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Corporate governance structure, managerial discretion, and the R&D investment in China
International Review of Economics and Finance 19 (2010) 180–188
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International Review of Economics and Finance j o u r n a l h o m e p a g e : w w w. e l s e v i e r. c o m / l o c a t e / i r e f
Corporate governance structure, managerial discretion, and the R&D investment in China☆ Jing Dong a,⁎, Yan-nan Gou b,1 a b
School of International Business Administration, Shanghai University of Finance and Economics, 777 Guo-ding Road, Shanghai 200433, China School of International Relations and Public Affairs, Fudan University, 220 Han-dan Road, Shanghai 200433, China
a r t i c l e
i n f o
Article history: Received 12 March 2009 Accepted 17 July 2009 Available online 13 October 2009 JEL classification: G34
Keywords: R&D investment Managerial discretion Corporate governance China
a b s t r a c t This article studies the influence of corporate governance factors on firm R&D investment in a transitional economy like China. By using the data from the listed companies in China, this article statistically tests the hypotheses on the relations between corporate R&D intensity and managerial discretion of CEOs, independent outside directors, degree of share concentration, share held by the state, and share held by a manager. According to the results, the managerial discretion of CEOs has a significant and negative correlation with the firm R&D investment. The number of the independent outside directors in the board has a positive influence on the R&D investment. And as the shares held by a manager increase, the firm R&D intensity will decrease at first, and then increase along an inverted parabolic curve. All these findings show that the improvement of corporate governance and stock incentive plan, and the cultivation of active and long-term stock investors, may finally lead to the upgrade of corporate innovation capabilities. © 2009 Elsevier Inc. All rights reserved.
1. Introduction Studies show that R&D and technological capabilities are the key sources of growth and competitive edge for firms and industries. In recent years, the central government of China has been consistently emphasizing the importance of technology development in the manufacturing sector and viewing technology development as an engine for the process of catching up with advanced industrial economies and industrialization. It is believed that over the long-term, China's economic performance will ultimately depend upon its ability to acquire, adapt, and create new technologies (Guo, 2008). One of the main goals of China's 11th Five-Year Program (2006–2010) adopted in 2006 is “scientific development” and a determined emphasis to encourage “an innovation-oriented nation” (Dobson & Safarian, 2008). China's recently announced “Medium to Long Term Science and Technology Development Plan, 2006–2020” has two bold aims: one is to raise R&D intensity to the current OECD average by 2020 (increasing spending as a share of GDP from 1.3% to 2.5%); another is “to reduce sharply reliance on imported technology, obtain advanced core technologies in the equipment manufacturing, the information industry, and so on” (Government of the People's Republic of China, 2006). To achieve the innovation and technology-based development, the governments of China issue regulations and policies to encourage innovation and technology investment. For example, the technology development expenditure of a company could be ☆ This study is supported by the Leading Academic Discipline Program-211 Project for Shanghai University of Finance and Economics (the 3rd phase). And the first draft of this paper was presented in the IX International Academic Conference “Modernization of Economy and Globalization,” Moscow, April 2008. The authors thank the anonymous referee for comments that significantly improved this manuscript. The authors also thank Ming Yu and Xian-hui Tang for help in collecting and processing the data. ⁎ Corresponding author. Tel.: +86 1381 8217 061; fax: +86 21 6511 2354. E-mail addresses: [email protected] (J. Dong), [email protected] (Y. Gou). 1 Tel: +86 1350 1996 823. 1059-0560/$ – see front matter © 2009 Elsevier Inc. All rights reserved. doi:10.1016/j.iref.2009.10.001
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calculated as 150% of the real spending in tax deduction. For instruments and equipments purchased for R&D activities, companies could employ accelerated depreciation. High-tech startups in the national high-tech industrial development zones could enjoy 2year tax-exemption and a 15% income tax rate from the third year (Ministry of Finance People's Republic of China, 2006). There are also direct subsidies from the governments to high-tech companies and specific R&D projects under the names of Star-fire Plan, Torch Plan, and etc. Enterprises are the main body in pursuing innovation and technology development. How do Chinese companies make their innovation and R&D investment decisions? Scholars study the influence of external environment on company's innovation activities. Dobson and Safarian (2008) interview 11 high-tech companies in Zhejiang province and find the increasing competitive pressure on firms that encourages learning. Intense product competition and demanding customers encourage rising R&D spending and the development of new products and processes, imitation of competitors, linkages with foreigners and local research institutions. With rising flows of FDI technology import, and the capacity to absorb foreign technology, Chinese domestic companies increasingly gain access to the international knowledge base, which is elevating the productivity of domestic R&D labor, and encouraging companies to pursue innovation. Gao and Jefferson (2007) argue that once the take-off economy has integrated with the international economy, its knowledge frontier converges to that of the advanced economies and grows at the same rate as that of the other advanced economies. But Zhu, Xu, and Lundin (2006) report the effect of government's direct funding is somehow ambiguous. This ambiguity may also reveal risk aversion in industrial sector's investment behavior. In other words, when both technical and market risks are high, the government support may not be sufficient enough to stimulate investments in industrial sectors. Hout (2006) also argues that the incentive structure for technology-based innovation is shaped by firms in the private sector responding to market forces, not government policies and funding. As for how technological advance occurs in the modern world, Nelson (1993) stresses the significance of institutions involved in industrial innovation. The institutions are not only regulations, policies, markets, and networks in a company's external environment, but also institutions inside of a company, especially corporate governance structure. We argue that the corporate governance structure, including the top management, the board, and the structure of the shareholders, plays an important role on R&D investment decision. In general, R&D activities are quite long-term with a low rate in success. The success of R&D projects usually will lead to a large profit, but the risk is also very high. So investment in R&D is high return together with high risk (Millet-Reyes, 2004). In face of the features of R&D, inevitably conflicts exist between the managers and the investors on the R&D investment decisions, because of the different interests from each side. Studies find managers usually would not like to invest in R&D projects. For the reason that a manager's salary depends on the performance of the company, if the high-risk R&D investment fails, it will bring trust crisis and profession risk to the managers (Alchian & Demsetz, 1972). Baysinger and Hoskisson (1989) find that shareholders and directors usually judge a manager's performance by the financial goals, such as return on investment. Because long-term R&D investment will reduce present net income, managers prefer those short-term projects with quick revenue showed in the accounting book. This is especially true for old managers. Young managers tend to take risks more than the old (Barker & Mueller, 2002). Basically, the behavior and the preference of managers are influenced by incentive pay, monitoring, and regulatory requirements in companies (Ang, Lauterbach, & Schreiber, 2001). As for the influence of corporate board on R&D investment, studies focus on independent outside directors. Outside directors do not hold inside positions and do not get compensation from the company (Luoma & Goodstein, 1999). Usually the views on outside directors are that they should analyze company decisions fairly and objectively, and should supervise managers, and alleviate the information asymmetry between managers and shareholders, and should improve the corporate value by their expertise like finance (Lee, Rosenstein, & Wyatt, 1999). Originally scholars prove that independent outside directors could improve the R&D investment in companies for their long-term orientation. So the proportion of outside directors in the board should have a positive correlation with the R&D investment (Baysinger & Hoskisson, 1990). But the empirical studies by other scholars have a totally different conclusion. They find that the existence of outside directors would lead to the decrease of R&D investment. The reason they provide is the information weakness of outside directors. Outside directors have difficulty in getting inside information. What they could get usually are some financial information rather than complete information about the company. So the outside directors rely more on the familiar financial activities (Gilson & Kraakman, 1991; Hill & Snell, 1988; Hoskisson, Hitt, Johnson, & Grossman, 2002). Shareholders can be split to institutional investors and individual investors. Most of the shares held by individual investors are quite scattered. So in comparison to institutional investors, individual investors usually have less influence on company decisions. Many scholars concentrate their studies on institutional investors. Up to now, the mostly studied companies are the US companies, where the institutional investors include financial institutions like investment companies, insurance companies, and public pension funds, etc. (Bushee, 1998, 2001). Graves (1988), Graves and Waddock (1990) argues that these financial institutions are typically risk-aversive, prefer those short-term projects that could bring quick returns, and would not like to invest in R&D activities. His empirical study on 22 computer manufacturers supports this view. Hoskisson and Hitt (1988) claim that the negative attitude of financial investors on R&D investment leads to the diversified production lines of companies, which could spread the risk, and leads to the decrease of the interest of the management on R&D investment and new product plans. But some scholars argue that financial institutions have the capability to diversify their investment, and should encourage the invested companies to pursue the projects with potentials and prospects. So the institutional investors should be a stimulator not a limiter for firm R&D investment, and some empirical studies support this argument (Baysinger, Kosnik, & Turk, 1991; Hill & Hansen, 1989; Kochhar & David, 1996).
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For the conflict and difference in studies on institutional investors, one of the reasons maybe is the different segments of the institutional investors. David, Hitt, and Gimeno (2001) find that the public fund investors, like pension foundation, expect companies to invest on R&D projects. They would like to wait for the projects to get long-term revenue, rather than to get opportunistic short-term return by constantly buying and selling. By studying the large manufacturing companies in Standard & Poor's, Hoskisson et al. (2002) also point out that pension (public) fund investors have a strong positive correlation with company R&D investment and new products release. Kochhar and David (1996) split institutional investors to pressure-sensitive, pressureresistant, and pressure-indeterminate, and report that the more the financial pressure the institutional investors could resist, the more they would prefer the long-term projects like R&D. The pressure-resistant institutions are mainly public pension funds, mutual funds. 2. Theories and hypotheses The American companies are a group of firms well studied in terms of governance structure and R&D investment. What would be the relation between corporate governance and R&D investment in Chinese companies? After all, Chinese companies have different governance structure, and are running in quite different environment. This article tries to study the correlation between R&D investment and the corporate governance factors in China, and tries to find implications for companies to improve their innovation capabilities in a transitional economy. 2.1. Managerial discretion Managerial discretion reflects the manger's influence on business decisions in the company. Discretionary power of manager is affected by 3 factors — governance structure, management structure, and personalities of manager. According to Baysinger and Hoskisson (1989), Hoskisson et al. (2002), in general, managers hold a negative attitude towards R&D, and prefer to reduce the R&D investment, to improve short-term financial performance and avoid the risks from R&D activities. Now that for managers the less the R&D investment the better, if managers have more discretionary power, they could reduce the corporate R&D investment as they want. This may be especially true in China. Chinese companies rely heavily on short-term financing, which usually leads to the pressure for managers to make short-term returns (Delcoure, 2007). Hypothesis 1. Managerial discretion has negative correlation with corporate R&D investment. 2.2. Governance structure According to the political, social, and economical environment in China, this article has following hypotheses in terms of corporate governance structure and R&D investment. 2.2.1. Shares held by the state At present, the state still owns or controls a lot of large companies in China. Companies with high proportion of the state-hold shares usually have a more monopolistic position in the related industry. For the weak competition in the market and the passive nature of the state shareholders, companies with large state shares usually have less motivation to improve their operations and are not very enthusiastic on R&D investment. Hypothesis 2. The proportion of the state-hold shares has a negative correlation with the company R&D investment. 2.2.2. Shares held by a manager If the shares held by top manager increase, the manager is not only a manager but also a shareholder. Study finds that the managerial shareholdings are significantly and positively related with the corporate performance (Chan, Fung, & Thapa, 2007). To increase share value, manager tends to support R&D activities that is good for the company's long-term development. Hypothesis 3. Shares held by a manager have positive influence on the corporate R&D investment. 2.2.3. Degree of share concentration When fewer shareholders (usually institutional investors) hold more shares, these shareholders will have more control power, and could intervene more deeply in the company's operation. For the higher the share concentration, the harder the liquidation of the shares, shareholders in this condition will concern more with the long-term development of the company, and may have a positive influence on the corporate R&D investment. Hypothesis 4. The degree of share concentration has a positive correlation with the corporate R&D investment. 2.2.4. Independent outside directors Most of the independent outside directors in China are from universities, research institutions, and law firms. According to the characteristics of this group of people, this article argues that the outside directors prefer R&D activities.
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Table 1 Industry distribution of the samples. Mechanism
Electronic
Chemical
Pharmaceutical
Automotive
Total
43
42
22
21
14
142
Hypothesis 5. The number of the independent outside directors in the board has a positive correlation with the corporate R&D investment. 3. Data and methods By empirical analysis this article tries to find out the correlations between the corporate R&D investment and managerial discretion, shares held by the state, shares held by a manager, degree of share concentration, and independent outside directors. The analytical tools of regression and scatter are employed to test the 5 hypotheses. 3.1. Samples Samples are from the manufacturing companies listed in Shanghai Stock Exchange and Shenzhen Stock Exchange in China. The focus on manufacturing industries is because companies in this sector usually have more R&D activities than those in service sector. The data are from their annals of 2005 and 2007 fiscal years. In the 436 random samples, after some data were unavailable or invalid, only 142 samples are effective. Table 1 shows the industrial distribution of these samples. Data collected from the samples include operating income, R&D investment, liquid capital, number of board directors, number of independent outside directors, salaries of the management team, percentage of state-hold shares, shares held by the top 10 shareholders (as the measure of the degree of share concentration), shares held by top manager, and other related information, which are shown in Table 2. 3.2. Measures 3.2.1. R&D investment intensity This article takes the ratio of R&D expenditure to operating income as the measure of the intensity of R&D investment. According to the Accounting Standard of China, there is no account title like R&D investment or R&D expenditure, which means companies are not required to report their total R&D investment directly. So we take the Development and Design Cost, Technology Development Cost, and Research Cost, which are reported under the account title of Cash Paid for the Business Related Activities in a company's financial statement as the R&D expenditure. 3.2.2. Managerial discretion The CEO is the most important person in making key decisions in a company. This article mainly studies the discretionary power of CEO. Some scholars measure the discretionary power of CEO by position power effect, salary effect, and operation power effect (Li, 2002). The definitions and the measures of these three effects are as following: a. Position power index means the power related with the position itself. The measure of this index is the reciprocal of the number of the top management team. The larger this reciprocal value, the more the position power seems to be, and the more discretionary power the CEO may hold.
Table 2 Description of the samples.
R&D intensity (%) R&D (million RMB) Operating income (million RMB) Liquid capital (million RMB) Employee Board directors Independent directors Share held by a manager (%) Share held by state (%) Share concentration (%) N = 142. RMB is the currency of China.
Mean
s.d.
Minimum
Maximum
0.83 51.07 6,062.23 168.4 6,163 9.53 3.42 0.9 33.25 58.89
1.38 178.1 12,478.9 246.21 10,434.6 2.09 0.74 6.18 24.44 14.33
0 0.14 61.38 0.49 24 5 2 0 0 15.06
13.15 1372 81,104.75 957.68 65,506 19 7 70.26 84.98 93.71
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Table 3 Definitions and measures of the variables. Variable
Description
Name
R&D investment intensity Managerial discretion of CEO
The ratio of company's R&D expenditure to the operating income. Position power index Salary power index Operation power index The percentage of shares held by the top 10 shareholders Percentage of shares held by top manager Percentage of shares held by the state Numbers of independent outside directors in the board
RD MD
Degree of share concentration Share held by a manager Share held by the state Independent outside directors
SC SHBM SHBS IOD
b. Salary power index reflects the power of CEOs by their salary levels. The measure of this index is the ratio of the CEO salary to the lowest salary in the top management team. The higher this ratio, the more important the CEO may be in the company, and the more discretion he or she may have. c. Operation power index reflects the amount of money that the CEO could allocate in the company. The measure of this index is the ratio of the liquid capital to the operating income. The average value of the standardized position power index, salary power index, and operation power index is the measure of the discretionary power of CEO. 3.2.3. Degree of share concentration The percentage of the shares held by the top 10 shareholders is the measure of the degree of share concentration. Share held by the state is the percentage of the shares owned by the state. Share held by a manager is the percentage of the shares owned by the top manager. Independent outside director is the number of the independent outside directors in the board. For the percentage of independent outside directors in the board of a listed company in China is always 1/3 or 1/4, the percentage is not a good measure to explain the influence of outside directors on R&D investment. Table 3 shows all the measures. The correlation test result of the independent variables is showed in Table 4. 4. Tests and results 4.1. Model 1 This article employs multiple-linear-regression analysis to test the correlation between the corporate R&D investment intensity and the share held by state, the number of the outside directors, the share held by a manager, share concentration, and managerial discretion. And the size of the company is taken as a controller. The model is as follows: lnRD = α + β1 lnðsizeÞ + β2 SHBS + β3 IOD + β4 lnðSHBMÞ + β5 SC + β6 MD + u
ð1Þ
The test result shows that Model (1) is statistically significant (F = 3.119, P < 0.01), and R2 is 12.2%. According to Table 5, the number of the independent outside directors is positively and significantly correlated with the corporate R&D investment intensity (P < 0.05). The discretionary power of CEO has negative and significant influence on corporate R&D investment
Table 4 Correlations between the independent variables.
1. 2. 3. 4. 5. 6.
ln(Size) Share held by state Independent directors ln(SHBM) Share concentration Managerial discretion
N = 142. ⁎ P < 0.05. ⁎⁎ P < 0.01. ⁎⁎⁎ P < 0.001.
1
2
3
4
5
0.232 ⁎⁎ 0.219 ⁎⁎ −0.025 0.243 ⁎⁎ 0.133
0.054 −0.012 0.422 ⁎⁎⁎ 0.218 ⁎⁎
0.073 0.114 0.533 ⁎⁎⁎
−0.056 0.121
0.279 ⁎⁎
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Table 5 Results of regression analysis of Model (1).
1. 2. 3. 4. 5. 6.
ln(Size) ln(SHBM) Share held by the state Independent directors Share concentration Managerial discretion
Standardized coefficients beta
t
Sig.
− 0.262 ⁎⁎ − 0.068 0.062 0.241 ⁎
− 3.051 − 0.832 0.687 2.473 1.446 − 2.945
0.003 0.407 0.493 0.015 0.151 0.004
0.134 − 0.296 ⁎⁎
N = 142. ⁎ P < 0.05. ⁎⁎ P < 0.01.
(P < 0.01). To sum up, in Model (1), Hypothesis 1 and Hypothesis 5 are supported by the statistic test, while other 3 hypotheses are not. Scatter diagrams could directly show the relations between two variables. According to Figs. 1 and 2, the relations between R&D intensity and share held by the state, and share concentration, are quite random. No significant correlations exist between them. Together with the test results from Table 5, Hypothesis 2 and Hypothesis 4 are not proved. But as shown in the scatter diagram of share held by management (that is ln(SHBM)) and R&D investment intensity (Fig. 3), the points are concentrated along an inverted parabolic curve. According to this finding, this article forms Model (2) to take (ln(SHBM))2 as a new variable. 4.2. Model 2 In Model (2), the independent variables include share held by the state, number of independent outside directors, quadratic ln(SHBM), degree of share concentration, and managerial discretion of CEO. 2
lnRD = α + β1 lnðsizeÞ + β2 SHBS + β3 IOD + β4 ðlnðSHBMÞÞ + β5 SC + β6 MD + u
Fig. 1. Scatter between share held by the state and the R&D intensity.
ð2Þ
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Fig. 2. Scatter between degree of share concentration and R&D intensity.
Fig. 3. Scatter between log(SHBM) and R&D intensity.
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Table 6 Results of regression analysis of Model (2).
1. 2. 3. 4. 5. 6.
ln(Size) (ln(SHBM))2 Share held by the state Independent directors Share concentration Managerial discretion
Standardized coefficients beta
t
Sig.
− 0.276⁎⁎⁎ 0.316⁎⁎⁎
− 3.389 4.007 1.114 2.177 1.352 − 2.334
0.001 0.000 0.267 0.031 0.179 0.021
0.096 0.202⁎ 0.118 − 0.226⁎
N = 142. ⁎P < 0.05. ⁎⁎P < 0.01. ⁎⁎⁎P < 0.001.
Compared with Model (1), the test result of Model (2) (F = 6.02, P < 0.001) is much better, which is very significant and can explain 21.1% of the sample companies' R&D investment intensity. At the same time, according to Table 6, (ln(SHBM))2 shows a very significant correlation with the R&D investment intensity of companies (P < 0.001). 5. Discussion and conclusion This article tests the correlations between corporate R&D investment intensity and the discretionary power of CEO, share held by the state, share held by a manager, and independent outside directors, by using the data from the listed companies in China. According to the empirical test results, the discretionary power of CEO has significant and negative correlation with the R&D investment intensity both in Model (1) and Model (2). The relation between share held by a manager and R&D investment follows an inverted parabolic curve, and the quadratic logarithm of share held by a manager is positively and very significantly correlated with the corporate R&D investment intensity. The number of the independent outside directors has positive and significant influence on the R&D investment in Model (1) and Model (2). These three findings support Hypothesis 1, Hypothesis 3, and Hypothesis 5. But Hypothesis 2 and Hypothesis 4 are not supported by the tests. The inverted parabolic curve relation between the share held by a manager and R&D investment intensity means that as the percentage of the shares held by the management is increasing, the corporate R&D investment intensity will decrease at first, and then increase. The possible explanation is as follows. When the manager holds a quite minority shares, the share returns and the share value only account for a small portion of their incomes. They have little motivation to stimulate the share price by short-term projects. As the shares they hold are increasing, the returns and the value of shares become a very important source of income for the managers, which make the managers care about the share price and dividend, and lead to their preference of short-term projects that could improve the financial performance of the company. When the shares held by the managers are substantial, they cannot easily liquidate the shares in short term for the regulations and the managers' emotion. In this situation, the managers prefer long-term projects like R&D investment to strengthen the company's long-term competitiveness. Hypothesis 2 assumes that a negative correlation exists between share held by the state and the corporate R&D investment, for usually a substantial percentage of the state-hold-shares means the company is in a monopoly position and faces low level competition, and has less motivation to innovate. But the test does not provide support for this hypothesis. The reason maybe companies with high percentage of state shares are more easily to be influenced by the state policies and directions. In recent years, from central to local, Chinese governments are emphasizing more and more the importance of innovation and technology. The governments encourage companies to increase innovation investment by releasing guidelines, providing subsidies, and issuing preferential tax policies. As the main group to fulfill and achieve government will, state-controlled listed companies may have to invest in R&D. And actually, in China, state-owned large-and-medium-enterprises (LMEs) have advantageous access to government supports, including fiscal subsidies and bank loans, most R&D appropriations and public technological resources are deployed in LMEs, especially state-owned LMEs (Zedtwitz, 2005). This special environment and the state-owned companies' natural inertia in innovation make the correlation between shares held by the state and corporate R&D investment not significant. The positive coefficients of Share Held by State (0.062 in Model (1), 0.096 in Model (2)) show that, now in China, this variable is at least not a negative influencing factor on corporate R&D investment. As for Hypothesis 4, the tests do not find any significant correlation between the degree of share concentration and corporate R&D investment. The explanation goes into the categories of the institutional investors in China, for in most cases institutional investors are the top shareholders. The institutional investors in China stock markets are mainly the state, fund companies (including public offering funds and private equity funds), industrial enterprises, securities companies, insurance companies, and pension funds. These institutional investors are greatly different from each other in terms of strategies and interests. The state and the pension funds have the longest share holding time. The state shareholders have quite complicated interests, which include revenue, the state strategies in related industry, and social responsibilities like employment. The pension funds are not strong investors in China stock markets, for they only account for less than 1% of the total investment. Funds companies in China are usually short-term investors. Under the pressure of fund investors, they care more about the financial performance of the listed companies. As shareholders, the industrial enterprises have diversified purposes on the invested companies. If they are strategic investor, they may give more importance to R&D investment and long-term development of the listed companies. If they are short-
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term return pursuers, they may not support R&D projects. Securities companies and insurance companies are generally short-tomedium-term investors. These differences in institutional investors make some investors think highly of sustainable development capabilities of the invested companies and encourage technology innovation, while others stress the importance of short-term financial performance. The degree of share concentration cannot tell these differences in investors, so it could not show significant correlation with the R&D investment. In addition, according to the test results, the size of companies shows significant and negative influence on the R&D investment in both Model (1) and Model (2). For a long time, whether large company or small company is more innovative, is a hot issue (e.g. Johannisson & Lindstrom, 1971; Kamien & Schwartz, 1978; Schumpeter, 1997). At least, in terms of R&D investment intensity, large companies are not very innovative compared with small companies in China's stock market in this case. The study in this article provides people a better understanding of the influence of corporate governance factors on the corporate R&D investment. To enhance companies' innovation and R&D capabilities, they need to improve their corporate governance. In case of China, from the view of corporate governance, the low investment in R&D activities in general (the average R&D investment intensity of the sample companies is only 0.83%) is closely related with the relatively great discretionary power of CEOs, the less developed stock incentive plans, and the passive and opportunistic investors. In the circumstances, reasonably devised stock incentive plan could be a good way to motivate the management and the CEOs to invest in R&D activities with longterm benefit. 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Strategic control systems and relative R&D investment in large multiproduct firms. Strategic Management Journal, 9(6), 605−621. Hoskisson, R. E., Hitt, M. A., Johnson, R. A., & Grossman, W. (2002). Conflicting voice: The effects of institutional ownership heterogeneity and internal governance on corporate innovation strategies. Academy of Management Journal, 45, 697−716. Hout, T. (2006). The ecology of innovation.China Economic Quarterly, 34−38 3rd quarter. Johannisson, B., & Lindstrom, C. (1971). Firm size and inventive activity. Swedish Journal of Economics, 73(4), 427−442. Kamien, M. I., & Schwartz, N. L. (1978). Self-financing of an R&D project. American Economic Review, 68(6), 252−261. Kochhar, R., & David, P. (1996). Institutional investors and firm innovation: A test of competing hypotheses. Strategic Management Journal, 17, 73−84. Lee, Y. S., Rosenstein, S., & Wyatt, J. (1999). The value of financial outside directors on corporate boards. 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International Review of Economics and Finance j o u r n a l h o m e p a g e : w w w. e l s e v i e r. c o m / l o c a t e / i r e f
Corporate governance structure, managerial discretion, and the R&D investment in China☆ Jing Dong a,⁎, Yan-nan Gou b,1 a b
School of International Business Administration, Shanghai University of Finance and Economics, 777 Guo-ding Road, Shanghai 200433, China School of International Relations and Public Affairs, Fudan University, 220 Han-dan Road, Shanghai 200433, China
a r t i c l e
i n f o
Article history: Received 12 March 2009 Accepted 17 July 2009 Available online 13 October 2009 JEL classification: G34
Keywords: R&D investment Managerial discretion Corporate governance China
a b s t r a c t This article studies the influence of corporate governance factors on firm R&D investment in a transitional economy like China. By using the data from the listed companies in China, this article statistically tests the hypotheses on the relations between corporate R&D intensity and managerial discretion of CEOs, independent outside directors, degree of share concentration, share held by the state, and share held by a manager. According to the results, the managerial discretion of CEOs has a significant and negative correlation with the firm R&D investment. The number of the independent outside directors in the board has a positive influence on the R&D investment. And as the shares held by a manager increase, the firm R&D intensity will decrease at first, and then increase along an inverted parabolic curve. All these findings show that the improvement of corporate governance and stock incentive plan, and the cultivation of active and long-term stock investors, may finally lead to the upgrade of corporate innovation capabilities. © 2009 Elsevier Inc. All rights reserved.
1. Introduction Studies show that R&D and technological capabilities are the key sources of growth and competitive edge for firms and industries. In recent years, the central government of China has been consistently emphasizing the importance of technology development in the manufacturing sector and viewing technology development as an engine for the process of catching up with advanced industrial economies and industrialization. It is believed that over the long-term, China's economic performance will ultimately depend upon its ability to acquire, adapt, and create new technologies (Guo, 2008). One of the main goals of China's 11th Five-Year Program (2006–2010) adopted in 2006 is “scientific development” and a determined emphasis to encourage “an innovation-oriented nation” (Dobson & Safarian, 2008). China's recently announced “Medium to Long Term Science and Technology Development Plan, 2006–2020” has two bold aims: one is to raise R&D intensity to the current OECD average by 2020 (increasing spending as a share of GDP from 1.3% to 2.5%); another is “to reduce sharply reliance on imported technology, obtain advanced core technologies in the equipment manufacturing, the information industry, and so on” (Government of the People's Republic of China, 2006). To achieve the innovation and technology-based development, the governments of China issue regulations and policies to encourage innovation and technology investment. For example, the technology development expenditure of a company could be ☆ This study is supported by the Leading Academic Discipline Program-211 Project for Shanghai University of Finance and Economics (the 3rd phase). And the first draft of this paper was presented in the IX International Academic Conference “Modernization of Economy and Globalization,” Moscow, April 2008. The authors thank the anonymous referee for comments that significantly improved this manuscript. The authors also thank Ming Yu and Xian-hui Tang for help in collecting and processing the data. ⁎ Corresponding author. Tel.: +86 1381 8217 061; fax: +86 21 6511 2354. E-mail addresses: [email protected] (J. Dong), [email protected] (Y. Gou). 1 Tel: +86 1350 1996 823. 1059-0560/$ – see front matter © 2009 Elsevier Inc. All rights reserved. doi:10.1016/j.iref.2009.10.001
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calculated as 150% of the real spending in tax deduction. For instruments and equipments purchased for R&D activities, companies could employ accelerated depreciation. High-tech startups in the national high-tech industrial development zones could enjoy 2year tax-exemption and a 15% income tax rate from the third year (Ministry of Finance People's Republic of China, 2006). There are also direct subsidies from the governments to high-tech companies and specific R&D projects under the names of Star-fire Plan, Torch Plan, and etc. Enterprises are the main body in pursuing innovation and technology development. How do Chinese companies make their innovation and R&D investment decisions? Scholars study the influence of external environment on company's innovation activities. Dobson and Safarian (2008) interview 11 high-tech companies in Zhejiang province and find the increasing competitive pressure on firms that encourages learning. Intense product competition and demanding customers encourage rising R&D spending and the development of new products and processes, imitation of competitors, linkages with foreigners and local research institutions. With rising flows of FDI technology import, and the capacity to absorb foreign technology, Chinese domestic companies increasingly gain access to the international knowledge base, which is elevating the productivity of domestic R&D labor, and encouraging companies to pursue innovation. Gao and Jefferson (2007) argue that once the take-off economy has integrated with the international economy, its knowledge frontier converges to that of the advanced economies and grows at the same rate as that of the other advanced economies. But Zhu, Xu, and Lundin (2006) report the effect of government's direct funding is somehow ambiguous. This ambiguity may also reveal risk aversion in industrial sector's investment behavior. In other words, when both technical and market risks are high, the government support may not be sufficient enough to stimulate investments in industrial sectors. Hout (2006) also argues that the incentive structure for technology-based innovation is shaped by firms in the private sector responding to market forces, not government policies and funding. As for how technological advance occurs in the modern world, Nelson (1993) stresses the significance of institutions involved in industrial innovation. The institutions are not only regulations, policies, markets, and networks in a company's external environment, but also institutions inside of a company, especially corporate governance structure. We argue that the corporate governance structure, including the top management, the board, and the structure of the shareholders, plays an important role on R&D investment decision. In general, R&D activities are quite long-term with a low rate in success. The success of R&D projects usually will lead to a large profit, but the risk is also very high. So investment in R&D is high return together with high risk (Millet-Reyes, 2004). In face of the features of R&D, inevitably conflicts exist between the managers and the investors on the R&D investment decisions, because of the different interests from each side. Studies find managers usually would not like to invest in R&D projects. For the reason that a manager's salary depends on the performance of the company, if the high-risk R&D investment fails, it will bring trust crisis and profession risk to the managers (Alchian & Demsetz, 1972). Baysinger and Hoskisson (1989) find that shareholders and directors usually judge a manager's performance by the financial goals, such as return on investment. Because long-term R&D investment will reduce present net income, managers prefer those short-term projects with quick revenue showed in the accounting book. This is especially true for old managers. Young managers tend to take risks more than the old (Barker & Mueller, 2002). Basically, the behavior and the preference of managers are influenced by incentive pay, monitoring, and regulatory requirements in companies (Ang, Lauterbach, & Schreiber, 2001). As for the influence of corporate board on R&D investment, studies focus on independent outside directors. Outside directors do not hold inside positions and do not get compensation from the company (Luoma & Goodstein, 1999). Usually the views on outside directors are that they should analyze company decisions fairly and objectively, and should supervise managers, and alleviate the information asymmetry between managers and shareholders, and should improve the corporate value by their expertise like finance (Lee, Rosenstein, & Wyatt, 1999). Originally scholars prove that independent outside directors could improve the R&D investment in companies for their long-term orientation. So the proportion of outside directors in the board should have a positive correlation with the R&D investment (Baysinger & Hoskisson, 1990). But the empirical studies by other scholars have a totally different conclusion. They find that the existence of outside directors would lead to the decrease of R&D investment. The reason they provide is the information weakness of outside directors. Outside directors have difficulty in getting inside information. What they could get usually are some financial information rather than complete information about the company. So the outside directors rely more on the familiar financial activities (Gilson & Kraakman, 1991; Hill & Snell, 1988; Hoskisson, Hitt, Johnson, & Grossman, 2002). Shareholders can be split to institutional investors and individual investors. Most of the shares held by individual investors are quite scattered. So in comparison to institutional investors, individual investors usually have less influence on company decisions. Many scholars concentrate their studies on institutional investors. Up to now, the mostly studied companies are the US companies, where the institutional investors include financial institutions like investment companies, insurance companies, and public pension funds, etc. (Bushee, 1998, 2001). Graves (1988), Graves and Waddock (1990) argues that these financial institutions are typically risk-aversive, prefer those short-term projects that could bring quick returns, and would not like to invest in R&D activities. His empirical study on 22 computer manufacturers supports this view. Hoskisson and Hitt (1988) claim that the negative attitude of financial investors on R&D investment leads to the diversified production lines of companies, which could spread the risk, and leads to the decrease of the interest of the management on R&D investment and new product plans. But some scholars argue that financial institutions have the capability to diversify their investment, and should encourage the invested companies to pursue the projects with potentials and prospects. So the institutional investors should be a stimulator not a limiter for firm R&D investment, and some empirical studies support this argument (Baysinger, Kosnik, & Turk, 1991; Hill & Hansen, 1989; Kochhar & David, 1996).
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For the conflict and difference in studies on institutional investors, one of the reasons maybe is the different segments of the institutional investors. David, Hitt, and Gimeno (2001) find that the public fund investors, like pension foundation, expect companies to invest on R&D projects. They would like to wait for the projects to get long-term revenue, rather than to get opportunistic short-term return by constantly buying and selling. By studying the large manufacturing companies in Standard & Poor's, Hoskisson et al. (2002) also point out that pension (public) fund investors have a strong positive correlation with company R&D investment and new products release. Kochhar and David (1996) split institutional investors to pressure-sensitive, pressureresistant, and pressure-indeterminate, and report that the more the financial pressure the institutional investors could resist, the more they would prefer the long-term projects like R&D. The pressure-resistant institutions are mainly public pension funds, mutual funds. 2. Theories and hypotheses The American companies are a group of firms well studied in terms of governance structure and R&D investment. What would be the relation between corporate governance and R&D investment in Chinese companies? After all, Chinese companies have different governance structure, and are running in quite different environment. This article tries to study the correlation between R&D investment and the corporate governance factors in China, and tries to find implications for companies to improve their innovation capabilities in a transitional economy. 2.1. Managerial discretion Managerial discretion reflects the manger's influence on business decisions in the company. Discretionary power of manager is affected by 3 factors — governance structure, management structure, and personalities of manager. According to Baysinger and Hoskisson (1989), Hoskisson et al. (2002), in general, managers hold a negative attitude towards R&D, and prefer to reduce the R&D investment, to improve short-term financial performance and avoid the risks from R&D activities. Now that for managers the less the R&D investment the better, if managers have more discretionary power, they could reduce the corporate R&D investment as they want. This may be especially true in China. Chinese companies rely heavily on short-term financing, which usually leads to the pressure for managers to make short-term returns (Delcoure, 2007). Hypothesis 1. Managerial discretion has negative correlation with corporate R&D investment. 2.2. Governance structure According to the political, social, and economical environment in China, this article has following hypotheses in terms of corporate governance structure and R&D investment. 2.2.1. Shares held by the state At present, the state still owns or controls a lot of large companies in China. Companies with high proportion of the state-hold shares usually have a more monopolistic position in the related industry. For the weak competition in the market and the passive nature of the state shareholders, companies with large state shares usually have less motivation to improve their operations and are not very enthusiastic on R&D investment. Hypothesis 2. The proportion of the state-hold shares has a negative correlation with the company R&D investment. 2.2.2. Shares held by a manager If the shares held by top manager increase, the manager is not only a manager but also a shareholder. Study finds that the managerial shareholdings are significantly and positively related with the corporate performance (Chan, Fung, & Thapa, 2007). To increase share value, manager tends to support R&D activities that is good for the company's long-term development. Hypothesis 3. Shares held by a manager have positive influence on the corporate R&D investment. 2.2.3. Degree of share concentration When fewer shareholders (usually institutional investors) hold more shares, these shareholders will have more control power, and could intervene more deeply in the company's operation. For the higher the share concentration, the harder the liquidation of the shares, shareholders in this condition will concern more with the long-term development of the company, and may have a positive influence on the corporate R&D investment. Hypothesis 4. The degree of share concentration has a positive correlation with the corporate R&D investment. 2.2.4. Independent outside directors Most of the independent outside directors in China are from universities, research institutions, and law firms. According to the characteristics of this group of people, this article argues that the outside directors prefer R&D activities.
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Table 1 Industry distribution of the samples. Mechanism
Electronic
Chemical
Pharmaceutical
Automotive
Total
43
42
22
21
14
142
Hypothesis 5. The number of the independent outside directors in the board has a positive correlation with the corporate R&D investment. 3. Data and methods By empirical analysis this article tries to find out the correlations between the corporate R&D investment and managerial discretion, shares held by the state, shares held by a manager, degree of share concentration, and independent outside directors. The analytical tools of regression and scatter are employed to test the 5 hypotheses. 3.1. Samples Samples are from the manufacturing companies listed in Shanghai Stock Exchange and Shenzhen Stock Exchange in China. The focus on manufacturing industries is because companies in this sector usually have more R&D activities than those in service sector. The data are from their annals of 2005 and 2007 fiscal years. In the 436 random samples, after some data were unavailable or invalid, only 142 samples are effective. Table 1 shows the industrial distribution of these samples. Data collected from the samples include operating income, R&D investment, liquid capital, number of board directors, number of independent outside directors, salaries of the management team, percentage of state-hold shares, shares held by the top 10 shareholders (as the measure of the degree of share concentration), shares held by top manager, and other related information, which are shown in Table 2. 3.2. Measures 3.2.1. R&D investment intensity This article takes the ratio of R&D expenditure to operating income as the measure of the intensity of R&D investment. According to the Accounting Standard of China, there is no account title like R&D investment or R&D expenditure, which means companies are not required to report their total R&D investment directly. So we take the Development and Design Cost, Technology Development Cost, and Research Cost, which are reported under the account title of Cash Paid for the Business Related Activities in a company's financial statement as the R&D expenditure. 3.2.2. Managerial discretion The CEO is the most important person in making key decisions in a company. This article mainly studies the discretionary power of CEO. Some scholars measure the discretionary power of CEO by position power effect, salary effect, and operation power effect (Li, 2002). The definitions and the measures of these three effects are as following: a. Position power index means the power related with the position itself. The measure of this index is the reciprocal of the number of the top management team. The larger this reciprocal value, the more the position power seems to be, and the more discretionary power the CEO may hold.
Table 2 Description of the samples.
R&D intensity (%) R&D (million RMB) Operating income (million RMB) Liquid capital (million RMB) Employee Board directors Independent directors Share held by a manager (%) Share held by state (%) Share concentration (%) N = 142. RMB is the currency of China.
Mean
s.d.
Minimum
Maximum
0.83 51.07 6,062.23 168.4 6,163 9.53 3.42 0.9 33.25 58.89
1.38 178.1 12,478.9 246.21 10,434.6 2.09 0.74 6.18 24.44 14.33
0 0.14 61.38 0.49 24 5 2 0 0 15.06
13.15 1372 81,104.75 957.68 65,506 19 7 70.26 84.98 93.71
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Table 3 Definitions and measures of the variables. Variable
Description
Name
R&D investment intensity Managerial discretion of CEO
The ratio of company's R&D expenditure to the operating income. Position power index Salary power index Operation power index The percentage of shares held by the top 10 shareholders Percentage of shares held by top manager Percentage of shares held by the state Numbers of independent outside directors in the board
RD MD
Degree of share concentration Share held by a manager Share held by the state Independent outside directors
SC SHBM SHBS IOD
b. Salary power index reflects the power of CEOs by their salary levels. The measure of this index is the ratio of the CEO salary to the lowest salary in the top management team. The higher this ratio, the more important the CEO may be in the company, and the more discretion he or she may have. c. Operation power index reflects the amount of money that the CEO could allocate in the company. The measure of this index is the ratio of the liquid capital to the operating income. The average value of the standardized position power index, salary power index, and operation power index is the measure of the discretionary power of CEO. 3.2.3. Degree of share concentration The percentage of the shares held by the top 10 shareholders is the measure of the degree of share concentration. Share held by the state is the percentage of the shares owned by the state. Share held by a manager is the percentage of the shares owned by the top manager. Independent outside director is the number of the independent outside directors in the board. For the percentage of independent outside directors in the board of a listed company in China is always 1/3 or 1/4, the percentage is not a good measure to explain the influence of outside directors on R&D investment. Table 3 shows all the measures. The correlation test result of the independent variables is showed in Table 4. 4. Tests and results 4.1. Model 1 This article employs multiple-linear-regression analysis to test the correlation between the corporate R&D investment intensity and the share held by state, the number of the outside directors, the share held by a manager, share concentration, and managerial discretion. And the size of the company is taken as a controller. The model is as follows: lnRD = α + β1 lnðsizeÞ + β2 SHBS + β3 IOD + β4 lnðSHBMÞ + β5 SC + β6 MD + u
ð1Þ
The test result shows that Model (1) is statistically significant (F = 3.119, P < 0.01), and R2 is 12.2%. According to Table 5, the number of the independent outside directors is positively and significantly correlated with the corporate R&D investment intensity (P < 0.05). The discretionary power of CEO has negative and significant influence on corporate R&D investment
Table 4 Correlations between the independent variables.
1. 2. 3. 4. 5. 6.
ln(Size) Share held by state Independent directors ln(SHBM) Share concentration Managerial discretion
N = 142. ⁎ P < 0.05. ⁎⁎ P < 0.01. ⁎⁎⁎ P < 0.001.
1
2
3
4
5
0.232 ⁎⁎ 0.219 ⁎⁎ −0.025 0.243 ⁎⁎ 0.133
0.054 −0.012 0.422 ⁎⁎⁎ 0.218 ⁎⁎
0.073 0.114 0.533 ⁎⁎⁎
−0.056 0.121
0.279 ⁎⁎
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Table 5 Results of regression analysis of Model (1).
1. 2. 3. 4. 5. 6.
ln(Size) ln(SHBM) Share held by the state Independent directors Share concentration Managerial discretion
Standardized coefficients beta
t
Sig.
− 0.262 ⁎⁎ − 0.068 0.062 0.241 ⁎
− 3.051 − 0.832 0.687 2.473 1.446 − 2.945
0.003 0.407 0.493 0.015 0.151 0.004
0.134 − 0.296 ⁎⁎
N = 142. ⁎ P < 0.05. ⁎⁎ P < 0.01.
(P < 0.01). To sum up, in Model (1), Hypothesis 1 and Hypothesis 5 are supported by the statistic test, while other 3 hypotheses are not. Scatter diagrams could directly show the relations between two variables. According to Figs. 1 and 2, the relations between R&D intensity and share held by the state, and share concentration, are quite random. No significant correlations exist between them. Together with the test results from Table 5, Hypothesis 2 and Hypothesis 4 are not proved. But as shown in the scatter diagram of share held by management (that is ln(SHBM)) and R&D investment intensity (Fig. 3), the points are concentrated along an inverted parabolic curve. According to this finding, this article forms Model (2) to take (ln(SHBM))2 as a new variable. 4.2. Model 2 In Model (2), the independent variables include share held by the state, number of independent outside directors, quadratic ln(SHBM), degree of share concentration, and managerial discretion of CEO. 2
lnRD = α + β1 lnðsizeÞ + β2 SHBS + β3 IOD + β4 ðlnðSHBMÞÞ + β5 SC + β6 MD + u
Fig. 1. Scatter between share held by the state and the R&D intensity.
ð2Þ
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Fig. 2. Scatter between degree of share concentration and R&D intensity.
Fig. 3. Scatter between log(SHBM) and R&D intensity.
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Table 6 Results of regression analysis of Model (2).
1. 2. 3. 4. 5. 6.
ln(Size) (ln(SHBM))2 Share held by the state Independent directors Share concentration Managerial discretion
Standardized coefficients beta
t
Sig.
− 0.276⁎⁎⁎ 0.316⁎⁎⁎
− 3.389 4.007 1.114 2.177 1.352 − 2.334
0.001 0.000 0.267 0.031 0.179 0.021
0.096 0.202⁎ 0.118 − 0.226⁎
N = 142. ⁎P < 0.05. ⁎⁎P < 0.01. ⁎⁎⁎P < 0.001.
Compared with Model (1), the test result of Model (2) (F = 6.02, P < 0.001) is much better, which is very significant and can explain 21.1% of the sample companies' R&D investment intensity. At the same time, according to Table 6, (ln(SHBM))2 shows a very significant correlation with the R&D investment intensity of companies (P < 0.001). 5. Discussion and conclusion This article tests the correlations between corporate R&D investment intensity and the discretionary power of CEO, share held by the state, share held by a manager, and independent outside directors, by using the data from the listed companies in China. According to the empirical test results, the discretionary power of CEO has significant and negative correlation with the R&D investment intensity both in Model (1) and Model (2). The relation between share held by a manager and R&D investment follows an inverted parabolic curve, and the quadratic logarithm of share held by a manager is positively and very significantly correlated with the corporate R&D investment intensity. The number of the independent outside directors has positive and significant influence on the R&D investment in Model (1) and Model (2). These three findings support Hypothesis 1, Hypothesis 3, and Hypothesis 5. But Hypothesis 2 and Hypothesis 4 are not supported by the tests. The inverted parabolic curve relation between the share held by a manager and R&D investment intensity means that as the percentage of the shares held by the management is increasing, the corporate R&D investment intensity will decrease at first, and then increase. The possible explanation is as follows. When the manager holds a quite minority shares, the share returns and the share value only account for a small portion of their incomes. They have little motivation to stimulate the share price by short-term projects. As the shares they hold are increasing, the returns and the value of shares become a very important source of income for the managers, which make the managers care about the share price and dividend, and lead to their preference of short-term projects that could improve the financial performance of the company. When the shares held by the managers are substantial, they cannot easily liquidate the shares in short term for the regulations and the managers' emotion. In this situation, the managers prefer long-term projects like R&D investment to strengthen the company's long-term competitiveness. Hypothesis 2 assumes that a negative correlation exists between share held by the state and the corporate R&D investment, for usually a substantial percentage of the state-hold-shares means the company is in a monopoly position and faces low level competition, and has less motivation to innovate. But the test does not provide support for this hypothesis. The reason maybe companies with high percentage of state shares are more easily to be influenced by the state policies and directions. In recent years, from central to local, Chinese governments are emphasizing more and more the importance of innovation and technology. The governments encourage companies to increase innovation investment by releasing guidelines, providing subsidies, and issuing preferential tax policies. As the main group to fulfill and achieve government will, state-controlled listed companies may have to invest in R&D. And actually, in China, state-owned large-and-medium-enterprises (LMEs) have advantageous access to government supports, including fiscal subsidies and bank loans, most R&D appropriations and public technological resources are deployed in LMEs, especially state-owned LMEs (Zedtwitz, 2005). This special environment and the state-owned companies' natural inertia in innovation make the correlation between shares held by the state and corporate R&D investment not significant. The positive coefficients of Share Held by State (0.062 in Model (1), 0.096 in Model (2)) show that, now in China, this variable is at least not a negative influencing factor on corporate R&D investment. As for Hypothesis 4, the tests do not find any significant correlation between the degree of share concentration and corporate R&D investment. The explanation goes into the categories of the institutional investors in China, for in most cases institutional investors are the top shareholders. The institutional investors in China stock markets are mainly the state, fund companies (including public offering funds and private equity funds), industrial enterprises, securities companies, insurance companies, and pension funds. These institutional investors are greatly different from each other in terms of strategies and interests. The state and the pension funds have the longest share holding time. The state shareholders have quite complicated interests, which include revenue, the state strategies in related industry, and social responsibilities like employment. The pension funds are not strong investors in China stock markets, for they only account for less than 1% of the total investment. Funds companies in China are usually short-term investors. Under the pressure of fund investors, they care more about the financial performance of the listed companies. As shareholders, the industrial enterprises have diversified purposes on the invested companies. If they are strategic investor, they may give more importance to R&D investment and long-term development of the listed companies. If they are short-
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term return pursuers, they may not support R&D projects. Securities companies and insurance companies are generally short-tomedium-term investors. These differences in institutional investors make some investors think highly of sustainable development capabilities of the invested companies and encourage technology innovation, while others stress the importance of short-term financial performance. The degree of share concentration cannot tell these differences in investors, so it could not show significant correlation with the R&D investment. In addition, according to the test results, the size of companies shows significant and negative influence on the R&D investment in both Model (1) and Model (2). For a long time, whether large company or small company is more innovative, is a hot issue (e.g. Johannisson & Lindstrom, 1971; Kamien & Schwartz, 1978; Schumpeter, 1997). At least, in terms of R&D investment intensity, large companies are not very innovative compared with small companies in China's stock market in this case. The study in this article provides people a better understanding of the influence of corporate governance factors on the corporate R&D investment. To enhance companies' innovation and R&D capabilities, they need to improve their corporate governance. In case of China, from the view of corporate governance, the low investment in R&D activities in general (the average R&D investment intensity of the sample companies is only 0.83%) is closely related with the relatively great discretionary power of CEOs, the less developed stock incentive plans, and the passive and opportunistic investors. In the circumstances, reasonably devised stock incentive plan could be a good way to motivate the management and the CEOs to invest in R&D activities with longterm benefit. 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