• Controlling Shareholders and the Performance and Market Valuation of Corporate Innovation: Evidence from Taiwan’s Electronics Industry

Abstract

Given the relatively large extent of information asymmetry associated with innovation activity, corporate executives can and often do exploit this asymmetry to make suboptimal innovation investments for their own utilities at the expense of outside shareholders. Hence, the innovation outcomes may be different across firms according to the level of firms’ agency problems. In emerging markets, the majority of public firms exhibit concentrated ownership in the hands of a controlling shareholder. Such an ownership structure leads to the agency problem between controlling shareholders and minority shareholders. This agency problem is different from that between managers and shareholders for the U.S. firms with disperse ownership. When the divergence in control and ownership is greater, a controlling shareholder has more incentives to extract private benefits, thereby reducing firm value and expropriating the minority shareholders’ wealth. In light of this, the present study aims to examine how a controlling shareholder’s expropriation incentive affects the performance and market valuation of corporate innovation. Using a sample of the electronics firms listed on the TSE or trading on Taiwan’s OTC market from 1997 to 2004, this study finds that innovation performance is negatively associated with the degree of divergence in a controlling shareholder’s control and his/her ownership. Furthermore, the evidence shows that this divergence has a negative effect on the market valuation of corporate innovation. These findings indicate that the managerial effectiveness of economic resources invested in innovation activities depends highly on the level of agency problems arising from controlling shareholders.

Keywords: Ownership structure, Innovation, Control rights, Cash flow rights, Board of directors