The influence of foreign institutional investors,institutional directors,and the share pledge ratio of directors on financial performance of tourism firms

Abstract

Corporate governance is a critical component relevant to firm performance. In the tourism sector, corporate governance is an underexamined issue. The purpose of the current study is to bridge this gap by examining the influence of foreign institutional investors, institutional directors, and shares pledged by directors on tourism firms’ financial performance. Data are derived from listed tourism firms in Taiwan. Ordinary least square regressions and two-stage least square regressions are used to examine the hypotheses. Results show that the presence of foreign institutional investors and a low share pledge ratio of directors have significant effects on return on assets and Tobin’s Q. The presence of institutional directors has a positive effect on Tobin’s Q. Implications for owners, policy makers, and investors are discussed.

Keywords

foreign institutional investors institutional directors share pledge ratio tourism governance

Introduction

Governance is critical for tourism firms because it facilitates cooperation, partnership, and leadership, which in turn can aid in producing economic benefits (Song et al., 2013; Yeh and Trejos, 2015). However, agency theorists argue that a problem exists when ownership and management are separated in firms (Fama and Jensen, 1983). To reduce this agency problem, owners use governance mechanisms to align managers’ interests with those of owners (Jensen and Meckling, 1976). Within the governance mechanism, ownership structure and board composition are issues of great importance, due to their significant influence on firm performance (Chen et al., 2006; Desender et al., 2012; Jermias and Gani, 2014). As to the ownership structure, with increasing economic globalization, foreign institutional investors have emerged as a critical group of shareholders in invested firms. Their presence implies supply of financial resources, managerial know-how, competition to increase efficiency, globalization, and intensive supervision (Bekaert and Harvey, 2000; Min and Bowman, 2015). Prior studies have indicated a close relationship between foreign institutional ownership and firm management (Ferreira and Matos, 2008; Gillan and Starks, 2003).

The literature suggests that board composition can influence a board’s supervision capabilities (Chiang and He, 2010; Daily et al., 1999). To better examine the influence of board composition, three types of directors have been identified: executive directors, independent directors, and institutional directors (Garcia Osma and Gill-de-Albornoz Noguer, 2007). Existing research on board composition mainly focuses on issues of executive directors and independent directors (Dalton et al., 1998; Erhardt et al., 2003; Markarian and Parbonetti, 2007). The issue of board members assigned by institutional investors has attracted little attention. It is generally acknowledged that institutional investors are active monitors in firms due to their sizable shareholdings (Edmans, 2009; Khurshed et al., 2011). When institutional investors are elected as board members, they become institutional directors who can directly vote on critical managerial decisions. That is, institutional investors become more influential after being appointed as board members (Colpan and Yoshikawa, 2012).

While agency theory argues that a board of director is a critical governance vehicle to reduce agency problems between owners and managers (Fama and Jensen, 1983), the board of directors is generally not supervised by other governance mechanisms. Thus, another kind of agency problem may derive from the conflicts between directors and owners. A director may show self-interested behavior, such as pledging shares in exchange for cash (Kao et al., 2004; Lee and Yeh, 2004). Shares pledged by directors should be regarded as personal behaviors and should not be considered pertinent to firm performance, but directors may use firm resources against shareholder interests to protect their personal benefits (Lee and Yeh, 2004). Indeed, some studies have unearthed how this borrowing behavior of directors is related to firm performance from different perspectives, and that weak governance is relevant to a high share pledge ratio of directors (Lee and Yeh, 2004; Wu, 2012).

Tourism governance in the extant literature is mainly investigated in two ways, namely public governance and corporate governance (Dredge and Jamal, 2013; Presenza et al., 2013; Yeh and Trejos, 2015). Many existing studies have placed much attention on issues of public governance. Few attempts have been made to examine governance at the corporate level (Song et al., 2013; Yeh and Trejos, 2015). Issues of public governance include policy/regulation making, public–private coordination, and relationships among stakeholders. Much of the pubic governance literature is linked to sustainable tourism development (Dredge and Jamal, 2013; Erkuş-Öztürk and Eraydın, 2010; Hultman and Hall, 2012). Contributions to corporate governance range from board composition to ownership structure (Al-Najjar, 2015; Lu et al., 2012; Yeh, 2013). Regardless of the way it has been examined in the tourism literature, good governance has been identified as critical vehicle to ensure effective corporate performance and tourism development.

Since foreign institutional investors, institutional directors, and those directors who pledge shares increasingly perform crucial roles in governing corporations, it is worth investigating their influence on firm performance. In particular, little tourism research confirms the importance of these variables in tourism firms. As such, the purpose of the current study is to close this gap in the literature by empirically examining the influence of foreign institutional investors, institutional directors, and the share pledge ratio of directors on listed tourism firms’ financial performance, measured by return on assets (ROA) and Tobin’s Q.

Recent studies have identified that foreign institutional investors, institutional directors, and share pledge ratio are critical governance mechanisms in the context of nontourism firms (Lee and Yeh, 2004; Min and Bowman, 2015; Pucheta-Martinez and Garcia-Meca, 2014). However, the influence of governance varies across sectors (Al-Najjar, 2015; Earle et al., 2005; Li and Naughton, 2007; Rose, 2006). Therefore, the effectiveness of governance is subject to the environment in which firms operate (Aguilera et al., 2008; Desender et al., 2012; Judge, 2012). Firms should adapt their governance mechanisms based on the context in which they exist (Al-Najjar, 2014; Garcia Osma and Gill-de-Albornoz Noguer, 2007).

The tourism sector is characterized by a changing environment (Tsai et al., 2011). Such factors as seasonality, terrorism, and floating exchange rates lead to changing customer demands (Guillet and Mattila, 2010; Ooi et al., 2015; Singal, 2015; Tsai et al., 2011). An enhanced monitoring mechanism is needed for tourism firms to supervise management and therefore properly respond to this changing market (Yeh and Trejos, 2015). Foreign institutional investors are generally regarded as active external supervision mechanisms (Huang and Zhu, 2015). With foreign institutional investors in place, tourism firms are under enhanced supervision. Meanwhile, institutional directors are internal supervision mechanisms. By getting directly involved in board meetings and firm management, institutional directors can effectively perform supervisory functions (Colpan and Yoshikawa, 2012). It is therefore expected that tourism firms with a high level of foreign institutional ownership and institutional directors are more likely to perform better than their counterparts. In addition, tourism firms need to ensure that interest alignments exist between directors and shareholders to avoid agency problems. This is particularly important for tourism firms because they need directors to make timely and proper decisions in response to changing markets. A high share pledge ratio of directors can lead to an agency problem, which in turn is harmful for firm performance (Kao et al., 2004; Lin and Shen, 2012).

By closing the current research gap, the present study makes contributions in several ways. First, it contributes to the tourism literature by exploring the influence of governance on firm performance. Despite existing empirical evidence that shows governance as critical to tourism firm performance (Al-Najjar, 2014, 2015; Yeh, 2013; Yeh and Trejos, 2015), the effects of foreign institutional investors, institutional directors, and shares pledged by directors have been underexamined in the tourism sector. The current study is among the first attempts to confirm the importance of these variables, expanding the literature on tourism governance. Second, the current study contributes to literature on general governance that investigates casual effects of governance on firm performance. There are limited studies on foreign institutional investors and institutional directors, while there are ample studies on shares pledged by directors in the general literature. Among these studies, the above variables have been identified as significant factors for firm performance (Ferreira and Matos, 2008; Lin and Shen, 2012; Pucheta-Martinez and Garcia-Meca, 2014). However, effects of governance practices may differ by industries in which they are implemented. The current study is to verify their importance in the tourism sector and, therefore, can contribute to the governance literature by adding empirical evidence from a tourism perspective.

Third, to gain a better understanding of the roles of institutional investors within the governance system of tourism firms, the current study examines specific institutional investors, including foreign institutional investors and institutional directors. This contribution is significant, because there are no major studies focusing on the roles of different institutional investors in both the nontourism and tourism sectors. Fourth, due to the lack of well-grounded governance recommendations for the tourism sector, the current results contribute to the knowledge of policy makers and tourism managers by providing empirical evidence for regulations and managerial decision-making. Fifth, the current study offers empirical outcomes relevant to tourism firms’ financial performance. Share investors can also make use of the results when devising investment strategies.

Literature review

Tourism governance

Tourism governance is a complicated issue regarding interactions among a variety of stakeholders at different levels (Zahra, 2011). Bramwell and Lane (2011:412) argue that tourism governance is to “involve various mechanisms for governing, steering, regulating and mobilizing action, such as institutions, decision-making rules and established practices.” One major goal of tourism governance is to increase the economic benefits of stakeholders (Presenza et al., 2013). To ensure these benefits, tourism governance has been probed from different perspectives.

In this regard, tourism researchers attempt to find ways to facilitate partnership, cooperation, and coordination among stakeholders to develop sustainable tourism. For example, Dredge and Jamal (2013) used the Gold Coast to examine destination governance. They identified how policies developed by different levels of government led to mobilities in tourists, residents, laborers, and investment. A reexamination of the relationships among competing demands was recommended to achieve sustainable destination governance. d’Aangella et al. (2010) investigated 13 European tourism destinations, establishing destination governance archetypes for destination managers to efficiently govern destinations. By studying the Antalya tourism region, Erkuş-Öztürk and Eraydın (2010) emphasized the important role played by a governance network in sustainable tourism development.

Song et al. (2013) conducted an in-depth review on tourism value chain governance, proposing a conceptual framework in which governance performance is based on the governance environment, structure, and mechanisms. To understand the attractiveness of destinations, Hultman and Hall (2012) empirically examined tourism place-making agency using governance as the theoretical framework to clarify interactions among stakeholders. Based on the concept of open-style governance, the perception toward tourism development in an Italian destination was measured by Presenza et al. (2013) to classify residents into four clusters in order for policy makers and destination managers to develop strategies and deliver services effectively. Moreover, Zahra (2011) examined the governance of regional tourism organizations using a New Zealand case to enrich the understanding of regional tourism governance. The author found that the principle of subsidiarity could support governance if the organizations had a spirit of service and communicated openly with the community.

Another research stream in the tourism governance literature is corporate governance. Corporate governance refers to “the combination of mechanisms which ensure that the management (the agent) runs the firm for the benefit of one or several stakeholders (principals)” (Goergen and Renneboog, 2006: 100). It mainly

deals with mechanisms by which stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected. The stakeholders of a corporation include equity holders, creditors and other claimants who supply capital, as well as other stakeholders such as employees, consumers, suppliers, and the government. (John and Senbet, 1998: 372)

Empirical studies on corporate governance in the general business sector are primarily concerned with boards of directors, the role of CEO, and ownership structure (Daily et al., 2003; Demsetz and Lehn, 1985; Elsayed, 2007).

While the literature has increasingly explored tourism governance, much research attention has been placed on public governance. Tourism research on corporate governance is relatively limited. Among these studies, Chen et al. (2011) examined the ownership structure of hotel firms. Their results support the conclusion that managerial ownership can affect a firm’s financial performance. Ozdemir and Upneja (2011) studied the board composition in the US lodging industry. The authors argued that board independence was related to CEO compensation.

Lu et al. (2012) investigated the influence of board characteristics, such as board size and CEO duality, on the efficiency of US airline companies. Also, in the airline industry of the United States, Kole and Lehn (1999) examined the evolution of governance structure, such as ownership concentration and CEO payment. Nwabueze and Mileski (2008) studied how corporate governance influenced Swiss Air’s decision-making processes.

In Beritelli et al.’s (2007) investigation, corporate governance, such as transaction costs and informal connections, was examined to understand the effectiveness of managing tourist destinations in the Swiss Alps. Pechlaner et al. (2012) explored how corporate governance, such as stakeholder involvement, of destination management organizations influenced cooperation between destination actors.

In addition, based on a sample of tourism firms from four economic regions in Asia, Ooi et al’s (2015) research focused on the effect of board diversity in social and human capital. Chen et al. (2009) investigated the relationship between the presence of foreign institutional investors and share performance of listed tourism firms. Al-Najjar (2015) explored the role of foreign investors in tourism firms. Al-Najjar (2014) also studied the effect of small and independent boards in publicly listed tourism firms in five Middle Eastern countries. Using UK travel and leisure listed firms as samples, Al-Najjar (2017) probed the impact of board and CEO attributes on CEO payment. Tan et al. (2017) investigated the effect of corporate governance on corporate environmental responsibility across countries. Yeh (2018) inspected how board governance of listed tourism firms in Taiwan influenced the investment preferences of foreign institutional investors. Furthermore, issues of board size, presence of large shareholders, board gender diversity, board independence, CEO duality, and managerial ownership in the publicly traded tourism firms were comprehensively scrutinized by Yeh (2013) and Yeh and Trejos (2015).

While there is an increasing number of studies on tourism governance, Song et al. (2013) argue that, with the growth of tourism industries, there is still a need to investigate the effect of various governance mechanisms in the tourism sector to reduce conflicts among stakeholders and ensure the efficiency of tourism development. Notwithstanding, if governance mechanisms in tourism firms alleviate conflicts derived from agency problems and protect shareholder interests, then the investigation of corporate governance will become critical for understanding its effect embedded in firm performance.

Foreign institutional investors

Conflicts of interest between owners and managers are one area of focus when examining corporate governance (Jensen and Meckling, 1976). The ownership structure of firms is an essential component relevant to eliminating agency problems (Lemmon and Lins, 2003). Based on this theoretical rationale, there is considerable evidence of the relationship between ownership structure and firm performance (Chen et al., 2006; Dalton et al., 2003; Holderness et al., 1999; Singh and Davidson III, 2003). Because different owners have different investment objectives and have different agency relationships, there is mixed evidence. However, it is generally acknowledged that one major effect of ownership structure on firm performance is related to the amount of owner investment (Bruton et al., 2010; Cho, 1998; Jensen and Meckling, 1976). In the case of corporations, institutional investors have been perceived to be critical owners due to their relatively sizable investment (Edmans, 2009; Khurshed et al., 2011).

Institutional investors are a group of diverse institutions (Wang, 2014). Within the group of institutional investors, foreign institutional investors are important (Ting et al., 2008). Foreign institutional investors generally play an active role in monitoring the governance practices of invested firms (Ferreira and Matos, 2008). They are able to influence invested firms in two ways. First, due to their sufficient financial capital, foreign institutional investors are able to hold a large amount of shares. As such, foreign institutional investors can have more influence than other investors when voicing their advice. Second, foreign institutional investors can sell their larger block of shares. Heavy selling may put pressure on stock prices, which may be thought as a negative signal by other investors and induce further selling (Gillan and Starks, 2003).

There are limited empirical studies specifically examining the effect of foreign institutional investors on the management of firms. For example, Ting et al.’s (2008) study on the Chinese stock market revealed that the presence of foreign institutional investors placed stress on auditors to issue careful auditing opinions. In Ferreira and Matos’s (2008) study, companies with a higher proportion of foreign institutional ownership had better firm value, operation, and performance. Furthermore, foreign ownership may contribute to globalization of local firms.

In the tourism sector, Chen et al.’s (2009) research is one of the few studies specifically examining the role of foreign institutional investors on tourism firms. Their results showed that listed tourism firms with a higher percentage of foreign institutional investors had better stock performance on Mondays. A similar study was conducted by Al-Najjar (2015). Without specifically examining the influence of foreign institutional investors, his study used Jordanian publicly listed tourism companies to examine the effect of foreign investors on company performance. Results of this study showed that foreign investors had little influence in the governance mechanism within listed companies. In addition, there are few studies empirically investigating the relationship between the presence of foreign institutional investors and firm performance in both the nontourism and tourism sectors. The current study can shed a light on this issue in the context of tourism.

In a dynamic market, tourism firms face the challenge of responding to changing customer demands (Yang, 2012; Yeh and Trejos, 2015). To survive in such a market, enhanced supervision of tourism firms’ management is needed (Bowie et al., 2017; Cohen et al., 2014; Yeh and Trejos, 2015). Governance has internal and external supervisory mechanisms (Fama and Jensen, 1983; Jensen and Meckling, 1976). The board of directors is the formal internal supervisory mechanism. On the other hand, foreign institutional investors are active in participating in shareholder meetings and in making suggestions for invested firms. Compared to other institutional investors that may have business relations with invested companies and feel compelled to support invested companies’ management, foreign institutional investors are more likely to take an active role in monitoring these companies (Ferreia and Matos, 2008; Gillan and Starks, 2003; Huang and Zhu, 2015). As such, they are regarded as important external monitoring mechanisms (Huang and Zhu, 2015). When active external surveillance is in place, tourism firms are under enhanced supervision and agency problems can be alleviated. Therefore, tourism firms are expected to respond properly to customer demands and to have good financial performance. Based on the earlier discussion, the current study developed the following hypothesis.

H1: The ownership proportion of foreign institutional investors positively influences the financial performance of tourism firms.

Institutional directors

The corporate form of firms leads to a separation of ownership and management (Schellenger et al., 1989). The owners (principals) hire agents, such as managers, to lead firms. However, these agents may not manage firms for the best interest of owners. Subsequently, agency problems derived from a conflict of interest in the principal–agent relationship happen in firms (Eisenhardt, 1989; Fama and Jensen, 1983; Jensen and Meckling, 1976). To manage and minimize this conflict, owners establish a monitoring mechanism, such as a board, to ensure that managers act the best interest of owners (Jensen and Meckling, 1976).

Since a board is seen as an important component of corporate governance, issues regarding corporate boards of directors have attracted much research attention from different disciplines (Dalton et al., 1998; Goodstein et al., 1994; Yeh, 2013). The literature has suggested that supervising and advising top management on running the corporation are two major roles of a board of directors (Pucheta-Martinez and Garcia-Meca, 2014; Yeh and Trejos, 2015). The main purpose of many published studies is to examine the role played by a board of director in terms of mitigating agency problems and in turn contributing to firm performance (Agrawal and Knoeber, 1996; Brennan and McDermott, 2004; Carter et al., 2003; Chaganti et al., 1985).

Institutional investors generally have a large amount of capital in the stock market. They buy and sell large numbers of stocks. Once they become institutional directors, they have a strong incentive to actively supervise management to protect their investment, enhance a firm’s financial performance, and increase the value of their investment (Lopez-Iturriaga et al., 2015; Pucheta-Martinez and Garcia-Meca, 2014). Despite much research on the influence of institutional investors, there is limited research on their influence when they are elected as institutional directors. The research in this stream has identified institutional directors as able to contribute to firm performance (Colpan and Yoshikawa, 2012; Garcia Osma and Gill-de-Albornoz Noguer, 2007; Pucheta-Martinez and Garcia-Meca, 2014).

For example, Pucheta-Martinez and Garcia-Meca (2014) studied institutional directors in Spanish listed firms. Their results show that institutional directors were more active in monitoring a firms’ financial performance, and therefore the presence of institutional directors was positively related to the financial reporting quality of firms. Similarly, Garcia Osma and Gill-de-Albornoz Noguer (2007) studied the Spanish stock market, finding that there was a negative association between the proportion of institutional directors and manipulation of financial statements. Also in Spain, Lopez-Itrriaga and his colleagues (2015) identified that institutional directors having no business link with the invested firms played a superior supervision role in alleviating the agency problem. In addition, Colpan and Yoshikawa (2012) studied Japanese manufacturing companies, finding that it was more likely that executives pursue company growth when the proportion of institutional directors was high.

Supervising top management is one of the major roles performed by a board of directors (Pucheta-Martinez and Garcia-Meca, 2014; Yeh and Trejos, 2015). It has been suggested by the literature that an independent board is more effective in supervision (Brennan and McDermott, 2004; Markarian and Parbonetti, 2007). Institutional directors may be different from independent directors, but they have greater incentives to monitor management due to their relatively large shareholding. Jensen and Meckling (1976) argued that enhancing supervision can help a firm align managers’ interests with those of owners. The active monitoring behavior of institutional directors, therefore, can reduce the agency problem. When the agency problem is alleviated, managers act in the best interest of shareholders (Jensen and Meckling, 1976).

The tourism market is characterized by fierce competition (Singal, 2015; Yeh and Trejos, 2015). To survive in a competitive market, tourism firms need to have greater supervision on management (Guillet and Mattila, 2010; Singal, 2015). When institutional investors become institutional directors, they can perform arm’s length supervision. By getting involved in board meetings, institutional directors are able to directly observe and monitor critical decision-making of invested firms (Colpan and Yoshikawa, 2012). They are capable of being closer to top management and have specific firm knowledge. With this specific knowledge, institutional directors can supervise firms more effectively (Pucheta-Martinez and Garcia-Meca, 2014). Therefore, a positive effect of the presence of institutional directors in the boardroom on financial performance of tourism firms is expected. The following hypothesis was accordingly developed.

H2: The proportion of institutional directors positively influences the financial performance of tourism firms.

Share pledge ratio

Shares pledged by directors mean that directors take their shares of firm equities to financial institutions, such as banks, as collaterals for loans (Kao et al., 2004; Lee and Yeh, 2004). While directors still keep their voting rights, pledging shares is relevant to corporate governance because it can lead to an agency problem (Kao et al., 2004; Lin and Shen, 2012; Yeh et al., 2009). When directors pledge their shares at banks, their personal financial stress becomes associated with the share price (Wu, 2012). The maximum amount that directors can borrow is around 60% of the base value of pledged shares. The base value is the market value calculated by the closing price or average closing price in the past 3 or 6 months (Kao et al., 2004).

After evaluating the value of pledged shares, a pledge contract is signed by directors who pledge shares, in which a maintenance requirement is generally included. The fluctuation in share price can then cause changes in the value of pledged shares. When share prices remain the same or increase, directors can keep their pledges. On the other hand, when the share prices drop, decreasing the value of pledged shares below the maintenance level, directors are asked by banks to take actions to make up for the price drop. They can either offer more pledges or make a payment (Huang and Xue, 2016; Yeh et al., 2009). If directors fail to do so, their pledged shares will be sold by banks and directors will lose their voting rights in firms (Kao et al., 2004).

Due to the stress of margin calls for their pledge shares, directors have to maintain the share price at a certain level. With their governing power, they can expropriate firm resources to avoid margin calls. For example, directors are able to use the firms’ capital to purchase shares, with the hope of maintaining share prices (Huang and Xue, 2016; Shen and Chih, 2011; Yeh et al., 2009). Studies have shown that this repurchasing of shares can support share prices by misleading investors or absorbing selling pressure (Chan et al., 2010; Ginglinger and Hamon, 2007). Thus, directors become more likely to manage firms for personal interests rather than those of shareholders (Kuan et al., 2011; Shen and Chih, 2011). The major focus of directors is on day-to-day stock prices instead of governing the firm (Shen and Chih, 2011; Yeh et al., 2009). Another type of agency problem is, therefore, derived from the conflicts of interest between owners and directors (Kao et al., 2004). In addition, when pledging their shares for bank loans, directors can cash out their investment from firms (Kuan et al., 2011; Yeh et al., 2009). As such, directors have less motivation to monitor management because they have already pledged their shares in exchange for cash at a low cost (Lin and Shen, 2012; Wu, 2012).

Empirical studies on the influence of pledge shares are abundant in the nontourism sector of Asian countries. For example, Lee and Yeh (2004) studied the differences in share pledge ratio of directors between distressed and healthy firms in the exchange market of Taiwan. They found that distressed firms had a higher share pledge ratio of directors. Lin and Shen’s (2012) research on the effect of corporate governance on firm policy in Taiwan found that firms with good corporate governance had a relatively lower share pledge ratio from board directors. Moreover, Wu (2012) indicated in his study on listed companies in Taiwan that the stock pledge ratio of directors was negatively related to the credibility of repurchase announcements made by companies. He found that, when directors had less or no stock pledge, they felt no or less stress about changes in the stock price. Therefore, directors were less likely to make fake repurchase decisions. Kuan et al. (2011) discovered that the influence of directors’ share pledges was significant on the level of cash holding in family controlled firms in Taiwan. If directors in family-controlled firms had a high level of share pledges for personal borrowing, they were more likely to pursue personal interests at the cost of owners.

Shen and Chih (2011) also studied listed companies in Taiwan and found a negative relationship between the share pledge ratio of directors and good corporate governance. Huang and Xue (2016) researched public companies in China. They identified that, after the split share reform in China, those companies pledging shares had a tendency to smooth earnings. Additionally, Kao et al. (2004) found that listed companies in Taiwan with a high share pledge ratio of directors had agency problems and poor financial performance measured by ROA and return on equity. Also using samples of listed companies in Taiwan, Lou and Wang et al. (2009) unearthed a positive relationship between fraud probability and share pledge ratio of directors.

The issue of shares pledged by directors in the tourism firms has attracted little attention. The current study argues that if directors of tourism firms have a high share pledge ratio, this potentially reduces interest alignments and increases agency problems. The board of directors is an internal supervision mechanism. Since tourism firms are operated in a changing market, the board of directors is expected to closely supervise management and acts in the interests of owners to help tourism firms make timely responses to changing customer demands (Hodari et al., 2017; Ku et al., 2011; Yeh, 2013). Agency theory argues that the board of directors is a governance mechanism that ensures interest alignments between owners and managers (Fama and Jensen, 1983). If directors own tourism firms’ shares, it can enhance the alignment of their interests with firms. When tourism firms have such interest alignment, it is a positive signal that they are under close supervision by the board of directors (Yeh, 2018). However, when directors pledge their shares for personal borrowing, they have incentives to use firm resources to mitigate the stress from margin calls and to keep their voting rights. In other words, directors affect firm management for self-interest at the expense of shareholders, in particular when the prices of pledged shares decrease below the maintenance level. If directors pursue their own interests in the boardroom, agency is impaired. When directors fail to supervise management and deprive the firm resources at the expense of owners, agency problems exist not only between managers and owners but also between directors and owners. Interests between the directors and the firms are not aligned. Therefore, a high share pledge ratio is indicative of weak governance (Kao et al., 2004). Weak governance is harmful for firm performance (Ammann et al., 2011; Bhagat and Bolton, 2008). Empirical studies have also provided evidence that share pledges by directors hardly contribute to firm performance. Accordingly, the current study developed the following hypothesis.

H3: The share pledge ratio of directors negatively influences the financial performance of tourism firms.

Methodology

Based on the hypotheses, two estimated equations are developed as follows:

\begin{array}{l} ROA = β 0 + β 1 FINS + β 2 INSD + β 3 PLEDGE + β 4 FSIZE + β 5 FDEBT + β 6 FSALE \\ + ε_{1} (model 1) \end{array}

Tobin' s Q= β 0 + β 1 FINS + β 2 INSD + β 3 PLEDGE + β 4 FSIZE + β 5 FDEBT + β 6 FSALE + ε_{1} (model 2)

Dependent variables

Financial performance is multidimensional. Two types of measurements are commonly used to objectively reflect financial performance dimensions for tourism firms, namely ROA, the accounting-based measurement, and Tobin’s Q, the market-based measurement (Inoue and Lee, 2011; Sun and Kim, 2013; Wang and Xu, 2014). ROA reflects how efficiently the firm uses its assets to generate profits, representing the short-term profitability. Tobin’s Q reflects the firm’s market value, implying the future profitability. One goal of tourism governance is to increase economic benefits of stakeholders (Presenza et al., 2013). By using both the accounting- and market-based measurements, the current study is able to inform stakeholders how governance influences the short-term profits and long-term values of selected tourism firms. Therefore, both ROA and Tobin’s Q indicators were used to measure the financial performance. ROA was measured by dividing a firm’s annual net income by its total assets. Tobin’s Q was measured by dividing a firms’ market stock value plus the book value of debt by its book value of total assets (Campbell and Minguez-Vera, 2008; Palia and Lichtenberg, 1999).

Independent variables

In the equations, FINS means the ownership percentage of foreign institutional investors in the tourism firms. Institutional directors were represented by INSD as the percentage of these directors in the board. The share pledge ratio was represented by PLEDGE. This was measured by dividing the number of pledged shares by the total shares held by directors. The firm size (FSIZE), debt ratio (FDEBT), and sale growth rate (FSALE) were included in the equations as control variables. FSIZE was measured as the natural logarithm of total assets. FDEBT was measured by dividing total liabilities by total assets. FSALE referred to the growth rate in sales from preceding period.

Sample and data

The current study was conducted on a sample of publicly listed tourism-related firms from the Taiwan Stock Exchange or Taipei Exchange. Both of these stock markets follow the Standard Industrial Classification of the Republic of China, published by the Directorate General of Budget, Accounting and Statistics of the Executive Yuan, Taiwan. The sample includes firms that belong to tourism industries, such as hotels, food and beverage providers, travel agencies, and attractions. These are crucial participants who provide tourism products in common and work together to shape the tourism industries (Cook et al., 2018). Data from the first quarter of 2011 to the fourth quarter of 2015 were collected. There were 15 tourism firms having complete data on governance during the study period. Therefore, there were a total of 300 observations. All data were collected from the database of the Taiwan Economic Journal, cnYes.com, and the Market Observation Post System.

The Taiwan government has identified tourism as the key for the development of the national economy (Wang, 2015). The important role of tourism industries is ascertained. The World Travel and Tourism Council (2018) reported that, in 2017, revenues of tourism industries in Taiwan totaled US$24.4 billion, which represent 4.3% of Taiwan’s GDP. The tourism industries in Taiwan employed about 584,500 people, generating 5.2% of Taiwan’s total employment. The amount of investment in the tourism industries reached US$6.4 billion, accounting for 5.3% of total investment in Taiwan.

The development of the stock market stimulates economic growth (Marques et al., 2013). This implies that listed tourism firms perform a leading role for the development of tourism business. Listed tourism firms in Taiwan are more subjected to market pressure and regulatory requirements when compared to unlisted tourism firms, due to that both the Taiwan Stock Exchange and Taipei Exchange have enacted Corporate Governance Best-Practice Principles for listed firms. The increasing requirements in transparency and solid governance pressure listed tourism firms in Taiwan into placing more efforts on securing shareholder interests.

While listed tourism firms cannot represent all tourism firms in Taiwan, the current study still placed focus on them for two reasons. First, listed tourism firms generally attract more research and practical attention from a variety of stakeholders, such as media, investors, and unlisted firms. They serve as the demonstration models for unlisted tourism firms (Wang and Xu, 2014). The current study emphasizes the importance of corporate governance, which might motivate unlisted tourism firms to examine their governance practices. Second, it is more challenging to gather the required governance and financial data of unlisted tourism firms than their listed counterparts, which are required to publicly release these data. Under closely security by the authorities, the data of listed tourism firms are more reliable (Wang and Xu, 2011, 2014). Therefore, the current study used listed tourism firms as the samples and can be regarded as an exploratory study on the selected variables from the tourism perspective.

Results

Descriptive results

The descriptive data are shown in Table 1. The mean ownership of foreign institutional investors was 13.47%. Previous research done in other stock markets report the following values: 10.04% in UK firms that conducted mergers and acquisitions (Andriosopoulos and Yang, 2015), 6.7% in US firms, 11.6% in Japanese firms, 20.9% in Canadian firms, and 23.9% in German firms (Ferreira and Matos, 2008). The findings show that mean ownership of foreign institutional investors in listed tourism firms from Taiwan was similar to those of listed firms elsewhere.

Table 1.

Descriptive results.

Variables	N	Mean	Minimum	Maximum	Std. dev.
FINS	300	13.47	0.00	62.36	17.11
INSD	300	44.36	0.00	100.00	36.96
PLEDGE	300	10.69	0.00	62.26	17.27
FSIZE	300	21.81	19.99	23.23	1.00
FDEBT	300	34.16	10.56	69.33	14.69
FSALE	300	4.89	−45.87	37.26	10.81
ROA	300	3.41	−14.46	28.02	5.53
Tobin’s Q	300	15.58	2.49	77.86	13.70

Note: ROA: return on assets.

The average percentage of institutional directors was 44.36. This result was similar to the 44.39% of institutional directors reported by Pucheta-Martinez and Garcia-Meca’s (2014) on Spanish listed companies, as well as the 40.5% of institutional directorship shown in another study conducted in the Spanish Stock Exchange by Garcia Osma and Gill-de-Albornoz Noguer (2007). Moreover, the mean share pledge ratio was 10.69, with a maximum of 62.26. Other studies showed similar outcomes. In China, the average percentage of pledged shares in the stock market was 10.06 (Yeh et al., 2009). The share pledge ratio of directors in family-controlled firms in Taiwan was 11% (Kuan et al., 2011). The outcomes show that listed tourism firms in Taiwan did not have a great difference in the share pledge from those abroad.

Hypothesis test

The hypotheses were first tested using ordinary least squares (OLS) regression. As shown in Tables 2 and 3, when either ROA (model 1) or Tobin’s Q (model 2) was the dependent variable, the results of variance inflation factor (VIF) analysis were between 1.18 and 1.62, lower than the acceptable threshold of 10, thus indicating no violation of normality (Hair et al., 2006). Tables 2 and 3 display that models 1 (F = 10.34, p < 0.01) and 2 (F = 18.48, p < 0.01) were both significant. Hypothesis 1 proposed that there was a positive influence of ownership proportion of foreign institutional investors on tourism firm financial performance. The results show that in both models 1 (column I in Table 2; β₁ = 0.10, p < 0.01) and 2 (column I in Table 3, β₁ = 0.36; p < 0.01), the positive influence was statistically significant. Therefore, hypothesis 1 was accepted. The second hypothesis proposed that the proportion of institutional directors had a positive influence on tourism firm performance. In model 1, there was a negative but insignificant influence (β₂ = −0.01, p > 0.05). This influence, however, was positive and significant in model 2 (β₂ = 0.07, p < 0.05). Therefore, hypothesis 2 was partially supported. Hypothesis 3 proposed that the relationship between the share pledge ratio of directors and tourism firm performance was negative. The results of models 1 (β₃ = −0.06, p < 0.01) and 2 (β₃ = −0.14, p < 0.01) supported hypothesis 3.

Table 2.

Results of OLS, random effects, and 2SLS regressions (model 1).

Model 1
Dependent variable = ROA
Variables	VIF	(I) OLS		(II) Random effects		(III) 2SLS		(IV) 2SLS		(V) 2SLS
		(I) OLS		(II) Random effects		Endogenous variable = FINS		Endogenous variable = INSD		Endogenous variable = PLEDGE
		Coefficient	t statistics	Coefficient	t statistics	Coefficient	t statistics	Coefficient	t statistics	Coefficient	t statistics
(Constant)		10.57	1.33	10.38	1.36	9.14	1.16	8.12	1.02	8.28	1.06
FINS	1.38	0.10	4.79**	0.10	4.99**	0.10	4.49**	0.09	4.79**	0.09	4.69**
INSD	1.50	−0.01	−1.37	−0.01	−1.44	-0.02	−1.59	−0.02	−1.68	−0.02	−1.64
PLEDGE	1.18	−0.06	−3.41**	−0.06	−3.56**	−0.06	−3.55**	−0.07	−3.58**	−0.07	−3.67**
FSIZE	1.62	−0.27	−0.72	−0.26	−0.72	−0.20	−0.52	−0.14	−0.38	−0.15	−0.42
FDEBT	1.19	−0.04	−1.93	−0.04	−1.92	−0.05	−2.13*	−0.05	−2.13*	−0.04	−1.90
FSALE	1.21	0.03	1.07	0.03	0.90	0.03	0.92	0.03	0.95	0.03	0.92
F-ratio/Wald χ²			10.34**		66.24**		10.04**		10.53**		10.59**
R ²			0.17		0.20		0.18		0.18		.18

Note: OLS: ordinary least squares; 2SLS: two-stage least squares.

**Significant at the 0.01 level; *significant at the 0.05 level.

Table 3.

Results of OLS, fixed effects and 2SLS regressions (model 2).

Model 2
Dependent variable = Tobin’s Q
Variables	VIF	(I) OLS		(II) Fixed effects		(III) 2SLS		(IV) 2SLS		(V) 2SLS
		(I) OLS		(II) Fixed effects		Endogenous variable = FINS		Endogenous variable = INSD		Endogenous variable = PLEDGE
		Coefficient	t statistics	Coefficient	t statistics	Coefficient	t statistics	Coefficient	t statistics	Coefficient	t statistics
(Constant)		55.42	3.01**	43.37	2.34*	50.06	2.72**	53.61	2.89**	52.07	2.84**
FINS	1.38	0.36	7.79**	0.36	7.54**	0.33	6.59**	0.36	7.83**	0.36	7.74**
INSD	1.50	0.07	3.07**	0.06	2.74**	0.07	2.99**	0.07	2.83**	0.07	2.93**
PLEDGE	1.18	−0.14	−3.25**	−0.17	−3.85**	−0.15	−3.42**	−0.14	−3.33**	−0.16	−3.42**
FSIZE	1.62	−2.25	−2.58*	−1.74	−1.98*	−1.99	−2.28*	−2.16	−2.44*	−2.08	−2.40*
FDEBT	1.19	0.08	1.62	0.13	2.54*	0.09	1.70	0.08	1.56	0.09	1.70
FSALE	1.21	−0.001	−0.02	−0.05	−0.72	0.01	0.16	−0.01	−0.07	−0.01	−0.12
F-ratio/Wald χ²			18.48**		19.02**		15.19		17.96		18.19**
R ²			0.28		0.27		0.27		0.27		0.27

Note: OLS: ordinary least squares; 2SLS: two-stage least squares.

**Significant at the 0.01 level; *significant at the 0.05 level.

The results of OLS regressions initially supported hypotheses 1 and 3 and partially accepted hypothesis 2, but biases may have influenced these results. One of the biases is that OLS regressions overlook the influence of omitted variables, causing different intercepts for each firm. To overcome this shortcoming, either fixed or random effects regression is performed. The Hausman test was carried out to determine the appropriateness of the fixed or random effects regression (Chen and Lin, 2013; Chen et al., 2017; Naudé and Saayman, 2005). The results of the Hausman test were insignificant (χ² (6) = 0.25, p = 0.99) in model 1 and significant in model 2 (χ² (6) = 17.47, p < 0.01), indicating the appropriateness of using random effects regression for model 1 and fixed effect regression for model 2. Results of random and fixed effect regressions (column II of Tables 2 and 3) displayed that hypotheses 1 and 3 were still supported. Hypothesis 2 was partially supported.

Despite the robustness of fixed and random effects regression, it has been argued that potential endogenous relationships exist between governance variables and firm performance (Agrawal and Knoeber, 1996; Campbell and Minguez-Vera, 2008; Yeh, 2013; Yeh and Trejos, 2015). To manage the endogenous effects, the current study conducted two-stage least squares (2SLS) regression. The Durbin–Wu–Hausman (DWH) analysis was initially investigated to validate the use of 2SLS. Results of DWH showed that when either ROA or Tobin’s Q was the dependent variable, residuals of FINS, INSD, and PLEDGE were significant at the 1% level. This indicates that FINS, INSD, and PLEDGE were endogenous variables. As such, the current study went on to conduct the 2SLS regression. Lagged governance variables were used as instrumental variables when performing the 2SLS regression (Al-Najjar, 2014; Ammann et al., 2011; Guest, 2009; Hoechle et al., 2012). The Sargan test supported the validity of these instrumental variables because the p values of instruments were insignificant. The results of 2SLS regression for models 1 and 2 are displayed in columns (III), (IV), and (V) of Tables 2 and 3, respectively. 2SLS regression results show that the influence of the proportion of foreign institutional investors on tourism firm performance was significantly positive and that an increase in the share pledge ratio of directors could decrease tourism firm performance. Moreover, the positive effect of the proportion of institutional directors on Tobin’s Q was significant. Therefore, the 2SLS results supported outcomes of OLS, fixed and random effects regressions.

Discussion

Corporate governance has been widely examined in the nontourism sector, but there is limited research on tourism corporate governance (Yeh, 2013; Yeh and Trejos, 2015). Being aware of this study gap, the present research focused on three elements of corporate governance in tourism firms: foreign institutional investors, institutional directors, and shares pledged by directors. It provides a close examination of the influence of these variables on tourism firm performance measured by ROA and Tobin’s Q. The results of the current study are particularly significant in showing whether these critical components of corporate governance can be considered important for tourism firms.

Previous empirical research from the general business sector has emphasized the critical effect of foreign institutional investors on firm financial performance (Ferreira and Matos, 2008). Similar to previous research, the empirical evidence provided by the current study proves the importance of foreign institutional investors in corporate governance. More precisely and consistent with the first hypothesis, the proportion of foreign institutional investors is found to positively influence ROA and Tobin’s Q of tourism firms. These results confirm the notion that, when facing a changing market with the presence of foreign institutional investors, tourism firms are under active supervision which can reduce the agency problem associated with financial performance. Also based on the results, foreign institutional investors can be regarded as a supplementary supervision vehicle to improve ROA and Tobin’s Q of listed tourism firms. Past tourism research has not explored the role of foreign institutional investors. As such, the current study is unique in enriching the literature on tourism governance.

The second hypothesis proposes a positive effect of institutional directors on tourism firm performance. The results show that institutional directors have no influence on accounting-based performance (ROA), but a positive influence on market-based performance (Tobin’s Q). This suggests that a high market value of tourism firms can be created by the presence of institutional directors even though tourism firms face a competitive market. While the current results are mixed, they still support studies in the nontourism sector that institutional directors can contribute to firm performance (e.g. Colpan and Yoshikawa, 2012; Garcia Osma and Gill-de-Albornoz Noguer, 2007). In particular, the current study sheds light on a performance-specific effect of institutional directors. Moreover, as addressed by the hypothesis, the proportion of shares pledged by directors negatively influences financial performance of tourism firms. This outcome is consisted with some research in the nontourism industries (e.g. Kao et al., 2004; Lee and Yeh, 2004), supporting the notion that a high ratio of shares pledged by directors is indicative of weak governance. A high ratio of shares pledged by directors creates conflicts of interest between owners and directors. When pledging their shares, directors are more concerned about self-interest. They become inactive in supervising management but active in using the firms’ resources to maintain the share price at a certain level to avoid margin calls made by the lending institution. That is, the agency problem is derived from a high ratio of share pledges by directors. This agency problem causes tourism firms to experience deterioration in financial performance. As such, the ratio of shares pledged by directors can be used to determine the extent to which interests align between owners and directors. The higher this ratio is, the more likely that directors have opportunistic behaviors that reduce firms’ financial performance.

The findings of the current study empirically enrich the understanding of agency theory, a well-established theory in the governance literature. Much extant research argues that board structure is a critical governance element to reduce the agency problem (Dalton et al., 1998; Fama and Jensen, 1983; Forbes and Milliken, 1999). Results of the current study suggest that mitigating the negative effects of the agency problem is tied to the presence of foreign institutional investors and a low share pledge ratio of directors. In other words, researchers should take into account the ownership structure and borrowing behavior of directors when examining the agency problem.

In addition, the findings of the current study have significant practical implications for tourism firms, policy makers, and investors, given the lack of specific evidence of governance in the tourism industries. The first empirical implication is for tourism firms that seek to enhance governance and increase financial performance. The major objective of institutional investors is to look for gains on their investment (Borochin and Yang, 2017). Foreign institutional investors are one type of institutional investors. It has been argued that the investment of foreign institutional investors is crucial for the development of the tourism sector, due to their possession of financial capital (Wang and Xu, 2011). To protect their large amount of investment, foreign institutional investors are active monitors. The current results demonstrate that by using equity investments in the tourism sector of Taiwan, foreign institutional investors are not simply financial resource providers but also supervisors for the interests of invested firms. This protection contributes to the development of governance within tourism firms. With a proper governance system in place, tourism firms’ activities are under close monitoring and economic benefits can be secured (Yeh and Trejos, 2015). Meanwhile, if an agency problem exists in tourism firms, these can use foreign institutional investors as a supplementary monitoring mechanism to enhance supervision functions. Second, the results imply that the effect of appointing institutional investors as directors for mitigating the agency problem is mixed. Tourism firms should adopt different board structures when they pursue different financial goals.

Third, the separation of ownership and management creates demand for a supervision mechanism, such as a board, to prevent managers from using firm resources to pursue their own interests rather than the interests of shareholders. However, investors and policy makers should realize that director supervision may become less effective if directors pledge their shares. For investors, the level of share pledge ratio can be regarded as a critical indicator when making investment decisions. For policy makers, a high share pledge ratio of directors should be considered as a risk factor for governance. Fourth, the current outcomes imply that corporate governance is crucial in tourism development. The tourism sector relies on a combination and coordination of individual firms (Haugland et al., 2011). Individual firms can be directed and controlled well when proper corporate governance is in place (Yeh and Trejos, 2015). Good governance can mitigate conflicts among stakeholders (Song et al., 2013; Yeh and Trejos, 2015), which in turn increases the cooperation of firms and enhances competitiveness of the tourism sector (Komppula, 2014). The current outcomes empirically inform stakeholders about the influence of three studied governance variables on firm performance. While these results are based on the context of Taiwan, they can be regarded as a basis for other studies on corporate governance in the tourism sector.

Several limitations of the current study should be acknowledged. First, there are a variety of institutional investors in the ownership structure. The current study examines only the influence of foreign institutional investors. The effect of other types of institutional investors, such as domestic institutional investors and financial institutions, on tourism firm performance is not well understood. For example, domestic institutional investors may be more likely to influence governance practices, such as terminating under-performing general managers of invested firms, due to being familiar with local environments. It will be worthwhile to investigate about these effects to understand the roles performed by diverse types of institutional investors. Second, the current research explores the role of institutional directors. While results indicate mixed effects, the influence of a board of directors may be dependent on its structure. For example, independent institutional directors may be more vigilant than dependent directors when supervising firms. Future studies can examine the effects of different board structures to enrich the literature on boards of directors from the tourism perspective.

Third, the current study examines the effect of directors’ borrowing behavior by using the share pledge ratio. This may not robustly and fully describe how the agency problem is affected by the specific characteristics of directors. Future research may consider the link between board governance, such as directors’ financial expertise, to the alleviation of agency problems. For example, directors with financial expertise may have higher risk perceptions toward investment opportunities when considering the owners’ interests. Fourth, the current study uses data from 2011 to 2015 only. Future research can extend the study time period to avoid a period-specific relationship. Fifth, the tourism firms included in the current study are those publicly traded firms in the stock markets. Results may not be generalized to unlisted tourism firms. Future research that studies unlisted tourism firms can compare the similarities and differences in governance between unlisted and listed tourism firms. Sixth, the current results are based on the stock markets of Taiwan. The application to other nations may be limited. Future research with similar variables conducted in other nations is therefore encouraged to provide tourism managers, investors and policy makers with more general evidence.

Footnotes

Declaration of conflicting interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author(s) received no financial support for the research, authorship, and/or publication of this article.

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