefits, and may enhance the market for corporate

control. Our finding that foreign shareholdings increase with a more dispersed ownership among
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large shareholders suggests that foreign investors invest less in firms with greater possibility of

expropriation by the largest shareholders. Moreover, we find that larger firms and firms with

greater international presence (characterized by the possession of B or H shares) are more likely
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to attract large foreign shareholdings, supporting the role information plays in foreign investors’

portfolio choice. In short, we provide strong evidence that foreign investors invest less in Chinese

firms in which controlling shareholders have greater ability to extract private benefits of control.
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Second, we contribute to the literature by investigating whether a country’s changing

institutional environment affects foreign shareholding. We find that the presence of large foreign

shareholding increases significantly after the Chinese government started to allow certain qualified
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foreign institutional investors to hold Chinese A shares from 2002, and after the onset of the split-

share structure reform in 2005. These findings support the conjecture that when a country’s

institutional environment offers greater protection of shareholder rights and reduces the extent of

market segmentation, firms can attract higher levels of foreign shareholding. Our paper provides

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implications on how firms can best position themselves to attract foreign capital, and whether

Chinese government’s reform efforts were effective to help companies attract foreign investors.

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Third, we investigate how the extent of large foreign shareholding affects firm

performance. A certain level of foreign shareholding may provide the maximal benefit to Chinese

publicly traded companies in the spirit of Greenaway, Guariglia, and Yu (2014). Our results

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indicate that, the extent of large foreign ownership has an inverted U-shaped relation with firms’

Tobin’s q and accounting performance (return on assets and return on equity). Moreover, we

examine how the implied optimal foreign ownership changes during different subperiods.

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Interestingly, we find that the optimal level of foreign ownership increases when the restriction for

foreign shareholding is relaxed by the Chinese government, and after the Chinese government’s

split-share structure reform in 2005.

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Fourth, unlike Leuz, et al. (2009) who examine only U.S. institutional investors’

shareholding in foreign companies, we examine the shareholding of both U.S. and non-U.S. large

foreign investors so that our findings are more general on the country origin of foreign investors.
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Fifth, our paper also contributes to the home bias literature. Lau et al. (2010) argue that

investors with concentrated domestic asset holdings would have greater required rate of returns.

Thus, a greater extent of home bias would result in a higher cost of capital. They provide evidence

that countries may experience substantially lower cost of capital by reducing the extent of their
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home bias. Covrig et al. (2007) suggest firms that voluntarily adopt International Accounting

Standards have enhanced ability to attract foreign institutional investors and reduce home bias

among foreign investors. Using country-level data on U.S. investors’ foreign investment allocation

and firm-level data for a sample of Korean firms, Kho et al. (2009) provide evidence that higher

level of insider ownership limits portfolio holdings by foreign investors. Our findings provide new

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firm-level evidence that improved corporate governance that reduces controlling shareholders’

ability to extract private benefits may alleviate the home bias toward Chinese companies among

foreign investors.

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The remainder of this paper is organized as follows. Section 2 reviews the related literature,

and Section 3 describes the institutional environment for listed Chinese companies. Section 4

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develops testable hypotheses and Section 5 describes the data and methods. We present the

empirical results in Section 6 and conclude in Section 7.

2. Literature Review re-

Previous studies suggest that both country-level and firm-level factors affect the extent of

a firm’s foreign shareholding. Studies focusing on firm-level factors include Dahlquist and

Robertsson (2001), Giannetti and Simonov (2006) and others. Dahlquist and Robertsson (2001)
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find that for a sample of Swedish firms, foreign investors prefer large firms, firms paying low

dividends, and firms with large cash positions on their balance sheets, but underweight firms with

a dominant owner. For a sample of Swedish companies, Giannetti and Simonov (2006) provide
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evidence that foreign investors appear more reluctant than domestic investors to hold firms with

weaker corporate governance. Moreover, Ferreira and Matos (2008) find that foreign institutional

investors have preferences to invest in firms in the MSCI World Index, firms that are cross-listed
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on a U.S. exchange, and firms that have external visibility through foreign sales and analyst

coverage.

In addition to the firm-level evidence in the aforementioned studies, Ahearne et al. (2004)

and Chan et al. (2005) link a firm’s foreign shareholding with country-level institutional

environment under which the firm operates. Ahearne et al. (2004) find that poor quality and low

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credibility of financial information in many countries can justify the underweight of the equity of

these countries in U.S. investor portfolios. Chan et al. (2005) examine mutual fund holdings from

26 developed and developing countries and find that stock market development and familiarity,

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economic development, capital controls, and withholding tax variables have significant effect on

the foreign bias of the mutual funds. Ammer et al. (2012) find that when firms from a weak

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accounting background cross-list their shares in the U.S, they experience a strong increase in

shareholding by U.S. investors.

Another set of studies examine the importance of both firms’ internal corporate governance

characteristics and external institutional environment in determining the level of foreign

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investments in the companies. Aggarwal et al. (2005) find that at the country level, U.S. funds

show a preference for emerging markets with stronger accounting standards, shareholder rights,

and legal frameworks. At the firm level, they find that firms with more transparent accounting
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disclosures and firms that issue American Depository Receipts attract greater US. mutual fund

investments. Leuz et al. (2009) suggest that foreign investors’ information disadvantage relative

to domestic investors helps explain why a firm’s foreign shareholding is likely to be affected by
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its corporate governance characteristics. For a sample of 4409 firms from 29 non-U.S. countries,

Leuz et al. (2009) examine whether and why concerns about corporate governance result in fewer

holdings of U.S. investors. They find that U.S. investors hold significantly fewer shares in firms
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with high levels of managerial and family control when these firms are located in countries with

poor outsider protection and disclosure. However, firms with substantial managerial and family

control do not experience less foreign investment when they reside in countries with extensive

disclosure requirement and strong investor protection. This suggests that country-level

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institutional environment influences the relation between a firm’s control structure and its foreign

ownership.

The relation between foreign shareholding and firm performance has been examined in

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different contexts by previous studies. For a sample of Venezuelan firms from 1976 to 1989,

Aitken and Harrison (1999) find that foreign equity participation is positively correlated with plant

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productivity (i.e., plant real output) only for small enterprises. For a sample of Indian firms,

Chhibber and Majumdar (1999) report that only firms with foreign ownership level at 51 percent

or higher have relatively superior performance on return on assets and return on sales. Harris

(2002) and Harris and Robinson (2003) find that foreign-owned companies in the United Kingdom
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have greater productivity than domestic-owned companies. For a sample of firms in 27 countries,

Ferreira and Matos (2008) find that foreign institutional investors have a positive effect on a firm’s

operating performance and firm value. Aggarwal et al. (2011) also find a positive effect of foreign
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institutional ownership on firm value for a sample of firms in 23 countries. Wei et al. (2005) find

that foreign ownership is significantly positively related to firms’ Tobin’ q for a sample of China's

privatized firms from 1991 to 2001. Greenaway et al. (2014) examine the relation between foreign
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ownership and firm performance for Chinese unlisted private companies for the period of 2000 to

2005, and find that joint ventures perform better than either wholly foreign-owned or purely

domestic firms. For a sample of listed Chinese companies from 2006 to 2012, Hai et al. (2018)

report that foreign shareholdings can reduce firms’ agency costs and cost of equity and improve
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firm performance. Overall, the aforementioned studies suggest that although the relation between

foreign ownership and firm performance depends on the samples studied, in general, there is a

positive relation between the two.

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In summary, previous empirical studies have not examined the effect of changing

institutional environment within a country on firms’ foreign ownership, nor have they investigated

the determinants of large foreign ownership for these firms. Little is known about how Chinese

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firms’ internal corporate governance characteristics and external institutional environment affect

their foreign ownership, and whether there is an optimal foreign ownership for publicly traded

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Chinese companies. Our paper fills the void in the literature by investigating these unexplored

issues with a sample of listed Chinese firms, and by examining how large foreign shareholding

affects the accounting performance and market valuation of these companies.

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3. Institutional Environment for Listed Chinese Companies

Chinese stock markets have developed rapidly after the establishment of Shanghai Stock

Exchange and Shenzhen Stock Exchange in 1990 (Allen et al., 2005). Chinese firms may issue
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different types of tradable shares on domestic stock exchanges (either the Shanghai Stock

Exchange or the Shenzhen Stock Exchange) and various overseas markets. On the domestic stock

exchanges, a firm may issue A shares and B shares. The A shares can only be traded by Chinese
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mainland investors with the exception of certain qualified foreign institutional investors (QFII)

who may also trade in the A-share market after December 1, 2002. Although B-Share stocks were

initially designated only for foreign investors, starting from February 2001, mainland investors
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can trade B shares in US dollars or Hong Kong dollars as well. In addition to the domestic

exchanges, a Chinese company may also list its shares on the overseas markets. A Chinese firm's

shares listed on the Hong Kong Stock Exchange are called H shares, while Chinese shares listed

on the New York Stock Exchange and the London Stock Exchange are called N shares and L

shares, respectively. Foreign-listed stocks can only be traded by foreign investors until April 2006,

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after which certain qualified domestic Chinese institutional investors (QDII) were allowed to

invest in overseas stocks for the first time under a quota system.

Since joining the World Trade Organization (WTO) in 2001, China has had greater access

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to the world markets and has also been expected to create an institutional environment that

promotes better corporate governance (Du and Kong, 2020). Compared with other countries, a

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unique ownership feature of listed Chinese companies is the prevalence of controlling state shares

and/or legal entity shares which are non-tradable on the stock exchanges prior to April 2005 (Firth

et al., 2010). As shown in Table 2, the percentage of the non-tradables shares as a percentage of

the number of shares outstanding for Chinese firms averages about 44% during the period of 1994
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to 2014. 1 The press is full of reports on how controlling non-tradable shareholders make corporate

decisions to benefit themselves at the expense of public shareholders.

It is well recognized that the conflicts of interests between controlling non-tradable

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shareholders and tradable shareholders have severely hindered the improvement of corporate

governance of Chinese companies and negatively impacted firm performance (Firth et al., 2010;

Chen et al., 2016). However, attempts by Chinese regulators to reduce non-tradable shares in 2001
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failed and the sale of non-tradable shares was halted in 2002 because of strong negative reaction

of tradable A-share investors. After a few years of discussions and review, Chinese regulators

issued the "Circular on Issues relating to the Pilot Reform of Listed Companies Split Share
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Structure" in April 2005 to specifically address the reform of non-tradable shares and formally

initiated the sale of non-tradable shares of four pilot companies in the stock market. In September

2005, the China Securities Regulatory Commission (CSRC) issued to all the listed companies the

Circular on Promulgating the Administrative Measures on the Split Share Structure Reform of

1
The time-series average of 58% is reported by Eun and Huang (2007) for the percentage of non-tradable shares for
listed Chinese firms during the period of 1995 to 2004.

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Listed Companies. As suggested by Chen et al. (2016), this reform has the potential to bring

significant institutional changes to reduce the agency costs of listed companies. The Chinese stock

market responded positively to this new round of reforms to float the non-tradable shares. The

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2005 development not only highlights the importance of eliminating non-tradable shares in

improving firms' corporate governance system, but also provides us with an excellent exogenous

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setting to examine the effect of both firm-level and country-level changes of corporate governance

on foreign shareholding.

4. Theory and Testable Hypotheses re-

As argued by Giannetti and Simonov (2006), corporate governance does matter for

investors’ security selection. Giannetti and Simonov state that “corporate governance affects how

a firm’s value is divided between security benefits, which accrue to all shareholders pro-rata, and
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private benefits, which only a subset of shareholders with large participations or connections with

the management can enjoy.” They argue that different investors may have different preferences

for firms with distinctive quality of corporate governance. In their paper, investors who enjoy only
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security benefits mainly include small domestic individual investors, domestic institutional

investors, and foreign individual and foreign institutional investors, while investors who may

extract private benefits mainly include large domestic individual investors. However, the
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theoretical framework of Giannetti and Simonov (2006) does not distinguish small domestic

individual and institutional investors from foreign investors, neither do they distinguish large

foreign investors from other foreign investors. If large foreign shareholders only expect to extract

security benefits, we expect large foreign shareholders to be less likely to invest in Chinese

companies in which controlling shareholders have greater incentives to extract private benefits.

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However, if large foreign shareholders mainly expect to extract private benefits, they are more

likely to invest in Chinese companies with poorer corporate governance. Given the prevalence of

non-tradable shares in China, it is unlikely that foreign investors can be the largest controlling

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shareholders of a Chinese company. We therefore expect that large foreign investors’ incentives

of extracting security benefits dominate their incentives to extract private benefits, and large

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foreign shareholders are less willing to hold shares of Chinese companies in which controlling

shareholders or managers have greater incentives to extract private benefits.

Leuz et al. (2009) argue that information asymmetries between foreign and domestic

investors are especially pronounced with respect to the evaluation of a firm’s governance structure
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and the scope of expropriation by controlling insiders. They explain that assessing whether

controlling insiders pose a threat to outside investors requires an intricate knowledge of political

connections, banking relations, family social status, and connections among the business elite, all
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of which foreign investors are less likely to have. It is because of this reason that foreign investors

are less willing to invest in firms that are poorly governed. The studies of Giannetti and Simonov

(2006) and Leuz et al. (2009) form the theoretical basis of the following testable hypothesis.
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H1: The prevalence and the extent of large foreign shareholdings of Chinese companies increase

when the companies’ controlling shareholders or managers are more constrained to extract
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private benefits.

Moreover, as described in Section 3, since the beginning of the 2000s, two major reforms

have been made in the Chinese stock market that could be inducive to foreign investors. One event

is the announcement by the Chinese regulators to allow certain qualified foreign institutional

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investors (QFII) to trade in the A-share market after December 1, 2002. We expect that this

permission would increase the presence of foreign ownership in listed Chinese companies. Another

event is the 2005 split share structure reform by the Chinese government to specifically address

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the agency problems caused by non-tradable shares. We expect that this reform has led to reduced

incentives and ability for controlling shareholders to extract private benefits. Along the lines of

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Giannetti and Simonov (2006) and Leuz et al. (2009), we propose our second hypothesis as

follows.

H2: The presence and the extent of foreign shareholdings of Chinese companies would increase
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after the onsets of the two country-level institutional environment changes, which occurred in 2002

and 2005 respectively.

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Stulz (1999) argues that foreign investors may help a firm lower its cost of capital through

achieving a globally diversified investor base and improved corporate governance. In particular,

Stulz (1999) suggests that large foreign investors—as outsiders—are more likely to perform
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effective monitoring that enhances firm value. Lemmon and Lins (2003), Lins (2003), and

McConnell and Servaes (1990) find a weak performance for firms in which minority shareholders

are potentially most subject to expropriation. Klapper and Love (2004) find that corporate
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governance quality is significantly positively correlated to both operating performance and market

valuation. Huang and Zhu (2015) suggest that foreign institutional investors are less prone to

political pressure than domestic institutional investors, and they help reduce the agency problem

of controlling shareholders during the split-share structure reform in China. Ferreira and Matos

(2008) find that foreign institutional investors have a positive effect on firm value and operating

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performance. If large foreign investors can monitor and improve firm performance of the Chinese

companies, we expect a positive relation between foreign shareholding and firm performance.

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Notwithstanding, foreign ownership and domestic ownership may result in different

monitoring effectiveness under distinctive situations. Kang and Kim (2010) conjecture that foreign

investors in the U.S. are less likely to be informed about a domestic firm than domestic investors

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due to factors such as physical distance, language barrier, cultural distance, and differences in

shareholder rights between the U.S. and the foreign acquirer’s home country. They find that

foreign investors are less likely to engage in governance activities in domestic acquisition targets.

Based on evidence from earnings management for a sample of firms from 29 countries, Kim et al.
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(2016) find that foreign institutional investors have comparative advantage over their domestic

peers in limiting earnings management when firms’ governance controls are weaker, but domestic

institutional investors have relative advantage over their foreign peers when information
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asymmetry between the firms and outside investors is higher. They suggest that foreign

institutional investors’ monitoring advantages originate from their proclivity toward activism and

superior monitoring technologies, while the advantages of the domestic institutional investors are
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due to their geographic, linguistic and cultural proximity to local firms. Greenaway et al. (2014)

argue that the relation between foreign ownership and firm performance may not be monotonic.

This is because foreign investors may bring in modern technologies, capital, and better corporate

governance, domestic investors contribute knowledge of the local market and political
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connections. Greenaway et al. develop a theoretical model that depicts an inverted U-shaped

relationship between foreign ownership and corporate performance. The pros and cons of having

foreign ownership suggest that the net effects of foreign shareholders on firm performance could

be nonlinear.

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We emphasize the tradeoff between better corporate governance and less information on

Chinese markets associated with increased foreign ownership. This tradeoff can explain why a

high level of foreign ownership beyond the inflection point harms firm performance. We model

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the non-linear inverted U-shaped quadratic relation between the conditional mean of the

performance and the percentage of foreign ownership as:

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E(Perf |FrgnOwn) = B0 + B1 FrgnOwn + B2 FrgnOwn2 (1)

where Perf represents firm performance and FrgnOwn is the percentage of foreign ownership. The

conditions for the inverted U-shape with an optimal solution between 0% and 100% are:

i)

ii)
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B2 < 0 (concavity condition necessary for an interior optimal solution)

B1 > 0 (need of large foreign investors)

iii) B1 + 2B2 < 0 (need of large domestic investors)

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When all these conditions are satisfied, the optimal level of foreign ownership is given by

Optimal FrgnOwn = – B1/2B2. (2)

The 2005 split share structure reform makes it harder for controlling shareholders to take
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private benefits. For example, as Firth et al. (2010) documents, the state is overall the largest non-

tradable shareholder prior to the 2005 reform. The split share structure reform makes non-floating

shares tradable and significantly reduces the proportion of state ownership for listed Chinese firms.

If foreign investors invest more in firms with better corporate governance quality, the enhanced
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corporate governance after 2005 encourages greater foreign shareholding that brings in improved

monitoring and accountability to the firm. Thus our tradeoff argument suggests that the optimal

foreign ownership is expected to increase after the 2005 reform. Going beyond the study of

Greenaway et al. (2014), we expect that if the inverted U-shaped curve as specified in equation (1)

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has an upward shift to the right after the reform of non-tradable shares in 2005, then Optimal

FrgnOwn would increase as shown in Graph 1.

Graph 1

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Performance

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Optimal Level 1 Optimal Level 2 Foreign Ownership Percentage
(FrgnOwn)
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We thus test the following hypothesis.

H3: There is an inverted U-shaped relation between foreign ownership and firm performance for

publicly traded Chinese companies. The optimal foreign ownership increases when changes in
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external institutional environment alleviate the conflicts between controlling shareholders and

public investors.
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5. Data and Methods

Our sample construction begins with all the publicly traded Chinese firms included in the

PACAP-CCER China database from 1994 to 2014. Our sample period starts in 1994 because there
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is no information on the type of top ten largest shareholders prior to this time. We end our sample

period in 2014 because China experienced stock market crash and dramatic changes in the

institutional environment in 2015 (Lim, 2017). As reported by the Guardian on July 8, 20152,

2
The article can be found at
https://web.archive.org/web/20150709211502/http://www.theguardian.com/business/2015/jul/08/china-stock-
markets-continue-nosedive-as-regulator-warns-of-panic.

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the Shanghai stock market had fallen 30 percent over three weeks as more than half of listed

companies filed for a trading halt in an attempt to prevent further losses. The Chinese government

enacted many measures to alleviate market turbulence. Regulators limited short selling and

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stopped initial public offerings for some time. In addition, China Securities Regulatory

Commission (CSRC) imposed a six-month ban on stockholders owning more than 5 percent of a

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company's stock from selling those stocks. Lim (2017) documents that in 2015 China's State

Council approved to shift to a US style registration system for stock market flotations. China

announced to create the Strategic Emerging Industries Board in the SHSE in 2015. In order not to

let these events confound our findings, we end our sample period in 2014.
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We extract information on firms’ corporate governance structure including the type and

the percentage ownership of the top ten shareholders from the PACAP-CCER’s Corporate

Governance database. We also obtain the financial statements and monthly stock returns data of
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Chinese companies from the PACAP-CCER database. Our final sample includes 2,699 listed

Chinese companies. We define large foreign shareholders as those that rank among the firm’s top

ten shareholders. Large foreign investors are particularly important to a company not only because
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of their financing roles, but also because of their potential ability to monitor and influence

managers’ decisions.
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Empirical models

We generate two variables using the top-10 shareholder information to measure foreign

ownership: (1) a dummy variable indicating the presence of a foreign investor among the top ten

investors (Dforeign), and (2) the proportion of a firm’s shares held by large foreign investors that

are among the top ten shareholders of the company (FrgnOwn). To analyze the effect of

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corporate governance quality on the probability for a given firm to attract a foreign investor

among its top ten shareholders, we use the following Logit model:

of
′
𝑒 𝑥𝑖 𝛼
𝑃𝑟(𝐷𝑓𝑜𝑟𝑒𝑖𝑔𝑛𝑖 = 1) = ′ (3)
1+𝑒 𝑥𝑖 𝛼

where Dforeigni is a binary variable taking the value 1 in case of the presence of one or more

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foreign investors among the top ten shareholders of company i, and 0 otherwise; xi represents a

vector of explanatory variables for firm i, and α is a vector of coefficients.

We also analyze the percentage of shares held by all the foreign investors that are among

the firm’s top ten largest shareholders (FrgnOwni) over the total number of shares outstanding. As
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pointed out by Dahlquist et al. (2003), not taking into account the fact that firms may have a portion

of non-floating shares (e.g., non-tradable shares that are held by large controlling shareholders)

may create a bias in examining foreign investors’ portfolio choice. We thus also use the ratio of
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the number of shares held by large foreign investors over the number of floating shares as an

alternative measure of FrgnOwn. We use the standard Tobit model to examine the factors that

affect the extent of large foreign shareholdings:

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𝐹𝑟𝑔𝑛𝑂𝑤𝑛𝑖∗ = 𝑧𝑖′ 𝛽 + 𝑢𝑖 , 𝑢𝑖 |𝑧𝑖 ~𝑁(0, 𝜎 2 ) (4)

𝐹𝑟𝑔𝑛𝑂𝑤𝑛𝑖 = 𝑚𝑎𝑥(𝐹𝑟𝑔𝑛𝑂𝑤𝑛𝑖∗ , 0) (5)

where 𝐹𝑟𝑔𝑛𝑂𝑤𝑛𝑖∗ is the latent variable of large foreign ownership, and zi is a vector of explanatory
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variables assumed to follow a standard normal distribution 𝑁(0, 𝜎 2 ), and  is a vector of

coefficients. We observe a positive percentage of shares held by foreign investors FrgnOwni for

firm i when there is at least one foreign investor among the top ten shareholders. This clustering

problem is similar to the censored random variable and the Tobit model is suitable for this type of

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analysis. Leuz et al. (2009) also use the Tobit model in their analysis of U.S. investors’ ownership

of non-U.S. companies.

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To examine the relation between foreign ownership and firm performance, we perform

the following regression models:

pro
Regression of interest

Perfi = B0 + B1 FrgnOwni + B2 FrgnOwni2 + Sizei + u (6)

 Selection equation

Pr (Dforeigni=1|Xi) = Φ(XiC) and Pr (Dforeign=0|Xi) = 1- Φ(XiC) (7)

re-
where Xi is a set of explanatory variables for firm i explaining the presence of foreign investor

among the top ten shareholders, C represents a vector of parameters, and Φ is the cumulative

distribution function of the standard normal distribution. We control for firm size (Size) in the
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performance regressions. As in Leuz et al. (2009), Size is measured as the log of the market value

of equity. Given the selection bias introduced by the choice of large investors (i.e., top ten

shareholders of a firm), we use the Heckman (1979) bias correction model where the selection
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equation is a probit model on the probability for firms to have large foreign shareholders.

Variables used in the analysis

Table 1 lists the definition of all the variables used in the empirical analysis. We employ
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three variables to measure firm performance: (1) return on assets (ROA), (2) return on equity

(ROE), and (3) Tobin’s q. These measures are calculated using annual data. ROA is estimated as a

firm’s net income over its total assets, and ROE is a firm’s net income over its shareholders’ equity.

Tobin’s q is the sum of a firm’s market value of equity and the book value of liabilities divided by

its total assets.

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To examine the relation between a firm’s foreign shareholding and its corporate

governance quality, we include variables that measure information asymmetry between domestic

and foreign investors, and variables on the potential expropriation by controlling insiders. Our

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main explanatory variables are the corporate governance variables similar to those of Bai et al.

(2004). Foreign investors may find that their interests are better served in companies where large

pro
shareholders are closely monitoring each other. We include the logarithm of the sum of squares of

the percentages of shares held by the second largest to the tenth largest shareholders, Lnher2_10,

as one of the explanatory variables. Higher value of Lnher2_10 is associated with a less dominant

position of the largest shareholder. Following Bai et al. (2004), we also include the fraction of
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independent members of the board of directors (Pct_indptdir) as a measure of the quality of

monitoring provided by the board of directors. A larger fraction of independent directors on the

board is expected to facilitate monitoring and mitigate mishandling of company resources. We

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expect Pct_indptdir to be positively related to foreign shareholding.

Another measure of corporate governance quality is the concentration of power in the CEO

position by allowing the same person to occupy the CEO and to serve on the board of directors.
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The quality of monitoring by the board could be compromised when the CEO, who is supposed to

be monitored, serves also as the Chairman or as a director of the monitoring body. Bhagat and

Bolton (2008) find that CEO-Chairman role separation is positively associated with

contemporaneous and subsequent operating performance. Alternatively, it is likely that having the
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CEO serve on the board streamlines strategic decision-making and corporate policy

implementation and prevents value-destructive conflicts between senior management and the

board of directors. We thus include a dummy variable CEO_is_topdir to proxy for directors’

independence. CEO_is_topdir is a dummy variable taking value 1 if the CEO is either the chairman

of the board of directors, or the CEO is held by any director on the board; and 0 otherwise. In

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addition, we include the percentage of shares held by senior manager, Pct_mg, as an explanatory

variable. Larger managerial ownership may be associated with greater agency cost due to

controlling owner’s expropriation of private benefits (Shleifer and Vishny, 1986), but it may also

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lead to greater alignment of the interests of the top managers with those of the shareholders.

To examine the effect of state ownership on foreign shareholding, we include the

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percentage of state or state legal person ownership in the top ten shareholders (Pct_statetop10) as

a governance variable as well. As Shleifer and Vishny (1997) point out, greater state ownership

could be associated with greater adverse incentives for managers and thus lower quality of

corporate governance. We also include a dummy variable for the presence of B or H shares for a
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particular company. Dum_intl equals 1 if a firm has B or H shares, 0 otherwise. B or H shares can

be traded in the stock market by foreign investors. We expect that firms with B or H shares have

better information disclosure and are better known to foreign investors.

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In addition, our regressions control for a number of firm characteristics that are standard in

the literature (e.g. Leuz et al., 2009; and Kang and Stulz, 1997). We use the capital asset pricing

model (CAPM) to estimate the systematic risk (Beta) and the unsystematic risk measured as the
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variance of the residuals from the CAPM regressions (Volatility) and excess return (Exret). For

each firm and for a given year we perform the regression of monthly excess-return of the firm on

the monthly excess return of the market. Our control variables include Lmvequity, BM, Leverage,

Beta, Volatility and Exret. Lmvequity is the logarithm of the market value of equity. BM is the
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book value of equity to market value of equity. Leverage is total liabilities over total assets. Exret

is the excess return measured as a firm’s stock return minus the risk-free rate. We also control for

subperiod effects by including two time dummies: Dum02 and Dum05. Dum02 equals 1 if an

observation is in the post 2002 period (i.e., the period of 2002-2014), and 0 otherwise. Dum05

equals 1 if an observation is the post 2005 period (i.e., the period of 2005-2014), and 0 otherwise.

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6. Empirical results

Figure 1 graphs the annual means of foreign presence (Dforeign) and foreign shareholding

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(FrgnOwn) from 1994 to 2014. It shows that the presence of large foreign shareholders and the

percentage of large foreign shareholdings in Chinese companies in general increase over time,

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albeit not necessarily increasing every year.

Table 1 lists the definition of the variables in our analysis, and Table 2 provides the

summary statistics of selected variables. Over the entire period of 1994 to 2014, on average 14.1%

of listed Chinese companies have foreign investors among their top ten shareholders. For those
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firms with foreign shareholders, the average percentage of foreign shareholding is 17.65%.

Table 3 provides correlation coefficients of the explanatory variables included in our

regressions. It indicates that multicollinearity among most explanatory variables is not likely to be
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a concern for our multivariate regressions. However, there are high correlations between Dum02

and Pct_indptdir and between Dum05 and Pct_indptdir. We thus do not include Pct_indptdir and

the time dummies (Dum02 and Dum05) at the same time in the regressions.
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Table 4 reports the logit panel regressions with Dforeign as the dependent variable, while

Table 5 reports the Tobit panel regressions with the proportion of shares held by large foreign

investors as the dependent variable. Both tables report five regression specifications in Columns

L1 to L5.3 We analyze different characteristics of corporate governance along with the impact of
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two major institutional environment changes which took place in China in December 2002 and in

April 2005. Firm stock price characteristics, capital structure and market capitalization are also

3
We also perform two robustness tests. In the first robustness test, we run regressions for which data are available
for variables included in all the five specifications. The numbers of observations for these regressions are the same
in this case. In the second robustness test, we have performed the regressions in Tables 4 and 5 using lagged
explanatory variables. Results from both robustness tests are qualitatively the same as those in Tables 4 and 5.

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used as control variables. The logit and Tobit regressions in Tables 4 and 5 directly test our first

and second hypotheses (H1 and H2).

As shown in Table 4, the coefficients on variable lnher2_10 are significantly positive in all

of
the five logit regressions in columns L1 to L5. An increase in concentration of shares in the hands

of the second to the tenth largest shareholders may more effectively restrain the largest shareholder

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from transferring firm resources for private benefits, and thus enhances the firm’s corporate

governance quality. Our finding that the presence of large foreign investors increases with

lnher2_10 suggests that foreign investors invest less in firms with greater possibility of

expropriation by the largest shareholders. In addition, the coefficients on Dum_intl are also
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significantly positive in all the regressions. This suggests that firms with international presence are

more likely to have large foreign shareholders. Firms that are present in different stock markets

through their B and H-shares should be better known by foreign investors. These findings support
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our first hypothesis (H1) which states that the prevalence of large foreign shareholdings of Chinese

companies increase when the companies’ controlling shareholders or managers are more

constrained to extract private benefits. Moreover, Table 4 shows that the coefficient on the
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percentage of independent directors in the board (Pct_indptdir) is significantly positive in Panels

L3 and L5, and the coefficients on the dummy for CEO on the board (CEO_is_topdir) in column

L3 has a significantly negative effect on the presence of large foreign investor. Column L5 of
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Table 4 shows that the presence of state ownership among the top ten large investors

(pct_statetop10) is significantly negatively related to the presence of foreign investors. These

results are consistent with the first hypothesis as well.

In addition to firm-specific characteristics, foreign ownership could be affected by the

institutional environment in China as well. In December 2002, some qualified foreign institutional

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investors were allowed to trade Chinese A-shares. Another important event is the reform of the

share split structure for listed companies in 2005. This change paved the way for improvement in

the companies’ corporate governance quality. The significantly positive coefficients of Dum02 and

of
Dum05 in Table 4 suggest that the presence of foreign shareholding increased after 2002, and

continued to increase further after 2005. These results support our second hypothesis (H2) that the

pro
presence of foreign shareholdings of Chinese companies changes with the transformation of the

institutional environment.

The economic significance inferred from Table 4 is also informative. The coefficient of

Dum02 is positive and ranges between 0.841 and 1.481 depending on the model specification. This
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means that the log of the odds to have a foreign investor among the top ten shareholders increases

by about one after 2002. The coefficient of Dum05 ranges from 1.2515 to 1.7856, indicating a

further increase in the magnitude of the log of the odds of having foreign shareholders among the
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top 10 shareholders after 2005. The estimated value of the coefficient of Dum_intl suggests that

the log of the odds of having a foreign investor in the top ten shareholders increase by 6 when the

firm has B or H shares. This is expected because the B and H shares are designated for foreign
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investors, while A shares can only be traded by Chinese investors with the exception of certain

qualified foreign institutional investors.

To have a better understanding of these results, we use the mean of the variables in the L1
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model specification to estimate the likelihood of a firm to have a foreign investor among the top

ten shareholders. We find that the probability of the “average” company to have a foreign investor

is 0.44% before 2002, 1.92% during 2002-2004, and 7.22% after 2005. The increase in probability

after 2002 is not surprising because the 2002 QFII scheme started to allow foreign investors to

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invest in the domestic A share market. After the 2005 split share structure reform, the likelihood

of having a foreign investor among the top ten shareholders increases more dramatically.

With regard to corporate governance characteristics, a key variable with a significant and

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robust impact on foreign ownership is Lnher2_10, which captures the concentration of

shareholding of the second to the tenth largest shareholders. A one standard deviation increase of

pro
this variable increases the probability of having a foreign investor among the top ten shareholders

from 0.44% to 0.70% before 2002, from 1.92% to 3.03% for the period of 2002-2005, and from

7.22% to 11.02% after 2005. This suggests that when the largest shareholder is less dominant, the

likelihood of the presence of a foreign shareholder is much stronger.

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Table 5 reports the Tobit panel regressions on the determinants of the proportions of large

foreign shareholding (FrgnOwn). The findings are in line with those of Table 4 and lend support

to H1 and H2. In particular, Table 5 shows that the percentage of foreign shareholding is
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significantly positively related to Lnher2_10, Pct_indptdir, Dum_intl, Dum02 and Dum05, and

significantly negatively related to Pct_statetop10.

In addition, Table 5 shows that neither the dummy variable on whether the CEO is a top
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director (CEO_is_topdir) nor the percentage ownership of senior management (Pct_mg) has any

effect on the percentage foreign ownership in the top ten shareholders. These results are not

surprising given there is no consensus in the literature on the effect of these variables on the

effectiveness of firms’ corporate governance systems.

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The control variables in Tables 4 and 5 indicate that the likelihood of having large foreign

shareholders and the percentage of large foreign investors are positively associated with firm size

(Lmvequity), book-to-market ratio (BM) and beta, and negatively associated with a firm’s excess

returns (Exret). The positive sign of the coefficient on BM may look a bit ‘counterintuitive’ as

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high BM may signal a lack of growth opportunities. However, if we look at it from the foreign

investors’ perspective, it is possible that they are attracted more by value stocks companies. In

fact, foreign investors often have less information about companies’ prospects compared to

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domestic investors. Therefore, they may tend to invest in companies with high BM which can be

seen as cheaper. As Lakonishok et al. (1994) reports, value investing based on measures such as

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the book-to-market ratio is a strategy often adopted by contrarian investors.

As Zou and Adams (2006) point out, the market value of non-tradable shares prior to the

2005 reform could be overstated if we use the price of tradable shares to calculate their market

value. To assess whether the potential overstatement of the market value of non-tradable shares in
re-
the calculation of book-to-market ratio (BM) affects our results, we also estimate the regressions

in Tables 4 and 5 for the post-2005 subperiod only as a robustness test. The results of the

coefficients on BM are still significantly positive. This suggests that the findings that foreign
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shareholding increases with BM is less likely to be due to the overstatement of the market value

of non-tradable shares prior to 2005.

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Now, we turn to the results on the relation between foreign ownership and firm

performance (as measured by the ROA, ROE and Tobin’s q) in Tables 6 to 9. Table 6 reports the

coefficients of both the regressions of interest and the Heckman’s selection probit regressions as

described in Section 5.4 Variable FrgnOwn in Table 6 is the proportion of foreign shareholding
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over the total number of shares outstanding. Results are similar if we estimate foreign ownership

as the proportion of foreign shareholding over the number of tradable shares. To conserve space,

4
We report the correlation between the residuals of the regression of interest and the residuals of the selection equation
rho in Tables 6 and 8. When rho ≠ 0, standard regression techniques applied to the first equation yield biased results,
and Heckman’s two-step estimation procedure can be used to correct this bias. The p-values of the test for rho=0 are
0.0000 in Tables 6 and 8, rejecting the independence of the probit model for the selection equation and the regression
model of interest.

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Table 6 only shows the full regressions using the first measure of foreign ownership. The

coefficients of FrgnOwn and the square of FrgnOwn (i.e., FrgnOwn_sq) are significantly positive

and negative, respectively. This suggests that there is an inverted U-shaped relation between

of
performance and foreign ownership, and there are optimal foreign ownerships for listed Chinese

firms. This result goes beyond the findings of Greenaway et al. (2014) who study a sample of

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unlisted Chinese companies. These findings support the first part of Hypothesis 3 which states that

there is an inverted U-shaped relation between foreign ownership and firm performance for

publicly traded Chinese companies. Table 7 presents the coefficients of FrgnOwn and

FrgnOwn_sq (B1 and B2) using the first and second measures of foreign ownership in Panels A
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and B, respectively. Each panel reports the implied optimal foreign ownerships estimated with

these coefficients using equation (2). Panel A shows that the optimal percentages of foreign

shareholding over total number of shares outstanding are 32%, 22% and 14% respectively for
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ROA, ROE and Tobin’q. Panel B reports the optimal percentages of foreign shareholding over the

number of floating (tradable) shares as 38%, 33% and 12% respectively for the three performance

measures.
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To examine whether the optimal foreign ownership increases when changes in external

institutional environment alleviate the loss from conflicts between non-tradable shareholders and

public investors, as stated in H3, we add the cross product of FrgnOwn and Dum05 as an additional
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explanatory variable in the performance regressions and report the results in Table 8, in which

FrgnOwn is measured as the percentage of foreign shareholding over the total number of shares

outstanding. We can show mathematically that if the optimal levels of foreign ownership and firm

performance increase after the split-share structure reform in 2005 as shown by Graph 1 in Section

4, the coefficient on FrgnOwn × Dum05 in the performance regressions should be positive. Results

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in Table 8 support this conjecture and show that the coefficients of this cross product are

significantly positive for all the three performance regressions.

Table 9 reports the implied optimal percentages of foreign shareholding based on the

of
coefficients estimated in Table 8. Table 9 measures FrgnOwn as the percentage of large foreign

shareholding over all the shares outstanding. Table 9 shows the implied optimal foreign

pro
shareholding during the post-2005 period for the three performance measures are all significantly

higher than those of the pre-2005 estimates. In particular, Panel A of Table 9 reports that the

implied optimal foreign ownerships for the pre-2005 period are 7.17%, 10.12% and 1.09% to

maximize ROA, ROE, and Tobin’s q respectively, while the corresponding optimal foreign
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ownership values are 32.86%, 24.50% and 18.03% for the post-2005 period. These findings

strongly support Hypothesis 3 which states that the optimal foreign ownership increases when

changes in external institutional environment alleviate the conflicts between controlling

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shareholders and public investors.

7. Conclusion
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This paper examines how a firm’s corporate governance characteristics and institutional

environment are related to the presence of large foreign shareholding of listed Chinese companies,

and how a firm’s foreign ownership affects its financial performance. Our sample includes 2699
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firms listed on the Chinse stock market, one of largest emerging markets in the world. We find

that both firm-level governance characteristics and country-level institutional environment affect

the presence and the extent of large foreign shareholding. In particular, the probability of having

foreign investors among a firm’s top ten shareholders and the percentage of these large foreign

shareholdings tend to increase when the largest shareholder of the firm is more constrained by

other influential investors from obtaining private benefits of control, and when there is a greater

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presence of independent directors on the board. Moreover, we find that larger firms and firms with

international presence are more likely to attract large foreign shareholders. Results indicate that

the presence of large foreign shareholding increases significantly after the Chinese government

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started to allow certain qualified foreign institutional investors to hold Chinese A shares from

2002, and after the government announced the reform plan for Chinese firms’ non-tradable shares

pro
in 2005. These findings suggest that changes of both firm-level corporate governance quality and

country-level institutional environment contribute to the increased presence of large foreign

investors in China.

We also find that the extent of large foreign ownership has an inverted U-shaped relation
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with firms’ accounting performance (return on assets and return on equity) and Tobin’s q, and the

average implied optimal foreign ownership increases when the external institutional environment

provides greater shareholder protection. This supports the existence of a tradeoff between better
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corporate governance and less information on domestic Chinese markets associated with increased

foreign ownership. Our estimates of the optimal foreign ownership range from 14% to 33%, while

the average foreign shareholding for our sample firms that have foreign shareholders is 17.65%.
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This suggests that there is room to increase foreign ownership to reach its optimal level, especially

for firms that do not have large foreign shareholders. This highlights the important role of country-

level efforts in improving the institutional environment to reduce the opportunity for controlling
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shareholders to extract private benefits at the expense of public investors.

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Figure 1: This figure presents the evolution of foreign presence, which is the annual mean of variable
Dforeign. Foreign presence measures the proportion of firms with at least one foreign investor among
their top ten shareholders. Foreign shareholding corresponds to variable FrgnOwn (the percentage of
firms' stock held by foreign investors who are among the top ten shareholders).

of
Evolution of Foreign Shareholding In chinese Companies

24.00%
Foreign Presence Foreign Shareholding

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22.00%

20.00%

18.00%

16.00%

14.00%

12.00%

10.00%

8.00%

6.00%
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4.00%

2.00%
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0.00%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
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Table 1 Definition of the variables

Variable Name Variable definition

Foreign Presence Variables
Dforeign Dummy equals 1 if a firm has any foreign ownership among its top ten

of
shareholders, and 0 otherwise.
FrgnOwn The percentage of stock ownership of foreign investors who are among the
top ten shareholders.

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Performance Variables
ROA Company return on assets, i.e., net income/total assets
ROE Company return on equity, i.e., net income/shareholders’ equity
Tobin’s q (Market value of equity + book value of liabilities)/total assets
Governance Variables
Pnonfloat Ratio of the number of non-floating shares to total number of shares
outstanding.
Pct_statetop10

CEO_is_topdir
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Sum of stock ownership of state or state legal person who are among the
top ten shareholders.
Dummy taking value 1 if the CEO is either the chairman of the board of
directors, or the CEO is held by any director on the board, and 0
otherwise.
Pct_indptdir Percentage of independent directors relative to the size of the board of
directors.
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Pct_mg Percentage of shares held by senior managers.
Her2_10 Sum of squares of the percentages of shares held by the second largest to
the tenth largest shareholders.
Lnher2_10 The logarithm of the sum of squares of the percentages of shares held by
the second largest to the tenth largest shareholders.
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Dum_intl International presence (dummy equals 1 if a firm has B or H shares, and 0

otherwise)
Control Variables
Assets Book value of total assets
Mvequity Market value of equity
Lmvequity Logarithm of the market value of equity
BM Book-to-market ratio (book value of equity/market value of equity)
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Leverage Total liabilities/total assets

Exret Excess return (firm stock return – risk free rate)
Beta Firm beta estimated from the CAPM regression
Volatility Variance of residual terms from the CAPM regression

Dum02 Dummy equals 1 if an observation is from the period of 2002-2014, and 0

Dum05 otherwise.
Dummy equals 1 if an observation is from the period of 2005-2014, and 0
otherwise.

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Table 2 Summary Statistics

This table presents the number of observations, the mean, the standard deviation, the minimum and the maximum of
the specified variables for all the annual observations in our sample. The difference in the number of observations
for the variables is due to the missing observations. The sample period is from 1994 to 2014. ROA, ROE, Tobin’s q,
and BM are winsorized at the 1 and the 99 percentiles. See Table 1 for definitions of the variables. Unless specified
in percentage (%), variables are kept in their numerical values.

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Variable No. of Obs. Mean Std. Dev. Min Max
Dforeign 28,874 0.141 0.348 0 1
FrgnOwn (%) (for firms with foreign shareholders) 4,028 17.65 16.62 0.03 98.40
ROA 28,933 0.033 0.071 -0.339 0.206

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ROE 28,932 0.059 0.197 -1.164 0.782
Tobin’s q 28,682 2.518 1.725 0.892 11.308
Pnonfloat (%) 28,939 43.8 27.7 0 100
Pct_statetop10 (%) 28,821 25.1 25.7 0 97.0
CEO_is_topdir (%) 26,762 8.9 28.4 0 100
Pct_indptdir (%) 26,532 48.3 23.5 0 100
Pct_mg (%) 15,565 5.683 13.447 0 97.9
Lnher2_10
Dum_intl
Lassets (log (¥))
re- 28,821
37,052
28,982
-5.3
0.285
21.383
2.208
0.452
1.277
-21.142
0
10.842
-1.031
1
29.02
Lmvequity (log (¥)) 28,687 21.808 1.036 18.214 29.242
BM 28,683 0.387 0.261 -0.259 1.276
Leverage 28,980 0.473 0.244 0.049 1.606
lP
Exret (%) 35,571 0 5.4 -12 16.5
Beta 35,571 0.936 0.67 -0.909 3.031
Volatility 35,571 0.018 0.027 0.001 0.187
Dum02 37,052 0.809 0.393 0 1
Dum05 37,052 0.688 0.463 0 1
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Table 3 Correlation coefficients for selected variables

Variables Dum02 Dum05 Dum_intl Lnher2_10 CEOistopdir Pctindptdir Pct_mg Pctstatetop10 Lmvequity BM ROE Leverage Exret Beta Volatility

Dum02 1.000
Dum05 0.721*** 1.000
Dum_intl -0.006 0.023*** 1.000

Lnher2_10 0.125*** 0.138*** 0.076*** 1.000

CEO_is_topdir
Pct_indptdir

Pct_mg
Pct_statetop10
0.015**
0.803***

0.213***
0.001
0.032***
0.659***

0.290***
-0.128***
-0.008
-0.015**

-0.133***
0.097***
0.041***
0.125***

0.287***
-0.282***
1.000
0.050***

0.142***
-0.105***
re-1.000

0.280***
-0.141***
1.000
-0.384*** 1.000
Lmvequity 0.178*** 0.283*** 0.174*** 0.007 -0.050*** 0.114*** -0.012 0.170*** 1.000
BM 0.196*** 0.137*** 0.124*** -0.090*** -0.058*** 0.175*** -0.096*** 0.143*** -0.001 1.000

ROE -0.014** 0.031*** -0.004 0.024*** -0.009 0.027*** 0.068*** -0.013** 0.190*** -0.046*** 1.000
Leverage 0.075*** 0.037*** 0.075*** -0.082*** -0.022*** 0.033*** -0.327*** 0.137*** -0.039*** -0.032*** -0.135*** 1.000
lP
Exret 0.141*** 0.244*** 0.110*** 0.040*** 0.011* 0.072*** 0.082*** -0.052*** 0.304*** -0.331*** 0.092*** -0.006 1.000

Beta 0.079*** 0.027*** -0.019*** -0.035*** -0.028*** 0.017*** -0.055*** 0.066*** -0.066*** 0.141*** -0.037*** 0.060*** 0.000 1.000

Volatility 0.045*** 0.147*** 0.202*** 0.092*** 0.031*** 0.146*** 0.230*** -0.137*** 0.049*** -0.160*** 0.023*** -0.040*** 0.438*** 0.087*** 1.000

*** p<0.01, ** p<0.05, * p<0.1

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Table 4 Logit panel regressions of the variable Dforeign (the presence of foreign investors among the top ten shareholders) on
various explanatory variables. Chi2 is the value of the Chi-square statistic for the Wald test of global goodness-of-fit and p-value
(Chi2) is the corresponding probability for the Chi-square distribution with corresponding degree of freedom to exceed this value.
The sample period is from 1994 to 2014. See Table 1 for definitions of the variables.

L1 L2 L3 L4 L5

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Dum02 1.4810*** 1.4632*** 0.8410*** 1.1341***
[0.123] [0.131] [0.234] [0.189]
Dum05 1.3804*** 1.2515*** 1.7856*** 1.4916***
[0.095] [0.109] [0.160] [0.167]

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Dum_intl 5.2406*** 5.8494*** 6.6871*** 6.3614*** 5.9690***
[0.228] [0.267] [0.317] [0.330] [0.332]
Lnher2_10 0.2108*** 0.2449*** 0.2507*** 0.2634*** 0.2594***
[0.022] [0.023] [0.036] [0.037] [0.036]
CEO_is_topdir -0.3495* -0.2069 -0.2333
[0.179] [0.182] [0.183]
Pct_indptdir 0.6853* 2.8578***

Pct_mg
re- [0.362]
-0.0078
[0.006]
-0.0023
[0.007]
[0.242]
-0.0005
[0.007]
Pct_statetop10 0.172 -0.4776 -0.5260*
[0.295] [0.303] [0.296]
Lmvequity 0.6571*** 0.7610*** 0.9159***
lP
[0.047] [0.071] [0.071]
BM 0.1033 0.5478** 1.1558***
[0.159] [0.245] [0.240]
Leverage -0.0646 0.1708 0.5855*
[0.229] [0.340] [0.339]
Exret -4.9063*** -5.2899*** -4.5285***
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[0.723] [1.064] [1.074]

Beta 0.1442*** 0.0841 0.0587
[0.046] [0.064] [0.065]
Volatility 0.4391 0.6048 2.9265
[1.507] [2.224] [2.229]
Constant -5.7918*** -20.0120*** -5.8670*** -22.4483*** -25.6098***
[0.172] [1.070] [0.275] [1.631] [1.632]
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Observations 28,821 27,124 14,839 14,417 14,100

Number of Firms 2,699 2,578 2,196 2,125 2,111
chi2 1176 1241 671.1 668.1 616
p-value (Chi2) 0.0000 0.0000 0.0000 0.0000 0.0000
Standard errors in brackets
* , **, ***: Statistically significant at the 10%, 5% and 1% levels, respectively.

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Table 5 Tobit panel regressions of the variable FrgnOwn (proportion of shares held by foreign investors who are among the top
ten shareholders) on different variables. The Tobit regression is used with a left threshold of 0, meaning that all firm without
positive foreign shareholding for a given year is left-censored. The sample period is from 1994 to 2014. See Table 1 for
definitions of the variables.

T1 T2 T3 T4 T5

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Dum02 0.1021*** 0.0950*** 0.0576*** 0.0731***
[0.008] [0.008] [0.013] [0.010]
Dum05 0.0609*** 0.0412*** 0.0565*** 0.0337***
[0.006] [0.006] [0.008] [0.008]

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Dum_intl 0.3182*** 0.3339*** 0.3666*** 0.3262*** 0.3217***
[0.018] [0.020] [0.020] [0.020] [0.021]
Lnher2_10 0.0233*** 0.0241*** 0.0225*** 0.0226*** 0.0226***
[0.002] [0.002] [0.002] [0.002] [0.002]
CEO_is_topdir -0.0108 -0.0023 -0.0044
[0.010] [0.010] [0.010]
Pct_indptdir 0.0399** 0.1350***

Pct_mg
re- [0.020]
-0.0005
[0.000]
-0.0002
[0.000]
[0.013]
-0.0003
[0.000]
Pct_statetop10 -0.0403** -0.0731*** -0.0642***
[0.017] [0.017] [0.017]
Lmvequity 0.0448*** 0.0419*** 0.0468***
lP
[0.003] [0.004] [0.004]
BM 0.0267*** 0.0253* 0.0424***
[0.010] [0.013] [0.013]
Leverage 0.0027 0.0323* 0.0439**
[0.015] [0.019] [0.019]
Exret -0.3101*** -0.3323*** -0.3225***
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[0.045] [0.055] [0.056]

Beta 0.0118*** 0.0061* 0.0062*
[0.003] [0.003] [0.004]
Volatility -0.0132 0.0781 0.143
[0.096] [0.119] [0.120]
Constant -0.3879*** -1.3515*** -0.3284*** -1.2339*** -1.3384***
[0.012] [0.068] [0.015] [0.087] [0.084]
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Observations 28,821 27,124 14,839 14,417 14,100

Number of Firms 2,699 2,578 2,196 2,125 2,111
chi2 1048 1238 629.2 722.6 685.3
p-value (Chi2) 0.0000 0.0000 0.0000 0.0000 0.0000
Standard errors in brackets.
* , **, ***: Statistically significant at the 10%, 5% and 1% levels, respectively.

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Table 6 Firm performance and the proportion of foreign shareholding over the total number of shares outstanding. The Heckman
bias correction is used due to the selection of companies with foreign investors among the top ten shareholders. Panel A presents
the regression of interest, while Panel B shows the auxiliary Heckman Probit regression for the selection model, and panel C is
the correlation used to test the selection bias. FrgnOwn_sq is the square of FrgnOwn. See Table 1 for variable definitions.

ROA ROE Tobin’s q

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Panel A: Regression of Interest

FrgnOwn 0.0690*** 0.1690** 0.5592

[0.026] [0.068] [0.582]

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FrgnOwn_sq -0.1093* -0.3785** -2.0095
[0.062] [0.161] [1.387]
Lassets 0.0073*** 0.0180*** -0.5098***
[0.001] [0.002] [0.016]
Constant1 -0.1411*** -0.3591*** 13.6663***
[0.017] [0.044] [0.382]

Panel B: Heckman Selection Probit Regression

Dum02

Dum05
re-
0.5134***
[0.052]
0.5817***
0.5178***
[0.053]
0.5867***
0.5118***
[0.053]
0.5948***
[0.039] [0.039] [0.039]
Lnher2_10 0.1414*** 0.1417*** 0.1421***
[0.006] [0.006] [0.006]
lP
Dum_intl 2.1587*** 2.1583*** 2.1561***
[0.034] [0.034] [0.035]
Levarage -0.3631*** -0.4280*** -0.4496***
[0.057] [0.055] [0.055]
Exre -0.8229*** -0.7921*** -0.6757***
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[0.226] [0.226] [0.231]

Constant2 -1.4383*** -1.4155*** -1.4035***
[0.052] [0.052] [0.052]

Panel C:Test of Bias Selection

No. of Obs 27,125 27,124 27,129
Rho 0.1400 0.0871 -0.0506
P-value (Rho = 0)
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0.0000 0.0000 0.0000

Standard errors in brackets
* , **, ***: Statistically significant at the 10%, 5% and 1% levels, respectively.

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Table 7 Summary for the optimal level of foreign ownership (FrgnOwn) among top ten shareholders as estimated
in equation (2).

ROA ROE Tobin’s q

Panel A: FrgnOwn is measured as the percentage of large foreign shareholding over all shares outstanding

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B1 (Coefficient of FrgnOwn) 0.0690*** 0.1690** 0.5592
[0.026] [0.068] [0.582]
B2 (Coefficient of FrgnOwn_sq) -0.1093* -0.3785** -2.0095
[0.062] [0.161] [1.387]

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Optimal FrgnOwn 32% 22% 14%

Panel B: FrgnOwn is measured as the percentage of large foreign shareholding over total tradable shares
outstanding

B1 (Coefficient of FrgnOwn) 0.0577*** 0.1423*** 0.1254

[0.017] [0.044] [0.383]
B2 Coefficient of FrgnOwn_sq)

Optimal FrgnOwn
re-
-0.0753***
[0.026]
38%
-0.2137***
[0.068]
33%
-0.5391
[0.587]
12%
Standard errors in brackets
* , **, ***: Statistically significant at the 10%, 5% and 1% levels, respectively.
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Table 8 Firm performance and the proportion of foreign shareholding over the total number of shares outstanding. The Heckman
bias correction is used due to the selection of companies with foreign investors among the top ten shareholders. Panel A presents
the regression of interest, Panel B shows the auxiliary Heckman Probit regression for selection model, and Panel C is the correlation
use to test the presence of selection bias.

ROA ROE Tobin’s q

Panel A: Regression of Interest

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FrgnOwn 0.0218 0.0908 0.0539
[0.027] [0.071] [0.609]
FrgnOwn_sq -0.1520** -0.4487*** -2.4662*

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[0.063] [0.162] [1.395]
FrgnOwn × dum05 0.0781*** 0.1291*** 0.8356***
[0.014] [0.035] [0.304]
Lassets 0.0068*** 0.0172*** -0.5144***
[0.001] [0.002] [0.017]
Constant1 -0.1336*** -0.3461*** 13.7480***
[0.017] [0.044] [0.382]

Panel B: Heckman Selection Probit Regression

Dum02
re-
0.5116***
[0.052]
0.5173***
[0.053]
0.5129***
[0.053]
Dum05 0.5898*** 0.5899*** 0.5932***
[0.039] [0.039] [0.039]
Lnher2_10 0.1412*** 0.1416*** 0.1421***
lP
[0.006] [0.006] [0.006]
Dum_intl 2.1580*** 2.1581*** 2.1564***
[0.034] [0.034] [0.034]
Levarage -0.3549*** -0.4261*** -0.4489***
[0.057] [0.055] [0.055]
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Exret -0.8356*** -0.7979*** -0.6889***

[0.226] [0.226] [0.231]
Constant2 -1.4478*** -1.4188*** -1.4036***
[0.053] [0.052] [0.052]

Panel C:Test of Bias Selection

No. of Obs 27,125 27,124 27,129
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Rho 0.155 0.0963 -0.0433

P-value (Rho = 0) 0.0000 0.0000 0.0000
Standard errors in brackets
* , **, ***: Statistically significant at the 10%, 5% and 1% levels, respectively.

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Table 9 Summary for the optimal level of FrgnOwn among top ten shareholders as estimated in equation (2).
FrgnOwn is measured as the percentage of large foreign shareholding over all shares outstanding.

Sub-period ROA ROE Tobin’s q

Coefficient of FrgnOwn 0.0218 0.0908 0.0539
[0.027] [0.609]

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Coefficient of FrgnOwn _sq -0.1520** -2.4662*
[0.063] [0.162] [1.395]
Coefficient of FrgnOwn × dum0514 0.0781*** 0.1291*** 0.8356***
[0.014] [0.035] [0.304]

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Optimal FrgnOwn Pre-2005 7.17% 10.12% 1.09%
Post-2005 32.86% 24.50% 18.03%

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Author Statement Journal Pre-proof

Author Statement:

Foreign Shareholding, Corporate Governance and Firm Performance:

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Evidence from Chinese Companies

Georges Tsafack Lin Guo

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University of Rhode Island Suffolk University, Boston

We have a very collaborative work at any stage of the project and equally contribute to the
conception, methodology, analysis and writing of the paper.

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