Academic journal article Journal of Southeast Asian Economies

Insider Ownership and Industrial Competition: Causes and Consequences of Information Asymmetry

Academic journal article Journal of Southeast Asian Economies

Insider Ownership and Industrial Competition: Causes and Consequences of Information Asymmetry

Article excerpt

I. Introduction

The issues of corporate governance stem from the problem of information asymmetry, when agents have the information that other external shareholders do not have. The problem prevails between the managerial (Jensen and Meckling 1976) or controlling large shareholders (Shleifer and Vishney 1997) and other external and minority shareholders. Recent research shows that information asymmetry affects corporate governance (Chung et al. 2010) while Guadalupe and Perez-Gonzalez (2006) proved that improved information can reduce agency costs and produce a more accurate relative performance evaluation.

Corporate governance in the twenty-first century should be viewed to accommodate other institutional factors such as financial markets and industrial competition (Blair 1995). In this regard, industrial competition is essential to complement the corporate governance framework which is currently largely based on Jensen and Meckling's (1976) incentive alignment framework (Williamson 1988). A less competitive industry (highly concentrated industry) can provide rent seeking opportunities which increase costs of transaction and misalign firms' corporate governance mechanisms (Bebchuk and Roe 1999). In such environments, the propensity of the insiders (board members with interest in firms) to extract personal interest increases and corporate governance become misaligned with the objective of maximization of shareholders' value. In order to protect their interest in a rent interest prevailing environment, insiders tend to escalate information asymmetry so as to effectively control corporate policies. Therefore, information asymmetry is more severe in a low competitive industry, which could drive the cost of financing upwards and could impede the firms' value. In addition, firms in low competitive industries can readily generate sufficient profits internally to avoid monitoring from external capital providers. These firms are free from bankruptcy pressure because market competition is not present. In contrast, in a highly competitive industry, market competition forces firms to operate efficiently and competitively, and reduces information asymmetry between insiders and external shareholders.

Although it is difficult to measure information asymmetry, bid-ask spread is widely used as a proxy to measure information asymmetry (e.g., Fehle 2004; Attig et al. 2006). Pertaining to this, external shareholders who realize their informational disadvantages relatively to insiders tend to post a wider bid-ask spread in stock prices to reduce their potential losses in their stock investments.

Eventually, share prices do not reflect their true value as the posted value is often higher than the real value which increases the cost of external financing to firms. The higher bid-ask spread benefits controlling shareholders due to information asymmetry advantages which provide them with the opportunities to realize the abnormal profits before the market adjusts its share prices to their real value, while external shareholders' returns diminish and lead to losses if they adopt a buy and hold strategy that incurs the cost of illiquidity (Demsetz 1986). Apparently, the issues of information asymmetry above are widely highlighted from agency theory's perspective. However, there are limited studies on the causes of information asymmetry through industrial competition and from an emerging market's perspective.

Malaysia provides a platform to study the causes of corporate information asymmetry and shareholders' value. Malaysia's economy was largely criticized as having capital input growth rather than productivity growth (Tham 1995). In this perspective, Claessens et al. (2003) showed that approximately 70 per cent of Malaysian firms pursued diversification policy that led to misallocation of capital. Moreover, the evidence in the 1990s shows that there was high debt financing and investment as compared to declining trends in return on assets indicating that there was a problem of information asymmetry in this economy (Claessens et al. …

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