Does Confucianism Reduce Corporate Over‐Investment? Evidence from China

• Author: Yan Ye,Khalil Jebran,Shihua Chen
• Date: 01 April 2019
• DOI: http://doi.org/10.1111/ajfs.12254
• Published date: 01 April 2019

Does Confucianism Reduce Corporate

Over-Investment? Evidence from China*

Shihua Chen

School of Business Administration, Dongbei University of Finance and Economics, China

Yan Ye

School of Business Administration, Dongbei University of Finance and Economics, China

Khalil Jebran**

School of Accounting, Dongbei University of Finance and Economics, China

Received 11 June 2018; Accepted 8 February 2019

Abstract

In this study, we argue that Confucianism, as an informal institution, mitigates agency prob-

lems and thus curbs managerial over-investment behavior. Using a sample of Chinese listed

firms over the period 2000 to 2015, we find strong evidence that Confucianism is negatively

associated with over-investment. Furthermore, we document that the negative association

between Confucianism and over-investment is weaker for state-owned enterprises than for

non-state-owned enterprises. Overall, the findings enrich our understanding that informal

institutions can play a significant role in influencing corporate behavior.

Keywords Confucianism; Over-investment; Agency conflicts; State-owned enterprises; China

JEL Classification: G30, G11, Z12

1. Introduction

According to Modigliani and Miller (1958), a firm’s investment in a frictionless sys-

tem should be driven only by its investment opportunities, as measured by Tobin’s

Q (Tobin, 1969). However, a firm’s investment may deviate from the optimal level

because of capital market frictions (Chen et al., 2017). The extant research suggests

that the agency problems between management and shareholders, as well as those

between controlling and minority shareholders, and the information asymmetry

*The authors are thankful to the special issue editor, Professor Bohui Zhang, and two anony-

mous referees for many insightful comments and suggestions. This article is supported by the

National Natural Science Foundation of China (Project No. 71472030).

**Corresponding author: School of Accounting, Dongbei University of Finance and Eco-

nomics, 217 Jianshan Street, Shahekou District, Dalian, China. Tel: +86-178-6654-8542, Fax:

+86-411-8471-0099, email: khaliljebranuom@gmail.com.

Asia-Pacific Journal of Financial Studies (2019) 48, 210–235 doi:10.1111/ajfs.12254

210 ©2019 Korean Securities Association

between management and financial institutions, can influence a firm’s investment

decisions (Myers and Majluf, 1984; Jensen, 1986; Chen et al., 2006; Jiang et al.,

2010; McLean et al., 2012). These problems are severe in emerging economies where

formal governance mechanisms are weak and far from perfect (Young et al., 2008;

Jiang et al., 2010; Du, 2015). Therefore, studies are recognizing that informal insti-

tutions combined with weak formal governance mechanisms can mitigate agency

problems (Du, 2013, 2014, 2015). This study attempts to investigate whether and

how Confucianism, as an informal institution, can curb agency problems and, con-

sequently, curb corporate over-investment in Chinese firms.

Confucianism has had a significant influence on people’s behavior for thousands

of years (Yao, 2000). Studies show that Confucian philosophy can influence busi-

ness ethics (Whitcomb et al., 1998; Chan, 2008), organizational communications

(Chen and Chung, 1994), management practices (Dollinger, 1988), contemporary

business ethics (Ip, 2009), economic growth (Lam, 2003), corporate social responsi-

bility (Wang and Juslin, 2009), and interpersonal relations (Wang and Juslin, 2009).

Most recent research shows that Confucianism reduces minority shareholders’

expropriation and boards’ gender diversity (Du, 2015, 2016). However, the research

on the influence of Confucianism on corporate investment decisions is less preva-

lent, if not absent.

To test the above argument, we use a sample of Chinese listed firms over the

period 2000 to 2015 and test the influence of Confucianism on over-investment.

We find strong evidence that Confucianism negatively impacts over-investment.

Our results are consistent with the notion that Confucianism, as an ethical culture,

mitigates agency conflicts and thereby curbs over-investment. Furthermore, we

document that the influence of Confucianism on over-investment is weaker for

state-owned enterprises (SOEs) than for non-SOEs. Our results are consistent with

a battery of robustness tests and alternative measures of Confucianism and over-

investment.

This study contributes to the literature in several ways. First, it extends the

research on corporate investment from a different perspective. Specifically, we

investigate how Confucianism, as an informal institution, influences the over-invest-

ment behavior of Chinese firms. Our results demonstrate that Confucianism is on e

of the important ethical systems that can mitigate agency conflicts and therefore

reduce managerial over-investment behavior.

Second, this study contributes to the finance literature by showing that Confu-

cianism is a significantly important determinant of corporate investment policies.

Prior studies mostly show that various governance mechanisms can influence cor -

porate investment decisions, such as controlling shareholders, insider ownership,

institutional investors, state ownership, higher level of debt, larger board size, etc.

(Shleifer and Vishny, 1997; Cho, 1998; Huang and Shen, 2009; Tang et al., 2010;

He and Kyaw, 2018). However, the literature on the influence of informal institu-

tions (such as religion, social norms, and culture) on corporate investment deci-

sions is less abundant, if not absent.

Confucianism and Corporate Over-Investment

©2019 Korean Securities Association 211