Abstract:

Permanent large shareholders have different governance incentives and mechanisms than institutional investors. Theoretically, they could be active monitors or passive investors with the option to cut and run. Using the split-share structure reform in China as an exogenous shock, we find evidence consistent with internal monitoring as opposed to cutting and running by permanent large shareholders. Specifically, large shareholders rely on directors that they have direct control of to monitor management by making these directors less busy and more diligent in board meeting attendance. Large shareholders also improve incentive compensation contracts by increasing executive pay-performance sensitivity. These effects are more pronounced when gains from monitoring accrued to large shareholders are higher or when large shareholder monitoring is less susceptible to the free-rider problem. We also find that large shareholder monitoring is associated with improved monitoring by the overall board, though not particularly by independent directors. Finally, executive perks decrease after the reform, consistent with improved direct monitoring by large shareholders.