Mediation or Moderation? The Role of R&D Investment in the Relationship between Corporate Governance and Firm Performance: Empirical Evidence from the Chinese IT Industry

• Author: Lilin Chen,Qing Zhang,Tianjun Feng
• Date: 01 November 2014
• DOI: http://doi.org/10.1111/corg.12073
• Published date: 01 November 2014

Mediation or Moderation? The Role of R&D

Investment in the Relationship between

Corporate Governance and Firm Performance:

Empirical Evidence from the Chinese

IT Industry

Qing Zhang, Lilin Chen, and Tianjun Feng*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper explores whether R&D investment has a mediating and/or moderating effect on the

relationship between corporate governance and f‌irm performance.

Research Findings/Insights: This empirical study of Chinese IT-industry listed companies during the 2007–2008 period

shows that R&D investment does not moderate, but instead mediates the relationship between corporate governance and

f‌irm performance.

Theoretical/Academic Implications: This paper takes the perspective of technological innovation to empirically examine

the effect of corporate governance on f‌irm performance. This study makes a contribution to the literature by showing that

technological innovation (i.e., R&D investment) mediates the effects of various governance mechanisms (i.e., ownership

concentration, managerial compensation, and asset-debt ratio) on f‌irm performance.

Practitioner/Policy Implications: The results provide important managerial implications for the practice of corporate

governance in emerging economies. Companies in emerging economies can enhance technological innovation through

maintaining relatively high ownership concentration, designing effective managerial compensation systems, and optimiz-

ing capital structure. In addition, emerging economies should adopt effective public policies on technological innovation to

improve the relationship between corporate governance and f‌irm performance.

Keywords: Corporate Governance, R&D Investment, Firm Performance, Mediation and Moderation, Chinese IT

Industry

INTRODUCTION

Over the past few decades, researchers have examined

corporate governance and f‌irm performance exten-

sively (Bhagat & Bolton, 2008; Ravenscraft & Scherer, 1987;

Shleifer & Vishny, 1997). Research indicates that there is a

direct relationship between these two variables (Bhagat &

Bolton, 2008; Jensen & Murphy, 1990). At the same time,

several papers establish an indirect relationship between

corporate governance and f‌irm performance (Bethel &

Liebeskind, 1993; Ravenscraft & Scherer, 1987; Shimizu &

Hitt, 2005). Previous f‌indings indicate that several variables

mediate this relationship, including refocusing strategy

(Bethel & Liebeskind, 1993), divestiture strategy (Shimizu &

Hitt, 2005), merger and acquisition strategy (Ravenscraft &

Scherer, 1987), and CEO external advice network

(McDonald, Khanna, & Westphal, 2008).

Therefore, previous f‌indings are inconsistent with respect

to the relationship between corporate governance and f‌irm

performance. This paper aims to investigate the relationship

between corporate governance and f‌irm performance from

the perspective of R&D investment. We take this approach

because as market competition among f‌irms increases, the

product life cycle decreases signif‌icantly, and thus R&D

investment becomes increasingly important for f‌irms’ sur-

*Address for correspondence: TianjunFeng, School of Management, Fudan University,

Shanghai, P.R.China 200433. Tel: 86-21-25011182; Fax: 86-21-65642412; E-mail: tfeng@

fudan.edu.cn

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Corporate Governance: An International Review, 2014, 22(6): 501–517

© 2014 John Wiley & Sons Ltd

doi:10.1111/corg.12073

vival and development (Lee & O’Neill, 2003). According to

the China Science and Technology Statistics Data Book

(2011), the total R&D investment was RMB 518.55 billion,

and 40,049 patents were authorized in China during 2010. A

f‌irm’s R&D investment inf‌luences its patentoutput, which in

turn inf‌luences its future competitiveness. This implies that

R&D investment is critical for f‌irms and may play an impor-

tant role in the effect of corporate governance on f‌irm

performance.

To the best of our knowledge, none of the extant research

examines the role of R&D investment in the relationship

between corporate governance and f‌irm performance. The

previous literature focuses mainly on the relationship

between each pair of these three variables, such as the effect

of corporate governance on f‌irm performance (Bethel &

Liebeskind, 1993; Bhagat & Bolton, 2008; Boone, Casares

Field, Karpoff, & Raheja, 2007; Shleifer & Vishny, 1997), the

effect of corporate governance on R&D investment (e.g.,

Atanassov, 2013; Barker III & Mueller, 2002; Lee & O’Neill,

2003), or the effect of R&D investment on f‌irm performance

(Hitt, Hoskisson, & Kim, 1997; Sougiannis, 1994). From the

perspective of technological innovation, however, it is not

clear whether corporate governance has a direct or indirect

effect on f‌irm performance, which is also a central topic in

the current corporate-governance debate, as discussed pre-

viously. Therefore, the main purpose of this study is to test

the potential mediating and moderating effects of R&D

investment on the relationship between these two variables,

based on a sample of China’s listed information technology

(IT) companies. China’s IT industry is chosen in this study

because the IT industry is technology intensive and needs

high levels of R&D investment to maintain sustainable com-

petitiveness. In addition, as a strategic emerging industry in

China, the IT industry has developed rapidlyin recent years.

The results of this study have several theoretical implica-

tions for designing and optimizing the corporate-

governance structure, which contribute to the theory of

corporate governance.First, we f‌ind that governance mecha-

nisms (i.e., ownership concentration, managerial compensa-

tion and asset-debt ratio) can havean indirect impact on f‌irm

performance through R&D investment. The prior literature

on corporate governance either emphasizes the direct effect

of corporate governance on f‌irm performance or suggests

that corporate governance can indirectly inf‌luence f‌irm per-

formance through refocusing strategy (Bethel & Liebeskind,

1993), divestiture strategy (Shimizu & Hitt, 2005), and

merger and acquisition strategy (Ravenscraft & Scherer,

1987). By contrast, this paper takes the perspective of tech-

nological innovation to empirically examine the indirect

impact of corporate governance on f‌irm performance.

Second, this paper provides empirical evidence that R&D

investment does not moderate, but mediates the relationship

between corporate governance and f‌irm performance. On

one hand, this is consistent with the f‌indings of Miller and

Del Carmen Triana (2009) and Yang (2009). On the other

hand, while f‌irm reputationand innovation partially mediate

the relationship between the board diversity and f‌irm per-

formance (Miller & Del Carmen Triana, 2009), this study

suggests the mediating effect of R&D investment in the rela-

tionship between corporate governance and f‌irm perfor-

mance. In Yang (2009), innovation is treated as a broad

concept, referring to organizational innovation and market

innovation, whereas innovation is specif‌ied as technological

innovation in this study.

The rest of the paper is organized as follows. In the next

section, we describe a conceptual framework by proposing

the potential mediating and moderating effect of R&D

investment on the relationship between corporate gover-

nance and f‌irm performance. Next, we report the methodol-

ogy and data, followed by the empirical results, theoretical

and managerial implications as well as limitations of the

paper. Finally, we present the main conclusion of the paper.

CONCEPTUAL FRAMEWORK AND

HYPOTHESES FORMULATION

Literature Review

This study is related to three main streams of existing

research literature. As discussed above, the f‌irst research

stream addresses the relationship between corporate gover-

nance and f‌irm performance. Although there is no consen-

sus on whether the relationship between them is direct or

indirect, research well establishes that corporate governance

inf‌luences f‌irm performance (Bethel & Liebeskind, 1993;

Bhagat & Bolton, 2008; Boone et al., 2007; Shleifer & Vishny,

1997). Effective corporate governance, for example,

weakens managers’ “control power” endowed by share-

holders and creditors, who supervise managers to ensure

that they invest in prof‌itable projects (Shleifer & Vishny,

1997). Effective corporate governance can better align man-

agers’ own interests with those of shareholders and thus

increase the f‌irm’s value (Boone et al., 2007), because the

relative effectiveness of corporate governance provides

useful information to investors and creditors, and signif‌i-

cantly inf‌luences f‌irm performance. Wu’s (2006) extensive

survey of 161 listed or over-the-counter (OTC) companies in

Taiwan indicates that corporate governance has a positive

effect on f‌irm performance. Alexander and Lee (2006) show

that non-prof‌it hospitals using corporate governance

perform better (i.e., more patients and greater market share)

than those using human-based management. Bhagat and

Bolton (2008) suggest that corporate governance is signif‌i-

cantly positivelyassociated with contemporaneous and sub-

sequent operating performance.

The second research stream focuses on the relationship

between corporate governance and R&D investment.

Researchers identify variousfactors related to corporate gov-

ernance that affect R&D investment, including ownership

structure (Lee & O’Neill, 2003); managers’ characteristics,

attitudes, risk preferences, salaries, stock shares, and options

(Barker III & Mueller, 2002); and institutional investors’

investment preferences (Baysinger, Kosnik, & Turk, 1991).

Furthermore, various external factors affect R&D invest-

ment, including market structure (O’Sullivan, 2000), hostile

takeovers (Atanassov, 2013), takeover provision protection

(Becker-Blease, 2011), shareholder protection, access to stock

market f‌inancing, and legal rules (Brown, Martinsson, &

Petersen, 2013). Meanwhile, internal and external mecha-

nisms of corporate governance interact with each other to

affect a f‌irm’s motivation to invest in technological innova-

tion, which in turn inf‌luences the f‌irm’s technological-

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Volume 22 Number 6 November 2014 © 2014 John Wiley & Sons Ltd