The Investment Opportunity Set Director Ownership

Journal of Corporate Finance 10 (2004) 383 – 408
www.elsevier.com/locate/econbase
The investment opportunity set, director ownership,

and corporate policies: evidence from an
emerging market
Simon S.M. Ho a,*, Kevin C.K. Lam a,1, Heibatollah Sami b,2
a
School of Accountancy, The Chinese University of Hong Kong, Shatin, NT, Hong Kong, China
b
Department of Accounting, The Fox School of Business and Management, Temple University, Philadelphia,
PA 19122, USA
Received 31 May 2001; accepted 17 May 2002
Abstract
This paper provides evidence of the association between a firm’s investment opportunity set
(IOS), director ownership, and corporate policy choices. Using a sample of growth and non-growth
firms in an emerging Asian market, we find that the IOS theory has significant explanatory power in
the financing, dividend, executive compensation, and leasing aspects of corporate policies. Growth
firms have lower debt-to-equity ratios and dividend yields, pay higher cash compensation and bonus
amounts to their top executives, and finance a higher proportion of their asset acquisitions through
operating leases. We also find that director ownership moderates and counteracts the association
between IOS and corporate policies. Our results are consistent with contracting theory predictions
that high director ownership mitigates the need for incentive or bonus compensation plans in growth
firms.
D 2002 Elsevier B.V. All rights reserved.
JEL classification: G32

Keywords: Growth opportunities; Director ownership; Corporate governance; Corporate policies; Hong Kong
*
Corresponding author. Tel.: +1-852-2609-7742; fax: +1-852-2603-5114.
E-mail addresses: simon@baf.msmail.cuhk.edu.hk (S.S.M. Ho), kevinl@baf.msmail.cuhk.edu.hk
(K.C.K. Lam), hsami@sbm.temple.edu (H. Sami).
1
Tel.: +1-852-2609-7894; fax: +1-852-2603-5114.
2
Tel.: +1-215-204-8149; fax: +1-215-204-5587.
0929-1199/$ - see front matter D 2002 Elsevier B.V. All rights reserved.
doi:10.1016/S0929-1199(02)00024-X
384 S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408
1. Introduction
Using data compiled at the industry level, Smith and Watts (1992) found that corporate
financing, dividend, and compensation policies are significantly affected by a firm’s
investment opportunity set (IOS). More specifically, they discovered that firms with more
growth opportunities use less debt in their capital structures, pay less dividends and more
executive compensation, and rely more on stock option plans. Gaver and Gaver (1993)
conducted analyses at the firm level using a composite measure of the IOS. Their results
indicated that growth firms have lower debt to equity ratios, lower dividend yields, higher
cash compensation for their executives, and higher incidence of stock option plans than
non-growth firms. These firm-level results are consistent with those of Smith and Watts at
the industry level. Baber et al. (1996) extended the paradigm further in the area of
incentive compensation plans and found consistent results. Lehn et al. (1990) found that
growth opportunities affected organizational form in that high growth firms tend to adopt
dual-class capitalizations versus leveraged buyouts.
Smith and Watts (1992) suggested leasing, hedging, and corporate accounting choices
and disclosure policies as other corporate policies that warranted investigation. Following
their suggestion, Skinner (1993), using a large sample of COMPUSTAT firms from 1989,
documented an association between firm accounting procedure choices and the IOS,
controlling for managerial contractual incentives. Nance et al. (1993) found that hedging
firms experience more growth opportunities. Gul and Tsui (1998) examined how IOS
together with a firm’s free cash flow and debt position affects audit pricing. Based on a
sample of Hong Kong firms, they found that low growth firms with high free cash flow and
low debt level paid significantly higher audit fees. They interpret their results as these firms
pose higher audit risk to the auditors. Finally, Gul (1999a,b) extended parts of the Smith and
Watts (1992) study to samples of firms from Japan and China. Consistent with the
contracting cost arguments, he found a negative association between the IOS and financing
and dividend policies.
The purpose of our study is twofold. First, we examine whether the IOS theory has
explanatory power in the cross-sectional structure of corporate policy choices in Hong
Kong. Our test of the theory in Hong Kong will enhance the generalizability of the IOS
effects to emerging economies with different regulatory frameworks and market environ-
ments. We also extend prior studies in this area by considering the association between the
IOS and leasing policy (operating leases). Second, the share ownership of the listed
companies that form our sample are concentrated in founding families and family
members who serve as directors and senior executives. An examination of the hypothe-
sized associations in an economy like Hong Kong, with its unique regulatory framework
(relatively non-stringent financial reporting requirements) and corporate governance
structure (most listed firms are family controlled), will provide a much needed under-
standing of the applicability of the IOS theory and how director/family ownership affects
the association between growth opportunities and corporate policies.
Our results show that growth firms have lower debt-to-equity ratios, pay lower
dividends, pay higher cash compensation and bonus amounts to their top executives,
and finance a higher proportion of their assets acquisition through operating leases. There
are, however, insignificant differences between growth and non-growth firms with regard
S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408 385
to the incidence of stock options and bonus plans. When we add the director ownership
variable to the regressions, we find that it moderates or even counteracts the association
between growth opportunities and corporate policies. Director owned firms pay lower cash
compensation and bonus amounts, finance a lower portion of their assets through leases,
and for most of the other policy variables that are studied present an association opposite
to that of the IOS alone. We also find that most interaction effects between IOS and
director ownership are negative. Our results on director ownership are consistent with the
notion that such ownership aligns shareholder and management (i.e., director) interests and
mitigates agency costs. Thus, the intensity required for monitoring or incentive mecha-
nisms is alleviated.
The remainder of the paper is organized as follows. Section 2 develops the hypotheses.
Section 3 describes our procedures for selecting growth and non-growth firms. Section 4
discusses the empirical proxies for IOS based on prior research, and correlation analyses
regarding these proxies. In Section 5, the policy variables and descriptive statistics are
discussed. We present our regression results in Section 6. Section 7 contains sensitivity
analyses and robustness checks. Section 8 summarizes and concludes the paper.
2. Hypotheses
Similar to that of Gaver and Gaver (1993), a central premise of this study is the
existence of cross-sectional differences regarding the nature of the investment options that
are faced by firms.3 We use contracting cost theory and agency theory to develop our
hypotheses because the results of prior studies are consistent with these theories.
2.1. Capital structure policy
Based on Smith and Watts (1992) and Gaver and Gaver (1993), firms with substantial
growth options are expected to pursue a low debt financing policy. Firms finance growth
with equity, rather than debt, to control the potential under-investment problem that is
caused by risky debt (Myers, 1977). In other words, they are expected to have lower debt-
to-equity ratios. This leads to the first hypothesis, as follows:
H1. Growth firms have lower debt-to-equity ratios than non-growth firms.
2.2. Dividend policy
According to Smith and Watts (1992), the higher the amount of investment in a period,
the lower the dividend or the higher the amount of new equity issued. As Jensen (1986)
argued that more growth opportunities for firms result in lower free cash flows and
dividend payments, high growth firms are expected to pay less dividends. In addition,
growth firms are expected to pay lower dividends because contractual arrangements
encourage firms without profitable investment opportunities to pay higher dividends,
3
For a detailed discussion of the validity of this premise see Gaver and Gaver (1993, p. 128).
rather than undertake negative net present value projects (Smith and Warner, 1979).
Hence, the second hypothesis is:
H2. Growth firms pay lower dividends than non-growth firms.
2.3. Executive compensation
Growth firms are expected to pay higher levels of compensation to executives because
the selection of investment projects is more risky and commands a higher equilibrium
wage than the supervision of existing assets in place (Smith and Watts, 1992). Chung and
Charoenwong (1991) indicated that non-growth firms are likely to be less risky than
growth firms, and the managers of growth firms demand higher total compensation for
facing this higher risk.
In terms of incentive compensation schemes adopted, Smith and Watts (1992) and
Gaver and Gaver (1993) posited that because managerial actions are less observable in
growth firms, such firms have a higher incidence of market-based incentive plans in an
effort to align managerial and stockholder goals. For the same reason, we expect that
growth firms are more likely to have accounting-based bonus plans. Moreover, the amount
of bonus that is paid should be much higher in these firms. Consequently, the third to sixth
hypotheses are:
H3. Growth firms pay higher levels of average compensation to top five executives than
non-growth firms.
H4. There is a higher incidence of market-based incentive schemes in growth firms than in
non-growth firms.
H5. There is a higher incidence of accounting-based incentive plans in growth firms than
in non-growth firms.
H6. Growth firms pay higher bonuses than non-growth firms.
2.4. Leasing policy
Firms with substantial growth options need much more funding to finance their
profitable investment projects. Stulz and Johnson (1985) showed that high-priority claims,
such as leasing, can help to mitigate the under-investment problem relative to other forms
of debt. Barclay and Smith (1995, p. 908) argue that firms with a greater proportion of
growth opportunities are expected to ‘‘issue significantly fewer fixed claims in the form of
capital leases’’. However, their results indicated that ‘‘firms with more growth oppor-
tunities use capitalized leases more extensively’’ (p. 908) than other types of fixed claims.
Thus, it is expected that growth firms which want to avoid under-investment problems
owing to higher debt prefer those types of financing with no effect on the amount of debt
in their capital structure (balance sheet), such as operating leases. Hence, the seventh
hypothesis is:
H7. Growth firms finance a higher proportion of their assets through operating leases than
non-growth firms.
2.5. Director ownership
La Porta et al. (1999) found that firms with a dominant shareholder (usually a
family) are common outside of the United States. This issue is particularly important
to markets (including Hong Kong) in which ownership is concentrated in founding
families and directors/executives are family members (Ho and Wong, 2001; Chen and
Jaggi, 2000).
In Hong Kong, the management style is traditional Chinese, even though it has a British
style company law and accounting system and an American style regulatory body
overseeing the stock market (Tricker, 1994). Most listed companies in Hong Kong are
subject to dominant family control (HKSA, 1997). A majority of these companies have a
major shareholder who alone or with family members owns 25% or more of the shares.
Moreover, the members of the boards of directors of such companies held an average of
43.5% of total shares on the SEHK (Staff, Hong Kong Economic Journal, 1995). Thus, the
executive directors of many Hong Kong listed firms are also the major shareholders of
those firms.
In theory, high levels of managerial ownership to some extent can ease the free-rider
problem in monitoring (Shleifer and Vishny, 1996) and align the interests of managers and
shareholders (Jensen and Meckling, 1976). As management and shareholder interests are
substantially aligned, there is less need for incentive plans in director-controlled firms.
Core et al. (1999), for instance, examined 205 large US firms over a 3-year period, and
Table 1
Summary of the sample selection process
Sampling frame
Requirements
Firms listed in the Stock Exchange of Hong Kong in 1994 and 1995
Firms included in the Pacific Basin Capital Hong Kong Database
Firm is not a financial institution or a regulated firm
Firm is not a subsidiary of another corporation
Number of firms qualifying 462
Screen for investment opportunity measures
Requirements
Firms that have 5 years of complete data prior to and including 1994
Screen for growth subsample
Requirements
Firms appear in sampling frame
Firms pass the screen for IOS measures
Firms have factor score on the upper 25% of firms with non-missing IOS measures
Screen for non-growth subsample
Requirements
Firms appear in sampling frame
Firms pass the screen for IOS measures
Firms have factor score on the lower 25% of firms with non-missing IOS measures
found that CEO compensation decreased as a function of CEO ownership stake. This leads
to the following hypothesis:
H8. There is a negative moderating effect of director ownership on the association
between growth opportunities and executive compensation and bonus amounts.
3. Sample selection
We start with the Pacific Basin Capital (PACAP) Hong Kong database. This database
contains all of the companies that were listed in the SEHK during the period under
review, which is from 1994 to 1995. Of these 641 companies,4 we exclude 153 firms that
are finance and banking related (PACAP industry code = 1) and 26 firms that are
regulated (e.g., utility and telecommunication firms). Of the remaining 462 firms, we
exclude a further 150 firms that do not have the complete set of data that is required. We
rely on the annual report microfiche that is supplied by the SEHK for stock option plan,
bonus, and executive compensation data, all of which are not available in the PACAP
database. Table 1 provides a summary of the sample selection procedures leading to our
final sample.
4. Empirical proxies for IOS
As the IOS is not directly observable and there is no agreement in the literature
regarding proper proxy variables, our IOS proxies are similar to those used by Smith and
Watts (1992), Gaver and Gaver (1993), and Skinner (1993). There are four exceptions
from these studies due either to data availability or difference in the economic and business
environments of Hong Kong. For instance, the variable that represents the decisions of
managers of growth-oriented mutual funds is not used in this study because there is no
such fund classification in Hong Kong. Firm spending on research and development is
also not used in this study because such expenses are generally immaterial for Hong Kong
companies.
Following Christie (1989), we use the variance on asset-deflated revenue as a
variability measure. Finally, Hong Kong firms separately report capital expenditures
incurred and committed. Thus, we use capital expenditure committed as an extra proxy
for the IOS. Usually, the level of capital expenditure committed is an indication of
future growth potential. Overall, the addition of two new variables should give a more
reliable IOS index provided that these additional variables are theoretically relevant.
Although, there is no recommended number of variables in a factor analysis, the
number ranges from 3 to 30 in the literature. The most important criterion is that many
of these variables have high correlation among themselves and they share common
constructs.
4
The PACAP has 660 listings, but 19 are duplicate listings of firms that have both A and B shares.
Hence, we use the market-to-book asset, market-to-book equity, and earnings-to-

price ratios of Gaver and Gaver (1993),5 the depreciation to book total assets and
capital expenditure incurred to book total assets of Smith and Watts (1992), the
variance of asset-deflated sales of Christie (1989), the ratio of gross property, plant,
and equipment divided by the firm’s market value of Skinner (1993), as well as capital
expenditure committed to book total assets, which is a new measure, as proxies for the
IOS.
4.1. Descriptive statistics and correlations among alternative measures of the IOS
This section presents descriptive statistics and correlations for the measures of the
investment opportunity set: market-to-book assets (MKTBKASS), market-to-book-equity
(MKTBKEQ), the earnings/price ratio (EP), the variance of asset-deflated sales (VAR-
SALE), the ratio of total capital expenditure incurred to book total assets (RACTCE), the
ratio of capital expenditure committed to book total assets (RCAPEXC), the ratio of total
depreciation to book total assets (RTODEP), and the ratio of plant, property, and
equipment divided by the market value of the firm (PPVR). These variables are defined
as follows.
MKTBKASS ¼ fTotal assets Total common equity

þ Shares outstanding Share closing priceg=Total assets6
MKTBKEQ ¼ fShares outstanding Share closing priceg=Total common equity7
EP ¼ EPS before extraordinary items=Share closing price8
VARSALE ¼ Variance of asset deflated sales over the past 5 years9
RACTCE ¼ Capital expenditure incurred in the 1994 fiscal year=Total assets
5
The justifications for these alternative measures are presented by Gaver and Gaver (1993, pp. 131 – 133).
6
Total assets, total common equity, and shares outstanding, unless otherwise specified, are the balances at the
end of the company’s fiscal year. The share closing price denotes the closing price at the end of the fiscal year.
The PACAP codes are BAL9 (total assets), BAL21 (total common equity), MKT5 (shares outstanding), and
MKT3 (share closing price).
7
The PACAP codes are BAL21 (total common equity), MKT5 (shares outstanding), and MKT3 (share
closing price).
8
The PACAP does not include the EPS figure. We compute the EPS by using net income (PACAP code
INC9) after adjustment for extraordinary gains or losses (INC8) and dividing the resulting figure by the total
number of common shares outstanding (MKT5).
9
Asset-deflated sales are calculated as sales divided by total assets. The PACAP codes are INC1 (sales) and
BAL9 (total assets).
RCAPEXC ¼ Capital expenditure committed as of the end of the 1994

fiscal year=Total assets
RTODEP ¼ Depreciation expense during the year=Total assets10
PPVR ¼ The plant; property; and equipment

=fShares outstanding share closing priceg11
Table 2 presents the descriptive statistics and correlation matrix of the above IOS
proxies. The highest correlations are between MKTBASS and MKTBKEQ (0.9646) and
between RTODEP and RCAPEXC (0.6354). Our goal is to isolate the underlying factors
that are common to all of the proxies, which will then be used to measure the firm IOS and
construct growth and non-growth samples. To this end, we use common factor analysis to
load individual proxies into one or more factors that contain common constructs of the
investment opportunity set.
Table 3 presents the results of the common factor analysis. In Panel A, the starting
communalities of the individual measures (proxies) of the investment opportunity set are
shown. Panel B presents the eigenvalues of the reduced correlation matrix of the eight
individual measures of the investment opportunity set. In our case, three factors are
required to explain the interrelations among the individual measures (Harman, 1976).
Factor one is related to the stock market performance of the firm, as the loadings on
MKTBASS and MKTBKEQ are very high (see Panel C). The second factor is related to
the capital expenditure of the firm. The loadings on RCAPEXC and RTODEP are very
high. Factor three is related to firm asset position, as the important loadings are PPVR and
RACTCE.
4.2. Selection of growth and non-growth firms
The growth index is constructed by computing the individual factor scores from the
factor analysis and then by summing the scores of the three factors.12 In our complete data
set of 312 firms, we label the top 78 firms (upper 25%) as growth firms, and the bottom 78
firms (lower 25%) as non-growth firms. We ignore the middle 156 firms and regress only
on the remaining growth and non-growth firms.
10
The information on capital expenditure incurred, capital expenditure committed, and depreciation expenses
was collected from the footnotes of the annual reports of the companies studied for the 1994 fiscal year. The total
assets for the 1994 fiscal year are based on PACAP code BAL9.
11
The PACAP codes used are BAL7 (plant, property and equipment), MKT5 (shares outstanding), and
MKT3 (share price).
12
The final results, however, are not sensitive to whether we use the first factor, the first two factors, or the
first three factors for classification. We obtain the same qualitative results under all three classifications.
Table 2
Descriptive statistics and correlations of eight measures of the investment opportunity set for 312 SEHK listed
firms at the end of 1994
MKTBKEQ MKTBKASS EP PPVR VARSALE RACTCE RCAPEXC RTODEP
Panel A: descriptive statistics
Maximum 18.6916 7.8405 2.3387 2.0937 1.5689 0.6346 2.5429 0.2821
Third quartile 1.2149 1.1495 0.1739 0.3556 0.0851 0.0770 0.0477 0.0224
Median 0.7496 0.8798 0.0952 0.1805 0.0238 0.0231 0.0118 0.0112
First quartile 0.4563 0.6560 0.0322 0.0608 0.0074 0.0022 0.0000 0.0036
Minimum 0.1553 0.1973 1.8839 0.0000 0.0000 0.0000 0.0000 0.0000
Mean 1.2766 1.0754 0.0785 0.2597 0.0785 0.0552 0.0628 0.0178
Panel B: correlations
MKBKEQ 1.0000
MKTBKASS 0.9646*** 1.0000
EP 0.1023* 0.0833 1.0000
PPVR 0.1885*** 0.2149*** 0.0573 1.0000
VARSALE 0.0466 0.0462 0.0258 0.0076 1.0000
RACTCE 0.0651 0.0749 0.0463 0.1725*** 0.0309 1.0000
RCAPEXC 0.0066 0.0053 0.0077 0.0312 0.0044 0.1074* 1.0000
RTODEP 0.0394 0.0320 0.0403 0.1781*** 0.0014 0.2816*** 0.6354*** 1.0000
The sampling frame consists of all firms in the PACAP 1994 Hong Kong file that meet the following criteria: (1)
publicly traded, (2) non-regulated and non-financial, (3) non-missing data items in assets, sales, closing stock
prices, year-end shares outstanding, dividend per share, total common equity for fiscal year 1994. 462 firms
satisfy these criteria. Of these 462 firms, 312 firms have complete data and are therefore included in the factor
analysis.
MKTBKASS={Total assets Total Common equity + Shares outstanding Share closing price}/Total assets. All
items are the balances as of 1994 fiscal year end.
MKTBKEQ={Shares outstanding Shares closing price}/Total common equity.
EP={EPS before extraordinary items}/Share closing price.
VARSALE = Variance of asset deflated revenue for 5 years up to and including 1994.
RACTCE = Capital expenditure incurred in fiscal year 1994/total assets at 1994 year end.
RCAPEXC = Capital expenditure committed as of the end of the fiscal year 1994/total assets at 1994 year end.
RTODEP = Depreciation Expense during the year/total assets at 1994 year end.
PPVR = The plant, property and equipment/{Shares outstanding shares closing price}.
* p-value < 0.1.
*** p-value < 0.01.
Tables 4 and 5 compare the size and industry membership of the 312 firms in our
sample and the 78 growth and 78 non-growth firms. Table 4 presents the distribution
of firms from each sub-sample for the asset (size) quartiles that are derived from the
overall sample of 312 firms. If the size distributions of each sub-sample are identical
to that of the overall sample, then 25% of all firms will be classified in each quartile.
For the growth firms, this is generally true. However, the non-growth firm sample
shows an interesting distribution. In general, non-growth firms tend to be larger.
About 50% are in the top quartile, and less than 7% are in the lowest quartile. Our
results are quite different from those of Gaver and Gaver (1993), in that their growth
firms were larger firms. In our sample, the growth firms that are identified seem to be
those with market niches in their product segments, and not necessarily the largest
firms.
392
Table 3
S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

Selected statistics related to a common factor analysis of eight measures of the IOS for a sample of 312 SEHK firmsa
Panel A: estimated communalities of eight IOS measuresb
MKTBASS MKTBKEQ EP PPVR VARSALE RACTCE RCAPEXC RTODEP
0.949 0.951 0.016 0.177 0.005 0.137 0.744 0.771
Panel B: eigenvalues of the reduced correlation matrix

1.000 2.000 3.000 4.000 5.000 6.000 7.000 8.000
1.989 1.528 0.233 0.106 0.087 0.038 0.158 0.221
Panel C: correlations between the common factor and IOS measures

MKTBASS MKTBKEQ EP PPVR VARSALE RACTCE RCAPEXC RTODEP FACTOR1 FACTOR2 FACTOR3
Factor1 0.965 0.963 0.112 0.236 0.027 0.079 0.127 0.201 1.000 0.904 0.849
Factor2 0.138 0.126 0.040 0.051 0.002 0.221 0.843 0.854 0.904 1.000 0.793
Factor3 0.017 0.092 0.039 0.344 0.066 0.286 0.127 0.046 0.849 0.793 1.000
Fact-sum 0.978 0.995 0.118 0.177 0.051 0.044 0.073 0.093 0.997 0.874 0.865
Panel D: descriptive statistics of the common factor extracted from six IOS measures
Factor1 Factor2 Factor3 Factor-sum
Maximum 24.482 2.178 1.832 23.043
Third quartile 2.213 0.077 0.269 2.273
Median 1.492 0.145 0.187 1.552
First quartile 1.007 0.247 0.109 1.096
Minimum 0.108 3.271 0.164 0.332
Mean 2.201 0.218 0.225 2.208
Table 4
Asset size distribution for firms in the overall sample and firms in the growth and non-growth subsamples
Book value of Overall sample, Growth firms, Non-growth
assets (HK$million) N = 312 (%) N = 78 (%) firms, N = 78 (%)
Less than 313.171 25.00 24.36 6.41
313.171 < book value of 25.00 25.64 10.26
assets < 751.281
751.281 < book value of 25.00 25.64 33.33
assets < 1936.653
More than 1936.653 25.00 24.36 50.00
The book value of assets are for 1994 fiscal year end.
The overall sample consists of all firms in the PACAP 1994/1995 Hong Kong file that meet the following criteria:
(1) publicly traded, (2) non-regulated and non-financial, (3) non-missing data items in assets, sales, closing stock
prices, year-end shares outstanding, dividend per share, total common equity for 1994 and 95 fiscal years. A total
of 462 firms satisfy these criteria. Of these 462 firms, 312 firms have complete data for both 1994 and 1995 and
are therefore included in the factor analysis.
The growth (non-growth) subsample consists of 78 firms from the overall sample that have growth factor scores
in the top (bottom) 25% of the distribution of scores for firms with non-missing investment opportunity set
measures. To determine the factor scores, common factor analysis is applied to the following IOS measures: (1)
the market-to-book ratio of common equity, (2) the market-to-book ratio of assets, (3) the earnings/price ratio, (4)
the variance of asset deflated sales, (5) capital expenditures committed to book total assets, (6) depreciation to
book total assets, (7) capital expenditures incurred to book total assets and (8) property, plant and equipment to
market value of assets.
Table 5 presents the industry representations in the overall sample and in the
growth/non-growth sub-samples, and identifies the percentage of firms that fall into the
PACAP industry classifications. The PACAP database divides firms into the following
classifications: banking and finance, utility, properties, consolidated enterprises, indus-
trial, hotel, and others. Most of the firms in our overall sample are industrial firms
Notes to Table 3:
MKTBKASS={Total assets Total Common equity + Shares outstanding Share closing price}/Total assets. All
items are the balances as of 1994 fiscal year end.
MKTBKEQ={Shares outstanding Shares closing price}/Total common equity.
EP={EPS before extraordinary items}/Share closing price.
VARSALE = Variance of asset deflated revenue for the past 5 years before 1994.
RACTCE = Capital expenditure incurred in fiscal year 1994/total assets at 1994 year end.
RCAPEXC = Capital expenditure committed as of the end of the fiscal year 1994/total assets at 1994 year end.
RTODEP = Depreciation Expense during the year/ total assets at 1994 year end.
PPVR = The plant, property and equipment as a portion of the firm’s market value.
Factor-sum is the sum of all factors (Factor1, Factor2 and Factor3).
a
The overall sample consists of all firms in the PACAP 1994 Hong Kong file that meet the following criteria:
(1) publicly traded, (2) nonregulated and nonfinancial, (3) nonmissing data items in assets, sales, closing stock
prices, year-end shares outstanding, dividend per share, total common equity for fiscal year 1994. 462 firms satisfy
these criteria. Of these 462 firms, 312 firms have complete data and are therefore included in the factor analysis.
b
Communalities are equivalent to the squared multiple correlations obtained from regressing each of the
investment opportunity set measures on the other seven measures.
Table 5
Industry representation of firms in the overall sample and firms in the growth and non-growth subsamples
Industry classification Overall sample, Growth firms, Non-growth firms,
N = 312 (%) N = 78 (%) N = 78 (%)
Properties 24.04 10.26 58.97
Consolidated Enterprises 32.37 47.44 24.36
Industrial 38.47 35.90 11.54
Hotel 3.52 1.28 3.85
Others 1.60 5.13 1.28
100.00 100.00 100.00
Industry classification is based on PACAP database industrial types.
The overall sample consists of all firms in the PACAP 1994 and 95 Hong Kong file that meet the following
criteria: (1) publicly traded, (2) non-regulated and non-financial, (3) non-missing data items in assets, sales,
closing stock prices, year-end shares outstanding, dividend per share, total common equity for 1994 and 95 fiscal
years. 462 firms satisfy these criteria. Of these 462 firms, 312 firms have complete data and are therefore included
in the factor analysis.
The growth (non-growth) subsample consists of 78 firms from the overall sample that have growth factor scores
in the top (bottom) 25% of the distribution of scores for firms with non-missing investment opportunity set
measures. To determine the factor scores, common factor analysis is applied to the following IOS measures: (1)
the market-to-book ratio of common equity, (2) the market-to-book ratio of assets, (3) the earnings/price ratio, (4)
the variance of asset deflated sales, (5) capital expenditures committed to book total assets, (6) depreciation to
book total assets, (7) capital expenditures incurred to book total assets and (8) property, plant and equipment to
market value of assets.
(38.47%), followed by consolidated enterprises (32.37%), and then by property firms

(24.04%). In our growth sub-sample, close to 50% of the firms are consolidated
enterprises. In contrast, only 35.90% of the sub-sample are industrial firms. Interest-
ingly, property firms account for around 59% of the non-growth sub-sample. Careful
analysis suggests that the property firms which are included in our non-growth sample
are those companies that rely on rental income as their major sources of revenue (e.g.,
Pokfulam and Hysan Development). In general, their growth opportunities are very
limited.
5. Policy variables
5.1. Variable definitions
Our empirical analysis concerns differences between growth and non-growth firms in
financing, dividend, leasing, and compensation policies. Consistent with Smith and Watts
(1992), we measure financing and dividend policies as the ‘market’ debt/equity ratio and
dividend yield, respectively.
Similar to Gaver and Gaver (1993), to assess compensation policy we compute the
average cash compensation that was paid to the top five executives in 1995. We also
record the existence (or nonexistence) of stock option plans and accounting-based bonus
plans (‘bonus plan’ hereafter) in 1995. Information concerning the compensation figures
and practices of sample firms is taken from the 1995 annual reports. Finally, to investigate
leasing policy, we compute operating leases as percentages of total assets. Definitions of

the policy variables are summarized below.
Financing policy13
Market debt=equity ratio
¼ Total liabilities=½Shares outstanding Share closing price
Dividend policy
Dividend yield ¼ Dividend per share=Closing price per share14
Compensation policy15
Average cash compensation
¼ Average cash compensation ðin thousands of Hong Kong dollarsÞ
received by the top five executives in 1995:
Stock option ¼ 1 if firm had a stock option plan in 1995; 0 otherwise
Bonus Plan ¼ 1 if firm had an accounting performance based bonus plan in 1995;
0 otherwise
Bonamt ¼ Bonus amount ðin thousands of Hong Kong dollarsÞ paid to

employees of the firm in 1995:16
Leasing policy17
Operating lease ¼ Operating lease as a percentage of total assets in 1995:
5.2. Descriptive statistics and univariate tests
Table 6 presents descriptive statistics for the policy variables for both the growth and
non-growth samples. The t-test results suggest that Hong Kong growth firms tend, on
average, to use less debt and have lower dividend yield than non-growth firms. These
13
Unless otherwise specified, all of these variables are the balances at the end of the 1995 fiscal year. The
PACAP codes are BAL17 (Total liabilities), MKT5 (Shares outstanding), and MKT3 (Share closing price).
14
PACAP codes MKT1 (Dividend per share) and MKT3 (Closing price per share).
15
Information on average compensation, stock options, and bonuses was collected from the footnotes in the
financial statements of the companies studied.
16
Logarithmic transformation is not used for the bonus amount because some firms did not pay bonuses. The
information on bonus amounts was collected from the footnotes of the annual report.
17
The information is based on data collected from the footnotes in the 1995 annual reports. We found that
almost all of the leases in Hong Kong are operating leases. As in all other countries outside of the United States, it
is relatively easy to classify such leases as operating leases.
396
Table 6
Descriptive statistics of policy variables for firms in the growth and non-growth subsamples
Policy variable Growth firms Non-growth firms t-Test for
No. of Mean First Median Ninth No. of Mean First Median Ninth mean diff.
firms decile decile firms decile decile

Market debt/equity ratio 78 0.6712 0.1660 0.4055 1.3683 78 1.2860 0.5178 1.0840 2.7262 ***
Dividend yield 78 0.0350 0.0000 0.0277 0.0783 78 0.0562 0.0000 0.0444 0.1034 *
Average cash compensation 62 2131.2 750.0 1475.0 5056.0 60 1494.8 500.0 1296.0 3300.0
top 5 executives
(HK$’000s)
Bonus amount (HK$’000s) 78 1012.8 0.0 0.0 1771.0 78 412.2 0.0 0.0 773.0 ***
Incidence stock option 78 0.4231 78 0.3590
Incidence bonus plan 78 0.1667 78 0.1795
Operating lease to 78 0.0275 0 0.00205 0.0661 78 0.0059 0 0.0002 0.0206 **
total assets
The growth (non-growth) subsample consists of 78 firms from the overall sample that have growth factor scores in the top (bottom) 25% of the distribution of scores for
firms with non-missing investment opportunity set measures. To determine the factor scores, common factor analysis is applied to the following IOS measures: (1) the
market-to-book ratio of common equity, (2) the market-to-book ratio of assets, (3) the earnings/price ratio, (4) the variance of asset deflated sales, (5) capital expenditures
committed to book total assets, (6) depreciation to book total assets, (7) capital expenditures incurred to book total assets and (8) property, plant and equipment to market
value of assets. Of these firms, 122 have data on executive compensation.
Market debt/equity = Total liabilities/[Shares outstanding Share closing price]. All variables use 1995 values.
Dividend yield = Dividend per share/Closing price per share. All variables use 1995 values.
Average cash compensation = Average cash compensation received by the top five executives in 1995.
Stock option = 1 if firm had a stock option plan in 1995, 0 otherwise.
Bonus = 1 if firm had a performance based bonus plan in 1995, 0 otherwise.
Bonamt = Bonus amount (in thousands of HK$) paid to employees in 1995.
Lease = Operating lease to total assets in 1995.
t-Tests for mean comparison reported are for assuming unequal variance. Results are similar with those assuming equal variance.
* p-value < 0.1.
** p-value < 0.05.
** * p-value < 0.01.
results are consistent with those of Gul (1999a,b), Gaver and Gaver (1993), and Smith and
Watts (1992).
Growth firms pay a significantly higher average cash compensation (HK$2,131,200
versus HK$1,494,800) to their top five executives and higher bonuses (HK$1,012,800
versus HK$412,200) to their employees. These results, although in the predicted direction,
are not significant at conventional levels for average cash compensation, but are significant
for bonus amount. However, it is interesting to note that growth firms pay a higher amount
of compensation and higher bonuses despite their smaller sizes (see Table 4).
Moreover, there are no significant differences between the growth and non-growth
firms with regard to the incidence of stock options and bonus plans, which is inconsistent
with the hypotheses. Hence, the results of the multivariate regression tests that are
presented in the next section should shed light on the insignificant univariate results.
These results are consistent with the notion that a high level of management (director)
ownership aligns the interest of shareholders and managers, and mitigates the need for
incentive or bonus plans in growth firms. With regard to leasing policy, as hypothesized,
growth firms lease a significantly higher proportion of their assets through operating leases
with a mean of 0.0275 for growth firms versus 0.0059 for non-growth firms.
Table 7 presents correlations among the variables for the combined and both the growth
and non-growth samples. Significantly negative correlations between the growth dummy
and size, return on market value, dividend yield, and debt-to-equity ratio imply that growth
firms are smaller, less profitable, pay lower dividends, and have less debt in their capital
structures. In addition, significantly positive correlations between the growth dummy and
the average cash compensation and operating lease ratio imply that growth firms pay
higher amounts of compensation and finance higher portions of their assets through
operating leases. All of these correlations are in the directions that are predicted by our
hypotheses.
However, there are significant positive correlations between size and cash compensa-
tion in the growth, non-growth, and combined samples. There are also significant
correlations between stock option plan and bonus plan in all samples. Hence, firms with
stock option plans are more likely to have accounting performance-based bonus plans as
well. It is also important to note that director ownership has significant and negative
correlations with bonus plan and bonus amount for the combined sample, as expected.
6. Results
6.1. Primary tests
Our empirical tests consist of regressing each policy variable on a dummy variable that
represents growth opportunities (GROWDUM) and the appropriate control variables. The
GROWDUM takes on the value of one when the firm is in the growth sample and zero
otherwise. Following Gaver and Gaver (1993), we include firm size (LASSETS) as a
control variable in all of the regression equations. The return on market value (ROMV) is
expected to influence average cash compensation for top five executives, and is included
only in the cash compensation and bonus amount regressions (Smith and Watts, 1992).
398
Table 7
Correlations among variables for firms in the growth and non-growth subsamples
Growdum Dirown Log Return on Dividend Debt/equity Stock Bonus Cash Bonus
assets market value yield (market) options plan compensation amount
Panel A: combined sample of growth and non-growth firms
Director ownership 0.0617
log(assets) 0.3817*** 0.1054
Return on market value 0.2360** * 0.0731 0.1385*
Dividend yield 0.1392* 0.1190 0.1002 0.8024***
Debt/equity (market) 0.3005** * 0.0051 0.0896 0.1567* 0.0201
Stock options 0.0657 0.0570 0.0431 0.1431* 0.0777 0.0867
Bonus plan 0.0169 0.1663* 0.0460 0.0262 0.0554 0.0546 0.2584***
Cash compensation 0.1614** 0.1220 0.4111*** 0.0519 0.0273 0.1846** 0.0621 0.0412
Bonus ammount 0.0916 0.2583*** 0.2332*** 0.0199 0.0305 0.0966 0.0539 0.0313 0.4748***
Operating lease /total assets 0.1940** 0.2376*** 0.2402*** 0.0019 0.0066 0.1050 0.0327 0.0035 0.0298 0.0229
Panel B: growth firms

log(assets) 0.08176
return on market value 0.10263 0.3145** *
Dividend yield 0.2090* 0.1319 0.5098***
Debt/equity (market) 0.0242 0.0832 0.2558** 0.0795
Stock options 0.1373 0.1756 0.0269 0.0261 0.0283
Bonus plan 0.2401** 0.0779 0.0147 0.0568 0.0176 0.3133***
Cash compensation 0.0818 0.5563** * 0.2204** 0.0075 0.1818 0.0355 0.0464
Bonus amount 0.2959*** 0.3427** * 0.1488 0.0445 0.0781 0.1027 0.0421 0.5077***
Operating lease /total assets 0.3271*** 0.2372* * 0.0228 0.0858 0.0546 0.0602 0.0026 0.0892 0.0412
Panel C: non-growth firms
log(assets) 0.0994 1.0000
Return on market value 0.0503 0.0749 1.0000
Dividend yield 0.0907 0.0248 0.8467*** 1.0000
Debt/equity (market) 0.0030 0.0385 0.2658** 0.0681 1.0000
Stock options 0.0480 0.1876* 0.1933* 0.0963 0.2501** 1.0000
Bonus plan 0.0869 0.0316 0.0530 0.0660 0.1371 0.2071* 1.0000

Cash compensation 0.0340 0.4496*** 0.0431 0.1171 0.0989 0.0887 0.0465 1.0000
Bonus amount 0.1980* 0.1766 0.0394 0.0100 0.0935 0.0428 0.0091 0.3069** 1.0000
Operating lease/total assets 0.1013 0.0039 0.2957*** 0.2719** 0.0889 0.0291 0.0356 0.1355 0.0529
Growth and non-growth firms: N = 122 for executive compensation, N = 156 for all others.
The growth (non-growth) subsample consists of 78 firms from the sampling frame that have growth factor scores in the top (bottom) 25% of the distribution of scores for
firms with non-missing investment opportunity set measures. To determine the factor scores, common factor analysis is applied to the following IOS measures: (1) the
market-to-book ratio of common equity, (2) the market-to-book ratio of assets, (3) the earnings/price ratio, (4) the variance of asset deflated sales, (5) capital expenditures
committed to book total assets, (6) depreciation to book total assets, (7) capital expenditures incurred to book total assets and (8) property, plant and equipment to market
value of assets.
Market debt/equity = Total liabilities/[Shares outstanding Share closing price] in 1995.
Dividend yield = Dividend per share/Closing price per share in 1995.
Average cash compensation = Average cash compensation received by the top five executives in 1995.
Stock option = 1 if firm had a stock option plan in 1995, 0 otherwise.
Bonus = 1 if firm had a performance based bonus plan in 1995, 0 otherwise.
Lease variables is self explanatory.
DIROWN = 1 if the company is director controlled (with 1/3 or above of shares controlled by board members) and 0 otherwise.
LASSETS = log(Total assets at the end of 1994).
ROMV = 1994 operating income divided by the market value of the firm at the beginning of 1994.
* p-value < 0.1.
** p-value < 0.05.
*** p-value < 0.01
399
Following Smith and Watts (1992), we do a logarithmic transformation on cash

compensation.
We use ordinary least squares analyses to estimate the relations for the debt/equity, cash
compensation, bonus amount, and operating lease models. Tobit analyses are used for the
dividend yield, as this variable has many observations equal to zero. Finally, for the
dichotomous policy variables (stock options and bonus plans), we use logit regression. To
alleviate spurious correlation, we use 1995 values for the dependent variables and 1994
values for the independent variables.
Model Dependent variable Independent variables

1 Market debt1995/equity1995 GROWDUM1994, LASSETS1994
2 Dividend yield1995 GROWDUM1994, LASSETS1994
3 Log(Cash compensation1995) GROWDUM1994, LASSETS1994, ROMV1994
4 Stock option1995 GROWDUM1994, LASSETS1994
5 Bonus plan1995 GROWDUM1994, LASSETS1994
6 Bonus amount1995 GROWDUM1994, LASSETS1994, ROMV1994
7 Operating lease1995 GROWDUM1994, LASSETS1994
Table 8 presents the regression results. As predicted by Hypotheses 1 and 2, growth

firms have significantly lower amounts of debt in their capital structures (t-value = 3.737)
and pay significantly lower dividends (v2 value = 22.577). These results support our debt-
and dividend-related hypotheses (H1 and H2).18
The results for Model 3 are presented after controlling for firm size and firm return.
Growth firms pay significantly higher cash compensation to the top five executives (t-
value = 5.018). Therefore, H3 is supported. The results on the adoption of the stock option
and bonus plans are not statistically significant. The lack of significance in the existence of
stock options and bonus plans (Models 4 and 5) is probably attributable to the high levels
of managerial ownership in Hong Kong, which alleviates agency costs (see discussion in
Section 6.2).
However, the intensity of the bonus (Model 6), as measured by the bonus amount paid,
is significantly higher for growth firms (t-value = 2.549). Hence, our evidence is consistent
with H6 regarding the amount of bonuses. In combination, our results support the notion
that although the number of firms which offer market-based incentive schemes and
18
To determine the robustness of our results to the possible effect of profitability on the relationship between
the growth dummy and dividend or leverage policy as suggested by Baker (1993), we include the ROMV as a
control variable in the empirical models that are related to these policies. To be concise, we do not present the
results in separate tables but summarize our findings here. With the inclusion of ROMV as an additional control
variable in least squares (debt/equity) and Tobit (dividend) regressions, we find that ROMV significantly affects
both policies. It has a significantly negative effect on leverage (coefficient = 1.3131; p-value < 0.002) and a
positive effect on dividend (coefficient + = 1.3464; p-value < 0.0005). However, ROMV affects neither the sign nor
the significance of growth opportunities on the respective policies. Growth firms still have much lower debts
(coefficient = 0.7430; p-value < 0.0001) and lower dividend yields (coefficient = 0.3847; p-value < 0.0021).
The results are qualitatively identical with and without the director ownership variable.
Table 8
Coefficients for firm policy variables regressed on a dichotomous variable representing the investment opportunity set and firm size
Model Empirical Dependent Number Intercept GROWDUM LASSETS ROMV Adj./pseudo F (v2) or
techniques variables of obs. R2 log-likelihood
1 OLS Debt/equity 156 1.5701 0.6377 0.0438 0.0791 7.661***
(market) (1.926) * ( 3.737)*** ( 0.352)

2 Tobit Dividend yield 156 0.2112 0.7092 0.4015 137.754***
(0.7747) (22.577)*** (13.136)***
3 OLS Cash 116 1.0342 0.2828 0.3204 0.1639 0.3730 23.804***
compensation (3.973)*** (5.018)*** (8.049)*** (1.277)
4 Logit Stock options 156 0.1700 (0.010) 0.2366 (0.442) 0.0632 (0.592) 0.0047 0.733
5 Logit Bonus plan 156 0.1062 (0.002) 0.2255 (0.233) 0.2517 (0.504) 0.0036 0.569
6 OLS Bonus Amount 156 9326.1398 1425.2178 1493.9402 489.6451 0.0754 5.213***
( 3.564)*** (2.549) ** (3.732)*** (0.351)
7 OLS Operating lease 156 0.1081 0.0133 (1.420) 0.0158 0.0284 3.269**
(2.417) ** ( 2.306) **
Tobit regression is used for the dividend yield regression. Logit regression is used for bonus and stock option plans. Ordinary least squares regressions are used for all
others.
Of the 156 firms, only 122 firms (62 growth and 60 non-growth) have compensation data available.
For OLS regression, the second row represents t-statistic. For Logit and Tobit regression, the second row in each cell represents the v2 values. The last column of each
regression represents the overall model significance ( F value for OLS and log-likelihood for Logit and Tobit). Adj. R2 is presented for OLS while pseudo R2 is presented
for Logit.
Market debt/equity = Total liabilities/[Shares outstanding Share closing price].
Dividend yield = Dividend per share/Price per share.
Cash compensation = log(Average cash compensation received by the top five executives in 1995).
Stock option = 1 if firm had a stock option plan in 1995, 0 if otherwise.
Bonus = 1 if firm had a performance based bonus plan in 1995, 0 if otherwise.
Operating lease = Operating lease to total assets in 1995.
GROWDUM = 1 if firm is classified as a growth firm, 0 if classified as non-growth firm.
* p-value < 0.1.
** p-value < 0.01.
401
***p-value < 0.05.
accounting-based incentive plans are similar for growth and non-growth firms, the amount
of the bonuses that are paid is significantly higher for growth firms.
Growth firms (Models 7) tend to finance a higher proportion of their assets through
operating leases, as indicated by the positive sign, although this is not statistically significant
(t-value = 1.420). However, after considering the interaction between director ownership
and growth, the GROWDUM coefficient is not only positive but also significant (see Table
10). Combined with the results of univariate analyses, this supports H7.
6.2. The moderating effects of director ownership
Most prior studies (e.g., Morck et al., 1988) used a 10% threshold of board member
ownership of company shares as a discrete measurement of family ownership. However, this
benchmark is not helpful in the Hong Kong environment, where family ownership is
typically much higher than 10%. Consequently, we adopt a higher benchmark and treat firms
with 1/3 or above of shares owned by the board of directors as family controlled. Those firms
with director – ownership levels that are lower than this benchmark are regarded as non-
family controlled.
Common to ownership data in other countries, director ownership data in Hong Kong is
plagued by the issues of indirect and cross shareholdings, pyramiding share control, and
interlocking directorships. Our ownership data is obtained from the Hong Kong Listed
Companies Handbook that is published by the Hong Kong Shanghai Commercial Bank
(1995 – 2000). This data set reports aggregate figures of director ownership. For the
relatively few companies that are not covered in the Handbook, we compute the data from
the Extel Card (formerly Wardley Card) compiled by the HSBC. Ho and Wong (2001)
found that directors in family-owned firms tend to vote together as a block. Moreover, the
ownership patterns of these companies are stable over time.
Even with this relatively high benchmark for director ownership, over 88% of our
sampled firms are classified as director owned, which signifies the prevalence of this form
of ownership in Hong Kong. Scrutiny of the samples suggests some non-director owned
firms. Some have a significant international presence, or are known for their Western style
of management and incentive systems. Many of these firms have substantial equity
participation from institutional or foreign owners.
Table 9 reports the results from regressions that incorporate the director ownership
variable. It is interesting to note that even after incorporating director ownership, the IOS
(growth opportunities) variable still has significant coefficients in the same models. None-
theless, as shown in the regressions, director owned firms paid significantly lower average
cash compensation (t-value = 1.915; p-value < 0.1) and lower accounting-based bonus
amounts (t-value = 3.89; p-value < 0.01). Moreover, consistent with the notion of trans-
ferring wealth from debt holders to shareholders, the director owned firms had a higher
dividend yield (v2 value = 1.951; p-value < 0.165). In addition, these firms used fewer
operating leases (t-value = 2.763; p-value < 0.01). Interestingly, they had a higher inci-
dence of accounting-based bonus plans (v2 = 3.797; p-value < 0.10).19 The impact of director
19
It is easy to install an incentive compensation system and leave it unused (i.e., to pay lip service to it).
Hence, we believe that higher incentive payments provide more convincing evidence.
Table 9
Coefficients for firm policy variables regressed on a dichotomous variable representing the investment opportunity set and director ownership variables
Model Empirical Dependent Number Intercept GROWDUM LASSETS DIROWN ROMV Adj. /pseudo F (v2) or
techniques variables of obs. R2 log-likelihood
1 OLS Debt/equity 156 1.5931 0.6383 0.0422 0.0367 0.0732 5.081***
(market) (1.912)* ( 3.728)*** ( 0.337) ( 0.144)

2 Tobit Dividend 156 0.2415 0.7040 0.3885 0.3930 136.920***
yield (0.090) (22.632)*** (12.505)*** (1.951)
3 OLS Cash 116 1.1519 0.2768 0.3231 0.1506 0.1768 0.3876 19.195***
compensation (4.355)*** (4.962)*** (8.208)*** ( 1.915)* (1.392)
4 Logit Stock options 156 0.0362 (0.0004) 0.2320 (0.4238) 0.0484 (0.0344) 0.3336 (0.4110) 0.0073 1.141
5 Logit Bonus plan 156 0.6318 (0.0778) 0.2451 (0.2712) 0.1825 (0.2745) 1.1042 (3.7973) * 0.0256 4.043
6 OLS Bonus Amount 156 7452.0199 1401.2130 1619.6638 2987.4195 774.2828 0.1509 7.885***
( 2.916)*** (2.615)*** (4.206)*** ( 3.809)*** (0.579)
7 OLS Operating 156 0.1319 0.0127 0.0141 0.0378 0.0970 6.547***
Lease (2.954)*** (1.385) ( 2.101)** ( 2.763)***
Tobit is used for dividend yield regression. Logit regression is used for bonus and stock option plans. Ordinary least squares regressions are used for all others. Of the 156
firms, only 122 firms (62 growth and 60 non-growth) have compensation data available.
For OLS regression, the second row represents t-statistic. For Logit and Tobit regression, the second row in each cell represents the v2 values. The last column of each
regression represents the overall model significance ( F value for OLS and Log-likelihood for Logit and Tobit). Adj. R2 is presented for OLS while pseudo R2 is presented
for Logit.
Market debt/equity = Total liabilities/[Shares outstanding Share closing price].
* p-value < 0.1.
** p-value < 0.05.
403
*** p-value < 0.01.
404
Table 10
Firm policy variables regressed on ‘‘Growth’’, family ownership and their interaction term
2
Model Empirical Dependent Number Intercept GROWDUM LASSETS DIROWN GDIROWN ROMV Adj. /pseudo F (v ) or
technique variables of obs. R2 log-likelihood
1 OLS Debt/equity 156 1.5624 0.5855 0.0423 0.0025 0.0591 0.0672 3.789***
(market) (1.780)* ( 1.189) ( 0.336) ( 0.006) ( 0.114)
2 Tobit Dividend 156 0.1089 0.9389 0.3877 0.2464 0.2526 136.818***

yield (0.016) (2.858)* (12.421)*** (0.296) (0.193)
3 OLS Cash 116 0.9137 0.6072 0.3274 0.0818 0.3703 0.1720 0.4109 17.043***
compensation (3.275)*** (3.984)*** (8.470)*** (0.647) ( 2.322) ** (1.380)
4 Logit Stock options 156 0.5993 1.2970 0.0503 0.3774 1.1922 0.0202 2.348
0.1046) (1.4845) (0.0367) (0.1866) (1.1470)
5 Logit Bonus plan 156 0.2446 0.4185 0.1844 0.6416 0.8040 0.0286 4.532
(0.0109) (0.1521) (0.2796) (0.5105) (0.4790)
6 OLS Bonus 156 8911.4569 3909.7852 1617.0534 1362.9409 2809.6165 752.1868 0.1631 7.042***
Amount ( 3.345)*** (2.611)*** (4.230)*** ( 1.141) ( 1.792)* (0.566)
7 OLS Operating 156 0.0906 0.0838 0.0142 0.0082 0.0795 0.1407 7.345***
Lease (1.980)** (3.266)*** ( 2.167)** (0.399) ( 2.956)***
Tobit is used for dividend yield regression. Logit regression is used for bonus and stock option plans. Ordinary least squares regressions are used for all others. Of the 156 firms, only 122 firms (62
growth and 60 non-growth) have compensation data available.
For OLS regression, the second row represents t-statistic. For Logit and Tobit regression, the second row in each cell represent the v2 values. The last column of each regression represents the overall model
significance ( F value for OLS and log-likelihood for Logit and Tobit). Adj. R2 is presented for OLS while pseudo R2 is presented for Logit.
Market debt/ equity = Total liabilities/[Shares outstanding Share closing price].
Bonamt = Bonus amount (in thousands of Hong Kong dollars) paid to employees in 1995.
GDIROWN = GROWDUM DIROWN.
* p-value < 0.1.
** p-value < 0.05.
*** p-value < 0.01.
ownership on debt-to-equity ratios and stock option plans is insignificant.20 These results
are consistent with contracting theory, in that director ownership reduces the need for
monitoring and incentive mechanisms.
Table 10 presents regression results involving the interaction between growth oppor-
tunities and director ownership. It is interesting to note that in the average cash
compensation and bonus amount, the signs of the interaction terms are significantly
negative, thus supporting our theory that in emerging economies, director control
counteracts the effects of growth on policy choices. Hence, even those growth firms with
heavy director ownership tend to pay significantly lower bonus amounts (t = 1.792;
p < 0.1), and lower average cash compensation (t = 2.322; p < 0.05). In addition, as
predicted by H7, operating lease model has significant and positive coefficient for the
GROWDUM. The effects on other policy variables are mostly negative but insignificant.
Therefore, H8 is supported.
Our evidence is also consistent with the widely held belief that for family-owned firms,
director or family control is regarded as equal to, if not more important than, future growth
(Redding and Pugh, 1986; Bond, 1993). The loss of control to outsiders is often regarded
as a family disgrace. Corporate policies that foster growth but loosen the family grip are
unlikely to be adopted in typical family (director) controlled businesses. This phenomenon
is seen not only in Asia but also in Asian owned businesses in America, no matter how
large the company has grown.21
7. Sensitivity analysis and robustness check
Following Gaver and Gaver (1993), we have adopted the procedure of labeling the top
25% of the sampled firms as growth firms, and the bottom 25% as non-growth firms.
However, our results are also robust to classifying firms with IOS indices that are equal to or
above the median IOS index as growth firms, and those below that index as non-growth
firms. Based on 312 firms and 50% of growth and 50% of non-growth firms, we find that
growth firms have lower debts (t = 4.601, p-value < 0.0001), lower dividends (v2 = 23.39;
p-value < 0.0001), higher compensation (t = 4.928; p-value < 0.0001), higher bonus amounts
(t = 2.178, p-value < 0.0302), and a higher proportion of operating leases (t = 2.118, p-
value < 0.035). The variables for the incidences of bonus schemes and stock option plans
are still insignificant.
The use of continuous factor scores (i.e., FACSUM = the sum of factor scores) produces
similar results. For the 312 sampled firms, those with higher FACSUMs have lower debt
ratios (t = 3.404; p-value < 0.0008), lower dividend yields (v2 = 13.71; p-value < 0.0002),
higher compensation (t = 3.999, p-value < 0.0001), and higher operating lease to asset ratios
(t = 5.150; p-value < 0.0001). Bonus plans and stock option plans are both insignificant. In
sum, our results are robust to different specifications for identifying growth firms.
20
We find nearly identical results when benchmarks such as 30% or 40% are used instead of 33%.
21
A well-known example is Wang Computers, which was once a Fortune 500 company. An Wang chose his
son instead of a more capable veteran of the company as his successor. This is very typical of family owned firms
in Asia.
8. Conclusion and discussion
The objective of this paper is to provide evidence of the association between a firm’s
IOS, director ownership, and a wide set of corporate policy choices. In line with theory
and our hypotheses, growth firms have significantly less debt in their capital structures,
pay lower dividends, pay significantly higher compensation and bonuses to executives,
and finance a significantly higher proportion of their assets through operating leases. We
have documented that director ownership tends to moderate the effect of growth
opportunities on corporate policies. These new findings add knowledge to corporate
policy research in emerging markets.
In sum, our results suggest that the IOS theory is somewhat applicable to this emerging
market. However, this applicability is higher for growth, non-director controlled firms.
Although the 5-year data requirement might bias the sample towards more successful
firms, we believe that any such bias is unlikely to affect our results in a significant way, as
the company liquidation rate of all incorporated firms in Hong Kong during the period
under review was a mere 0.1%.22 Another limitation of our study is that our data on
director ownership is directly extracted from a single source. It is not known how this
aggregate measure adjusts for cross-holdings and indirect ownership.
Clearly, additional research is needed to more fully understand the relationship between
the IOS, director ownership, and policy choices of firms. Future research should explore
the effects of specific ownership and corporate governance attributes on the relationship
between the IOS and corporate policy variables. More work on the interaction between the
nature of the financial reporting environment and corporate policy choices is also
warranted. Another possibility is to conduct a time-series test of the theory, rather than
a cross-sectional test.
Acknowledgements
We would like to thank the two anonymous reviewers, Gordon Richardson, In-Mu
Haw, Debra Sinclair, Joon Yang, the workshop participants at the Gadjah Mada
University in Indonesia, and the participants of the concurrent sessions of the 1999
AAA/TAA Globalization Conference by the 1999 Asian-Pacific Conference on Inter-
national Accounting Issues and the 2002 Annual Meeting of the European Accounting
Association for their helpful comments and suggestions. Simon S.M. Ho would like to
thank the support of CUHK Research Grant on the project entitled Corporate
Governance Family Ownership and Disclosure in the Far East. Kevin Lam wishes to
thank the support of CUHK Direct Grant #2070198. Heibatollah Sami would like to
thank the Fox School for its financial support. Any errors are the responsibility of the
authors.
22
See Adela Ma, ‘‘481 companies forced to liquidate’’ on p. 2 of the Business Section, The South China
Morning Post, January 11, 1996.
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Journal of Corporate Finance 10 (2004) 383 – 408

The investment opportunity set, director ownership,

JEL classification: G32

2.1. Capital structure policy

2.2. Dividend policy

2.3. Executive compensation

2.4. Leasing policy

2.5. Director ownership

4. Empirical proxies for IOS

Hence, we use the market-to-book asset, market-to-book equity, and earnings-to-

MKTBKASS ¼ fTotal assets Total common equity

MKTBKEQ ¼ fShares outstanding  Share closing priceg=Total common equity7

EP ¼ EPS before extraordinary items=Share closing price8

VARSALE ¼ Variance of asset deflated sales over the past 5 years9

RACTCE ¼ Capital expenditure incurred in the 1994 fiscal year=Total assets

RCAPEXC ¼ Capital expenditure committed as of the end of the 1994

RTODEP ¼ Depreciation expense during the year=Total assets10

PPVR ¼ The plant; property; and equipment

4.2. Selection of growth and non-growth firms

S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

Panel B: eigenvalues of the reduced correlation matrix

Panel C: correlations between the common factor and IOS measures

(38.47%), followed by consolidated enterprises (32.37%), and then by property firms

5.1. Variable definitions

leasing policy, we compute operating leases as percentages of total assets. Definitions of

Bonamt ¼ Bonus amount ðin thousands of Hong Kong dollarsÞ paid to

5.2. Descriptive statistics and univariate tests

S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

6.1. Primary tests

Panel B: growth firms

S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

Following Smith and Watts (1992), we do a logarithmic transformation on cash

Model Dependent variable Independent variables

Table 8 presents the regression results. As predicted by Hypotheses 1 and 2, growth

S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

6.2. The moderating effects of director ownership

S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

S.S.M. Ho et al. / Journal of Corporate Finance 10 (2004) 383–408

7. Sensitivity analysis and robustness check

8. Conclusion and discussion

S-ar putea să vă placă și

MKTBKEQ ¼ fShares outstanding Share closing priceg=Total common equity7