Can independent directors effectively monitor related party transactions? Evidence from Hong Kong

Abstract

This paper empirically investigates whether independent directors of Hong Kong listed companies effectively monitor related party transactions (“RPTs”). We employ a quasi-experimental approach, utilizing a mandatory rule introduced in 2004 that changed the minimum number of independent directors, and enhanced the independence and qualification requirements of independent directors for listed companies. Using a triple-differences setup, we find that companies affected by these new requirements experienced a significant increase in the value of announced RPTs. This positive effect is observed both in companies affected by all aspects of the reform and in those that only needed to increase their number of independent directors. We also observe that return on assets for the affected companies increased significantly following the rule change. However, these affected companies showed no significant reduction in their preference for RPTs. Our findings underscore the positive value created by independent directors of Hong Kong listed companies in vetting RPTs. They suggest that, within an appropriately structured regulatory framework, independent directors, even where the company is owner-controlled, can be effective in enhancing shareholder value. As the regulatory framework resulted from the 2004 reform has remained largely unchanged, our findings are still relevant for Hong Kong and offer valuable insights on the function of independent directors for other jurisdictions, particularly those with ownership-concentrated markets seeking to enhance their RPT monitoring mechanisms.