Corporate governance and labor investment efficiency: International evidence from board reforms

• Published date: 01 September 2022
• Author: Anh‐Tuan Le,Thao Phuong Tran
• Date: 01 September 2022
• DOI: http://doi.org/10.1111/corg.12422

ORIGINAL ARTICLE

Corporate governance and labor investment efficiency:

International evidence from board reforms

Anh-Tuan Le

1,2

| Thao Phuong Tran

2

1

Department of Finance, National Central

University, Taoyuan, Taiwan

2

International School of Business, University

of Economics Ho Chi Minh City, Ho Chi Minh,

Vietnam

Correspondence

Thao Phuong Tran, International School of

Business, University of Economics Ho Chi

Minh City, 59C Nguyen Dinh Chieu, District

3, Ho Chi Minh, Vietnam.

Email: thao.tran@isb.edu.vn

Funding information

Western Sydney University Vietnam;

University of Economics Ho Chi Minh City

Abstract

Research Question/Issue: This study investigates whether and how board reforms

affect labor investment efficiency using a difference-in-differences analysis of board

reforms in 41 countries worldwide as an exogenous shock.

Research Findings/Insights: Board reforms are positively associated with labor

investment efficiency because they benefit firms in reducing over-hiring, under-firing,

under-hiring, and over-firing. Further, we show that the positive effect is more pro-

nounced among firms with lower board independence before the reforms, firms with

high institutional foreign ownership, firms with higher corporate social responsibility

(CSR), and labor-intensive firms. While countries with rule-based reforms experience

a greater reduction in abnormal net hiring post-reform, the effects of reforms are

similar across civil and common law countries. Further analyses reveal that in coun-

tries with higher employment protection legislation, the beneficial relationship

between board reforms and labor investment efficiency is weaker.

Theoretical/Academic Implications: Our study suggests that one of the mechanisms

linking board reforms and labor investment efficiency is a reduction in frictions, such

as moral hazard and adverse selection, which hamper efficient labor investment. To

the best of our knowledge, this is the first international study that explores globally

the relationship between board reforms and firm labor policies, in particular, labor

investment efficiency.

Practitioner/Policy Implications: Given the importance of identifying and confirming

the role of corporate governance in human capital investment efficiency, our empiri-

cal investigation provides useful insights and policy implications for managers in

building efficient labor policies.

KEYWORDS

corporate governance, board reforms, labor investment efficiency

1|INTRODUCTION

There has been heightened attention to corporate governance issues

among both policymakers and academics since the 1990s. Many

countries worldwide have spent a great deal of effort addressing this

issue by implementing reforms to strengthen corporate governance.

One frequent method is to enhance the independence of company

boards and require audit committee and auditor independence. Many

reforms mandate or recommend the separation of the chairman and

chief executive officer (CEO) positions. While the effect of various

corporate governance mechanisms, induced by these reforms, on firm

value and corporate policy has been analyzed intensively,

1

the linkage

between board reforms and labor investment efficiency, frequently

treated as an important value driver for a business's success

Received: 28 January 2021 Revised: 15 December 2021 Accepted: 16 December 2021

DOI: 10.1111/corg.12422

Corp Govern Int Rev. 2022;30:555–583. wileyonlinelibrary.com/journal/corg © 2021 John Wiley & Sons Ltd 555

(Ben-Nasr & Alshwer, 2016),has been largely overlooked. In this study,

we fill this gap in the literature by using exogenousshocks to corporate

governance from board reforms around the world to test whether and

how such major reformsaffect firm labor investment efficiency.

Understanding the impact of governance board reforms on labor

investment efficiency represents a crucial distinction from prior litera-

ture. First, while corporate employment decision making has received

significant attention in the context of a single country, no interna-

tional study has exploited the perspective of corporate governance to

study firm labor policy. Given that labor represents a significant input

into a firm's production costs (Jung et al., 2014) and significantly con-

tributes to a business's competitive advantage and long-term growth

(Pfeffer, 1994), a cross-country analysis of labor investment efficiency

is crucial. Second, both theoretical and empirical predictions of the

real influence of board reforms on firm operations are a priori ambigu-

ous. We bridge this literature gap by opportunely confirming the influ-

ence of board reforms on human capital investment efficiency,

specifically labor efficiency.

The corporate governance system has been established to moni-

tor how well companies are run, providing a safeguard for share-

holders and investors. Better governance can enhance manager and

shareholder interest alignment, thus lessening information asymmetry

and agency costs, eventually improving investment efficiency. A major

reform will focus generally on the main aspects of the board's quality,

including board and audit committee independence, and the separa-

tion of the CEO and chairman positions. These components reduce

agency costs and help managers generate investments that maximize

shareholder value. For example, Fama and Jensen (1983) document

that independent directors enhance a board's monitoring effective-

ness, mitigate moral hazard issues, and prevent managers' empire-

building actions. Beasley (1996) shows that board independence ben-

efits firms in enhancing report quality and in reducing earning man-

agement in particular (Peasnell et al., 2005). Recent works show that

better corporate governance following major board reforms enhances

firm value (Fauver et al., 2017), reduces stock price crash risk (Hu

et al., 2020), and reduces cash balances (Chen, Guedhami,

et al., 2020). A plausible reason is that board reforms improve financial

transparency and boost internal corporate governance by strengthen-

ing monitoring roles and, in turn, mitigating information asymmetry

and agency problems. This argument supports a positive view of

board reforms, indicating that firms may obtain higher labor invest-

ment efficiency after major governance reforms.

Alternatively, one might argue that better corporate governance

(e.g., more independent directors) could be detrimental to a firm's

operation. For example, improved monitoring quality can lead to

greater managerial myopia (Faleye et al., 2011). Li et al. (2020) show a

significant increase in the cost of equity after board reforms world-

wide. Given that human capital expenditures are much higher than

capital expenditures (Jung et al., 2014), the increased cost of debt can

lead to financial shortages for investment, thereby reducing efficient

labor investment.

To examine whether and how board reforms affect labor invest-

ment efficiency, we investigate a list of major reforms implemented

between 1993 and 2012 in 41 countries. We apply a difference-in-

differences (DID) framework to remove the time-invariant country

influence that may lead to cross-country heterogeneities in corporate

employment decisions. Using a rich sample of 161,642 firm-year

observations from 20,185 unique firms during 1990 to 2015, we find

robust evidence that labor investment efficiency increases signifi-

cantly following board reforms. For example, firms incorporated in

countries with board reforms decrease abnormal net hiring by 1.6 to

2.6 percentage points following a major reform. Our findings are

robust to a reduced sample, which is limited to the 10-year period

around the reforms to alleviate concerns about confounding events

and correlated omitted variables. Notably, further analyses indicate

that better corporate governance resulting from major board reforms

helps firms reduce sub-optimal decisions regarding both over-

investment and under-investment, including over-hiring, under-firing,

under-hiring, and over-firing.

We extend our analysis further in several ways to obtain extra

empirical support. First, we consider the effect of three components

of board reforms on labor investment efficiency: (1) board indepen-

dence, (2) audit committee and auditor independence, and (3) the sep-

aration of the chairman and CEO positions. Our results show that

board reforms involving these components reduce abnormal net hir-

ing. Second, to ensure our results are not driven by the parallel trends

assumption underlying the DID framework, we conduct dynamic tests

and falsification tests using pseudo reform years during both the pre-

and post-reform periods. We find that the enhancement in labor

investment efficiency is due to the influence of board reforms, rather

than the changes in economic shocks. Moreover, there is no evidence

of changes in abnormal net hiring subsequent to the pseudo reform

years. Third, we apply the DID on a matched sample using propensity

score matching (PSM). Specifically, we use UK firms (the largest coun-

try passing board reforms before 2000) as the benchmark group and

restrict our sample to countries that adopt board reforms after 2000.

Our results support that board reforms are positively correlated to

labor investment efficiency after controlling differences in characteris-

tics between the treated and control firms, and the parallel trends

assumption.

Next, we inspect the economic channels underlying the effect of

board reforms on labor investment efficiency by investigating the

cross-sectional differences in this association. We show that the influ-

ence of board reforms on labor investment efficiency is more pro-

nounced for firms with high agency costs, high financial constraints,

or high cost of debt prior to the reforms. These findings are consistent

with the notion that better corporate governance resulting from board

reforms reduces moral hazard and adverse selection problems, which

boosts investment efficiency in labor.

As an additional test, we document that the effect of board

reforms on reducing abnormal net hiring is more concentrated in firms

most impacted, that is, firms without majority board independence in

the pre-reform period. In addition, our results show that the positive

relationship between labor investment efficiency and board reforms is

stronger among firms with high foreign institutional ownership, high

CSR, and labor-intensive firms. These results support the view that

556 LE AND TRAN