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The International Journal of Accounting 47 (2012) 235 262
Top management turnover, rm performance and

government control: Evidence from China's listed
state-owned enterprises
Fang Hu a,, Sidney C.M. Leung b
a
Department of Accounting, Finance and Economics, Griffith Business School, Griffith University, Australia
b
Department of Accountancy, College of Business, City University of Hong Kong
Received 9 July 2010
Abstract
Using a sample of 916 Chinese listed state-owned enterprises (SOEs) from 2001 to 2005, we nd that
the likelihood of top management turnover is negatively associated with rm performance, suggesting the
existence of an effective corporate governance mechanism in an emerging economy that is highly controlled by government. We also nd that the negative turnoverperformance relationship is stronger when
the SOE is directly held by the central or local government, holding a monopolistic position in a local economy or in a strategic/regulated industry. The results indicate that the market-based corporate governance
mechanism that disciplines top executives as a result of poor performance is not only used in Chinese
SOEs, but is used more frequently when the governance control of SOEs is more intense. Our ndings
support the notion that government control strengthens rather than weakens the turnoverperformance
governance mechanism. Our additional analysis shows that this complementary effect is stronger in
regions that lack pro-market institutions, such as investor protections and a functioning capital market.
2012 University of Illinois. All rights reserved.
JEL classification: M41; M48; M51
Keywords: Government control; Management turnover; Chinese SOEs; Firm performance
We appreciate comments from Kelvin Lam, Grant Richardson, Bikki Jaggi, Tianyu Zhang, Qingmei Xue, Oliver
Rui, participants of the 2009 American Accounting Association annual meeting, seminar participants at the Seoul
National University, the reviewer, and participants of the 2010 Illinois International Accounting Symposium at Taipei.
Corresponding author.
E-mail addresses: f.hu@grifth.edu.au (F. Hu), acsleung@cityu.edu.hk (S.C.M. Leung).
0020-7063/$ - see front matter 2012 University of Illinois. All rights reserved.
doi:10.1016/j.intacc.2012.03.006
236
F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262
1. Introduction
A large body of evidence from developed markets confirms the effectiveness of corporate governance in spurring CEO turnover (Banker & Datar, 1989; Bushman, Chen, Engel,
& Smith, 2004; Engel, Hayes, & Wang, 2003; Holmstrom & Milgrom, 1991; Murphy &
Zimmerman, 1993; Weisbach, 1988). However, the literature generally shows that there
are doubts over whether the corporate governance mechanisms that have been shown to
be effective in developed economies (market-based governance mechanisms) are equally
effective in state-owned enterprises (SOEs) in emerging economies because the significant
political influence that government has over such firms could lead to the emergence of a
stakeholder governance model, which is characterized by a relation-based contract rather
than a market-based contract (Ball, Kothari, & Robin, 2003; Ball, Robin, & Wu, 2000). It
has been argued that SOEs have multiple objectives, including political objectives, social
goals, and bureaucrats' self interests. SOEs also have to maintain close relationships
with their major stakeholders, such as governments, banks and financial institutions, and
labor unions, thus reducing the effectiveness of market-based corporate governance mechanisms aligned with firm performance. Recently, some researchers argue that effective
market and governance mechanisms are an important ingredient for the success of some
emerging economies such as China (e.g., Chow, 2010).
This study examines the corporate governance of listed SOEs in China, the world's largest emerging economy, which is characterized by intensive state and government control.
We address two research questions. First, is the market-based governance mechanism,
whereby top executives are punished for poor performance, effectively used in corporate
businesses with intensive government control or influence? Second, and more importantly,
is the association between top management turnover and poor performance stronger or
weaker when governance control of SOEs is more intense?
These two research questions are important given the opposite views on the effects of
government control of SOEs. On the one hand, doubts exist about the effectiveness of
market-based corporate governance in an emerging economy like China that is highly controlled by government (e.g., Ball et al., 2000, 2003; Bushman & Piotroski, 2006; Chan,
Lew, & Tong, 2001; Jaggi & Low, 2000; Opper & Brehm, 2007). On the other hand,
some studies suggest that government control/ownership is not necessarily less efficient
than private ownership (Caves & Christensen, 1980; Kole & Mulherin, 1997; Martin &
Parker, 1995; Wortzel & Wortzel, 1989). Government control could serve as a remedy
for a lack of pro-market institutions (Frye & Shleifer, 1997; Qian, 1996; Xu, Zhu, &
Lin, 2002) and offer a helping hand to ensure corporate business activity is efficiently governed (Chang & Wong, 2004a, 2004b; La Porta, Lopez-de-Silanes, Shleifer, & Vishny,
2000; Qian, 1996; Shleifer & Vishny, 1997). The findings of this study should enrich
our understanding of whether government control and corporate governance mechanisms
are complementary or substitutive in Chinese SOEs and should provide insights into the
role of government control in corporate governance in emerging economies.
China's economy, the biggest among emerging markets, is one throughout which the
government has traditionally played an important role. SOEs account for the majority of
the economy. The majority of China's listed firms are controlled by state shareholders
who retain their dominant control in the form of non-tradable state-owned shares.
237
Among the top 500 firms in China in 2007, 349 (about 70%) were SOEs. While China has
embarked on a series of reforms since the 1980s that have included privatization, corporatization, and the implementation of an incentive contract system for SOE managers, the
government retains dominant control through its ownership of non-tradable state-owned
shares or through its administrative authority over important SOE decisions. 1 For instance,
decisions to appoint or remove key SOE personnel, such as the chairman of the board or
the CEO, still rest with state-controlling shareholders (Wong, Opper, & Hu, 2004).
China's SOEs provide a setting that is particularly conducive to testing the role of
government control on corporate governance because the SOEs are mainly controlled at the
jurisdictional levels and there is considerable variation in the degree of political control and
the extent of regulation across the jurisdictional regions. The large number of SOEs and the
variety in market institutions across regions allow us to perform a meaningful analysis in a
single country and capture the direct effects of government control on corporate governance.
Using a sample of 4906 firm-year observations from 916 Chinese SOEs listed on the
Shanghai and Shenzhen securities markets from 2001 to 2005, we find that CEOs or chairmen are more likely to be replaced in firms with poor accounting performance, a result
which suggests that the market-based corporate governance mechanism is employed in
SOEs that are typically subject to government control. To test the intertwining effect of
government control on the turnoverperformance relationship, we use several proxies to
measure various aspects of government control: (1) the concentration of government ownership, in which government control is measured through property rights; (2) the jurisdictional level of government ownership, in which government control is measured by
administrative hierarchy; (3) the monopolistic position of an SOE, in which government
control interests are measured because of their importance to fiscal revenue and the political status of the local government; and (4) the strategic industry of an SOE, in which the
importance of the industry to the national economy and the extent to which it is subject to
government control through regulations are measured. We find that the negative relationship between top management turnover and firm performance is significantly stronger
among SOEs subject to central or direct local government control, SOEs in a monopolistic
position, and SOEs in a strategic industry. However, we do not find that the relationship is
affected by concentrated government ownership. The overall results support the view that
the tighter the government control, the greater the degree of corporate control exercised
through the turnoverperformance mechanism in China's SOEs, suggesting that these
control mechanisms are complementary. Our additional analysis shows that the complementary effect of government control on the turnoverperformance relationship is stronger
in firms from regions with poor investor protections and less market liberalization. The
results are consistent with the view that government control can serve as a remedy for a
lack of pro-market institutions as suggested by Xu et al. (2002) and Frye and Shleifer (1997).
This paper contributes to the existing literature in three ways. First, while most prior research suggests that the corporate governance system in developed economies is driven by
1
We appreciate comments from Kelvin Lam, Grant Richardson, Bikki Jaggi, Tianyu Zhang, Qingmei Xue,
Oliver Rui, participants of the 2009 American Accounting Association annual meeting, seminar participants at
the Seoul National University, the reviewer, and participants of the 2010 Illinois International Accounting
Symposium at Taipei.
238
the pressure of the external capital market, we show that the effectiveness of the important
corporate control mechanismmanagement turnover decisionscould also be driven by
government control and government interests in the economic success of SOEs in China, a
country which is similar to other emerging economies in its lack of full market competition
and democratization. Our results support the view that government control is complementary to the market-based turnoverperformance governance mechanism.
Second, despite criticism that the Chinese economy lacks a functioning capital market
and significant investor protection and is subject to extensive government influence and
control, China experienced remarkably rapid economic growth in the last two decades
and is expected to continue on its high growth trajectory in the next decade. Our findings
provide a partial explanation for this intriguing phenomenon. Although China's economy
lacks full market competition and pro-market institutions, our results suggest that government control could serve as a good check-and-balance mechanism that ensures more effective corporate decisions are made and as a remedy for incomplete pro-market institutions.
Third, the findings provide a better understanding of the managerial labor market in a
transitional economy that is still subject to significant government control. It is argued
that the Chinese government selects officers and managers based on political connections
or other political considerations (the non-performance hypothesis of Opper & Brehm,
2007). Although political connections remain a focus of attention in China, the evidence
of this present study is consistent with the performance hypothesis of managerial labor
in an emerging economy with strong government control. Our results suggest that observable performance measures are demanded as a control mechanism in a transitional economy if the government aims to establish a rule-based governance system (Chen & Wang,
2007; Li, Park, & Li, 2004).
The remainder of the paper is organized as follows. Section 2 reviews the literature and
provides the background to the study. Section 3 develops hypotheses, and Section 4 presents the research design. Section 5 describes the sample and data. Section 6 reports the
results, and Section 7 documents the results of robustness tests and additional analysis.
The final section summarizes and concludes the paper.
2. Literature review and background
2.1. Management turnover and firm performance
Management turnover is an important mechanism of a firm's governance system. When
ownership and control are separated, one of the methods stakeholders use to monitor and
control management is to align the manager's incentives with firm performance. Thus,
the relationship between management turnover and firm performance is a good way of
assessing the effectiveness of a firm's governance system and has been widely discussed
in the literature (e.g., Banker & Datar, 1989; Bushman et al., 2004; Engel et al., 2003;
Holmstrom & Milgrom, 1991; Murphy & Zimmerman, 1993; Weisbach, 1988). Existing
studies, which focus on privately held firms in developed market economies, have reached
two general conclusions. First, forced management turnover is significantly negatively associated with firm accounting performance (Brickley, 2003; Coughlan & Schmidt, 1985; Engel
et al., 2003; Kaplan & Minton, 1994; Morck, Shleifer, & Vishny, 1988; Weisbach, 1988).
239
The negative turnoverperformance relationship represents an efficient incentive mechanism

in which managers are removed because of poor performance. Second, the inverse relation
between management turnover and accounting information on firm performance is induced
by the pressure of the external capital market. Because the external capital market demands
a public, precise, and observable measure of firm efficacy, accounting information is a
useful measure in turnover or compensation decision making (Banker & Datar, 1989;
DeFond & Park, 1999; Engel et al., 2003; Holmstrom & Milgrom, 1991). However,
there is no clear evidence on the effectiveness of firm governance systems in a developing
market.
2.2. Government control and corporate governance in China's SOEs
Two different roles of government control should be considered in analyzing the objective functions of government owners in China's SOEs. The first role of government control
is to act as the largest shareholder in the SOE. The incentive problems that arise between
shareholders and managers and are most commonly discussed in the context of private
firms also arise in the governance of SOEs. In spite of their social and political goals, state
shareholders have ownership interests in the profitability of their companies (Blanchard &
Aghion, 1996; Earle, Estrin, & Leshcenko, 1996; Frydman, Pistor, & Rapaczynski, 1996;
Hellman & Schankerman, 2000). The second role government control plays is to allow the
government to exert political or regulatory influence over the SOE. Government officers or bureaucrats are appointed to supervise SOEs with objectives to serve social and political interests,
such as correcting market failures and providing additional employment opportunities and
social security to the public (Shleifer & Vishny, 1994, 1997). In addition, state ownership implies that bureaucrats exercise control on behalf of the government. They are motivated by
self-interest and will thus use state-owned company resources to promote their own personal
interests (Jones, 1985; Krueger, 1990; Shleifer & Vishny, 1994, 1998). As a result, the objective function of state owners is at best a weighted average of company performance and the
attainment of political goals that often detract from company performance.
Due to the complex incentives of government and individual bureaucrats, the corporate
governance structure of SOEs reflects a mixture of various controlling methods and incentive issues in which government control through state shareholdings may be employed as
an explicit control device alongside other modern corporate governance mechanisms. Most
existing studies focus on the objectives of individual politicians and neglect the incentive
issues of controlling shareholders (Blanchard & Aghion, 1996; Earle et al., 1996; Frydman
et al., 1996; Hellman & Schankerman, 2000; Kato & Long, 2006). Most theoretical arguments rely on the assumption that the government functions purely as a political body or
regulator that has objectives other than profitability and that these objectives encourage
the government to intervene in business activities.
Since the 1990s, the Chinese government has adopted a modern corporate governance
structure in an effort to transform Chinese SOEs into modern corporations while preserving state ownership of these enterprises. One of the modern corporate systems introduced
to Chinese SOEs is a system of incentive contracts designed to improve the firm's performance and monitor SOE managers. Performance contracts have been executed between
managers and state owners (Shirley & Xu, 2001). Such performance contracts (1) obligate
240
the top SOE manager to achieve a specified earnings target within a given time period and
(2) specify government rewards for achieving such goals and penalties for misconduct
(Chang & Wong, 2009; Shirley & Xu, 2001). In addition, the corporate governance structure of listed SOEs includes some major sources of political control for the benefit of state
shareholders (Chang & Wong, 2004a, 2004b). One of these is the decision-making rights
held by the government through shareholdings and control rights. A second source of political control is the authority or regulatory scrutiny exerted by government administrators
and line ministries to ensure that their shareholding benefits are maximized by political
checks and balances (Chang & Wong, 2004a, 2004b; Qian, 1996).
3. Hypothesis development
3.1. Top management turnover and firm performance in China's SOEs
As discussed in the last section, the role of government control in the governance of
SOEs is controversial. On the one hand, economists generally argue that government
control is detrimental to corporate operations because the government is obsessed with multiple objectives (the political agenda) or because there is no individual owner with strong
incentives to monitor SOE managers. Thus, the contention is that government control will
drive the company away from value maximization and will be unlikely to use marketbased governance mechanisms (Bai & Xu, 2005; Kornai, 1980; Shleifer & Vishny, 1994,
1997). Consistent with this view, Kato and Long (2006) find that relative to the listed private Chinese firms, the negative relation between CEO turnover and firm performance is
weaker for state-controlled firms. On the other hand, the government has strong incentives
as the owner of an SOE to adopt effective corporate control methods that allow it to monitor
managers on the basis of economic performance. The Chinese Central Government has emphasized the economic performance of Chinese SOEs since embarking on its economic reforms in the 1980s by promoting fiscal decentralization and yardstick competition policies.
The fiscal decentralization policy involves the decentralization of the revenue and expense
responsibilities of the Central Government to lower levels of government. This policy allows
local governments to tax local state enterprises and address social issues (Montinola, Qian, &
Weingast, 1995; Oi, 1992; Qian & Weingast, 1997). The yardstick competition policy involves competition among jurisdictions as regions are compared and evaluated by higher
level government bodies in accordance with standardized performance criteria, one of
which is the region's economic performance relative to its peers. The political status of the
local government or a local governor's career in the Central Government is determined by
the ranking of local economic performance (Maskin, Qian, & Xu, 2000; Qian & Xu,
1993). 2 Hence, senior government officials who act on behalf of state owners and the
major SOE shareholders have strong incentives to monitor managers' performance. 3
2
The Central Government rewards or punishes local ofcials on the basis of economic performance in their region, which motivates them to promote the local economy (Blanchard & Shleifer, 2001).
3
CEOs of SOEs may have relatively less freedom of decisions; however, the state owner still has strong shareholding incentives to select and monitor a CEO based on the rm's overall performance.
241
Accordingly, government/party officials have strong incentives to encourage better corporate

earnings that promote regional economic performance and allow them to discharge their
fiscal responsibilities so that they can stand out in the political competition for career
promotion.
Anecdotal evidence shows that Chinese leaders of a province or region are promoted to
a higher rank as a result of economic success in the province or region they govern. For
example, Chen Demin was the Governor of Shanxi province from 2004 to 2006 and was
promoted to become the Deputy Director of the National Development and Reform
Committee in 2006 after the GDP growth rate ranking of Shanxi rose from 18th in 2003
to first in 2006. 4 In addition, poor firm performance also limits the latitude and resources
available to politicians to help them serve their own personal objectives, such as on-the-job
consumption and the accumulation of personal wealth, thus further increasing their incentives to dismiss relatively poor performing managers (Chang & Wong, 2009). Based on the
fact that the state owner and government officials are most likely to act in their own selfinterest, the following hypothesis is proposed:
H1. The propensity of top management turnover in Chinese SOEs is negatively associated
with firm performance.
3.2. Government control and the association between top management turnover and firm
accounting performance
Because the government plays both a political role and a shareholder's role in statecontrolled business, government control could have both benefits and costs for the corporate governance of SOEs. Strong government control could serve as a substitute for or a
complement to the governance mechanism of top manager turnover based on poor performance. We discuss these possible effects below.
3.2.1. The substitutive effect
Stronger government control could weaken the manager turnover/performance governance
mechanism for three reasons. First, as the government looks to pursue its political and social objectives, it may rely less on the economic performance of SOE managers. Second, government
control mainly relies on information obtained through bureaucratic channels rather than on information provided by the capital market (e.g., the stock market, rating companies, investment banks, or consulting companies). Information on firm performance used to evaluate
managers would be noisier with greater government control. Third, bureaucrats from the
Party/government departments who exercise government control are not in a position and
have no incentive to appoint the best candidates to top management positions because decisions on such appointments are mainly politically motivated. Hence, tight government control
is likely to result in SOEs retreating from efficient corporate control mechanisms.
4
Another example of the promotion of government ofcials based on provincial economic performance is Bo
Xilai, the governor of Liaoning province from 2001 to 2004. He was promoted to e General Director of China's
Department of Commerce in 2004 after the nationwide GDP growth rate ranking of Liaoning province rose from
29th in 2001 to 14th in 2004.
242
3.2.2. The complementary effect

On the other hand, strong government control could strengthen the manager turnover/
performance governance mechanism. Unlike in developed economies where there is strong
legal protection for investors, where creditors have priority of payments over shareholders,
and where managers and directors can be sued for breach of fiduciary duty (La Porta et al.,
2000; Shleifer & Vishny, 1997), all of these investor safeguards are weak in a developing
economy like China's because of deficiencies in the legal system and law enforcement.
Managers are also subject to less pressure from the external managerial labor market and
face less legal risk for misconduct. Thus, managers have strong incentives to misappropriate state assets rather than to achieve wealth maximization for shareholders. Given managers' self-interest incentives, the exercise of tight government control by adhering to
the practice of rewarding or penalizing top managers according to firm performance serves
as an important mechanism for disciplining SOE managers and discouraging them from
engaging in behavior that reduces the amount of corporate resources over which the government or has stronger interests (Brada, 1996; Tang, Chow, & Lau, 1999).
In summary, the substitutive effect of government control weakens the performanceturnover governance mechanism, and the complementary effect of government control
enhances the performance-turnover government mechanism.
The adoption of fiscal decentralization and yardstick competition policies by the
Chinese government and competition among government officials for career promotion
strongly motivate senior government officials to push for better SOE profitability and to
monitor the performance of top managers. Therefore, we expect government control has
a complementary effect and enhances the use of the market-based performance-turnover
mechanism. Hence, the second hypothesis is stated as follows:
H2. The negative association between top management turnover and firm performance is
stronger in SOEs with tighter government control.
4. Research design
4.1. Measures
4.1.1. Top management turnover and firm performance
Top management turnover (Turnover) is an indicator variable equal to 1 if either the chairman or CEO (or both) leaves the firm for reasons other than retirement, health, change of
ownership, or the end of a temporary appointment as disclosed in the Chinese Stock Market
and Accounting Research (CSMAR) database, 5 and 0 otherwise. Firm performance is measured by return on assets lagged one period (ROAt 1), a proxy of previous firm performance
(Chang & Wang, 1994; Engel et al., 2003; Kato & Long, 2006; Weisbach, 1988).
5
Chinese Stock Market and Accounting Research (CSMAR) database reports 12 reasons for top management turnover as follows: 1 = rotation; 2 = retirement; 3 = expiration of the term; 4 = change of ownership; 5 = resignation; 6 =
re; 7 = health; 8 = personal reasons; 9 = improvement of corporate governance; 10 = criminalities; 12 = the end of a
temporary appointment. There is no reason 11 for top management turnover in the CSMAR database. Reasons 2, 4, 7,
and 12 are considered natural turnover and, therefore, are excluded.
243
4.1.2. Government control

Four metrics are used to measure the extent of government control or involvement
through property rights in or regulation of SOEs. They are described as follows:
1. The concentration of government ownership: Because the attributes of ownership determine government shareholder interests in firm performance and internal managerial
efforts (Boeker, 1992; Boeker & Goodstein, 1993; Denis, Denis, & Sarin, 1997;
Salancik & Pfeffer, 1980), the extent of government control through ownership is measured by its concentration.
2. The jurisdictional level of government control: Under China's planning system, in
which blocks or regions are the foundation of the planning system (Li et al., 2004;
Maskin et al., 2000), government ownership is affiliated with the following jurisdictional levels of government controlcentral, provincial, municipal, and county. Chinese
SOEs could be owned and controlled directly by central government and local (provincial, municipal, and county) governments or indirectly through other SOEs, legal representatives, or government-related entities. The government has a greater ability to
intervene in the firm's management in SOEs that are directly held by central and
local government than in SOEs that are indirectly controlled by the government (Fan,
Wong, & Zhang, 2007). SOEs directly governed by the central or local government
are expected to be subject to tighter government control than those indirectly held by
the government through other SOEs or government-related entities. Thus, we expect
the association between management turnover and firm performance to be stronger in
SOEs directly held by central or local government.
3. The monopolistic position of an SOE: A firm's monopolistic position is associated with
a market share advantage derived from its ability to obtain concessions, licenses, or
sizeable government contracts. The Chinese discourse on SOEs contains a number of
terms that denote the importance of certain companies and sectors in terms of their market power, such as backbone enterprises, pillar enterprises, and giant enterprises;
SOEs described in these terms are normally large firms that hold a monopolistic position in the local economy, are important for generating fiscal revenue, and play a
vital role in economic development. 6 Since SOEs with a monopolistic position are
more important to the local economy and regional development, such firms are likely
to be subject to political scrutiny and government control (Faccio, 2007).
4. Strategic SOEs: The Chinese government has identified seven sectors that are considered strategically important because they are related to national or economic security,
and the government maintains absolute control in these sectors through either sole ownership or an absolute controlling stake (Mattlin, 2007). These seven sectors are defense,
power generation and distribution, oil and petrochemicals, telecommunications, coal,
aviation, and shipping. 7 For SOEs operating in these strategic sectors, regulations
6
The Chinese government only recently specically dened those enterprises that it considers critical or
important.
7
SASAC Chair Li Rongrong revealed that these seven sectors are considered strategically important as they are
related to national or economic security and that the government has to maintain absolute control over rms in
these sectors through either sole ownership or an absolute controlling stake. Many of the biggest and most monopolistic Chinese companies operate within these seven industries.
244
dictate that firms' decision-making procedures are supplanted by the administrative process. The regulatory process that takes place in such enterprises exposes firms' decision
making to more political forces and government control and is likely to result in the imposition of political outcomes in place of private decisions or market outcomes
(Hadlock & Lee, 2002). The strategic status of the industry in which a firm operates
thus reflects the extent to which the firm is subject to government control through regulations and personnel control.
4.2. Model
To examine the sensitivity of management turnover to accounting measures of firm performance, we apply a logistic model to test H1 as follows.
Logit Turnover it 1 Perf ormanceit1
n
X
j CV it1j it
j2
Where:
Turnover a dummy variable equal to 1 if either the chairman or CEO, or both, is (are)
forced to leave the firm (other than for natural reasons disclosed in the CSMAR
database), and 0 otherwise;
Performance an accounting measure of previous firm performance: return on assets
lagged one period (ROAt 1);
The definitions of CV, the control variables, are based on previous studies (Berry,
Bizjak, Lemmon, & Naveen, 2000; Clayton, Hartzell, & Rosenberg, 2003; Fan & Wang,
2007; Smith & Watts, 1992) and are listed as follows:
Log(asset) the log of total assets, which is used to measure and control for rm size. Berry
et al. (2000) suggest that an increase in size increases management entrenchment
so that top executives are less likely to be found to be incompetent;
Leverage equal to the ratio of total debt to total assets and used to control for the firm's
financial risk. Gilson (1990) provides evidence that management turnover is
more prevalent in financially distressed firms;
Indus_MB the industry median market-to-book ratio by 2-digit SIC code, a surrogate for
the investment opportunity set (IOS). Prior research indicates that the IOS may
also be associated with management turnover because firms with a high IOS
demand high-quality managers (Smith & Watts, 1992);
Log(employee) the log of the number of employees. Some researchers argue that management in SOEs is also evaluated on the basis of social duties, such as maintaining
and increasing employment (Fan et al., 2007). Hence, the government is likely to
replace top executives if the unemployment rate is too high;
Log(GDP) the log of provincial GDP, a surrogate for regional variety. This is associated
with management turnover because of differences in local labor markets and local
economic development (Fan et al., 2007); and
Dual
245
a dummy variable equal to 1 for a manager who simultaneously holds the chairman
of the board and CEO positions. Prior studies suggest that the dual position of chairman and CEO results in greater management power and entrenchment as executives
who simultaneously occupy both positions are less likely to leave their company.
The first hypothesis predicts that 1 will be negative and is consistent with the disciplinary mechanism in which incompetent managers are dismissed when performance is poor.
To test the second hypothesis about the interaction of government control and corporate
control, we extend Model 1 as follows.
Logit Turnover it 1 GC it1 2 Perf ormanceit1
n
X
3 Perf ormanceit1 GC it1
j CV it1j it
j4
Where:
GC
is one of four measures of government control, which include concentration of

government ownership, jurisdictional level of government ownership, the monopolistic position of an SOE, and whether or not the firm is a strategic SOE. These
measures are defined as follows. Concentration of government ownership (Own)
is a dummy variable equal to 1 if the proportion of shares owned by the government is above the median level for the year, and 0 otherwise. Jurisdictional level
of government ownership (Central) is a dummy variable equal to 1 for SOEs that
are held directly by the central government or local government, and 0 for those
SOEs indirectly owned by legal representatives or government-related entities
(Fan et al., 2007). The monopolistic position of an SOE (LARGE_MS) is a
dummy variable equal to 1 if firm i's market sales are above the median level
for the year of all listed firms in the province in which it is located, and 0 otherwise. Finally, strategic SOE (Strategic) is a dummy variable equal to 1 for an SOE
in a regulated or strategic industry based on the SIC code issued by the China
Securities Regulatory Commission (CSRC), China's equivalent to the SEC, and
0 otherwise. These regulated or strategic industries are described earlier in this
paper. All other variables are as defined in Model 1.
Hypothesis 2 focuses on the estimate of the interaction term3, the coefficient of the interaction terms for government control and the turnoverperformance relationship. If 3 is
negative, then there is a stronger inverse relationship between top management turnover and
firm performance, indicating that stronger government control strengthens the turnover
performance relationship. In contrast, if 3 is positive, then there is a weaker inverse relationship between top management turnover and firm accounting performance.
5. Data and sample
The sample includes Chinese SOEs that were listed on the domestic Shanghai and
Shenzhen stock exchanges during the 20012005 period. We identify the ultimate controller
246
by examining the ownership structures of the sample firms as disclosed in their annual reports.
The management turnover data are downloaded from the CSMAR dataset. To be included in
the sample, firms must have sufficient accounting data available in the CSMAR dataset. In
identifying non-natural turnover of top managers, we exclude turnover events in which a
top manager left because of retirement, health reasons, change of ownership, or the end of
a temporary appointment to the position, all of which are natural reasons for turnover. This
screening procedure ensures that only non-natural top management turnovers are captured
in our analysis. To mitigate the outlier effect, we truncate the top and bottom 1% of the distribution for return on assets, total assets, net sales, total debt, and earnings before interest
and taxes (EBIT). The final sample consists of 918 unique SOE firms and 4,096 firm-year
observations.
Table 1 reports the descriptive statistics for the sample firms. For each variable used in
the regression model, we report the mean, median, and standard deviation across two sets
of sample firms: one being the sub-sample in which top management changed during the
Table 1
Descriptive statistics for firms by sub-sample. The turnover group, assigned the value of 1, comprises firms in
which there was a change in either the chairman or the CEO during the 20012005 period; the non-turnover
group, assigned the value of 0, comprises firms in which there was no change in top management. For variable
definitions, refer to Sections 4.1 and 4.2. p b 1%, ** = p b 5%, * = p b 10%.
Variable
Turnover
Mean
Median
Std. Dev.
Diff. (10) (t-test)
ROAt
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1222
2874
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
1
0
0.009
0.021
0.008
0.020
0.391
0.389
0.404
0.385
0.258
0.230
0.290
0.303
0.516
0.556
0.555
0.585
21.14
21.24
0.509
0.480
2.507
2.462
7.380
7.454
8.538
8.563
0.061
0.102
0.019
0.025
0.024
0.030
0.390
0.385
0
0
0
0
0.093
0.110
1
1
1
1
21.11
21.18
0.491
0.475
2.259
2.243
7.430
7.565
8.596
8.596
0
0
0.067
0.058
0.164
0.119
0.148
0.144
0.491
0.487
0.438
0.421
0.363
0.362
0.500
0.497
0.497
0.493
0.818
0.791
0.339
0.240
1.037
0.942
1.226
1.170
0.837
0.799
0.240
0.302
0.012
(5.26***)
0.012
(2.27**)
0.002
( 0.20)
0.019
( 1.16)
0.028
( 1.86*)
0.013
(1.05)
0.040
(2.35**)
0.030
(1.76*)
0.10
(3.60***)
0.029
( 2.77***)
0.045
( 1.32)
0.074
(1.78*)
0.025
(0.87)
0.041
(4.53***)
ROAt 1
Own
High_Own
Central
MS
LARGE_MS
Strategic
Log(assets)
Leverageit
Indus_MB
Log(employ)
Log(GDP)
Dual
247
year and the other sub-sample consisting of firms in which there was no turnover in top
management. The first two variables reported in Table 1 are accounting measures of
firm performance used in previous studies (Chang & Wang, 1994; Engel et al., 2003;
Kato & Long, 2006; Weisbach, 1988). Although the firms with management turnover on
average demonstrate both positive current performance (ROAit) and positive lagged performance (ROAit 1), they significantly underperform the non-turnover group (t-value = 5.26,
significant at the 1% level for ROAit; and t-value = 2.27, significant at the 5% level for
ROAit-1). The next two variables measure concentration of government ownership. The
t-test for the difference between the two sub-samples shows that the ownership proportion
for the management-turnover group is similar to that of the non-turnover group. The next
variable reported in Table 1 is the jurisdictional level of government ownership. We find
that management turnover is more likely to occur in SOEs with central government
ownership/control. A comparison of SOE market shares in terms of sales shows that the
management-turnover group has a somewhat lower market share than the non-turnover
group. The results also shows that the frequency with which management-turnover
firms appear in a strategic industry is significantly lower than that of non-turnover
firms, which is consistent with the argument that strategic or regulated industries are subject to less competitive labor market conditions.
6. Empirical results
6.1. Results for the relationship between top management turnover and firm performance
(H1)
Table 2 presents the correlation matrix of the independent variables included in the logit
analysis. Although many of the measures are significantly correlated, the magnitude of the
correlations (absolute value b 0.4) does not indicate potential problems of multicollinearity.
We test the first hypothesis by performing a likelihood analysis in which we regress the
likelihood of top management turnover on the accounting performance measure and several control variables in Model 1. The dependent variable is coded 1 for managementturnover firm-year observations, and 0 for non-turnover observations. Consistent with
the hypothesis that the frequency of management turnover is negatively associated with
the firm's prior accounting performance, the results in Table 3 show that the coefficient
on firm accounting performance is significantly negative ( 1.06; p-value = 0.033). Regarding the control variables in the regression, firm size has a negative but insignificant influence on the likelihood of management turnover. Management turnover is more frequent in
firms that face higher financial risks (i.e., firms with higher debt-to-asset ratios, as evidenced by Gilson, 1990). The industrial market-to-book (MB) ratio has a significantly negative influence on the likelihood of management turnover, implying that growing firms
have less management turnover. As expected, the existence of a top manager in a dual
role has a significantly negative influence on management turnover. This is consistent
with the results of prior studies showing that the appointment of the same individual to
the positions of chairman and CEO results in less management turnover because such individuals become entrenched in their positions. Regional variety (Log(GDP)) and social
duties (Log(employ)) have no significant influence on senior management turnover.
248
Variable
ROA(t)
ROA(t-1)
Own
Central
MS
Strategic
Log(asset)
Leverage
Indus_MB
Log(GDP)
Log(employ)
Dual
ROA
(t)
1
0.19
(b.01***)
0.12
(b.01***)
0.03
(0.04**)
0.06
(b.01***)
0.07
(b.01***)
0.21
(b.01***)
0.30
(b.01***)
0.08
(b.01***)
0.03
(0.03**)
0.05
(0.00***)
0.03
(0.03**)
ROA
(t 1)
Log
Own
Central
MS
Strategic
(asset)
Indus
Leverage
_MB
Log
(GDP)
Log
(employ)
Dual
1
0.06
(0.00***)
0.01
(0.51)
0.07
(b.01***)
0.03
(0.09*)
0.13
(b.01***)
0.31
(b.01***)
0.03
(0.05**)
0.00
(0.76)
0.02
(0.12)
0.04
(0.01***)
1
0.07
(b.01***)
0.02
(0.16)
0.10
(b.01***)
0.12
(b.01***)
0.11
(b.01***)
0.00
(0.97)
0.02
(0.28)
0.08
(b.01***)
0.06
(b.01***)
Note: *** = p b 1%, ** = p b 5%, * = p b 10%.
1
0.10
(b.01***)
0.14
(b.01***)
0.00
(0.98)
0.01
(0.45)
0.04
(0.01***)
0.00
(0.94)
0.03
(0.06**)
0.05
(b.01***)
1
0.06
(b.01***)
0.16
(b.01***)
0.03
(0.06*)
0.03
(0.09*0
0.07
(b.01***)
0.22
(b.01***)
0.02
(0.30)
1
0.03
(0.03**)
0.06
(0.00***)
0.07
(b.01***)
0.05
(b.01***)
0.15
(b.01***)
0.07
(b.01***)
1
0.01
(0.46)
0.13
(b.01***)
0.12
(b.01***)
0.42
(b.01***)
0.02
(0.22)
1
0.09
(b.01***)
0.06
(0.00***)
0.04
(0.02**)
0.02
(0.14)
1
0.19
(b.01***)
0.03
(0.10*)
0.03
(0.03**)
1
0.03
(0.04**)
0.02
(0.31)
1
0.02
(0.29)
Table 2
Pearson correlations between independent variables (p-value in parentheses).
249
Table 3
The relationship between management turnover and firm performance (Model 1).
Variable
Expected sign
Intercept
Performanceit 1
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
+/
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo-R-sq
0.54
(0.014***)
0.58
(0.030**)
Yes
Yes
4096
0.014
7.74
(b.0001***)
1.06
(0.033**)
0.07
(0.236)
0.40
(0.018**)
1.12
(b.0001***)
0.01
(0.809)
0.03
(0.519
0.51
(b.0001***)
Yes
Yes
4096
0.12
See Sections 4.1 and 4.2 for variable definitions. The dependent variable is the likelihood of management turnover. Performanceit 1 is measured by accounting measures, ROA is lagged one period. (P-value in parentheses:
*** p b 1%, ** p b 5%, * b 10%).
6.2. Results for the interaction of government control and the turnoverperformance
relationship (H2)
We next examine whether the inverse relationship between top management turnover
and firm accounting performance is stronger or weaker in firms with tighter government
control. We test the second hypothesis by estimating a logit model to which we add an interaction term between the firm performance variable and the variable proxied for government control. The four proxies we employ for the extent of government control are:
concentration of government ownership, jurisdictional level of government ownership,
the monopolistic position of the SOE, and whether or not the SOE is in a strategic industry.
The first column of Table 4 reports the results for the interaction term including concentration of government ownership. As expected, the coefficient of Performanceit 1 Ownit 1 is
negative and is not statistically significant.
The second column of Table 4 reports the results for the interaction term including jurisdictional level of government ownership. For the interaction term, including
the dummy variable for SOEs directly governed by the central or local government
(Central) and previous firm performance, Column 2 shows that the coefficient of
Performanceit 1 * Centralit 1 is negative and significant (2.78; p value = 0.029). This finding suggests that when an SOE is directly controlled by the central or local government, rather
than indirectly controlled by other state enterprises, the inverse relationship between top
250
management turnover and firm performance is stronger and performance-based turnover decisions are enforced more effectively.
The third column of Table 4 reports the results for the interaction term including
the monopolistic position of SOEs. The coefficient on the interaction term
Performanceit 1 * LARGE_MSit 1 is negative and significant ( 2.25; p-value = 0.051).
This finding suggests that the government has a greater interest in the performance
of SOEs, which have a greater market share in the local economy (based on provincial unit) because they make an important contribution to the fiscal revenue of the
Table 4
The influence of government control (GCit 1) on the relationship between top management turnover and firm
accounting performance measures with control variables (Model 2).
Variable
Expected (1)
sign
GC = government
ownership (%)
above median
Intercept
Performanceit 1
GCit 1
+/
Performanceit 1 *
GCit 1
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
+/
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo R-sq.
(2)
GC = central
government/Direct local
government control
(3)
(4)
GC = monopolistic GC = strategic
position by market industries
share
7.76
(b.0001***)
1.03
(0.132)
0.04
(0.650)
0.95
3.42
(0.008***)
1.52
(0.214)
0.05
(0.672)
2.58
6.87
(b.0001***)
0.48
(0.408)
0.08
(0.469)
2.25
7.13
(b.0001***)
0.02
(0.977)
0.13
(0.109)
3.56
(0.211)
0.07
(0.229)
0.41
(0.017**)
1.12
(b.0001***)
0.01
(0.812)
0.03
(0.518)
0.51
(b.0001***)
Yes
Yes
4096
0.12
(0.049**)
0.14
(0.020**)
0.32
(0.045**)
0.29
(b.0001***)
0.03
(0.503)
0.02
(0.654)
0.62
(b.0001***)
Yes
Yes
4096
0.04
(0.051**)
0.03
(0.704)
0.40
(0.018**)
1.12
(b.0001***)
0.006
(0.915)
0.02
(0.621)
0.50
(0.001***)
Yes
Yes
4096
0.08
(0.001***)
0.06
(0.313)
0.43
(0.013***)
1.02
(b.0001***)
0.02
(0.641)
0.02
(0.617)
0.51
(b.0001***)
Yes
Yes
4096
0.12
See Sections 4.1 and 4.2 for variable definitions. The dependent variable is the likelihood of management turnover. Performanceit 1 is measured by ROA lagged one period. GCit 1 is defined as: (1) the concentration of
government ownership, measured by a dummy equal to 1 if the proportion of ownership is above the median
level for the year; (2) jurisdictional government control, measured by a dummy variable equal to 1 if the SOE
is affiliated with the central government/directly held by the local government; (3) monopolistic position of
SOE, measured by a dummy variable equal to 1 if the SOE's market sales are above the median level of sales
in the provincial unit where it is located; (4) the strategic industries, measured by a dummy variable equal to 1
if the SOE is in one of seven industries that are strategically regulated by the government. (P-value in parentheses:
*** p b 1%, ** p b 5%, * b 10%).
251
local economy. Thus, government officials have strong incentives to ensure that top
management turnover will be tied more closely to firm performance in SOEs with a
monopolistic position.
The final column of Table 4 reports the results for the interaction term including
the strategic importance of SOEs. The results show that the coefficient of
Performanceit 1 * Strategicit 1 is negative and significant (3.56; p-value = 0.001). This
finding suggests that for SOEs in the seven strategic industrial sectorsdefense, power
generation and distribution, oil and petrochemicals, telecommunications, coal, aviation, and
shippingall of which are subject to more stringent regulatory processes and control, the
inverse relationship between top management turnover and firm performance is stronger.
Overall, there is clear evidence that the government and government officials representing the state interests in Chinese SOEs care more about the performance of SOEs with
tighter government control and that the effective corporate governance mechanism of
replacing top management for poor performance is more often used in SOEs with stronger
government control.
7. Additional tests
The objectives of this section are to provide additional evidence in support of our findings and shed additional insights into the effects of government control on the use of the
turnoverperformance governance mechanism.
7.1. Regional institutional factors
Prior studies (Chang & Wong, 2004a, 2004b; La Porta et al., 2000; Qian, 1996; Shleifer
& Vishny, 1997) suggest that corporate control and government control are more necessary
in regions with poor investor protection or undeveloped market institutions. We perform
additional analysis to evaluate whether the complementary effect of government control
on the turnoverperformance government mechanism is stronger in regions with different
institutional environments by stratifying the full sample according to regional institutional
factors and re-running Model 2 on alternative sub-samples. We partition the sample by the
yearly median value of the ratio of stock market capitalization to local GDP in a given region (province), the number of firms listed in a given region (province), and the number of
initial public offerings of equity in a given region (province). La Porta and Shleifer (1997)
use a sample of 49 countries and provide evidence that these three variables measuring the
size, breadth, and valuation of capital markets are positively associated with investor protection. We also partition the sample by the yearly median value of the comprehensive
marketization index of regions/provinces in China investigated by Fan and Wang (2007).
Table 5 reports the results of the sub-sample regressions. Panel A partitions the sample
by the yearly median value of the ratio of stock market capitalization to local GDP in a
given region (province). The results show that the interaction of government control and
firm performance (Performanceit 1 * GCit 1) is significantly negative if the ratio of the
stock market capitalization of firms in the region to local GDP is low where government
control is measured by the concentration of government ownership (see Column 1) or central/direct local government control (see Column 2). However, the inverse relation does not
252
Panel A: Partition by the

stock market capitalization
in a given region (La Porta
& Shleifer, 1997)
Expected
sign
Intercept
Performanceit 1
GCit 1
+/
Performanceit 1 * GCit 1
/+
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
+/
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo R-sq.
GC(1)
GC(2)
GC(3)
GC(4)
Low
High
Low
High
Low
High
Low
High
0.40
(0.824)
0.06
(0.939)
0.20
(0.086*)
3.91
(0.009***)
0.008
(0.926)
0.43
(0.029**)
0.30
(0.003***)
0.08
(0.279)
0.08
(0.142)
0.50
(0.012***)
Yes
Yes
2344
0.04
9.11
(b.0001***)
0.49
(0.331)
0.04
(0.745)
0.58
(0.554)
0.36
(0.0002***)
0.16
(0.677)
0.38
(0.0003***)
0.28
(0.0004***)
0.22
(0.002***)
0.86
(0.002***)
Yes
Yes
1718
0.09
0.82
(0.649
(1.78
(0.421)
0.31
(0.072*)
3.92
(0.094*)
0.03
(0.686)
0.39
(0.042**)
0.24
(0.019**)
0.08
(0.308)
0.07
(0.190)
0.56
(0.005***)
Yes
Yes
2344
0.04
9.07
(b.0001***)
1.26
(0.382)
0.29
(0.129)
1.79
(0.236)
0.36
(0.0002***)
0.15
(0.691)
0.40
(0.0002***)
0.28
(0.0006***)
0.21
(0.003***)
0.89
(0.002***)
Yes
Yes
1718
0.09
2.06
(0.330)
1.39
(0.108)
0.21
(0.131
0.78
(0.530)
0.09
(0.395)
0.44
(0.027**)
0.28
(0.005***)
0.09
(0.248)
0.08
(0.177)
0.53
(0.007***)
Yes
Yes
2344
0.04
8.06
(0.001***)
0.30
(0.674)
0.12
(0.478)
1.13
(0.272)
0.30
(0.009***)
0.12
(0.754)
0.37
(0.0003***)
0.29
(0.0003***)
0.23
(0.002***)
0.84
(0.003***)
Yes
Yes
1718
0.09
1.01
(0.545)
0.34
(0.631)
0.12
(0.273)
3.43
(0.016**)
0.01
(0.861)
0.42
(0.029**)
0.30
(0.001***)
0.10
(0.208)
0.07
(0.177)
0.54
(0.005***)
Yes
Yes
2344
0.04
8.86
(b.0001***)
1.38
(0.177)
0.04
(0.748)
3.07
(0.046**)
0.35
(0.0002***)
0.08
(0.826)
0.35
(0.0004***)
0.25
(0.001***)
0.18
(0.005***)
0.75
(0.006***)
Yes
Yes
1718
0.07
Table 5
Regression results of the interaction effects of government control and turnoverperformance relationship in China's SOEs using sub-samples stratified by regional institutional factors used as proxies for investor protection or market development.
Panel B: Partition by the

number of rms listed in
a given region (La Porta
& Shleifer, 1997)
Expected
sign
Performanceit 1
GCit 1
+/
/+
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
+/
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo R-sq.
GC(2)
GC(3)
GC(4)
Low
High
Low
High
Low
High
Low
High
6.46
(0.003***)
1.00
(0.410)
0.26
(0.085*)
6.96
(0.003***)
0.31
(0.004***)
0.04
(0.920)
0.23
(0.053**)
0.10
(0.214)
0.19
(0.015**)
0.45
(0.057*)
Yes
Yes
1515
0.07
2.69
(0.100*)
0.56
(0.238)
0.01
(0.923)
0.08
(0.919)
0.07
(0.338)
0.47
(0.015**)
0.32
(0.0003***)
0.11
(0.164
0.04
(0.417)
0.80
(0.0003***)
Yes
Yes
2547
0.05
6.22
(0.005***)
2.82
(0.277)
0.20
(0.325)
4.61
(0.104*)
0.31
(0.005***)
0.19
(0.650)
0.19
(0.106)
0.08
(0.317)
0.21
(0.008***)
0.48
(0.042**)
Yes
Yes
1515
0.07
2.66
(0.104*)
0.76
(0.514)
0.08
(0.620)
1.69
(0.179)
0.07
(0.376)
0.46
(0.016**)
0.32
(0.0004***)
0.12
(0.131)
0.04
(0.458)
0.81
(0.0003***)
Yes
Yes
2547
0.05
2.19
(0.406)
0.58
(0.624)
0.46
(0.012****)
3.27
(0.119)
0.12
(0.343)
0.03
(0.944)
0.21
(0.083*)
0.09
(0.289)
0.22
(0.006***)
0.40
(0.092*)
Yes
Yes
1515
0.07
3.17
(0.100*)
0.60
(0.286)
0.06
(0.638)
0.01
(0.985)
0.10
(0.290)
0.47
(0.015**)
0.32
(0.0003***)
0.11
(0.171)
0.04
(0.385)
0.80
(0.0003***)
Yes
Yes
2547
0.05
6.45
(0.002***)
1.55
(0.316)
0.25
(0.088*)
4.50
(0.026**)
0.35
(0.0006***)
0.21
(0.606)
0.26
(0.022**)
0.08
(0.320)
0.21
(0.004***)
0.35
(0.128)
Yes
Yes
1515
0.05
2.48
(0.112)
0.10
(0.857)
0.26
(0.013***)
2.27
(0.073*)
0.05
(0.526)
0.45
(0.017**)
0.32
(0.0001***)
0.09
(0.221)
0.07
(0.113)
0.80
(0.0003***)
Yes
Yes
254P
0.05
(continued on next page)

(continued on next page)
Intercept
GC(1)
253
254
Expected
sign
Intercept
Performanceit 1
GCit 1
+/
/+
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
+/
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo R-sq.
GC(1)
GC(2)
GC(3)
GC(4)
Low
High
Low
High
Low
High
Low
High
0.18
(0.930)
0.70
(0.295)
0.12
(0.368)
3.87
(0.026**)
0.01
(0.893)
0.46
(0.032**)
0.27
(0.009***)
0.01
(0.920)
0.005
(0.945)
0.45
(0.062*)
Yes
Yes
1756
0.06
6.20
(0.009***)
0.07
(0.936)
0.25
(0.096*)
0.09
(0.942)
0.28
(0.014***)
0.02
(0.962)
0.36
(0.003***)
0.20
(0.093*)
0.10
(0.173)
0.86
(0.009***)
Yes
Yes
1360
0.08
0.18
(0.933)
5.69
(0.091*)
0.03
(0.907)
9.01
(0.010***)
0.02
(0.857)
0.45
(0.038**)
0.23
(0.030**)
0.02
(0.842)
0.01
(0.906)
0.51
(0.036**)
Yes
Yes
1756
0.07
5.92
(0.013***)
0.31
(0.770)
0.11
(0.618)
0.30
(0.817)
0.26
(0.023***)
0.04
(0.922)
0.34
(0.006***)
0.22
(0.078*)
0.11
(0.165)
0.89
(0.007***)
Yes
Yes
1360
0.08
0.30
(0.903)
1.09
(0.246)
0.11
(0.536)
3.39
(0.086*)
0.02
(0.874)
0.50
(0.028**)
0.26
(0.012***)
0.02
(0.822)
0.02
(0.764)
0.45
(0.065*)
Yes
Yes
1756
0.06
2.65
(0.339)
0.05
(0.951)
0.44
(0.023**)
0.54
(0.734)
0.10
(0.478)
0.003
(0.995)
0.34
(0.004***)
0.24
(0.052**)
0.12
(0.118)
0.88
(0.008***)
Yes
Yes
1360
0.08
0.62
(0.758)
1.00
(0.295)
0.07
(0.579)
2.50
(0.152)
0.02
(0.828)
0.47
(0.032**)
0.27
(0.005***)
0.03
(0.787)
0.03
(0.615)
0.47
(0.049**)
Yes
Yes
1756
0.04
5.70
(0.010***)
1.05
(0.263)
0.29
(0.046**)
3.36
(0.053**)
0.21
(0.051**)
0.08
(0.843)
0.30
(0.007***)
0.18
(0.137)
0.05
(0.473)
0.89
(0.006***)
Yes
Yes
1360
0.05
Table
Table 55 (continued
(continued))
Panel C: Partition by the
number of initial public
offerings of equity in a
given region (La Porta &
Shleifer, 1997)
Panel D: Partition by
regional market index
(Fan & Wang, 2007)
Expected
sign
Performanceit 1
GCit 1
+/
/+
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
+/
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo R-sq.
GC(2)
GC(3)
GC(4)
Low
High
Low
High
Low
High
Low
High
7.43
(0.006***)
0.42
(0.706)
0.06
(0.715)
5.45
(0.030**)
0.28
(0.038**)
0.05
(0.918)
0.40
(0.002***)
0.17
(0.082*)
0.12
(0.214)
0.71
(0.022**)
Yes
Yes
1098
0.07
2.19
(0.174)
0.43
(0.338)
0.15
(0.133)
0.39
(0.619)
0.10
(0.143)
0.40
(0.027**)
0.29
(0.001***)
0.02
(0.799)
0.01
(0.865)
0.57
(0.003***)
Yes
Yes
2943
0.04
7.98
(0.003***)
1.52
(0.488)
0.04
(0.861)
2.73
(0.268)
0.30
(0.026**)
0.03
(0.956)
0.41
(0.002***)
0.18
(0.064*)
0.13
(0.191)
0.75
(0.017**)
Yes
Yes
1098
0.07
2.15
(0.182)
1.39
(0.324)
0.04
(0.776)
2.46
(0.101)
0.10
(0.182)
0.37
(0.039**)
0.28
(0.001***)
0.006
(0.941)
0.006
(0.896)
0.59
(0.002***)
Yes
Yes
2943
0.04
5.68
(0.075*)
0.24
(0.835)
0.27
(0.202)
0.60
(0.785)
0.19
(0.227)
0.11
(0.805)
0.40
(0.002***)
0.18
(0.061*)
0.14
(0.166)
0.71
(0.023**)
Yes
Yes
1098
0.07
1.35
(0.464)
0.40
(0.478)
0.11
(0.369)
0.32
(0.700)
0.06
(0.495)
0.40
(0.028**)
0.29
(0.001***)
0.006
(0.939)
0.005
(0.925)
0.57
(0.002***)
Yes
Yes
2943
0.03
7.24
(0.004***)
1.52
(0.288)
0.13
(0.406)
4.39
(0.024**)
0.29
(0.020**)
0.30
(0.498)
0.41
(0.001***)
0.14
(0.125)
0.11
(0.239)
0.73
(0.019)
Yes
Yes
1098
0.06
2.04
(0.189)
0.07
(0.900)
0.17
(0.097*)
2.30
(0.067*)
0.10
(0.159)
0.38
(0.032**)
0.29
(0.0003***)
0.02
(0.801)
0.01
(0.843)
0.57
(0.002***)
Yes
Yes
2943
0.03
255
The sample is partitioned alternatively by the yearly median value of the ratio of stock market capitalization to local GDP in a given region (province), the number of firms
listed in a given region (province), the number of initial public offerings of equity in a given region (province) (La Porta & Shleifer, 1997) and the comprehensive marketization index of regions/provinces in China investigated by Fan and Wang (2007). The dependent variable is the likelihood of management turnover. Performanceit 1 is
measured by ROA lagged one period. GCit 1 is defined as: (1) the concentration of government ownership, measured by a dummy equal to 1 if the proportion of ownership
is above the median level for the year; (2) jurisdictional government control, measured by a dummy variable equal to 1 if the SOE is affiliated with the central government
or is directly held by a local government; (3) monopolistic position of the SOE, measured by a dummy variable equal to 1 if the SOE's market sales are above the median
level of sales in the provincial unit where it is located; and (4) the strategic industries, measured by a dummy variable equal to 1 if the SOE is in one of seven industries that
are strategically regulated by the government. (P-value in parentheses: *** p b 1%, ** p b 5%, * b 10%).
Intercept
GC(1)
256
persist or is not significant if the firms are in regions with a high ratio of the stock market
capitalization to local GDP. In Columns 3 and 4, where the government control is
measured by the market shares of firms and strategic industries, respectively, the results
for the low and high sub-samples are not significantly different. Panel B partitions the sample by the yearly median value of the number of firms listed in a given region (province),
and Panel C divides the sample by the yearly median value of the number of initial public
offerings of equity in a given region (province). The results in both panels show that the
interaction of government control and firm performance (Performanceit 1 * GCit 1) is persistently negative in regions with a low number of listed firms for all measures of government control. However, the inverse relation does not exist or is not significant for regions
with a high number of listed firms. Panel D partitions the sample by the yearly median
value of the comprehensive marketization index of regions/provinces in China (Fan &
Wang, 2007). The results show that the interaction of government control and firm performance (Performanceit 1 * GCit 1) is significantly negative if the firms are from regions
with low marketization indices, where government control is measured by the concentration
of government ownership (see Column 1). However, the inverse relation is not significant if
the firms are from regions with high marketization indices. In Column 2 and Column 3,
where government control is measured by central/direct local government control and the
market shares of firms, respectively, the results for the low and high sub-samples are not
significantly different. In Column 4, where government control is measured by whether
or not the firm is in a strategic industry, the interaction termPerformanceit 1 * GCit 1 is significantly negative regardless of whether the firms are from a region with a high or low
marketization index. However, the economic effect of the interaction is stronger in the
low sub-sample than in the high sub-sample (4.39 in the low sub-sample vs. 2.30 in
the high sub-sample). Overall, the sub-sample regression results corroborate the results in
Table 4, providing further support for the argument that the complementary relation between government control and corporate control is more prominent in regions with poor investor protection or poor market institutions.
7.2. Endogeneity concern

Government administrators control not only the appointment/dismissal of top managers
but also the approval of large investment projects and asset disposals; therefore, it is possible that top management turnover and firm performance are both endogenously determined by omitted institutional factors. To address this potential problem, we follow Fan
et al. (2007) and re-run Model 1 as in Table 3 on sub-samples alternately stratified by
firm and regional institutional factors to evaluate whether the documented relations persist
in the sub-sample regressions. Specifically, we partition the sample by the sample median
value of (1) local (provincial) GDP, (2) local fiscal deficit levels, (3) local unemployment
rates, and (4) firm return on sales (ROS), respectively.
Table 6 reports the results of the sub-sample regressions. Top management turnover is
associated with significantly negative firm performance regardless of whether the firms are
from regions with high or low GDP, healthy or poor fiscal conditions, high or low employment rates, or whether the SOEs have high or low ROS. The sub-sample regression results
Expected
sign
Intercept
Performanceit 1
Log(assetsit 1)
Leverageit 1
Indus_MBit 1
Log(GDPit 1)
Log(employit 1)
Dualit 1
Year_dummy
Indus_dummy
Obs. #
Pseudo R-sq.
(1) GDP
(2) Fiscal decit
(3) Unemployment rate
(4) ROS
Low
High
Low
High
Low
High
Low
High
30.48
(0.906)
4.42
(0.086*)
0.53
(0.019**)
0.30
(0.740)
2.06
(b.001***)
0.00
(0.522)
0.21
(0.149)
0.46
(0.238)
Yes
Yes
971
0.18
22.98
(0.928)
5.00
(b.001***)
0.19
(0.059*)
0.26
(0.541)
1.17
(b.001***)
0.00
(0.148)
0.04
(0.546)
0.43
(0.065*)
Yes
Yes
3125
0.12
22.21
(0.893)
5.40
(0.004***)
0.19
(0.060*)
0.46
(0.300)
1.19
(b.001***)
+0.00
(0.080*)
0.06
(0.343)
0.36
(0.125)
Yes
Yes
2945
0.12
27.18
(0.904)
5.04
(0.029**)
0.41
(0.042**)
0.69
(0.381)
1.90
(b.001***)
0.00
(0.362)
0.23
(0.081*)
0.13
(0.715)
Yes
Yes
1151
0.17
27.59
(0.873)
4.29
(0.009***)
0.49
(b.001***)
0.05
(0.926)
1.49
(b.001***)
0.00
(0.194)
0.188
(0.038**)
0.60
(0.028**)
Yes
Yes
2285
0.16
21.37
(0.920)
5.33
(0.009***)
0.11
(0.419)
0.70
(0.262)
1.26
(b.001***)
0.00
(0.282)
0.12
(0.130)
0.11
(0.702)
Yes
Yes
1811
0.13
28.18
(0.863)
5.35
(0.002***)
0.38
(0.004***)
0.88
(0.135)
2.04
(b.001***)
0.00
(0.220)
0.03
(0.754)
0.41
0.164
Yes
Yes
2021
0.18
23.03
(0.919)
4.39
(0.026**)
0.26
(0.044**)
0.23
(0.658)
0.93
(b.001***)
0.00
(0.951)
0.021
(0.788)
0.10
(0.713)
Yes
Yes
2075
0.09
Table 6
Results of the sub-sample regressions. We re-run Model 1 (as in Table 3) on sub-samples alternately stratified by firm and regional institutional factors to examine whether
the predicted relations persist in the sub-sample regressions (Fan et al., 2007). We partition the sample by the sample median value of: (1) local (provincial) GDP, (2) local
fiscal deficit levels, (3) local unemployment rates, and (4) firm return on sales (ROS). The negative relations between top management turnover and firm's performance
(ROA) are robust in the sub-samples.
257
258
confirm that the results in Table 3 are not affected by the regional institutional factors, thus
providing additional support for the robustness of our findings.
7.3. Management turnover issue
We identified forced top management turnover by excluding natural reasons for turnover, such as retirement, change of ownership, health, and the end of a temporary appointment. The management turnover data in the analysis contain changes in top
management personnel at the expiration of the term of office (CSMAR turnover data item
number 3). It is possible that management turnover at the end of the term of office could be
a result of forced departure or for other reasons. As a sensitivity test, we excluded the management turnover at the end of term from our analysis. The results are qualitatively the same as
reported in Tables 3 and 4. We also conducted a sensitivity test to control the competence of
top managers by including their education levels in the regression model and still find consistent results.
7.4. Alternative firm performance measures
An alternative measure of firm performance used in the prior literature is market performance (stock price). We re-run our tests using stock price performance (cumulative return
based on 12 monthly returns) and, alternatively, Tobin's Q to measure firm performance. 8
The unreported results show no significant association between management turnover and
firm market performance in SOEs. This result is consistent with prior studies using SOEs
as the sample. For example, Chang and Wong (2004a, 2004b) find that managerial change
and selection in Chinese SOEs are not significantly associated with stock price performance because state-owned shares are usually non-tradable and can be transferred only
on receiving administrative approval. SASAC officials and other bureaucrats who exercise
control on behalf of the government are unable to capture any capital gains for themselves
when enterprise shares are not transferred. Consequently, state owners may be less concerned about long-term shareholder value as reflected in stock prices. Firth, Fung, and
Rui (2006) also show that chairman turnover is related to a firm's profitability but not to
its stock returns in Chinese-listed firms. But they don't provide any explanations. Peng
and Luo (2000) (p. 492) suggest that ROA is a preferred measure for Chinese firm performance because accounting for assets in China is typically more accurate than accounting
for equity as the equity contributions for a majority of Chinese firms are historically ambiguous, thus rendering it difficult to compute the stock return.
We also conduct robustness tests by using measures of adjusted firm performance such
as ROA adjusted by industrial mean ROA. The unreported results are consistent with the
results derived using firm-specific ROA and imply that the state owner normally uses earnings as a criterion in making management turnover decisions. 9
ValueLiabilities Book Values
Tobin0 sQ Equity MarketEquity
, wherein the non-tradable state shareholdings are valued by
Book Values
the market price of tradable state shareholdings.
9
This may be because the government can solicit accounting information (Laffont, 1994; Stigler, 1971) and
earnings are a single summary of rm performance that is easily understood.
8
259
7.5. Redefining the concentration of government ownership

Although the result for the interaction including concentration of government ownership is not significant, government ownership is a critical method of government control.
We, therefore, redefine concentration of government ownership to check on the robustness
of the earlier finding. First, we re-run the model by using an indicator variable for a high
level of government ownership, setting the cutoffs for a high degree of government ownership at the 20%, 50%, or 75% shareholding level. The interaction results remain insignificant. Second, we partition the sample into two sub-samples according to whether the firm
has a high or low proportion of government ownership and run Model 1 using these subsamples. For both the high and low government ownership level sub-samples, the likelihood of management turnover is significantly inversely associated with the two accounting
measures of firm performance.
8. Conclusions
This study examines the turnoverperformance relationship in Chinese SOEs by first
addressing the question: Is corporate control through performance-based turnover decisions effective in businesses subject to a high degree of government control, such as
Chinese SOEs, which operate in an institutional environment characterized by a mixture
of capitalism and socialism? Our findings show that the likelihood that top SOE management will be replaced increases when firm accounting performance is poorer. The evidence presented here suggests that despite insufficient external market pressure,
government owners of SOEs adopt a control mechanism that ties top management turnover to firm performance given the current interests of the Chinese government in economic performance.
Second, we investigate the intertwining role government control plays in the corporate
governance of Chinese SOEs. We measure government control by four metrics: concentration of government ownership, jurisdictional level of government control, the monopolistic
position (or market share) of the firm, and whether the firm is in a strategic industry. Overall, the findings show that stronger government control enhances the inverse relationship
between top management turnover and firm accounting performance. The results of our additional tests provide further evidence that the complementary relation between government control and corporate control is more prominent in regions with poor investor
protection or poor market institutions. Our findings are important given the debate on
whether privatization is an essential step for improving the performance of SOEs. Chinese
SOEs have been criticized for their potentially inefficient decisions and the ineffectiveness
of their governance systems. Despite the criticism of government influence in Chinese
enterprises, our results suggest that government control in SOEs could play a positive
role in ensuring the establishment of effective internal governance structures and provides
a partial explanation for the success of China's economic reforms.
A caveat of the study is that due to lack of available data we are unable to evaluate
departed top managers' competence and whether their departures are for promotion or
demotion. Future research could examine the turnoverperformance relationship in Chinese
SOEs by following the careers of departed management and determining whether the
260
departed chairman or CEO's next position is a promotion or demotion. This approach will
provide a deeper understanding of the managerial labor market in Chinese SOEs and the
interaction between the promotion/demotion of top management, firm performance, and
government control.
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The International Journal of Accounting 47 (2012) 235 262

Top management turnover, rm performance and

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

The negative turnoverperformance relationship represents an efficient incentive mechanism

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

Accordingly, government/party officials have strong incentives to encourage better corporate

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

3.2.2. The complementary effect

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

4.1.2. Government control

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

is one of four measures of government control, which include concentration of

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

Diff. (10) (t-test)

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

Note: *** = p b 1%, ** = p b 5%, * = p b 10%.

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

Panel A: Partition by the

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Panel B: Partition by the

(continued on next page)

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7.2. Endogeneity concern

(2) Fiscal decit

(3) Unemployment rate

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F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

7.5. Redefining the concentration of government ownership

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F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

F. Hu, S.C.M. Leung / The International Journal of Accounting 47 (2012) 235262

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Note: * = p b 1%, = p b 5%, * = p b 10%.