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Foreign Board Membership and Firm Value in Korea Hyang Mi Choi, Wonsik Sul, Sang Kee Min Paper

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Management Decision Emerald Article: Foreign board membership and firm value in Korea Hyang Mi Choi, Wonsik Sul, Sang Kee Min Article information: To cite this document: Hyang Mi Choi, Wonsik Sul, Sang Kee Min, (2012),”Foreign board membership and firm value in Korea”, Management Decision, Vol. 50 Iss: 2 pp. 207 – 233 Permanent link to this document: http://dx. doi. org/10. 1108/00251741211203533 Downloaded on: 18-11-2012 References: This document contains references to 72 other documents To copy this document: [email protected] com

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Foreign board membership and ? rm value in Korea Hyang Mi Choi College of Business Administration, Seoul National University, Seoul, Korea Foreign board membership 207 Wonsik Sul College of Economics and Business Administration, Sookmyung Women’s University, Seoul, Korea, and Sang Kee Min College of Business Administration, Seoul National University, Seoul, Korea Abstract Purpose – This paper seeks to explore such questions as: “What are the impacts of foreign investors and what are the channels through which foreign investors contribute to or detracts from ? m value in Korea? ” It aims to discuss how foreign investors and foreign outside directors interact to enhance ? rm value. Design/methodology/approach – Using longitudinal data from the KOSPI200 index in Korea during 2004-2007, the study examined the direct and interaction effect of foreign blockholders and foreign board members. To address the representativeness of foreign investors, the authors veri? ed the mandates of foreign board members though telephone interviews.

Findings – Foreign block shareholders and foreign outside directors respectively provide expertise and independent monitoring over management. Foreign blockholders’ management control via board membership is likely to mitigate leverage of value enhancement when foreign outside directors represent private interests of foreign blockholders. The moderating effect is also supported since foreign ownership concentration has an inverted U-shaped relationship with value enhancement. The paper con? rms that board independence reinforces the positive impact of foreign outside directors on ? m value. Research limitations/implications – This study offers a key to understanding corporate governance in that mutual monitoring and a balance among various types of stakeholders are crucial to value enhancement. Originality/value – The paper provides clues to the extant diverse ? ndings concerning the impact of foreign investors on ? rm value. It applies an integrated perspective to the empirical analyses of the impact of foreign investors by giving consideration to the agency – foreign outside directors – to implement management control on behalf of foreign blockholders.

Keywords Foreign ownership, Foreign board membership, Interaction effect, Firm value, Board independence, Boards, Korea, Economic value added Paper type Research paper 1. Introduction The process of globalization in corporate governance is well under way in Korea; foreign investment has been considerable during the years since the market opened to foreign investors to cope with the Asian ? nancial crisis in 1997. Ownership by foreign shareholders exceeded over 42 per cent of market value in 2004 and remained at 33 per cent in 2010 even in the aftermath of the subprime crisis (Korea Exchange, 2010).

The level of foreign ownership ranks ninth among the top 33 countries in the world and third among emerging economies (Financial Supervisory Service, 2007). Management Decision Vol. 50 No. 2, 2012 pp. 207-233 q Emerald Group Publishing Limited 0025-1747 DOI 10. 1108/00251741211203533 MD 50,2 208 In Korea, foreign blockholders – those who own more than 5 per cent of an individual ? rm – are not only investment providers but also unique monitors of ? rm management. Domestic institutional investors hold relatively little stock investment in their portfolios and they are not willing to provide control over the management.

Therefore, we focus on the independent internal governance embedded in ? rms by foreign block shareholders as objective supervisors. There are two ways in which foreign blockholders get involved in the governance structure. First, they may exercise their rights as principal shareholders since shareholders with 5 per cent ownership of a ? rm are entitled to rights such as the right to convene a general meeting (Commercial Act, Article 366), to inspect accounting records (Commercial Act, Article 466) and to inspect company affairs (Commercial Act, Article 467). Second, blockholders can exert their in? ence on board membership since they are entitled to the rights to nominate candidates for outside directors to be elected (Commercial Act, Articles 542) and to dismiss a director (Commercial Act, Article 385). Previous researches have made numerous attempts to identify the in? uence of foreign investors on ? rm value, yielding mixed results. Research on the relationship between foreign investors and ? rm value has suggested that foreign blockholders lead to more ef? cient management in terms of improving corporate governance (Sachs and Warner, 1995; Khanna and Palepu, 1999; Shin et al. 2004; Ahmadjian and Robbins, 2005;

Park and Lee, 2006; Kim and Eum, 2008). The role of foreign investors in the Korean economy, however, has been controversial since several cases of excessive payments of cash dividends and stock repurchases were made at the requests of foreign block investors. Foreign blockholders can have a signi? cant impact on a ? rm’s managerial decisions related to dividend policy (Sul and Kim, 2006; Koh and Kang, 2006). Yon and Park (2006) argue that foreign investors seek short-term performance since they demand high dividend payouts rather than plowing the pro? s back into the enterprises, impairing Korean ? rms’ potential growth opportunities as a result. Prior research on the management control of foreign blockholders in Korea has focused on the ownership ratio of foreign investors as principal shareholders, but how these investors participate in management when foreign ownership has the purpose of in? uencing management and corporate policy has not been fully addressed. When ? rm value varies depending on whether there is foreign block ownership, what are the channels through which foreign blockholders contribute to or detracts from ? m value? One of the channels foreign investors use as principal shareholders to control and monitor management is board membership, where foreign blockholders recommend foreign outside directors. Foreign outside directors have remained an uninvestigated contributor to ? rm value, but they should be taken into account if the true impact of foreign blockholders is to be understood because foreign outside directors are the agency that implements management control on behalf of foreign blockholders.

Foreign outside directors are considered to be relatively independent from majority shareholders since they are not part of the traditional domestic cronyism of regionalism, school relationships and kinship with majority shareholders. Therefore, foreign board membership is an important part of corporate governance, especially where the impact of foreign investors is increasing, as is the case in Korea. It has been more than ten years since the corporate governance reform subsequent to the Asian ? ancial crisis, so it is high time to sift out the true impact and implications of foreign blockholders in terms of their levels of ownership and their board membership. Under these research motivations, the current study performs an integrated analysis of corporate governance regarding foreign block investors and ? rm value. This study examines whether foreign block ownership and/or foreign board membership enhances ? rm value and whether foreign board membership moderates the relationship between foreign block ownership and ? m value. Our objective in this study is to examine the direct and moderating effects of foreign block shareholders and foreign outside directors using longitudinal data from the Korean KOSPI200 index covering 2004-2007. Korea is the epitome of drastically liberalized ? nancial markets as it sought to cope with the Asian liquidity crisis. In the meantime, foreign block investors are the largest equity providers, as well as unique and independent monitors over controlling shareholders. Global ? ancial integration is further being accelerated at present; emerging countries such as China, which have not completely opened their stock markets are about to face ? nancial liberalization. Therefore, Korea is an appropriate arena to observe and verify the impact of foreign block investors as substantial equity providers and independent outside monitors. This study investigates the impact of foreign blockholders by considering the agency that implements control on their behalf. This study’s evidence from Korea provides implications for emerging countries with ? ancial market openings ahead as it applies an integrated perspective to empirical analyses using longitudinal data in Korea, with its characteristic feature of foreign equity investors in a liberalized economy. In addition, this research lays the groundwork for further study by investigating the role of corporate governance in relation to foreign investors, which prior research regarding foreign ownership has not empirically established. This paper proceeds as follows. The next section reviews the literature on the impact of foreign ownership and develops hypotheses.

In section 3, we discuss the methodology and data of the statistical analysis, and we present the empirical results from panel regression, ordinary least squares (OLS) and three-stage least squares (3SLS) regressions in section 4. Section 5 provides a summary and a conclusion. 2. Literature review and hypothesis 2. 1 Korean stock market and foreign block investors The integration of ? nancial markets has attracted numerous investors to the Korean stock market of various nationalities. In addition, cross-border ? nancial ? ows are expanding rapidly through globalization (OECD, 2008).

Korea is the epitome of a rapidly integrated market since it experienced particularly drastic turbulence during the Asian ? nancial crisis of 1997-1998, which resulted in prompt and complete opening of the stock market to foreign investors in effort to cope with the liquidity crisis. From the small fraction of 4. 9 per cent shares held by foreign investors due to ownership restrictions in 1992, foreign ownership surged as a result, hitting a record high of 42 per cent in 2004 before falling to 33 per cent in 2010 in the aftermath of the subprime crisis (Korea Exchange, 2010).

As presented in Figure 1, Korea presently ranks eighth out of 135 countries in equity net in? ows (World Bank, 2009) and ranks third in terms of percentage ratio of foreign ownership over market capitalization among emerging economies (Financial Supervisory Service, 2007). In addition to their large equity ownership, foreign blockholders are not only equity providers to the Korean stock market, but also unique monitors of ? rm management. Foreign board membership 209 MD 50,2 210 Figure 1. Equity in? ws from foreign investors Large Korean business conglomerates, the so-called Chaebols – are characterized by the complete control of a “controlling minority” (Bebchuk et al. , 1999) in excess of their ownership stakes by pyramid, cross shareholding and circular investment. Frequently, in Korea, outside institutional investors are ? nancially af? liated with the companies in which they invest. Therefore, the disparity between the ownership rights and control rights of controlling shareholders reaches 32. per cent, which means that controlling shareholders have more control than ownership. Boards of directors are often assigned based on the recommendations of controlling shareholders, representing their interest, but also incurring interest misalignment between controlling shareholders and outside shareholders. Given the signi? cant presence of foreign investors in the Korean stock market, the ownership ratio of domestic institutional investors is relatively low and remains passive, as presented in Figure 2.

As of the end of 2009, a total of 359 foreign block investors announced their purchases and investment purposes whereas 160 domestic institutional investors reported their block purchases (Financial Supervisory Service, 2010). Domestic and foreign investors are dissimilar in that only 33 per cent of total block investments for the purpose of management control are made by domestic investors, while 67 per cent of total block investments are made by foreign blockholders for the purpose of controlling management (Financial Supervisory Service, 2010).

The inclinations of domestic institutional investors to exercise shareholder rights are distinguished from those of foreign investors to the extent that the Korean National Pension Service (NPS), the largest domestic institutional investor in the Korean stock market, is not an active shareholder, never attempting to invoke such rights as submitting shareholder proposals and recommending outside directors. The role of domestic institutional investors as outside monitors is limited and they remain passive, unless they exercise shareholder rights in favor of management (Choi and Cho, 2003).

In countries, where domestic sources of outside ? nancing are limited in globally integrated economies, foreign sources of outside ? nancing are increasingly crucial (Bekaert et al. , 2002). Moreover, foreign investors also affect ? rm governance indirectly as their decisions to buy or sell shares in particular Korean ? rms create an incentive for better governance to attract foreign capital because foreign investors prefer ? rms with better governance practices to secure better return on investment. In this regard, foreign block investors are unique monitors of ? m management in the Korean stock market, where domestic institutional investors and outside directors are not in the proper positions to supervise management and controlling shareholders in corporate governance. Therefore, we focus on the independent internal governance embedded in ? rms by foreign block shareholders as the largest outside shareholders and innate independent supervisors, versus controlling shareholders. Foreign board membership 211 Figure 2. Foreign investors in the Korean stock market MD 50,2 212 2. 2 Hypothesis Block shareholders are ef? cient monitors of management and enhance ? m value in many ways, including through exit, M&A threat and hostile takeover (Mikkelson and Ruback, 1985; Shleifer and Vishny, 1986; Barclay and Holderness, 1991). Domestic block shareholders in Korea, however, are not in a proper position to supervise management because they are ? nancially af? liated with the ? rm in many cases. Since 1998, when the restrictions on foreign ownership of companies on the Korean stock market were eliminated, foreign ownership has remained considerable. Therefore, we expect independent internal governance to be embedded in ? ms by foreign shareholders as objective supervisors instead of domestic block shareholders. Ahmadjian and Robbins (2005) suggest that foreign institutional investors play a critical role in diffusing their practices. Scholars have attempted to identify the relationship between foreign shareholders and ? rm value in the Korea. While Shin et al. (2004) and Park and Lee (2006) conclude that foreign blockholders lead to more ef? cient management through improvement of corporate governance, Yon and Park (2006) argue that the dividend payout ratio is positively related to foreign block wnership, resulting in the impairment of ? rm value. Since ownership and control have not been separated and domestic block shareholders are frequently af? liated with controlling shareholders in Korea, we expect that foreign block shareholders lead to more ef? cient management through independent monitoring. Foreign shareholders bear the liability of foreignness in terms of information accessibility, a handicap that results in their preference for the transparency and accountability of an improved corporate governance system.

A globalized governance structure improved by foreign block shareholders can play an important role in increasing the value of ? rms by improving the reputation of the ? rm in the market through signaling a departure from an ineffective controlling-shareholder system. Individual domestic investors have a tendency to follow foreign shareholders’ investment decisions because domestic investors consider foreign investment to be a signal of an increase in share prices since foreign shareholders can control management or exercise a threat of M&A to maximize their interests. Thus: H1.

There is a positive relationship between foreign block ownership and ? rm value. Given the separation of ownership and management, outside directors exist to represent and protect shareholders from inef? cient decision-making. Prior research has concluded that outside directors can serve as expert monitors of management, and that they have a positive relationship with performance (Kaplan and Reishus, 1990; Rosenstein and Wyatt, 1990; Byrd and Hickman, 1992; Beasley, 1996; Brickley et al. , 1997). On the other hand, other studies have suggested no association between the presence of outside directors and ? m performance (Agrawal and Knoeber, 1996; Yermack, 1997; Vafeas and Theodorou, 1998; Bhagat and Black, 2002; Hermalin and Weisbach, 2003). To enhance independent monitoring in corporate governance after the Asian ? nancial crisis, the law stipulated that outside directors should be included on boards of directors. However, ownership and management in Korea is not yet completely separate, so many ? rms are lacking monitors with expertise and independence. Kim (2006) argued that outside directors are relatively new in Korea, so they have no in? uence on ? m value except in the case of foreign outside directors. Furthermore, outside directors are frequently assigned through the recommendations of a majority shareholder. According to the research of the Korea Stock Exchange (2000), about 74 per cent of the recommendations of outside directors were made by controlling shareholders and 99 per cent of those recommendations met the board’s approval. Therefore, domestic outside directors in Korea are more likely to be so-called “gray outsiders,” who are closely related to controlling shareholders and lack monitoring incentive.

The effectiveness of outside directors introduced as a means of government efforts to keep management in check becomes dubious, given that roughly 90 per cent of outside directors at the top 100 ? rms support every issue submitted to the board according to data from the Financial Supervisory Service. Some boards of directors are likely to represent the interests of owner-managers, nullifying the incentive of independent monitoring over the management. Therefore, the presence of outside directors per se may not provide effective independent monitoring over the management of ? ms in Korea. Unlike domestic outside directors, foreign outside directors are not party to the kind of domestic cronyism that exists through regionalism, school relations and kinship with controlling shareholders. Therefore, they can be more independent; such independence from management and controlling shareholders is the core element that must be improved in Korean corporate governance. Foreign blockholders that intend to exert management control are able to exercise their shareholder rights in various ways, one of which is to recommend foreign outside directors on their behalf.

By contrast, other foreign blockholders choose different manners of exerting their rights, such as convening general meetings and inspecting corporate affairs. Approximately 12 per cent of foreign blockholders that intend to exert management control choose to recommend foreign outside directors on their behalf. Roughly 37 per cent of all the foreign block investors in Korea publicly disclose that they intend to participate in management (Financial Supervisory Service, 2010), while the rest are foreign block investors who invest for the purpose of portfolio investment, uninterested in direct control over management.

In this paper, we focus on foreign board membership as management participation by foreign blockholders. Monitoring ? rm management so as to prevent controlling shareholders from potential appropriations of outside shareholders is likely effectively performed by independent board membership. Effective monitoring also contributes to bettering the ? rm, enhancing balance between controlling shareholders and outside shareholders. In the meantime, voluntary efforts to enhance the expertise of the board of directors render recommendation committees to include foreign members on the board.

Despite the increased likelihood of additional costs, the rationale behind foreign board membership is to secure independence from managerial ties and if so, management decisions are likely to be made based on such experience or expertise. Oxelheim and Randoy (2003) argue that foreign board membership also signals stock markets as to a ? rm’s willingness to apply either an advanced governance structure or the expertise of foreign outside directors.

In this sense, foreign board membership is likely to effect independent monitoring over management and provide expertise that is missing in the managerial environment and thus, lead to value enhancement: H2. There is a positive relationship between foreign board membership and ? rm value. Foreign board membership 213 MD 50,2 214 Managers are self-interest-seeking, and ? rm value can be maximized when the ? rm is run on behalf of shareholders, rather than on behalf of mangers. It is through proper use of a governance system that shareholders are able to govern the ? rm in ways that increase ? rm value.

Foreign block shareholders are involved in management in various ways, one of which is to recommend outside directors. Empirical studies on the impact of outside monitors, including foreign blockholders and foreign outside directors, have argued that those foreign outside monitors enhance ? rm value through improved corporate governance (Oxelheim and Randoy, 2003; Shin et al. , 2004; Kim, 2006; Lee and Kim, 2009). However, the impact of foreign blockholders is conditional in that it depends on the purpose for their ownership. Foreign blockholders will have different levels of in? uence and degrees of nvolvement depending on the presence of foreign outside directors they recommend. Without proper representation of ownership in the board, the role of foreign ownership as an outside monitor on the governance system may be limited. Foreign board members are assumed to represent foreign blockholders and both foreign block ownership and foreign board membership can provide ? rms with global expertise and independent monitoring. Thus, the interaction between the two parties of corporate governance – foreign blockholders and foreign outside directors – is likely to reinforce their positive impact on ? m value, making the slope of the relationship even steeper than each does separately. Conversely, some previous studies have suggested that ownership and the market value of the ? rm have a signi? cant non-monotonic relationship (Morck et al. , 1988; McConnell and Servaes, 1990). Excessive concentration of ownership hurts corporate governance because of the entrenchment effect and private bene? t-seeking. Stulz (1988) and Wruck (1989) have also empirically shown that the relationship between ownership and performance has an inverted U-shape. When the mutual checks and balances are not in proper control, ? m value can be impaired since arm’s length supervision is an indispensable part of a sound corporate governance structure. Consequently, it could be the case that the more foreign outside directors there are representing foreign blockholders’ private interests, the more impaired the positive impact of foreign shareholders as independent monitors will be: H3-1. Foreign board membership positively moderates the relationship between foreign block ownership and ? rm value. H3-2. Foreign board membership negatively moderates the relationship between foreign block ownership and ? m value. Rosenstein and Wyatt (1990) concluded that outside directors served as independent monitors of management, and that such independence enhanced by outside directors has a positive relationship with ? rm value. Prior studies also provided evidences of the positive impact of board independence measured by outside directors on ? rm value (Kaplan and Reishus, 1990; Byrd and Hickman, 1992; Beasley, 1996; Brickley et al. , 1997). We expect that independence of board structure is a prerequisite for improving corporate governance.

Where board structure has not been established independent of management enough to enable foreign outside directors to exert their in? uences, including foreign outside directors may have a limited impact on corporate governance. Where the independence of board structure has been established to monitor the management, the role of foreign outside directors will be effectively ? lled. Thus, the impact on ? rm value of foreign board membership depends on board structure in terms of board independence. Board independence can enhance ? rm value to a greater extent when combined with the presence of foreign outside directors.

We expect that interaction between foreign board membership and board independence to have a positive relationship with ? rm value, and that board independence can serve as a positive moderator between foreign board membership and ? rm value: H4. Board independence positively moderates the relationship between foreign board membership and ? rm value. The research model is presented in Figure 3. 3. Methodology 3. 1 Sample The study uses a sample of ? rms in the Korean Exchange’s KOSPI200 index during 2004-2007, excluding companies in the ? nancial industries because of their divergent characteristics in terms of accounting principles and ? ancial attributes. The sample ? rms that comprise 896 observations in the data set over the four years are the constituent ? rms in the KOSPI200 index, with a combined value of $1 trillion as of July 2011. The KOSPI200 index is a market capitalization weighted index in which the ? rms are chosen from all issues listed on the Korean stock market, based on factors such as liquidity and how well they represent their industries and markets. The combined value of KOSPI200 index ? rms is approximately 88. 3 per cent of the market capitalization of the Korean stock market. We also use a separate sample of ? ms, not only the KOSPI200 index ? rms, but also all the ? rms listed on the Korean Exchange, excluding ? nancial companies. The empirical results of the latter sample are not presented here because the results are consistent with our ? ndings. In addition, we consider the KOSPI200 index constituents more appropriate for the study since foreign blockholders are attracted to sizable ? rms with enhanced liquidity and information access. The governance data for board membership and ownership were collected from annual reports and TS-2000 database which Korea Listed Companies Association (KLCA) provided.

Financial data were collected from KisValue and Financial Supervisory Service. Foreign board membership 215 Figure 3. Research model MD 50,2 216 To address the representativeness of foreign investors, we veri? ed the mandates of foreign board members by way of telephone interviews, in which 24 out of 29 ? rms with foreign board members veri? ed that those members had been recommended by foreign blockholders. Since information about some of the foreign board members’ recruitment was not available, the foreign ownership ratios before and after the appointment of foreign outside directors were compared using a paired t-test.

The result of the t-test shows signi? cantly higher ratios of foreign ownership subsequent to the public announcement of the appointment of foreign board members. 3. 2 Model speci? cation Drawing on previous research on corporate governance and ? rm value, the model includes independent variables and control variables that avoid model speci? cation errors in panel regression analyses. Corporate governance variables, such as foreign ownership, foreign board membership and board independence, are included in the panel regression model.

Panel regression analysis can control for omitted time-invariant variables that may bias observed relationships. We used panel regression analysis for the empirical studies of the relationship among foreign ownership, foreign board membership and ? rm value, as presented in equation (1): Tobin’s Qit ? b0 ? b1 F5it ? b2 FBMit ? b3 INTit ? b4 EXit ? b5 DEBTit ? b6 BETAit ? b7 DIVit ? b8 SIZEit ? b9 AGEit ? 1it ? 1? In equation (1), the independent variables of foreign block ownership (F5), foreign board membership (FBM), and the interaction effect (INT) are included.

We controlled for the ratio of excess outside directors (EX), the liability ratio (DEBT), ? rm beta (BETA), the dividend payout ratio (DIV), ? rm size (SIZE), and ? rm age (AGE). To select an appropriate estimator with panel data between OLS and the panel regression model, we carried out the Breusch-Pagan Lagrange multiplier test (Breusch and Pagan, 1979) to test the null hypothesis of homoscedastic disturbances. If the null hypothesis is rejected, the unobserved speci? c effects exist in favor of random effects or the ? xed effects model. We also performed a Hausman test in order to decide between the ? ed effects or the random effects model, where the null hypothesis was that the two estimates should not differ systematically. In other words, the covariance of an ef? cient estimator with its difference from an inef? cient estimator is zero, and these individual effects are uncorrelated with the other variables in the model. The null hypothesis was rejected with a Hausman test in all the analyses, so we used the ? xed effects as the model of choice. We additionally implemented OLS and 3SLS regression analyses to determine whether the results remained consistent. 3. 3 Variables We used Tobin’s Q as a proxy variable for ? m value. Tobin’s Q is measured as the ratio of the market value of a ? rm to the replacement cost of the ? rm asset. When a ? rm retains investment opportunities with a positive net present value or intangible assets, the market value of the ? rm is higher than the replacement value, leading to a high Tobin’s Q. Table I lists the de? nitions of the independent variables and control variables for this study. The independent variable, foreign block ownership (F5), is the percentage share of equity held by foreign investors in relation to total equity. The Amended 5 per cent Disclosure Rule of 2005 in Korea requires ? ms to provide information about external shareholders who own 5 per cent or more of the equity shares in issue. We limited foreign block shareholders to those who held 5 per cent or more of equity since they are considered to be independent monitors with expertise and willingness to control. We also used dummy variables for foreign ownership based on the percentage of block ownership for additional analyses: F5D was coded 1 if foreign investors owned 5 per cent or more of equity, and 0 otherwise. Foreign board membership (FBM) in H2 was coded 1 if there were foreign outside directors and 0 otherwise.

Other studies have found that a higher ratio of outside directors enhances the independence of board of directors (Beasley, 1996; Klein, 2002). We included board independence in order to separate outside directors’ impact on ? rm value. Securities Listing Regulations in 1998 required the boards of all companies listed on the Korea Exchange to have at least 25 per cent outside directors. Firms with assets of more than two trillion Korean won (KRW) are required to have at least 50 per cent of the board or three outside directors, whichever is more, on the board.

As a proxy of board independence, we measured the variable EX as the percentage of outside directors on the board in excess of the regulatory minimum criteria. We also used another dummy variable for board independence, coding EXD as 1 if excess outside directors were Foreign board membership 217 Variable Dependent variable Tobin’s Q Independent variables and control variables F5 F5D FBM INT EX EXD DEBT BETA DIV SIZE AGE De? nition [(The number of ordinary shares *stock price at the four year-ends) ? (the number of preferred shares *face value) ? ook value of total liabilities]/ book value of total assets Percentage of foreign block ownership with 5 per cent or more of the equity in issue A dummy variable that is coded 1 if foreign investors own 5 per cent or more of equity, and 0 otherwise A dummy variable that is coded 1 if a foreign outside director is present, and 0 otherwise Foreign block ownership *foreign board membership or foreign block ownership dummy *foreign board membership Ratio of the number of outside directors on the board in excess of the minimum criteria stipulated by law Dummy of outside directors on the board in excess of the minimum criteria stipulated by law Liability ratio ? otal liabilities/total assets Measure of volatility in comparison to the market movement Dividend payout ratio as a percentage of dividends/company earnings at the four year-ends Firm size variable, measured as Ln (total assets) Firm age variable, measured as Ln (number of years since incorporation) Table I. De? nition of variables MD 50,2 218 present, and 0 otherwise. The more outside directors that are on the board, the more power they are likely to have to prevent unfair decision-making by majority shareholders and managers. Since board independence is greater when the outside directors are in excess of the regulatory minimum, we expect board independence to have a positive relationship with ? rm value.

We measured the liability ratio as the ratio of total liabilities to total assets. Liabilities decrease the agency costs because liability deters additional investment in ? rms that have low growth opportunities (Lang et al. , 1996). In addition, ? rm value can be signi? cantly affected by corporate tax reduction (Modigliani and Miller, 1963), so we expected this control variable to be positive. The tax hypothesis argues that ? rm value is negatively related to dividends (Elton and Gruber, 1970), while the signaling theory argues that an increase in the dividend acts as a signal of an increase in ? rm value (Bhattacharya, 1979; John and Williams, 1985).

We used a variable for dividend payout ratio to control for the possible relationship between dividends and ? rm value. We used total assets as a proxy variable for ? rm size; total assets were derived by taking the natural logarithm of total assets for the four year-ends because the size of total assets is not normally distributed. We measured ? rm age as the number of years since incorporation using a form of natural logarithm. 4. Empirical ? ndings 4. 1 Descriptive statistics Table II presents the descriptive statistics of the variables used in this study and provides the mean, standard deviation, minimum and maximum of the variables. The mean value of foreign block ownership of the ? ms with no foreign outside directors is 6. 11 per cent, whereas the mean value of foreign ownership of the ? rms with foreign outside directors is 25. 51 per cent. This result suggests that ? rms with a high ratio of foreign block ownership are likely to have foreign outside directors. In the KOSPI200 index during the sample period, 46 per cent of the ? rms had one or more foreign block shareholders and 29 ? rms had one or more foreign outside directors. There were 88 foreign outside directors in the pooled data, while 65 ? rm-year observations had foreign board members. About 16 per cent of the sample ? rms had more outside directors than the minimum required by law.

Among the control variables, the average liability ratio to total assets is about 42 per cent, indicating that the liability ratio after the Asian ? nancial crisis decreased. The mean value of dividend payout ratios in the ? rms with foreign outside directors is 49 per cent, which is higher than that of the ? rms without foreign outside directors. The correlations matrix shown in Table III indicates that governance factors like foreign block ownership and board independence are signi? cantly correlated with Tobin’s Q at the 5 per cent level. Either foreign block ownership or foreign block ownership dummy is included in the regression model so the high correlation between the two variables does not lead to adverse effects.

There is a high correlation between foreign board membership and foreign block ownership, suggesting that the presence of foreign outside directors may be related to the presence of foreign block shareholders. In order to detect multicollinearity, we carried out a diagnostic of variance in? ation factor (VIF), but none of the VIFs of the variables reached the threshold, indicating the absence of serious multicollinearity. Variables 0. 66 12. 98 0. 50 0. 26 0. 20 0. 37 0. 19 57. 72 1. 51 0. 69 0. 19 0. 00 0. 00 0. 00 0. 00 0. 00 0. 02 0. 00 23. 42 0. 00 9. 68 82. 21 1. 00 1. 00 1. 50 1. 00 0. 93 1,454 31. 82 4. 70 1. 21 6. 11 0. 44 0. 00 0. 08 0. 16 0. 43 23. 88 27. 21 3. 43 831 0. 67 9. 24 0. 50 0. 00 0. 21 0. 36 0. 19 32. 75 1. 46 0. 70 0. 30 0. 00 0. 00 0. 00 0. 00 0. 00 0. 2 0. 00 23. 42 0. 00 9. 68 73. 85 1. 00 0. 00 1. 50 1. 00 0. 93 373. 4 31. 82 4. 70 1. 29 25. 51 0. 75 1. 00 0. 04 0. 18 0. 39 49. 40 28. 04 3. 57 65 Mean SD Total Min Max 0. 61 29. 94 0. 43 0. 00 0. 09 0. 39 0. 21 179. 1 1. 83 0. 36 Foreign board membership ? 0 Mean SD Min Max Foreign board membership ? 1 Mean SD Min Max 0. 19 0. 00 0. 00 1. 00 0. 00 0. 00 0. 09 0. 00 25. 05 2. 83 3. 08 82. 21 1. 00 1. 00 0. 50 1. 00 0. 78 1,454 31. 81 4. 30 Tobin’s Q F5 F5D FBM EX EXD DEBT DIV SIZE AGE No. of obs. 1. 21 7. 51 0. 46 0. 07 0. 08 0. 16 0. 42 25. 73 27. 27 3. 44 896 Foreign board membership 219 Table II. Descriptive statistics MD 50,2 220 Variable

Tobin’s Q F5 F5D FBM EX EXD DEBT DIV SIZE AGE 1 0. 625 * 0. 388 * 20. 063 20. 044 20. 120 * 0. 191 * 0. 024 20. 002 1 0. 164 * 20. 022 0. 006 20. 043 0. 033 0. 193 * 20. 004 1 20. 052 0. 019 20. 050 0. 115 * 0. 143 * 0. 055 1 0. 857 * 0. 175 * 2 0. 012 0. 082 2 0. 086 * 1 0. 192 * 0. 007 0. 225 * 2 0. 059 Note: *p , 0. 05 Table III. Correlation matrix 2 3 4 5 6 7 8 9 10 1 20. 071 0. 298 * 20. 074 1 0. 034 20. 023 1 0. 045 1 1 1 0. 086 * 0. 102 * 0. 026 0. 162 * 0. 137 * 0. 077 2 0. 049 0. 055 2 0. 205 * 4. 2 Regression results The estimates of panel regression and OLS analyses with regard to H1, H2 and H3 are shown in Tables IV and V. Based on the Hausman test statistics, we chose the ? ed effects model to examine the estimates. Both foreign block ownership and foreign board membership are positively related to ? rm value in line with H1 and H2, suggesting that foreign block shareholders and foreign outside directors both play a role as independent outside monitors in corporate governance. When there is no foreign outside director, an increase in foreign ownership can enhance ? rm value because of the improved governance that results from instilling a globalized governance system into the ? rm and the independent monitoring of domestic majority shareholders. When there are no foreign block shareholders, foreign outside directors also enhance ? m value by monitoring domestic majority shareholders and providing an alternative way of globalizing corporate governance. The inclusion of foreign outside directors signals that the ? rm is willing to improve its governance, so foreign board membership can replace the role of foreign ownership, resulting in value enhancement when there are no foreign block shareholders. Hence, foreign outside monitors respectively contribute to value enhancement. Figure 4 plots the impact of independent variables including the interaction term. The impact of foreign block ownership on ? rm value varies depending on the presence or absence of foreign board membership.

The joint effect of foreign ownership and board membership is smaller than the sum of the two, supporting H3-2 that the interaction effect with foreign board membership moderates the positive impact of foreign ownership on ? rm value. It is possible that foreign block shareholders do not necessarily guarantee the enhancement of ? rm value in proportion to their level of ownership, especially when they appoint board members to serve on their own behalf. Foreign shareholders are incented to monitor majority shareholders and management, but increased concentration of foreign ownership with board members on their own behalf is likely to promote entrenchment and the search for private bene? ts of control at the expense of minority shareholders.

Foreign investors may take advantage of their controlling power as their level of ownership increases and foreign board membership, as a mandate of foreign blockholders, enables them to increase their control. Therefore, the bene? t of including foreign ownership in internal governance is mitigated when it is combined with foreign board membership, especially when the ownership level is high enough to allow for the exercise of control. The value of a ? rm results not only from a globalized governance system with expertise and independence from majority shareholders, but also from independent supervision and a monitoring system that is concerned with a variety of stakeholders’ interests.

The implication is that, although the globalization of the internal governance system contributes to ? rm value, the mutual control and balances among various stakeholders are more important to ? rm value. In this regards, board independence has a signi? cantly positive relationship with Tobin’s Q, suggesting that the independence enhanced by outside directors is a factor in improving ? rm value. The liability ratio also has a positive impact on ? rm valuation. In order to check robustness, we also implemented a three-stage least squares (3SLS) regression. A higher ? rm value could be the result of the impact of foreign board members, but a higher ? rm value could also in? ence foreign board members’ decisions. The composition of the board may be endogenously determined through the Foreign board membership 221 MD 50,2 222 DV: Tobin’s Q 1. 355 0. 080 * 1. 867 0. 144 * 1. 755 2. 578 2. 029 0. 661 2 1. 483 2 0. 196 2 6. 733 4. 585 2. 557 2. 023 0. 719 2 1. 528 2 0. 013 2 6. 640 4. 389 2. 543 2. 051 0. 780 2 1. 336 2 0. 345 2 6. 616 4. 615 0. 005 * F5 F5D FBM INT EX DEBT BETA DIV SIZE AGE Constant n Adj. R 2 F-statistic Hausman statistic 0. 269 * * 0. 250 * * 0. 053 20. 000 20. 005 20. 203 * * * 1. 859 * * * 896 0. 063 10. 08 * * * 48. 33 * * * 0. 273 * * 0. 247 * * 0. 045 20. 001 20. 003 20. 207 * * * 1. 844 * * * 896 0. 073 10. 2 * * * 48. 10 * * * Notes: *p , 0:10; * *p , 0:05; * * *p , 0:01 Table IV. Regression estimates of the impact of foreign block ownership, foreign board membership and their interaction effect on ? rm value – panel regression analyses n Model (1) t-statistics n n n Model (2) t-statistics Model (3) t-statistics Model (4) t-statistics 1. 918 2. 066 2 2. 361 3. 642 n Model (5) t-statistics 0. 005 * * 2. 129 0. 223 * * 20. 009 * * 0. 389 * * * 1. 149 * * * 896 0. 014 4. 85 * * * 50. 89 * * * 40. 801 0. 264 * * 20. 008 * * 0. 284 * * * 0. 264 * * 0. 051 20. 000 20. 008 20. 207 * * * 1. 931 * * * 896 0. 067 8. 51 * * * 48. 21 * * 2. 455 2 2. 355 2. 681 2. 63 0. 751 2 1. 155 2 0. 515 2 6. 737 4. 780 0. 002 0. 271 * * 0. 247 * * 0. 049 20. 001 20. 000 20. 204 * * * 1. 749 * * * 896 0. 072 9. 83 * * * 48. 26 * * * DV: Tobin’s Q 1. 306 1. 806 1. 992 2 2. 254 3. 319 0. 080 * 1. 814 0. 149 * 1. 767 2. 259 2. 280 0. 618 2 1. 355 2 0. 460 2 6. 863 4. 800 1. 152 * * * 896 0. 014 4. 17 * * * 50. 89 * * * 2. 234 2. 273 0. 663 2 1. 390 2 0. 274 2 6. 773 4. 605 2. 219 2. 305 0. 713 2 1. 205 2 0. 590 2 6. 752 4. 820 0. 221 * * 20. 008 * * 0. 364 * * * 0. 004 * n Model (6) t-statistics n n n n 0. 005 * * Model (7) t-statistics Model (8) t-statistics Model (9) t-statistics Model (10) t-statistics 2. 066 0. 002

F5 F5D FBM INT EX DEBT BETA DIV SIZE AGE Constant n Adj. R 2 F-statistic Hausman statistic 0. 241 * * 0. 287 * * 0. 047 20. 000 20. 009 20. 213 * * * 1. 991 * * * 896 0. 066 10. 09 * * * 48. 33 * * * 0. 245 * * 0. 284 * * 0. 041 20. 001 20. 007 20. 216 * * * 1. 979 * * * 896 0. 066 10. 06 * * * 48. 10 * * * 39. 812 0. 243 * * 0. 284 * * 0. 044 20. 001 20. 004 20. 213 * * * 1. 881 * * * 896 0. 065 9. 84 * * * 48. 26 * * * 0. 273 * * 20. 009 * * 0. 256 * * 0. 302 * * 0. 044 20. 000 20. 012 20. 216 * * * 2. 069 * * * 896 0. 070 8. 52 * * * 48. 21 * * * 2. 467 2 2. 328 2. 358 2. 424 0. 656 2 1. 026 2 0. 767 2 6. 879 4. 995 Notes: *p , 0:10; * *p , 0:05; * * *p , 0:01 Foreign board membership Table V.

Regression estimates of the impact of foreign block ownership, foreign board membership and their interaction effect on ? rm value – OLS analyses 223 MD 50,2 224 Figure 4. Interaction effect between foreign block ownership and foreign board membership on ? rm value in? uence of ? rm value, so there may be an endogeneity problem between foreign board membership and ? rm value. A primary advantage of 3SLS regression is the ability to address the possible endogeneity problem. We added foreign listing (LIST), number of outside directors (NOD) and a conglomerate dummy (CONGLO) to predict foreign board membership. The empirical result presented in Table VI suggests that ? rm value does not signi? cantly in? ence potential foreign board members’ decisions. The result also shows that the impact of foreign ownership, foreign board membership and their interaction effect remains consistent with and as robust as in earlier empirical ? ndings. With regard to H4, the interaction between board independence and foreign board membership, shows a signi? cant positive relationship with ? rm value as presented in Table VII. Board independence enhances ? rm value to a greater extent when combined with the presence of foreign outside directors. In other words, board independence is an essential prerequisite for foreign outside directors to be able to supervise management adequately.

When board structure is not independent from majority shareholders or management, foreign outside directors are limited in their ability to contribute to ? rm value as independent outside monitors. Therefore, board independence serves as a signi? cant positive moderator between foreign board membership and ? rm value (see Figure 5). 4. 3 Further analyses To address the empirical results regarding the interaction effect in H3-2, we performed additional analyses to empirically test the proposition that the negative interaction effect is related to increased ownership concentration. We carried out additional empirical tests to determine whether there are entrenchment effects and private SLS regression analysis Dependent variable Tobin’s Q F5 FBM INT EX DEBT BETA DIV SIZE AGE NOD LIST CONGLO Constant n R2 x2 First stage FBM model (11) n t-statistics 22. 188 0. 012 * * 0. 221 0. 725 * 20. 059 20. 448 0. 076 0. 480 * * 0. 023 5. 254 896 228. 9531 97. 56 * * * 21. 620 2. 420 0. 778 1. 805 20. 521 21. 605 1. 105 2. 059 0. 066 1. 025 Second stage Tobin’s Q model (12) n t-statistics 0. 009 * * * 1. 026 * * 20. 027 * * * 0. 291 * * * 0. 377 * * * 20. 004 0. 000 20. 031 20. 225 * * * 3. 471 1. 993 2 2. 724 2. 586 2. 940 2 0. 190 0. 780 2 1. 505 2 6. 872 Foreign board membership 225 2. 552 * * * 896 0. 0279 89. 34 * * * 4. 706 Notes: *p , 0. 10, * *p , 0. 5, * * *p , 0. 01 Table VI. The estimates of a three-stage least squares regression of the impact of foreign block ownership, foreign board membership and their interaction effect on ? rm value interest-seeking based on the ownership concentration of foreign blockholders. We added a new variable for foreign block ownership squared (F5SQ) to test whether an increase in foreign ownership enhances ? rm value to some point, after which ? rm value declines. Table VIII shows a signi? cantly positive relationship between foreign block ownership and ? rm value and a signi? cantly negative relationship between foreign ownership squared and ? rm value.

Previous studies have found little agreement concerning the effect of foreign block ownership on value enhancement. We ? nd that ? rm value is not necessarily enhanced in proportion to foreign block ownership but that the relationship takes an inverted U-shape. The in? uence of foreign block ownership contribute to enhancing corporate governance through independent monitoring and expertise only when foreign investors are incented to provide such monitoring and expertise, but foreign ownership impairs corporate governance when it rises to a level of concentrated ownership, with its attendant control of board members as representatives of the foreign investors. As a result, concentrated foreign ownership can damage ? m value when the foreign block shareholders have controlling power to seek private bene? t, such as short-term pro? t and high dividends. 5. Conclusion The impact of increasing numbers of foreign investors on ? rm value has not yet been determined. While some researchers have concluded that foreign shareholders improve corporate governance resulting in increased ? rm value, others have argued that foreign block ownership reduces ? rm value because of requests for excessive payments of dividends and pressure in favor of short-term pro? tability. This study provides some MD 50,2 226 DV: Tobin’s Q 0. 236 * 1. 954 2. 542 0. 929 0. 162 * * * 0. 365 * 0. 008 0. 169 1. 13 0. 035 * * 0. 077 EX EXD INT FBM F5 DEBT BETA DIV SIZE AGE Constant n adj. R 2 F-statistic Hausman statistic 49. 702 0. 027 * 0. 117 0. 001 0. 242 * * 0. 054 2 0. 001 2 -0. 006 2 0. 202 * * * 1. 899 * * * 896 0. 065 8. 30 * * * 49. 21 * * * 1. 940 1. 329 0. 417 1. 980 0. 789 2 1. 553 2 0. 393 2 6. 549 4. 704 1. 182 * * * 896 0. 009 4. 85 * * * 51. 85 * * * Notes: *p , 0. 10, * *p , 0. 05, * * *p , 0. 01 Table VII. Panel regression estimates of the interaction effect between foreign board membership and board independence on ? rm value Model (13) n t-statistics Panel regression analyses Model (14) Model (15) n t-statistics n t-statistics 2. 55 1. 706 0. 093 n Model (16) t-statistics 48. 733 0. 114 * 0. 429 * * 0. 031 0. 001 0. 276 * * 0. 064 2 0. 001 2 0. 013 2 0. 207 * * * 2. 074 * * * 896 0. 065 8. 27 * * * 49. 32 * * * 1. 860 2. 034 0. 323 0. 836 2. 255 0. 935 2 1. 563 2 0. 809 2 6. 744 5. 056 1. 177 * * * 896 0. 016 6. 70 * * * 52. 00 * * * Foreign board membership 227 Figure 5. Interaction effect between board independence and foreign board membership on ? rm value clues to the extant diverse ? ndings concerning the impact of foreign investors on ? rm value. The present paper examines the impact of foreign block ownership and foreign board membership as well as the interaction ffect when foreign blockholders install foreign board members on their behalf. We also investigate the interaction effect between board independence and foreign board membership. The ? ndings are as follows. First, we ? nd that foreign ownership is positively related to ? rm value, suggesting that an increase in foreign ownership can enhance ? rm value due to independent monitoring over controlling shareholders. Second, foreign outside directors enhance ? rm value when there is limited foreign ownership. The inclusion of foreign outside directors signals that the ? rm is willing to break managerial ties with controlling shareholders and improve its board independence and expertise.

Therefore, foreign board membership can replace the role of foreign blockholders, resulting in value enhancement when there are no foreign blockholders. Third, these enhanced bene? ts are mitigated when foreign outside directors represent the private interests of foreign investors. We also ? nd that ? rm value is not necessarily enhanced in proportion to foreign block ownership but rather that the relationship takes an inverted U-shape. Foreign block ownership contributes to enhancing ? rm value through independent monitoring and expertise only when foreign investors are incented to do so; foreign ownership impairs ? rm value when it rises to a level of concentrated ownership, with its attendant control of board members as representatives of the foreign investors.

Fourth, the interaction between board independence and foreign board membership shows a signi? cantly positive relationship with ? rm value, suggesting that board independence is an essential prerequisite for foreign outside directors’ ability to supervise management adequately. Without board independence MD 50,2 228 DV: Tobin’s Q 2. 001 2 2. 041 1. 390 3. 587 0. 192 * * * 0. 007 * 2 0. 000 * 0. 162 * 0. 279 * * * 1. 854 2 1. 699 1. 760 2. 633 0. 007 * 2 0. 000 * * 0. 106 F5 F5SQ FBM EX EXD DEBT BETA DIV SIZE AGE Constant n Adj. R 2 F-statistic H-statistic 39. 642 0. 257 * * 0. 051 2 0. 000 2 0. 007 2 0. 205 * * * 1. 904 * * * 896 0. 065 8. 19 * * * 48. 09 * * * 2. 102 0. 747 2 1. 248 2 0. 449 2 6. 657 4. 705 1. 148 * * * 896 0. 10 3. 95 * * * 51. 23 * * * Notes: *p , 0. 10, * *p , 0. 05, * * *p , 0. 01 Table VIII. Panel regression estimates of the impact of foreign ownership concentration on ? rm value Model (17) n t-statistics Panel regression analyses Model (18) Model (19) n t-statistics n t-statistics 1. 955 2 1. 979 1. 144 3. 271 n Model (20) t-statistics 0. 007 * 2 0. 000 * 0. 150 1. 862 2 1. 698 1. 638 39. 252 0. 149 * * 0. 262 * * 0. 057 2 0. 000 2 0. 012 2 0. 206 * * * 2. 046 * * * 896 0. 064 8. 12 * * * 48. 44 * * * 2. 517 2. 144 0. 837 2 1. 266 2 0. 786 2 6. 707 4. 994 0. 007 * * 20. 000 * * 0. 129 0. 383 * * * 1. 148 * * * 896 0. 012 4. 49 * * * 50. 69 * * * stablished, foreign outside directors are limited in their ability to contribute to ? rm value as independent outside monitors. Korea is the epitome of drastically liberalized ? nancial markets as it sought to cope with the Asian liquidity crisis. In the meantime, foreign block investors are the largest equity providers, as well as unique and independent monitors over controlling shareholders. This study investigates the impact of foreign blockholders by considering the agency that implements control on their behalf. Global ? nancial integration is further being accelerated at present; emerging countries such as China, which have not completely opened their stock markets are about to face ? nancial liberalization.

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He holds a doctoral degree in International Finance and International Business from Seoul National University. He also holds a BA and MA in Business Administration from Seoul National University. His articles have been published in journals including R&D Management, Journal of Financial Management and Analysis, Asia-Paci? c Journal of Financial Studies, Journal of Asian Economics and Journal of Korea Trade. His research interests are in investment, banking and risk management. Wonsik Sul is the corresponding author and can be contacted at: [email protected] ac. kr Sang Kee Min is a Professor of International Finance at Seoul National University, Korea.

He received his doctorate in International Business from the University of Michigan, Ann Arbor, USA, and an MBA from Asian Institute of Management, Philippines. He also serves as Chairman of the Public Funds Oversight Committee in Korea. His articles have been published in journals including Korean Journal of Futures and Options, Korean Journal of Financial Studies and Journal of Korea Trade. His research interests are in foreign exchange risk management, investment and banking. Foreign board membership 233 To purchase reprints of this article please e-mail: [email protected] com Or visit our web site for further details: www. emeraldinsight. com/reprints

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