Why Investors Should Watch the Tenure of Directors in Listed Chinese Companies

Investors considering A-share listed Chinese companies on the Chinese stock market would be wise to look at the tenure of a company’s board of directors before buying shares. A new research study co-authored by CEIBS Cathay Capital Chair in Accounting Professor Ding Yuan and Assistant Professor of Finance Zhang Hua shows that when independent directors at Chinese firms resign in the middle of their term or leave only after one term, it often signals trouble ahead. In addition, this performance decline is even more severe if firms are facing more uncertainty, such as financial distress, over leverage, or impending CEO turnover at the firm.

The study is one of the first to examine the relationship between the departure of independent directors and firm performance in an institutional environment such as China’s where, the majority of shares at most companies are controlled by only a few. China’s regulatory environment makes it a good research lab to study this relationship because all board seats are up for election every three years – unlike the US where a certain percentage of board seats are up for election every year. Another unique aspect of Chinese regulations is that an independent director can only serve in one listed company for a maximum of two three-year terms. This allows the researchers to see clearly when independent directors depart normally (after completing a total six years’ tenure) or abnormally (leaving some time before the six-year tenure has expired). The role of independent directors gives them preferential access to private information about the firm. If they have a sense that the firm is headed for financial difficulties, they know they face the likelihood of an increased workload, possible loss of reputation and even litigation risk. This makes them more likely to resign or leaver their directorship early, and the researchers found there was a statistically significant negative change in firm performance following such early departures by directors. The researchers also looked at data on subsequent firm performance when directors departed normally, after completing their six-year term. There was no negative change observed.

The results of the study appear in the paper titled “Jumping Off the Sinking Ship: Informativeness of the independent director departures in China’s listed companies”. Co-authoring the paper with Professors Ding Yuan and Zhang Hua are Anthea Yan Zhang of Rice University, who was recently a Visiting Professor at CEIBS, and Yongjian Shen of the School of Accounting, Nanjing University of Finance and Economics. The paper received the Best Paper Award from the European Institute for Advanced Studies in Management (EIASM) 11th Workshop on Corporate Governance.

Image courtesy of Renjith Krishnan at FreeDigitalPhotos.net