Study on the impact of board governance on the research and
development innovations of Chinese listed small and medium
enterprises
Name: Tangwenhui
Student number: 10993967
Thesis supervisor: dr. ir. S.P. (Sander) van Triest Date: 30 May 2018
Word count: 13,528
MSc Accountancy & Control, specialization [Accountancy] Faculty of Economics and Business, University of Amsterdam
Statement of Originality
This document is written by student Wenhui Tang who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
The research aims to study the impact of board governance on the research and development innovations of Chinese small and medium enterprises. Building a reasonable and effective board governance in China's small and medium-sized listed companies is the key to promote the investment of R&D innovation. It deepens the research about the relationship between the board governance and R&D innovation. It will provide useful reference for the improvement of R&D innovation capability of China's small and medium-sized listed companies. This paper uses panel data about China's small and medium-sized listed companies in the 2013-2016. This paper summarizes the following conclusions. First, variables of the board structure such as board size, board independence and the CEO duality are significantly correlated with R&D innovation of small and medium-sized listed companies. Second, the variables board behaviour including board meeting frequency and the independent director entrust others to attend the meeting of small and medium-sized listed companies have significant correlation with R&D innovation. The board human capital variables including board director education background and professional background have significant correlation with the R&D innovation (including input and output). However, there is no significant correlation between the part-time position and the political relationship of directors in the board of directors' social capital and the R&D innovation of small and medium-sized listed companies. The time span of the study sample is small. As time goes on, the subsequent research will choose a wider time span and adopt lagging technology to innovate data Due to the availability of data and other reasons, variable selection needs to be further improved. From the perspective of contingency, the study is based on multi-level situational factors. It should pay more attention to the inner mechanism of the interaction and influence path between R&D innovation and the board of directors’ governance, to provide more specific reference to the company practise.
Contents
1 Introduction ... 5
2 Literature review&Hypotheses ... 9
2.1 The board structure and R&D innovation of small and medium listed companies ... 9
2.2 The board behaviour and R&D innovation of small and medium listed companies .... 14
2.3 The board capital and R&D innovation of small and medium listed companies ... 15
3 Methodology ... 19
3.1 Methods ... 19
3.2 Variables ... 21
3.3 Models ... 26
4 Results and findings ... 27
4.1 Description ... 27 4.2 Analysis ... 28 5 Conclusions ... 33 5.1 Conclusion... 33 5.2 Limitations& Expectations ... 34 References ... 35 Appendices ... 39
1 Introduction
1.1. The background of the research
The world's new scientific and technological revolution is developing rapidly. The economic pattern is breeding new changes. As the impact of the financial crisis has faded, global innovation has shifted significantly towards developing countries or regions. Against this background, China has put forward the strategic goal of "becoming an innovation-oriented country by 2020’. It further highlights the importance of independent innovation which serves as a strong support for economic and social development. INSEAD, Cornell University and the world intellectual property organization announced the global innovation index (GII) report of 2017. China’s innovation index ranked 22th in all the 130 countries and regions. It is the only developing country which ranked top 25 countries or regions. The rest of the countries or regions are all with high income (WIPO: Global Innovation Index 2017 - Switzerland, Sweden, Netherlands, USA, UK Top Annual Ranking, 2017). However, although China's innovation ability has the obvious improvement, there is still a gap with its economic superpower status. Enterprise's R&D innovation is the most important driving force of economic growth and economic development. To achieve the goals of innovative national strategies, it needs the support of enterprise R&D innovation. In the new economic era, the decision on the intensity and distribution of research and development innovations (hereafter called R&D innovation) is decisive for the survival and sustainable development of enterprises. For enterprises, R&D innovation is the process, enterprise through the application of new knowledge and technology to improve the quality of products and services, or develop and produce new products or provide services, or use innovative mode of production and management mode, thereby expanding market share and market value(Al-Musali & Ismail, 2015).
R&D innovation is important for enterprises to enhance the efficiency of production, lower production costs, increase market share and is very important in the promotion of the position of consumer perceptions. For small and medium-sized listed companies, improving the ability of R&D innovation is the theme of strategic transformation in coping with market orientation and also is the inevitable choice in the international competition under the new situation, promoting the sustainable development ability of the positive way. Years ago, the "DVD patent crisis" caused some small and medium-sized enterprises in China to pout (Min-Feng, Zi-Zhao & Office, 2016). Along with the rapid development of economic globalization, technology and the
strengthen R&D innovation ability of in China (Tuggle et al, 2010). But at the same time, multinational companies have not stopped the pace of development, more and more attentions have been paid to the implementation of patent strategic occupation and control of the market. In 2018, for example, Apple published a new patent, which could prevent the dust contamination in the keyboard.
Therefore, under the influence of the trend of economic integration and so on, the small and medium-sized listed companies in China are in the face of development opportunities. But, at the same time, it also faces the threats on the survival from the pressure of competition. R&D innovation as an improve enterprise core competitive ability, it could promote the development of enterprises. If China's small and medium-sized listed company wants to win the market, the R&D innovation would be one of the keys. R&D innovation investment, however, is a special form of investment. In practice, a number of R&D innovation investment often produced results only after years. Even more, sometimes, the investment is even difficult to get returns. As mentioned by Lippman & Rumelt (1982), R&D innovation has inevitable prior uncertainty. The uncertainty makes investors difficult to estimate the value of R&D innovation investment. It is also one of the main reasons that the majority of listed companies, especially small and medium-sized listed companies in China lack of R&D innovation.
More importantly, the enterprise R&D innovation is different from individual innovation activity. It needs an organization or group, according to certain law, to follow certain system restriction to carry on R&D innovation. For an enterprise, the external market environment of its survival and growth is very limited, especially in the case of market relative saturation and relative overproduction capacity. Therefore, in the face of this situation, enterprises want to gain a leading position in the market, and they must adopt the specialized division of labour and cooperation of externalization, or the internalized market integration. Innovation activities are not accidental aimlessly. It is also cooperation and the active work. This is, the enterprise innovation not only relies on the innovation ability of the individual, but also needs to integrate the resources of the enterprise, including technology, capital, talent, joint efforts for innovation etc. Therefore, the key to the enterprise's R&D innovation ability lies in the system arrangement of the system to activate.
Therefore, the key reason behind the lack of R&D innovation in many small and medium-sized listed companies is the lack of institutional innovation. Board governance is the core of modern enterprise system, which can stimulate the innovation potential of enterprises through the integration and mobilization of enterprise resources and incentive mechanism (Agrawal &
Cooper, 2017). R&D innovation behaviour is done under the established institutional framework of board governance. Therefore, although there are many factors affecting R&D innovation, the board governance is fundamental to affect enterprise R&D innovation. The practice of many Chinese and foreign enterprises also shows that in addition to the technology itself, the problems faced by enterprises in R&D innovation are closely related to the governance of the board. Therefore, to build a reasonable and effective board governance in China's small and medium-sized listed companies is the key to promote the investment of R&D innovation and improve the driving force of its R&D innovation. On the basis of the living environment and the state of small and medium-sized listed companies in China, this paper is going to make an in-depth discussion about the correlation between the board governance and R&D innovation. It will actively look for R&D innovation-oriented optimization approach of board governance. Based on the above background, this paper chooses the relationship between the board governance of small and medium listed and R&D innovation as the research topic and makes an in-depth analysis and elaboration on this subject by empirical research method.
1.2. Research significance
1.2.1. Theoretical significance
In a rapidly changing environment, innovation is a prerequisite for the success of modern enterprises (Stopford & Baden-fuller, 1994). Why do different companies have different R&D innovation capabilities? What factors determine the R&D innovation performance of a company? These problems have become the focus of the current theoretical circle. Since Schumpeter (1934) put forward innovation theory, western scholars, from the perspectives of enterprise scale, market structure, industry characteristics, entrepreneurial ability and financial structure of enterprise, carried on the positive exploration about R&D innovation and accumulated a wealth of literature. For example, Hoskisson Hitt, Johnson & Grossman (2002) proposed that corporate governance factors determine the allocation mechanism of a company's resource allocation and its return, which will have a greater impact on the company's technical performance. The influence of corporate governance on R&D innovation has attracted more and more scholars' attention. Therefore, corporate governance as the core system of the enterprise, there is no doubt that its perfection and innovation play the important role in enterprise R&D innovation and innovation performance. Scholars gradually study the corporate governance factors affecting the R&D investment and their R&D innovation ability, such as the board governance (e.g. Mezghanni, 2011). However, there is less research on the relationship
sized listed companies in China as the research object, based on the in-depth research about the relevance of the board governance and R&D innovation, it deepens the research about the relationship between the board governance and R&D innovation.
1.2.2. Practical significance
This paper systematically and deeply studies the intrinsic relationship between the board governance of China's small and medium-sized listed companies and R&D innovation. On this basis, it promotes the comprehensive interpretation about how to provide support for small and medium-sized listed company R&D innovation through the improvement of structure and mechanism of the board of directors of the company. The conclusion of this paper will provide useful reference for the improvement of R&D innovation capability of China's small and medium-sized listed companies, as well as the construction and improvement of the core competitiveness. Therefore, it is of great practical value.
1.3. The research questions
How does the board governance of China’s small and medium-sized listed companies relate to R&D innovation?
What kind of board structure and behaviour can have obvious promotion effect on the R&D innovation of small and medium-sized listed companies?
And how does the chairman's human capital and social capital affect the R&D innovation of the listed company?
1.4. The aim and objectives of the research
The aim of this research is to study the impact of board governance on the research and development innovations of Chinese small and medium enterprises
The objectives of the research are: to find the connections between board governance on the research and development innovations of small and medium enterprises based on the literature review, to test the impact of board governance on the research and development innovations of Chinese small and medium enterprises with empirical analysis and to put forward suggestions on the Chinese small and medium enterprises from the perspective of board governance.
2 Literature review & Hypotheses
As the strategic decision-making body of the listed company, the board’s strategic participation covers the whole process of the company's strategic system, implementation, control and evaluation (Chan & Richardson, 2014). And R&D innovation is one of the important strategic behaviours of enterprises, and the board will have an important influence on it. The corporate governance should be based on the governance of the company (Niu & Li 2016). The board is not only the proxy of shareholders but also the representative of the company, which is as important as the problem of agency. In practice, the board shall be responsible to the company and all shareholders. In the event of a conflict between the company and certain stakeholders, the board shall be in the overall interest of the company. Therefore, the board is of great importance for the company development. For the studies about the board, many scholars have studied it from the perspectives of the board governance (Desender, et al, 2016), board diversity (Ferrero,Ferrero & Muñoz,Torres, 2015), board governance impact on the company performance (Dharmadasa, 2014), board governance relation with the executive compensation (Conyon, 2014). They less studied the impact of the board governance on the R&D innovation. The relevance of the board to R&D investment is of particular concern because the board has an impact on all areas of corporate governance. For example, the board will influence governance by holding shares, developing strategies, adjusting compensation, implementing anti-merger provisions and selecting the CEO. For long-term investments such as R&D innovation, the impact of board governance should be significant. However, some research have shown that the board structure or the board have impact on the business technical efficiency like the García-Sánchez (2010) and the Valentine & Stewart (2013). Therefore, this paper will bridge the research gap and make theoretical analysis and empirical research on the relationship between board governance and R&D innovation from the aspects of board structure, board behaviour and board capital.
2.1 The board structure and R&D innovation of small and medium listed companies
2.1.1 Board size and R&D innovation
So far, the impact of board size on corporate performance or value has not yet reached a consensus. Its impact on R&D innovation remains to be determined. Chhaochharia & Grinstein (2009) argued, with the expansion of the board, directors also will increase the diversity. The opportunity that it can provide a variety of complementary knowledge for R&D innovation
decision probability also increases. It could improve the accuracy of decision-making, so as to improve the efficiency of R&D innovation, to reduce the risk of innovation. Therefore, it is pointed out that the large scale of board can significantly improve the level of R&D innovation. There are, however, Lipton and Lorsch (1992) pointed out that although the monitoring ability of the board will increase because of the expansion of the board, the cost by the increase of scale will be more than the benefits of it. The source of these sources is generally low efficiency of decision-making, the deviation of risk sharing and hitchhiking effects, etc. Scholars believed that the smaller boards have more flexible decision-making mechanism and more flexible to the environment, so they have a more obvious promotion effect on the R&D innovation of enterprises. Some scholars believed that there is not a simple linear relationship between the size of the board and R&D innovation, but a non-linear relationship. The majority of research verified that there is an inverted u-shaped relationship. As Yermack (1996) concluded, there is indeed a significant inverted u-shaped relationship between board size and R&D innovation. Zahra's et al. (2000) studied 239 manufacturing enterprises from 1991 to 1997 in the United States. They took the panel data as sample. Through empirical test, they found that there is a significant inverted u-shaped relationship between the board scale and the enterprise innovation (including product, process and organization innovation, etc.) However, due to the differences in size, different types of listed companies should have different research conclusions.
Therefore, empirical studies based on all listed companies may not reach an objective conclusion. This paper takes small and medium-sized listed companies as research objects, and probes into the correlation between board size and R&D innovation (Alves, Couto & Francisco, 2015). For small and medium-sized listed companies in China, diversity gradually strengthens with the increase of the scale of the board. It can help to absorb different opinions from all sides and reduce the management risk, which in turn will have obvious promoting effect on R&D innovation. But if the board size continues to increase after maximum, the decision-making speed decreases. It will also affect the communication and coordination between members of the board. The free-riding phenomenon will be more serious. The share of risk also can produce deviation, while the level of R&D innovation will be suppressed. Therefore, the following hypothesis is proposed:
H1-a: There is a significant u-shaped relationship between the size of the board and the input of R&D innovation
The above hypothesis means that before the peak of the board size, with the increasing scale of the board, the R&D innovation of small and medium-sized listed companies in China invest will
gradually increase. But when after the peak, as the scale of the board continues to increase, the R&D innovation of small and medium-sized listed companies into can significantly lower instead.
H1-b: There is a significant u-shaped relationship between the size of the board and the output of R&D innovation
The above hypothesis means that, before the peak of the board size, with the increasing scale of the board, the R&D innovation of small and medium-sized listed company production will gradually increase. But when after the peak, as the scale of the board continues to increase, the R&D innovation of small and medium-sized listed companies output will be significantly lower. 2.1.2 The average age of directors and R&D innovation
Generally speaking, the average age of directors is an important dimension reflecting the structure of the board. The higher the average age of the board members is, their life experience, work experience, experience and social relations will bring more social capital to the small and medium-sized listed companies. However, according to Liu (2016), when the age of the members of the board growth to a certain extent, in the face of the retirement or other cases, they may be short-term concerns focus on the enterprise's financial indicators, thereby reducing the preferences of the long-term investment on R&D innovation. And the average age of members of the board is small, they are more likely to consider the company's long-term goal as well as their own long-term reputation and career development. Combined with the enthusiasm for career goals to pursue, they will be more inclined to R&D innovation this type of long-term investment. However, if the average age is too small, the board members may lack more work experience and social capital, thus affecting the enterprise's R&D innovation ability. Therefore, the following hypothesis is proposed.
H2-a: There is a significant inverted u-shaped relationship between the average age of directors and the investment of R&D innovation
The above hypothesis means that, before the peak of the average, with the increase of an average age of directors, the R&D innovation of small and medium-sized listed companies invest will gradually increase. But when after the peak, as director of average age continues to increase, the R&D innovation of small and medium-sized listed companies into can significantly lower instead.
H2-b: There is a significant inverted u-shaped relationship between the average age of directors and the output of R&D innovation
The above hypothesis means that, before the peak, with the increase of an average age of directors, the R&D innovation of small and medium-sized listed company production will gradually increase. But when after the peak, as director average age continues to increase, the R&D innovation of small and medium-sized listed companies output will be significantly lower. 2.1.3 Board independence and R&D innovation
As a relatively independent and special social organization, the company is closely related to various stakeholders and bears extensive social responsibilities. In accordance with the Herreraecheverry et al (2016), the relative independence of the board is essential to ensure that the board is in the interest of the company and insists on the governance logic and strategic decision of the corporate ownership orientation. An independent board should be: not controlled by minority shareholders or internal managers; All stakeholders have spokespersons on the board; Board decisions should be as fair as possible, taking into account the interests of shareholders, the overall interests of the company and the public interest. Many documents show that higher independent directors can help improve corporate governance and improve corporate value. Studies have found that the companies with financial fraud problems have relative low independent directors proportion (Muth & Donaldson, 1998). Thus, they pointed out that the existence of the independent directors helps to reduce the company's financial fraud. Yermack (1996) found after the study of the size and structure of the board, the introduction of a certain number of independent directors is able to provide enterprises with a variety of innovative ideas, making its innovation decisions be more scientific.
British Hermes investment fund management companies in the "corporate governance statement", requires independent directors to perform the function of three aspects. The first aspect is the strategic functions: introducing relatively rational judgment of independent directors to the company's strategic decision-making process. Second aspect is the expertise: providing the company with the knowledge, skills and experience it lacks, which is particularly important for small and medium-sized enterprises with relatively small resources. Third aspect is the governance function: to ensure that the company abides by the code of conduct by supervising the conduct of the executive director and the selection and appointment of directors. It follows that for small and medium-sized listed companies in China, the role of independent directors is more important. Its effective supervision can restrain all sorts of opportunistic behaviour and
guide the directors and executives take the company long-term interests as the starting point, which has obvious effect for the promotion of R&D innovation. Therefore, the following hypothesis is proposed.
H3-a: The independence of the board is positively correlated with the investment of R&D innovation
Namely, the greater the independence of the board is, the more investment in R&D innovation of small and medium-sized listed companies will be.
H3-b: The independence of the board is positively correlated with the output of R&D innovation
Namely, the greater the independence of the board is, the more the R&D innovation output of small and medium-sized listed companies would be.
2.1.4 Board leadership structure and R&D innovation
The term "CEO Duality" is generally referred to as the "leadership structure" of the chairman and CEO. It usually reflects the company independence of the board and senior managers innovation free space. It is one of the most contentious issues in the board function argument. For this controversial research, it is usually based on agency theory and stewardship theory (Baliga, Moyer & Rao, 2010). The logic analysis based on the theory of the agent, the joining together of two positions will increase the power of management and reduce the independence of the board, so as to promote the manager's moral hazard and cause the damage to the value of the company (Beatty, & Zajac, 1994). But from the perspective of the butler theory, the combination of the two functions can help executives take innovative actions and increase the flexibility of the enterprise to deal with the environment. By on the basis of the above two kinds of views, empirical research about the impact of CEO Duality on the value of the company draws the different conclusion (Tuggle et al, 2010). But by group control theory, the insider control, which is strategic control, enterprise's actual controller must have enough incentive for innovation, and have enough knowledge and skills to promote the development of enterprise innovation. Therefore, the control of "insiders" rather than outside shareholders is a necessary condition for innovation (Krause, Semadeni & Jr, 2014). The corporate governance that can support this innovative enterprise system is controlled by the organization rather than the market. As the theory explains, the combination of two jobs can increase the innovation freedom
of senior managers, thus affecting the R&D innovation ability of enterprises. Therefore, the following hypothesis is proposed:
H4-a: There is a significant positive correlation between the CEO Duality and the investment of R&D innovation
Namely, the more investment of R&D innovation of the small and medium-sized listed companies would be made in the case of CEO Duality.
H4-b: There is a significant positive correlation between the CEO Duality and the output of R&D innovation
Namely, the more R&D innovation output of the small and medium-sized listed companies would be in the case of CEO Duality.
2.2 The board behavior and R&D innovation of small and medium listed companies
A well-functioning board should have at least three aspects. First, it should provide some strategic advice to the management to ensure the maximum long-term value of shareholders. Second, there is a need to help managers control risky behaviours, including those that capture short-term value at the expense of long-term interests. Third, responsible supervisors are responsible for short-term and long-term business results (Chen, 2014). However, the implementation of these functions not only requires good board structure, but also requires the active and diligent behaviour of the board. Some scholars believe that board behaviour has a greater impact on board performance. For example, the board meeting frequency plays an important role in the effective function of the board.
If the board meeting number of a company yearly is less, it lacks of communication between directors. It is hard to believe that there is a serious and responsible work of the board. Jensen (1993) pointed out that enough time is one of the basic conditions of directors to perform the regulatory functions. The more frequently the meeting of the board is, the directors will be ready to perform those duties consistent with shareholder interests. Fiegener (2005) pointed out that board members' participation will improve governance efficiency through active supervision of management. Many empirical studies show that the lack of board participation is the key to the decline of board efficiency (Mallette and Fowler, 1992). This paper holds that the higher the frequency of board meetings is, the more frequent communication between the directors is, the more opportunities for ideological collisions between them, resulting in more R&D innovation
inspiration. Therefore, the frequency of board meetings and the R&D innovation of small and medium-sized listed companies should also present positive correlation. Based on the above analysis, the following hypotheses are proposed:
H5-a: The frequency of board meetings is significantly related to the investment of R&D innovation of small and medium-sized listed companies
Namely, the more frequency of board meetings is, the more investment of R&D innovation of small and medium-sized listed companies would be.
H5-b: The frequency of board meetings is positively correlated with the R&D innovation output of small and medium-sized listed companies
Namely, the more frequency of board meetings is, the more R&D innovation output of small and medium-sized listed companies would be.
In addition, the independent directors of the board entrust others to attend the meeting is an important performance of the behaviour. If the independent directors always entrust others to attend the meeting, rather than to attend the meeting in person, whether he is diligent is easy to be questioned. The paper also measures the behaviour of the board by the proportion of the independent directors to attend the meeting. Therefore, the following hypothesis is proposed: H6-a: The independent directors entrust others to attend the meeting has significant influence for the R&D innovation of small and medium-sized listed companies
The lower the proportion of independent directors entrust others to attend the meeting, the more input of R&D innovation of small and medium-sized listed company will be.
H6-b: The independent directors entrust others to attend the meeting for the R&D innovation of small and medium-sized listed companies has a significant impact on output
The lower the proportion of independent directors entrust others to attend the meeting is, the more output of R&D innovation of small and medium-sized listed company the more would be.
2.3 The board capital and R&D innovation of small and medium listed companies
So far, the board's influence on R&D innovation has been based on the principal-agent theory, focusing on its control function (Jensen and Meckling, 1976). But the inference from the agent
theory is not always consistent. Hillman & Dalziel (2003), Dalziel, Gentry & Bowerman (2011) pointed out that the relevance of the board and R&D innovation should be re-examined based on the core viewpoint of resource dependence theory. According to the theory of resource dependence, the core of the board's role lies in the capital the board members has. Pfeffer (1978) considered the board as a business contact interface with the outside world. It is from the external access to valuable resources of the enterprise and provides the resources to the management to ensure the effective implementation of corporate strategy. Board behaviour to provide resources specific includes professional knowledge, helping enterprise management and the shareholders, and other important role to establish and maintain relationships, good public image, increases the chances of access to valuable resources, ensuring the communication with the outside world, promote innovation, etc (Maere, Jorissen & Uhlaner, 2014). The premise of board to provide these resources is having capital. Hillman & Dalziel (2003) pointed out that board capital is a measure of the ability of the board to provide resources to enterprises, including human capital and social capital.
2.3.1 Board human capital and R&D innovation
Human capital typically refers to the board members can bring the board with the combination of knowledge, skills, and abilities (Jermias & Gani, 2014). It can help the director find the new opportunities for the enterprise in the industry in and better able to seize these opportunities. As for the measurement of the human capital of directors, it is generally analysed from two aspects: education level and professional background. First, in a rapidly changing environment, the opportunity to find value depends on the ability of the director to grasp, recognize and analyse. The above capability is related to the education level of the directors (Kim & Kim, 2015). As a result, a higher degree will enable directors to better understand the situation of research projects and provide them with knowledge related to innovation management (Collins et al.,1991). This idea is accepted by most scholars (Carpenter and Westphal, 2001). They think that the level of education of a person to a certain extent, reflects its cognition and ability of analysing problems. For executives, different levels of education will affect the enterprise's strategic decision to avoid. H7-a: The directors’ education background is positively correlated with the investment in R&D innovation.
That is, the higher the board's degree is, the more investment in R&D innovation of small and medium-sized listed companies would be.
H7-b: The educational background of directors is positively correlated with the output of R&D innovation.
Namely, the higher the board's degree is, the more R&D innovation output of the small and medium-sized listed companies would be.
Furthermore, the strategic and investment preferences of directors, the ability to process information and the way to solve problems also depend on their professional background. Directors of different professional backgrounds have different cognitive preferences for R&D innovation. According to the theory of resource dependence, the value of the board to provide resources to the enterprise will have a great impact on the strategic decision of the enterprise. Based on this, Porter (1990) found that there is a significant correlation between the technical background and the company's innovation strategy. Finkelstein (1992) through the inspection, found that have research and development, marketing and design experience of decision makers pay more attention to enterprise's R&D innovation and new product development. As a result, the paper put forward the following hypothesis:
H8-a: The director’s professional background has a significant positive correlation with the R&D innovation of small and medium-sized listed companies output
The higher the proportion of directors with professional background is, the R&D innovation of small and medium-sized listed companies would be.
H8-b: The directors’ professional background is significantly positively related to the R&D innovation of small and medium-sized listed companies
The higher the proportion of directors is, the more output of the R&D innovation of small and medium-sized listed company would be.
2.3.2 Board social capital and R&D innovation
The social capital of the board is the internal and external interpersonal relationship of the members of the board, as well as an asset formed by the potential resources brought by these interpersonal relationships (Drobetz, et al, 2015). This paper measures the social capital of the board from three aspects: the part-time position of directors, the political association of directors and the average age of directors. With the intensification of competition, the relationship between the board has become an important source of competitive advantage. In general, the
enterprise in the company, thus establishing relationship with the members of the board of other enterprises. It could strengthen the exchange and sharing of information and resources (Gou & Dong, 2014). Celetkanycz (1997) pointed out that if the board members of an enterprise were working part-time in different industries, the company would be more likely to have a strategic change. Part-time directors in different enterprises, means that established a link between the board. The link can enlarge its access to information and resources, increase the grasp opportunities for innovation, to develop a more reasonable decision of R&D innovation, improve the company's R&D innovation ability. This chain relationship, especially with other listed companies, can provide more resources and information channels for the company (Sundaramurthy, Pukthuanthong & Kor, 2014). It is more important for small and medium-sized listed companies. Therefore, the following hypothesis is proposed:
H9-a: The higher the proportion of directors with part-time positions outside the listed company is, the more investment in R&D innovation of the small and medium-sized listed companies would be.
H9-b: The higher the proportion of directors who have part-time positions outside the listed company is, the more R&D innovation output of the small and medium-sized listed companies would be.
In China's transition economy, small and medium-sized listed companies will face many uncertainties in the process of R&D innovation from political and administrative management. This uncertainty will greatly increase the risk that enterprises will invest in R&D innovation (Sauerwald, Lin & Peng, 2016). The power of politics in the implementation of industry regulation, formulate industrial policy, tax fiscal policy makes the political relevance of the board to determine its whether it has certain advantages on access to effective information and avoid the risk.
H10-a: There is a significant positive correlation between the political resources of directors and the investment of R&D innovation
Namely, the higher proportion of directors with political connections, the more R&D investment will be made in small and medium-sized listed companies.
H10-b: There is a significant positive correlation between the political resources of directors and the output of R&D innovation
That is, the higher proportion of directors with political affiliation, there will be more R&D innovation output of the small and medium-sized listed companies.
3 Methodology
3.1 Methods
According to the above research questions in the first chapter, this paper intends to use panel data about China's small and medium-sized listed companies in the 2013-2016 and to explore the relationship between the board governance factors such as the characteristics of board, structure of the board capital with R&D innovation level based on correlation empirical test. Therefore, this chapter will explain the methodology of the research in detail.
The research ontology is divided into the objectivism and subjectivism. Ontology refers to the philosophical theory that explores the nature of the world (Creswell & Clark, 2011). The objectivism holds that, in the world, there is the realistic things which are independent of the subjective things in people’s mind like the spirit. For the subjectivism, it holds the minds of people like the spirit, experience, consciousness, concept and so on are the basis and source of the world (Collis & Hussey, 2013). This dissertation holds the objectivism as this paper is going to do empirical test to explore the relationship between the board governance factors such as the characteristics of board. It hopes to provide theoretical basis for small and medium-sized listed companies to build long-term value for company's board. And then, it is the epistemology. The epistemology is divided into the positivism and interpretivism. This paper intends to use the panel data about China's small and medium-sized listed companies in the 2013-2016 to carry out the empirical test. Therefore, this research insists the positivism. At the same time, this paper aims to test the impact of board governance on the research and development innovations of Chinese listed small and medium enterprises. The empirical research making use of the objective data could test the impact more objectively (Gray, 2013). Therefore, the positivism using the empirical test could give a more clear and convinced answer to the question of the paper. On the basis of literature review, based on the related theory, the paper builds the associated model of the board governance and R&D innovation, reveals the related mechanism. This paper first establishes the appropriate economic model and then gives the scientific explanation and gives the data support to the relationship between board governance and R&D innovation. To be specific, the use of Chinese small and medium-sized listed companies panel data, the corresponding measurement model and a mathematical model was constructed, and uses the Hausman test, for China's small and medium-sized listed empirical study on the correlation of the board governance and R&D innovation. Using this method to estimate parameters can
overcome problem such as serial correlation and heteroscedasticity more easily in the cross-section data or hybrid data analysis of error term and solve endogenous problems by the omitted variable does not change with time (Harrison, 2013). In the process of empirical test, by combining linear and nonlinear perspectives, the inverted u-shaped relationship between board governance and R&D innovation is proved.
In this paper, small and medium-sized companies listed on the SME board of Shenzhen stock exchange, the GEM board and the main board of Shanghai stock exchange and Shenzhen stock exchange were taken as research samples. The period from 2013 to 2016 is selected as the research range. These samples eliminate financial companies, ST companies, companies stop listing as well as the companies with not complete data. Finally, 267 listed companies meeting the above requirements during the period are got. In total, there are 1068 valid observations. The data about governance structure of listed company and relevant financial indicators data this article uses are from Chinese CSMAR database and the company annual reports and other announcements confirmed. Patent data comes from China patent database intellectual property.
3.2 Variables
3.2.1 Variable definition and calculation
The variables in the research include the independent variables. control variables and dependent variables (Lewis & Saunders, 2012). According to the literature review above, the independent variables include the board structure variables. In this paper, the board size, the proportion of independent directors and the integration of two functions are selected to measure the board structure.
3.2.2 Independent variables
First is the board size (BS), which is represented by the total number of directors at the end of the year. Second is the average age of directors (AAB), indicated by the average age of directors disclosed at the end of each year. And then, it is ratio of independent directors (RID), indicated by the ratio of the number of independent directors to the total number of directors of the company at the end of the year. Last is the CEO Duality (CD). This variable is set as a virtual variable. If the operator concurrently holds the positions of chairman or vice chairman, it is set as 1; otherwise, it is 0. Second, it is the independent variables of board behaviour. This article selects the board meeting frequency to measure the board behaviour and increases the
"commissioned by the independent director to attend the meeting" to measure the variables independent directors, to enrich and develop the variable measurement way. The frequency of board meeting (FBM). In this paper, the "frequency of board meeting" is used as a measurement index of event meeting behaviour. Scholars pointed out that the number of board meetings as an indicator of board behaviour is very intuitive, which directly reflects the strength of board behaviour. This paper will continue to use this index, which means the number of board meetings held within the year to represent the board's behaviour.
And then, it is the independent directors’ entrustment to attend the meeting (IDAB). Whether independent directors attend the meeting in person or on commission to some extent reflects their attention and diligence to listed companies. It is an important indicator to measure the behaviour of independent directors. In this paper, the "mean value of the ratio of the number of times the company's independent directors are entrusted to attend and the number of times they should attend" is selected to measure the index.
Third kind of independent variables is the board capital variables. The first kind is the human capital. In this paper, education degree of directors (ED) and professional background of directors (PB) were selected to measure the human capital of the board of directors. The variables such as part-time position of directors (PD) and political relations of directors (PR) were used to measure the social capital of the board of directors. First is the director education background (EB), which is the average number of highly educated board members. First of all, the highest academic qualifications of board members are assigned. The director with the doctoral degree would be assigned 4. The director with the master degree would be assigned 3. The director with bachelor degree would be assigned 2. The directors with the other degree would be assigned 1. Then, the average number of the highest educational qualifications of board members is calculated to measure the education degree of directors.
And then, it is the director's professional background (PB). This paper draws on the variable definition methods of relevant scholars and adopts "the proportion of directors with output functions such as R&D, marketing and design" to measure. For directors with the above output functions, the value is 1 and the others are 0, and the proportion of them in the total number of directors is calculated. The part-time position of directors (PP) is expressed as "the proportion of directors holding concurrent posts in other units other than the listed company. it will assign 1 to directors who have part-time jobs in other units, otherwise 0, and calculate their proportion in the total number of directors. Director political relations (PR). By referring to the variable definition methods of relevant scholars and others, the "proportion of directors who have served
in or concurrently served in government departments" is adopted to measure. All board governance variables are defined and calculated as shown in table 3-1.
Figure 3-1: The summary of the independent variables in the board Variable
classification
Variable Abbreviation
Board structure Board size BS
Average age of board AAB
Independence of board ID
CEO duality CD
Board behaviour Frequency of board meeting FBM
Independent directors’ entrustment to attend the meeting
IDEA
Board capital Human capital Educational background EB Professional background PB Social capital Part-time position PP Political relation PR 3.2.3 Control variables
The definition and calculation method of control variable are as follows. Ryan & Wiggins et al. (2002) pointed out that factors such as company size, growth, asset-liability ratio and so on all have a significant impact on the R&D investment of listed companies. Therefore, the above basic characteristic factors of the company are selected as control variables.
Where, the size of the company is measured by the natural logarithm of the total assets at the end of the term. Growth refers to the growth rate of total assets, i.e. (total assets at the end of the period -total assets at the beginning of a period)/ total assets at the beginning of a period. LEV uses the ratio of total liabilities to total assets in the company's annual disclosed balance sheet. Industry characteristics (INC) expressed in virtual variables. Due to that the difference between the high-tech company and the non-high-tech industry is obvious, it uses the binary
industries to 0. The profitability uses the ROE, which is to reflect the profitability of listed companies and the management level of the core index. The control variables are shown in table 3-2.
Table 3-2: Summary of control variables
Variables Abbreviation
Company size Size
Growth Grow
Asset-liability ratio LEV Industry characters IND
Profitability ROE
3.2.4 Dependent variables
Most of the existing researches choose ‘R&D spending’ as the operating variables of R&D innovation. But such variables often limit the R&D innovation to a single static dimension namely the R&D innovation investment. It ignores the process of R&D innovation and dynamic characteristics. Scholars pointed out that investment in the R&D process is only a necessary rather than sufficient condition for the realization of innovation. The risk and complexity of the R&D process also determine the uncertainty of its results. Therefore, this article chooses R&D innovation input and output of R&D innovation of two kinds of indexes to measure R&D innovation. The R&D innovation investment chooses R&D strength and technical personnel strength two specific indicators. The innovation output uses total number of patents, the number of innovations and the technology assets ratio three indexes. According to the research of scholars, this paper defines R&D innovation variables as shown in table 3-3.
Table 3-3: Summary of the dependent variables Variable
classification
Variables Abbreviation
R&D innovation input
R&D investment intensity RDI Technical staff intensity TS1 R&D innovation Sum of patent applications PA
input Number of the innovations NI Technical assets ratio TSU
The first is the R&D investment intensity (RDI). This article selects R&D Intensity as a measure of R&D innovation investment operating variables, measured by the ratio of spending on research and development and to main business income in the annual report disclosure of listed companies. Second is the Technical staff intensity (TSI). More than 50% of R&D spending is spent on training and salaries for research developers. However, this part cannot be obtained from the report, so technical staff strength is used instead. Technical personnel are the main part of the enterprise R&D innovation, the technical personnel from quantity to a certain extent, reflect the ability of R&D innovation in an enterprise of high and low, in this article, through manual query annual reports of listed companies.
And then, it is the total number of patent applications (PA). In this paper, the number of patent applications is chosen to measure the R&D innovation output, rather than the number of patents granted. Croby Griliches (1990) held that, compared with the number of patent application, patent number has a greater amount of uncertainty. It is more likely to fluctuate. Because whether the patent is granted or not is easily affected by human factors such as patent agencies. So, patent applications more than the number of patents granted reflect the actual level of R&D innovation output. The patent application data are collected manually from the database of China intellectual property network.
And then, it is the application number of the innovations (NI). Invention, utility model and appearance design are the three basic types of patents. "Invention" means a new technical proposal for a product, method or improvement thereof; Utility model "refers to the product's shape, structure, or their combination have put forward a new technical proposal is suitable for practical: design, refers to the product's shape, pattern or their combination, and the combination of colour and shape, pattern made by the rich aesthetic feeling and is suitable for industrial application of the new design. Therefore, if the total number of patent applications reflects the number of innovation output of listed companies, then the total number of patent applications reflects the quality of innovation output. Therefore, the total amount of invention patent application is selected as an important component index of innovation output.
Last is the technical assets ratio (TAR). Since patents are an important indicator of the innovation process, but they cannot reflect the final performance of innovation, it can be seen
that R&D innovation output should include other indicators. Intangible assets are the source of value creation in the intangible form formed by enterprise innovation activities. David Hitt & Gimeno (2001) also pointed out that R&D investment is an important investment of enterprises in developing intangible assets and implementing differentiated strategies, which represents the importance of R&D innovation to corporate strategy. Therefore, intangible assets and new product development should be regarded as the final output of R&D investment of listed companies. However, considering the availability of data, this paper selects the ratio of intangible assets to total assets, i.e., the ratio of technical assets, as another important indicator of innovation output.
3.3 Models
After determining the research variables, combining with the above research hypothesis, the research put forward the following research models shown in the table 3-4.
Table 3-4: The research models Testing content Model
Model 1
BS and R&D innovation
Yi,t= α + μi+ b1BSi,t+ b2BS2
i,t+ b3Sizei,j+ b4Growi,j
+ b5Levi,j+ b6INDI,J+ b7ROEi,j+ ei,j Model
2
AAB and R&D innovation
Yi,t= α + μi+ b1AABi,t+ b2AAB2
i,t+ b3Sizei,j+ b4Growi,j
+ b5Levi,j+ b6INDI,J+ b7ROEi,j+ ei,j Model
3
ID & CD and R&D innovation
Yi,t= α + μi+ b1IDi,t+ b2CDi,t+ b3Sizei,j+ b4Growi,j + b5Levi,j+ b6INDI,J+ b7ROEi,j+ ei,j Model
4
Board behaviour and R&D innovation
Yi,t= α + μi+ b1FRMi,t+ b2IDEAi,t+ b3Sizei,j+ b4Growi,j + b5Levi,j+ b6INDI,J+ b7ROEi,j+ ei,j
Model 5
Board capital and R&D innovation
Yi,t= α + μi+ b1EBi,t+ b2PBi,t+ b3PPi,j+ b4PRi,j
+ b5Sizei,j+ b6Growi,j+ b7Levi,j+ b8INDI,J + b9ROEi,j+ ei,j
4 Results& Finding
4.1 Description
This section will focus on different three dimensions of board governance in small and medium-sized listed companies and make panel data analysis respectively in the aspects of the structure of the board of directors, the behaviour board of directors and the board capital. It will make comprehensive interpretation of the relationship between board governance and R&D innovation in small and medium-sized listed companies, to overcome the limitations of previous research.
Table 4-1 shows the annually descriptive statistics of board governance variables of small and medium-sized listed companies, from board structure, board behaviour and board capital. In particular, it can be seen that the mean annual variables of board size, board independence and the CEO duality are not obvious. The average size of the board of directors is around 8.8, the average independence of the board of directors is around 0.365, and the average value of the CEO duality is around 0.28. The average age of directors was 47.406, 47.756, 48.402 and 48.602 respectively. The average number of board meeting frequency was 8.526, 9.296, 7.904 and 8.546 between 2013 and 2016 respectively. It appeared a peak in 2014. It may be related to the downward pressure on China's economy in 2014. Hence, the listed company faced many risks, thus increasing the meeting times to solve the problems faced by the company. The proportion that independent directors delegate to attend the conference in four years was separately 0.045, 0.032, 0.029 and 0.022. It shows that the independent director in person attends the meeting rather than entrust rise in the number of times. It reflects the behaviour of the independent directors to participate in the governance of listed company greatly improved.
In terms of board capital, the annual growth rate is not particularly significant. The average value of directors’ educational background is around 2.3. The number of directors with doctoral degrees was also increasing. Directors proportion with research and development, and other functions of the output was at about 44%. The average of the directors’ part-time position is around 55%. The mean percentage of directors associated with political background is about 40%. According to the descriptive statistical results, if the cross-sectional data is used for regression, the deviation result is likely to occur. In this paper, the panel data analysis method can effectively avoid the endogenous problems caused by time. This descriptive analysis shows that this paper is reasonable in method selection.
In order to prevent multiple collinearity problems among variables, person correlation tests are conducted for multiple variables governed by the board of directors in this paper, as shown in table 4-2. Generally speaking, if the simple correlation coefficient of two explanatory variables is higher than 0.8, it will indicate a high degree of correlation between them. It can be considered that there is a serious multicollinearity. It can be seen from the table 4-2 that there is no multicollinearity problem among multiple variables of board governance.
4.2 Findings
4.2.1 Analysis of the relationship between the board structure and the R&D innovation 4.2.1.1 The inverted-U relationship test between the board size and R&D innovation
Table 4-3 shows the inverted u-shaped relationship test results of board size (BS) and R&D innovation. Using the Hausman test, if the p>0.05, the null hypothesis will be accepted and the random effect model will be used. Or the null hypothesis will be rejected and it will use the fixed-effect model (FE). For the model which cannot be tested by the Hausman test, the random effect model would be used. In the following figure, the constant term is not reported.
The first column of the table 4-3 shows that when the dependent variable is R&D investment intensity, the coefficient of the board size is 0.0021, wh8ch is significant at the 0.05 level. The quadratic term coefficient is -0.0001, significant at the 0.05 level. This proves that there is a significant inverted u-shaped relationship between board size and R&D investment intensity. According to the absolute value of the coefficient, the highest point of board size is 12 people. The third column shows significant inverted u-shaped relationship between the total amount of patent application and the board size (the coefficient and quadratic term coefficient of board size was 4.1281 and -0.1791 respectively, significant at the 0.05 significance level). The highest point was calculated at 11.5. By the same token, the fourth column shows that invention patents as dependent variable, the board size has a positive coefficient, significant at the 0.05 level. The quadratic term is negative, significant at the 0.1 level. They both present a significant nonlinear relation. According to the coefficient absolute terms, the highest point of the scale of the board of directors is 11.40. From the analysis above, there is a significant inverted u-shaped relationship between the board size and R&D innovation input and output. It can be deduced, for small and medium-sized listed companies’ R&D innovation level, the size of the board of directors shall be 11-12 people. It can be seen that too large size of board of directors would not promote the R&D innovation of enterprises very well.
4.2.1.2 The inverted-U relationship test between the average age of the board and R&D innovation
Table 4-4 shows test results of the inverted u-shaped relationship between the average age of directors and R&D innovation. When the dependent variable is R&D investment intensity, according to Hausman test results, the random effect model should be selected.
At this point, the square coefficient of average age of directors is 0.000011, which is significant at the level of 0.05.
The coefficient of average age of directors is 0.0017, and significant at the level of 0.1. It can be seen from this that there is a significant inverted u-shaped relationship between the average age of directors and the intensity of R&D investment. According to the absolute value of the coefficient, the optimal value of the average age of directors is 47.2. When the dependent variable is the intensity of technicians, Hausmann test still chooses the random effect model. At this point, the director of the average age of the squared coefficient is -0.0002, significant at the 0.1 level. The coefficient is 0.0320, significant at the 0.05 level. Therefore, there is a significantly inverted u-shaped relationship between average age of directors and technical personnel strength. According to the absolute value of the coefficient, the optimal average age of directors is 51.8. When the dependent variable is the amount of patent and inventions, a random effects model was determined by the Hausman test. The square coefficient of the average age of directors is -0.0306. The coefficient is 2.9831, are significant at the 0.1 level. There is a significantly inverted u-shaped relationship between the average age of the directors and the total number of invention and patents. The optimal value is 49.2.
Based on the above results, it can be seen that there is a significant inverted u-shaped relationship between the average age of directors and the input and output of R&D innovation. Both h2-a and h2-b have been confirmed. Among the variables of R&D innovation output, there is a more significant correlation between the average age of directors and the quality of R&D innovation output. According to the variable coefficient, the optimal average age of directors is between 47 and 51 years old.
4.2.1.3 The relationship test of board independence, CEO duality and R&D innovation
column shows that there is a significant positive correlation between total amount of the patent application and board independence and significance level is 10%. Namely the stronger the board independence is, the more the application for a patent of small and medium-sized listed companies would be.
The fourth column shows that total amount of invention patents has a significant positive correlation with the CEO duality, and significance level is 5%. In the case of CEO duality, small and medium-sized listed company's application for patents and invention patents were higher. But the test result shows that the board independence and CEO duality of the board of directors only produce a certain degree of positive influence for the R&D innovation of small and medium-sized listed companies. But for the R&D innovation investment intensity, the influence is not significant. It can be seen from the panel data analysis results that the board size, board independence and the CEO duality and other variables in the board structure are significantly correlated with the R&D innovation of small and medium-sized listed companies. Specifically, the board size has significant inverted u-shaped relationship with the input and output of R&D innovation. The board independence has significantly positive correlation with innovation output. There is also a significant positive correlation between CEO duality and the output of R&D innovation.
4.2.2 Analysis on the correlation between board behaviour and R&D innovation
Table 4-6 shows the test results of the correlation between board behaviour variables such as board meeting frequency (FBM), independent directors' entrustment to attend the meeting (IDEA) and R&D innovation. The fourth column shows that the board meeting frequency has significantly positive correlation with the invention patents and the significance level is 10%. Namely, board meeting frequency is higher, the more the invention and patents would be. By the first column of table 4-6, the coefficient that independent directors entrust others to attend the meeting is negative, significant at 10% significance level. Therefore, the higher the number of independent directors entrust others to attend the meeting namely the number of independent directors to attend the meeting in person is, the small and medium-sized listed companies R&D strength would be lower. The empirical test results show that the board behaviour has significant positive correlation with the output of R&D innovation. There is a significant positive correlation between independent director behaviour and R&D innovation investment.
Therefore, from the empirical research results above, the frequency of the board meetings and independent directors entrust others to attend the meeting have significant correlation with small and medium-sized listed companies’ R&D innovation. Among them, the board meeting frequency presents a significant positive influence on R&D innovation output. The independent directors entrust others to attend the meeting presents a significant negative effect on R&D innovation investment. Namely, independent directors’ diligent behaviour has obvious promoting effect on R&D innovation investment.
4.2.3 The relationship analysis between the board capital and R&D innovation
Table 4-7 shows the test results of the correlation between board capital and R&D innovation. Among them, the directors’ education background (EB) shows a significant positive correlation with R&D strength, technical personnel strength, total quantity of patent application and invention patents, significant at the 5% significance level. This shows that the higher the educational background of board members is, the higher the R&D investment and technical personnel intensity of small and medium-sized listed companies and the level of R&D innovation investment would be; At the same time, the total number of patent applications and total number of invention applications also increased. That is, the level of R&D innovation output would be. Therefore, the background of education has a significant positive impact on the input and output of R&D innovation.
By the second and the fourth column data, the directors’ professional background (PB) also has obvious correlation with R&D innovation. The higher the proportion of directors with research and development, marketing as professional background is, the greater the intensity of technical personnel of small and medium-sized listed companies would be and the higher the invention patents are. Therefore, directors’ professional background has significant promotion effect on level of input and output of R&D innovation of small and medium-sized listed companies. In conclusion, the human capital of the board of directors can significantly promote the improvement of input and output level of R&D innovation of small and medium-sized listed companies. In order to build the board of directors of small and medium-sized listed companies that are conducive to R&D innovation, the increase of human capital of the board of directors should be an important prerequisite. However, it can be seen from the table that the correlation between board governance and directors' political relations (PR) is not significant. Therefore, by the empirical research result, there are significant correlation between the board human variables including the educational background and professional background of human capital and small
