Volume 9 Issue 8 - July 17, 2009
Voluntary Appointment of Independent Directors in Taiwan: Motives and Consequences
Chaur-Shiuh Young

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The Taiwan Stock Exchange (TSE) and Taiwan’s computerized over-the-counter market (known as GreTai Securities Market, the GTSM) Listing Rules of 2002 require public firms ‘that apply for initial listing’ on these exchanges to have at least two independent directors. The 2002 Listing Rules allow “unaffected firms” (i.e., firms that were listed prior to February of 2002, and thus were free from the mandatory requirements of appointing independent directors) latitude regarding whether to appoint or to increase independent directors. We take advantage of this natural setting to examine the motives for voluntarily appointing independent directors in unaffected firms, and investigate whether a voluntary increase in the percentage of independent directors is associated with an increase in firm performance.


We expect firms to use a combination of both the agency and managerial power models in establishing their board structure. The existing theories on corporate board determinants are grouped into the following three hypotheses:

Hypothesis 1 (alternative governance mechanisms hypothesis): The proportion of independent directors decreases with the strength of alternative corporate governance mechanisms.

Hypothesis 2 (agency cost hypothesis): The proportion of independent directors is positively related to the overall agency costs of firms.

Hypothesis 3 (managerial power hypothesis): The proportion of independent directors is negatively related to the level of managerial power.
Based on the argument that independent directors lead to stronger boards in emerging markets, we expect that the potential benefits of increases in board independence outweigh the potential costs for Taiwan market and propose the following hypothesis:
Hypothesis 4 (performance effect hypothesis): Voluntary appointment of independent directors is positively associated with firm performance.
3.Research Models

We use 492 TSE-listed unaffected firms (943 observations) with December 31 fiscal year-ends for the years 2001~2002 as our sample. To test hypotheses 1 to 3, the following equation (1) is estimated via OLS.

, where INDBOD_R is the proportion of independent directors; MGHOLD is managerial shareholding ratio; BLOCK is the outside block-holders’ shareholding ratio; ISHOLD is the institutional shareholding ratio; INDSUP is the proportion of independent supervisors for the firm; HHI is the market competition of the product of the firm; GROWTH is the growth opportunities of the firm; LEV is the average of debt ratios for the past three years; LN_SIZE is firm size; CEODIR is a dummy variable for CEO duality; BODSIZE is the size of the board of directors; q is Tobin’s q-ratio; FAMILY is a dummy variable for family business; REGUN is a dummy variable which equals 1 for the year 2002, the starting year of mandatory appointment of independent directors for newly listed firms, and 0 for the year 2001. LAMBDA is the inverse Mills ratio and is added to the model to correct for self-selection bias.

To test hypothesis 4, we estimate a simultaneous system of two equations with board structure and firm performance as the endogenous variables. The system we estimate includes the board structure equation and the firm performance equation. The board structure equation is the same as equation (1). The firm performance equation relates the extent of voluntary independent director appointments to firm performance, which is as follows:

The research variables in equation (2) are as defined in equation (1) above. We expect the coefficient on the primary variable of interest in equation (2), INDBOD_R, to have a positive sign.

4.Conclusions and Suggestions

Our findings indicate that, larger, higher growth, more leveraged, less managerially and institutionally held firms that operate in less competitive markets are more likely to voluntarily improve their board independence. This evidence is supportive of the agency model. Since each firm will tailor board structure to meet its internal monitoring needs based on the weaknesses of other governance mechanisms and the seriousness of agency problems, the mandatory request for Taiwan listed firms to have a minimum number and ratio of independent directors may not be a sound policy. Regulatory authorities in Taiwan should give average firms flexibility in deciding the number of independent directors.

As to the test of the performance effect hypothesis, we find that board independence has a significant and positive relation with firm performance in our study on Taiwan firms. This evidence is contrary to prior results on U.S. or U.K. firms that showed no relation between outside directors and firm performance.

Also lending support to the managerial power view, we find that family firms with boards dominated by family members are less likely to appoint independent directors. However, the firms will receive higher market valuation once they appoint independent directors. These results suggest that family firms can increase independent directors on the board to offset the value discount from the conflict of interest between majority and minority shareholders. Accordingly, government intervention may focus on correcting the long-lasting entrenchment problems of family controlling shareholders, who often resist improving board governance.
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