Can Independent Directors Effectively Monitor Controlling Shareholders? : Theory and Empirical Evidence

獨立董事能否有效監管控股股東?: 理論與實證研究

Student thesis: Doctoral Thesis

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Awarding Institution
  • Zhen Charles QU (Supervisor)
  • Lixin Su (External person) (External Co-Supervisor)
Award date26 Jul 2019


The monitoring effect of independent directors of public companies with controlling shareholders (“controlled companies”) is uncertain because of the doubt on the level of “independence” of independent directors. In this thesis, I conjecture and provide empirical evidence that, conditional on a proper regulatory design, independent directors selected by controlling shareholders can effectively monitor controlling shareholders and thereby create value for all shareholders.

To be effective monitors, independent directors need incentives and the ability to constrain controlling shareholders. The regulatory design of a specific monitoring role must expose independent directors to personal liability or a strong reputational concern and provide them with balancing power and adequate information.

This study tests this proposition in the context of independent directors’ vetting of related party transactions (RPTs) undertaken by companies listed on the Stock Exchange of Hong Kong. Given the regulatory framework of RPTs and related sanctions against directors, I hypothesize that independent directors in controlled companies in Hong Kong are incentivized and able to effectively perform their monitoring roles.

To test this hypothesis, I use data concerning the vetting of RPTs by independent directors from 2002 to 2006. In 2004, a change in the corporate governance rules in Hong Kong (the 2004 Reform) has forced some listed companies to appoint additional independent directors, whereas other listed companies were unaffected because they had already complied with the new requirements. I use this regulatory change as a quasi-experiment and employ the event study method to test whether the appointment of additional independent directors has a positive effect on the stock market valuation of RPTs. To better attribute the valuation effect to the addition of independent directors, I use difference-in-differences and difference-in-difference-in-differences methods in the analysis.

Results show that the mandatory addition of independent directors causes an average of 10% increase in the market valuation of non-asset-acquisition RPTs and a 14.9% reduction in companies’ use of non-asset-acquisition RPTs. By contrast, the addition of independent directors has no significant effect on asset-acquisition RPTs, which on average receive higher market valuation than arm’s length transactions.

The findings of this study make the following contributions to the literature. First, it provides a theoretical foundation and convincing empirical evidence to support the proposition that independent directors, despite being chosen by controlling shareholders, can become effective monitors. Second, empirical data collected and analyzed in this study demonstrate that, at least in the context of Hong Kong, effective monitoring by independent directors motivates controlled companies to use RPTs only when it is an efficient choice. Finally, the findings of this study provide a useful direction for regulators in ownership-concentrated economies to design policies for enhancing the effectiveness of independent directors.