Outside Directors, Ownership Structure and Firm Profitability in Korea

Abstract

The contribution of outside directors to firm performance has been shown to be inconsistent. Korean companies first began in 1998 to introduce outside directors to carry out governance reform. This paper analyses the impact of outside directors on corporate performance during the governance reform movement undertaken in Korea in 1999 as well as the moderating effect of the large shareholder and managerial ownership rate. We hypothesised a positive relationship between outside director effectiveness (outside director participation rate) and firm profitability, a negative moderating effect in terms of large shareholder ownership and managerial ownership, and a positive moderating effect when it comes to blockholder ownership. This moderating relationship is considered in order to investigate the role of large shareholders under the Korean governance structure. Our empirical analysis showed that outside directors had a weak positive impact, and that a large shareholder ownership rate and a block shareholder ownership rate moderated this relationship in a negative fashion. The managerial ownership rate did not show any significant moderating effects. We thus conclude that it is too early to assess the impact of outside directors on corporate performance, and that Korean companies exhibit an "owner-controlled" governance structure; that is, they are governed by large shareholders who have demonstrated a resistance to attempts to bring about governance reform through such means as the introduction of outside directors. Outside shareholders were found to possess insufficient power to monitor large controlling shareholders. This paper seeks to make a contribution to the field by conducting an analysis of governance structure in Korea in the aftermath of the currency crisis, as well as of outside directors in emerging economies, a subject rarely dealt with in governance studies. Copyright (c) 2007 The Authors; Journal compilation (c) 2007 Blackwell Publishing Ltd.

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