1

Corporate Governance and Firm Liquidity: Evidence from the Chinese Stock

Market

Ke Tanga,b

and Changyun Wangb,

a) Hanqing Advanced Institute of Economics and Finance, Renmin Uinversity of China

b) China Financial Policy Research Centre, and School of Finance, Renmin Uinversity of China

Abstract

This paper examines the cross-sectional relation between corporate governance and firm liquidity in

the Chinese stock market. Each year we construct a measure of overall quality of governance based

on publicly available information for each firm listed on the Shanghai Stock Exchange (SHSE) and

the Shenzhen Stock Exchange (SZSE) over the 1999-2004 interval. After accounting for other

liquidity-related factors, we present strong evidence that the level of corporate governance is

positively related to firm liquidity. An increase of 1% in corporate governance index (total 100%) is

on average associated with 1.2% increase in a firm‟s annual turnover ratio over the subsequent year.

Results from examinations of subindices of corporate governance provide further support for the

positive governance-liquidity relation. These findings have important implications for academics to

investigate the value of enhancing corporate governance, and for regulators to promote corporate

governance reform.

Keywords: Corporate governance; Firm liquidity; Chinese stock market

JEL Classification: G12; G34

Corresponding address: Changyun Wang, School of Finance, Renmin University of China, 59 Zhong Guan

Cun Street, Beijing, China. Phone: +8610 82509275: +8610 82509289; Email, wangchy@ruc.edu.cn. The

authors would like to thank the participants in the Symposium on Corporate Governance in China and India

(Virginia, 2008) for helpful comments. Financial support from the China National Science Fund for

Distinguished Young Scholars (No.:70725003) is gratefully acknowledged.

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1. Introduction

There is substantial evidence that corporate governance rules or governance practices at country

levels are associated with the development and strength of financial markets, namely, higher levels of

governance are related to larger securities markets, more frequent IPOs, lower costs of external

finance, and higher value of minority shares (La Porta et al., 1997, 1998, 2000, 2002; Berkowitz et al.,

2001; Lambardo and Pagano, 2000; Gompers et al., 2002; and Beck et al., 2003). Researchers have

also shown that within-country variations in corporate governance practices affect firm value. Black

(2001) finds a strong correlation between a governance index and share prices of Russian firms.

Durnev and Kim (2003) document that high scores of Credit Lyonnais Securities Asia (CLSA)

corporate governance index and the S&P disclosure index predict higher Tobin‟s Q for a sample of

859 large firms in 27 countries. Gompers et al. (2003) use the differences in takeover defense

provisions to create a corporate governance index for U.S firms, and find that firms with stronger

shareholder rights have better operating performance, higher market valuation, higher sales growth,

and are more likely to make acquisitions. Black et al. (2005) report that corporate governance is an

important factor explaining the variations in market value of Korean public companies. Cheung et al.

(2008) document a positive relation between the corporate governance index and various measures of

firm performance in the Hong Kong stock market.

Corporate governance aims at resolving conflict of interests between managers and shareholders

and between large shareholders and minority shareholders, and thus mitigates agency costs. Financial

transparency, operational transparency, and information disclosure are extremely important elements

of corporate governance. Firms that adopt poor corporate governance practices are usually associated

with a low level of financial and operational transparency, and low quality of information disclosure,

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which implies great information asymmetry and low firm liquidity. Botosan (1997) shows that an

increase of a firm‟s disclosure reduces information asymmetry between shareholders and managers.

Lang and Lundholm (1999) report that a higher level of transparency and higher quality of disclosure

are associated with lower information risk and smaller transaction costs. As a result, liquidity

providers, such as market makers and outsider investors (in electronic trading system), will take

actions to protect themselves by enlarging bid-ask spreads or limiting market participation. Several

studies have also documented that some particular aspects of corporate governance affect firm

liquidity. For example, Jain (2001) shows that bid-ask spreads are narrower in countries with better

shareholders‟ rights. Bacidore and Sofianos (2002) document that firms listed on the New York Stock

Exchange that are based in the U.S. exhibit higher liquidity than those based in outside the U.S. Attig

et al. (2003) find that deviations of ownership from control increase bid-ask spreads in the Canadian

stock market. Brockman and Chung (2003) show that liquidity costs are lower for the Hong

Kong-based blue chips than for the China-based firms, suggesting that better investor protection (for

blue chips in Hong Kong) is associated with higher liquidity. More recently, Chung et al. (2010)

examine the relation between transparency-related governance attributes and liquidity in the U.S.

stock market, and find that firms with better governance structure exhibit narrower quoted and

effective spreads, smaller price impact of trades, and lower probability of information-based trading.

However, there has been no study examining explicitly the relation between overall quality of

corporate governance and firm liquidity.

This paper contributes to the literature by analyzing the cross-sectional relation between overall

corporate governance and firm liquidity using individual firm data from the Shanghai Stock

Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE). Based on the theoretical predictions

4

and empirical evidence in the finance and economics literature, we construct a measure to evaluate

the overall quality of governance using governance practices-related information of listed companies

disclosed in their annual financial reports. After accounting for other liquidity related factors, we

report strong evidence that the level of corporate governance index is positively related to firm

liquidity in the subsequent year. An increase of 1% in corporate governance index (total 100%) is on

average associated with 1.2% increase of a firm‟s annual turnover ratio over the subsequent year. We

also construct two subindices of corporate governance based on governance attributes in board

structure and ownership structure respectively, and show that both the subindices of corporate

governance are positively related to firm liquidity.

The positive relation between corporate governance and firm liquidity has important

implications for academics. Empirical studies that utilized various corporate governance indices have

shown that corporate governance is positively associated with firm value or stock returns (Gompers

et al., 2003; Bebchuk et al., 2004). Studies of asset prices and liquidity document a negative relation

between stock return and liquidity (Amihud and Mendelson, 1986; Amihud, 2002). The negative

return-liquidity relation implies that firms with higher liquidity have lower costs of capital, and as a

consequence, higher firm value, lower required returns from investors. Therefore, our results suggest

that the value creation role of corporate governance reported in the extant literature tends to be

underestimated. Our empirical findings also have implications for market regulators to promote

corporate governance reform. A common concern is that corporate governance reforms may dampen

market liquidity (Bhide, 1993). Our findings imply that maintaining good corporate governance is

beneficial for firms in terms of both value creation and liquidity.

The remainder of this paper is organized as follows. In Section 2, we lay out the hypothesis

5

relating corporate governance to liquidity. Section 3 describes the data and methodology. Section 4

presents the empirical results. The final section concludes.

2. Hypothesis Development

Extant researches have shown that firms adopting poor corporate governance practices are

usually associated with a low level of financial transparency and operational efficiency, and low

quality of information disclosure. Therefore, poor corporate governance practices intensify

information asymmetry problems between insiders and investors, increase the probability of trading

against informed traders, and increase the likelihood of wealth expropriation of minority shareholders

by controlling shareholders.

Leuz et al. (2003) show that governance provisions improve financial transparency by mitigating

management‟s incentive and ability to distort information disclosure. Ajinkya et al. (2005) report that

more effective boards enhance the quality and frequency of information released by management,

and therefore, companies with more effective boards issue more frequent and accurate earnings

forecasts. Bebchuk et al. (2005) show that governance provisions help to protect shareholder interests

and limit the extent to which management expropriates firm value through shirking, empire building,

and perquisites. Diamond (1985) demonstrates that increased disclosure reduces both the precision of

private information and the incentive for private information search. A decrease in information

asymmetry between management and investors tends to reduce investors‟ incentive to acquire private

information, resulting in less heterogeneity in investor beliefs and smaller speculative position of

informed traders. In such an environment, liquidity providers or uninformed traders face smaller

adverse selection problems in the stocks, resulting in narrower bid-ask spreads and greater trading

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activity. Therefore, extant literature suggests that poor corporate governance is associated with a low

level of financial and operational transparency, and thus impairs stock market liquidity.

Several studies have examined the impact of cross-country differences in legal and regulatory

environments on stock market liquidity. Jain (2001) investigates the relation between institutional

design and firm liquidity. Although his study focuses primarily on variables under the control of

exchange (i.e., the market making system), one relevant result is that bid-ask spreads are narrower in

countries with better shareholder rights. Bacidore and Sofianos (2002) show that firms listed on the

New York Stock Exchange that are based in the U.S. exhibit higher liquidity than those based in

outside the U.S. Brockman and Chung (2003) examine the impact of investor protection on firm

liquidity using a sample of blue-chips and China-based firms traded on the Stock Exchange of Hong

Kong, and show that liquidity costs are lower for the Hong Kong-based blue chips than for the

China-based firms. They conclude that better investor protection (for blue chips in Hong Kong) is

associated with higher liquidity. Chen et al. (2007) analyze the relation between S&P‟s Transparency

and Disclosure (T&D) rankings and liquidity of the constituent firms in the S&P 500 index, and

report that T&D rankings are negatively associated with firm liquidity measured by the quoted half

spread and the effective spread.

Focusing on within-country differences in governance provisions, Lambardo and Pagano (2000)

provide evidence of an inverse relation between shareholder rights and required returns on monthly

equity indices, which implies an inverse relation between investor protection and liquidity costs.

Attig et al. (2003) show that deviations of ownership from control increase bid-ask spreads in the

Canadian stock market. Chung et al. (2010) examine the relation between transparency-related

governance attributes and liquidity in the U.S. stock market, and find that firms with better

7

governance structure exhibit narrower quoted and effective spreads, smaller price impact of trades,

and lower probability of information-based trading.

Researchers have also argued that some of corporate governance mechanisms aiming at reducing

agency costs can also depress firm liquidity. Large shareholders and ownership concentration provide

more adequate internal monitoring, but reduce stock liquidity by creating information asymmetry

problems (Coffee, 1991; Bhide, 1993). Heflin and Shaw (2000) report that a higher level of

blockholder ownership, regardless of whether the blockholders are managers, is associated with

reduced firm liquidity. Conversely, liquidity discourages internal monitoring by reducing the costs of

„exit‟ of unhappy shareholders, and thus impairs corporate governance. Kahn and Winton (1998)

contend that market liquidity can undermine the effective control by large shareholders by giving

them excessive incentives to speculate rather than to monitor. Bolton and Thadden (1998) develop a

simple model to show that when a firm decides to set up a controlling block, it reduces the number of

shareholders who can participate in the trading of the firm‟s stocks, and therefore, this effectively

reduces market capitalization and hence, the liquidity of the stock.

The finance theory does not appear to provide a definite answer for the relation between the

overall quality of corporate governance and firm liquidity. In this study, we hypothesize that overall

corporate governance is positively related to firm liquidity in the emerging Chinese stock market for

the following reason. The Chinese stock market has a short history, the quality of disclosure is low,

boards are often inefficient, and information asymmetries between insiders and small investors are

severe (Chakrararty et al., 1998). This is consistent with Akerlof‟s (1970, p.497) observation that

“markets in underdeveloped countries often strongly reflect the operation of Lemons Principle.”

Better governed firms can assure more efficient operations of corporate boards, better protection of

8

minority shareholders‟ interests, and maintain more appropriate disclosure and better transparency.

Therefore, the major hypothesis of our study is posited as higher quality of governance decreases

information asymmetries, enhances investor confidence, and is positively associated with firm

liquidity.

3. Data and Methodology

Our sample consists of all non-financial listed companies traded on the Shanghai Stock

Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE) over the 1999-2004 interval. We

exclude financial firms from this study because financial firms are abnormally large in size and their

book-to-market ratios have different implications from those of non-financial firms. We do not

analyze the post-2004 data because the ownership-split reform commencing in early 2005 generated

significant impacts on corporate governance, firm valuation as well as market liquidity. This data

screening process results in a sample consisting of firms varying from 918 firms at the end of 1999 to

1343 firms at the end of 2004 representing over 99% of the total number of listed companies traded

on the two stock exchanges. Table 1 presents the composition of sample firms for the SHSE and the

SZSE as well as the total number of listed firms over the sample period. Our data are collected from

the China Stock Market & Accounting Research Database (CSMAR).

<Insert Table 1 about here>

3.1. Measuring corporate governance

In contrast to most corporate governance indices that are based on responses to survey questions

(e.g., Klapper and Love, 2003; Durnev and Kim, 2005; Black, 2005), we construct an overall

governance index for each Chinese listed firm to measure the quality of corporate governance based

on disclosed governance-related information in their annual financial reports. Bai et al. (2004) also

9

use a similar approach to construct a corporate governance index and examine the relation between

the corporate governance index and firm value for individual Chinese listed firms in 2000. We

classify the governance related information into 5 groups: expropriation of minority interests, board

of directors‟ structure and process, supervisory board structure and process, ownership structure, and

financial transparency and disclosure. We score a variable if it contributes to the quality of corporate

governance based on the finance and economics literature. These 5 groups consist of 17 variables in

total.1 The details of each variable and the scoring criteria are summarized in Table 2.

<Insert Table 2 about here>

Obtaining scores of the above individual variables, we construct a corporate governance index

each year by first summing a firm‟s scores of all non-missing variables and then divide the score by

the number of non-missing variables. This technique avoids the problem resulting from missing

variables of some individual firms. The corporate governance index (CGI) for each firm each year

has a value ranging from 0 to 1. A higher value of CGI indicates higher quality of governance.

However, we recognize that there is no theoretical guidance on the weightage of each variable in the

construction of corporate governance index. Therefore, we use the equal-weight technique to assess

the quality of governance in this study. Bai et al. (2004) use a similar approach to construct corporate

governance index, and examine the relation between overall corporate governance and firm values.

3.2. Empirical method

The relation between corporate governance and firm liquidity is estimated using the fixed effect

panel regression. This method accounts for potential endogeneity of corporate governance measure

1 In addition to the governance provisions of Bai et al. (2004), this paper also considers tunneling motivated

related part transactions, board size, state as the controlling shareholder, institutional ownership, attendance

rate of annual shareholders‟ meeting, and audit opinions in the construction of corporate governance index.

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by controlling for potential unobservable firm-specific factors that could be driving both governance

and liquidity. Our empirical model is specified as

, , 1 ,i t i t j j t i tLIQ CGI (1)

where LIQi,t is a liquidity measure for firm i in year t; CGIi,t-1 denotes firm i‟s corporate governance

index in year t-1; and Xj,t denotes the jth control variable; λi denotes the firm-level fixed effect.

There is still a concern regarding the endogeneity problems in the examination of the relation

between corporate governance and liquidity. It is arguable that market liquidity affects corporate

governance because greater liquidity makes it easier for active shareholders to build positions so as to

effect changes in corporate policies. Moreover, market liquidity allows for the more effective use of

secondary equity market for corporate-control activities. We attack this issue by examining the

relation between liquidity and lagged corporate governance index as specified by equation (1).

Following the literature, we choose firm size (SIZE), leverage (LEVERAGE), book-to-market ratio (BM),

and volatility (VOL) as control variables in this study.

We use two commonly used measures of liquidity. The first liquidity measure is the tradable turnover

ratio (TURNOVER), which is defined as the average of monthly turnover ratios for a firm during the year,

and monthly turnover ratio is the number of shares traded in the month divided by total tradable A-shares

outstanding at the end of previous month.2 We use tradable turnover rather than total turnover, which is

the number of shares traded in a month divided by total shares outstanding, because a large portion of

shares (state shares and legal-entity shares) in a typical Chinese listed company is not allowed to trade.

Consequently, total turnover can be a distorted measure of liquidity in the Chinese stock market (Wang

2 Several extant studies have used turnover as a measure of trading volume of a stock, for example, Datar et al.

(1998), and Lee and Swaminathan (2000). Turnover is arguably superior to dollar trading volume because raw

trading volume is unscaled and highly correlated with firm size. As a result, it is difficult to distinguish between

the volume and size effects.

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and Chin, 2004).

The second measure for liquidity used in this study is the daily ratio of absolute stock return to its

trading volume averaged over a given period. This measure was proposed by Amihud (2002), which

is termed as Amihud ratio (AMIHUD) hereafter. Intuitively, the Amihud ratio can be interpreted as

the daily stock price response associated with one dollar of trading volume, which is consistent with

Kyle‟s (1985) concept of illiquidity, i.e. the response of price to order flow. We first calculate a daily

ratio for firm i as

, , ,/i t i t i tDaily Ratio R VOL

where ,i tR is the return of firm i for day t; ,i tVOL is the trading volume in Renminbi (RMB) in day t.

We then compute the annual Amihud ratio as an average of daily Amihud ratios for firm i in a

year as

, ,

1

1/ ( / )D

i i t i t

t

Anual Ratio D R VOL

(2)

where D is the number of trading days in a year for firm i.

4. Empirical Results

Summary statistics and contemporaneous correlations between these variables are presented in

Table 3. The average corporate governance index (CGI) is 0.46, with a standard deviation of 0.07.

The mean monthly turnover ratio over the 1999-2004 interval is as high as 27.4%, which means that

it takes about 4 months for tradable shares of a firm to change hands once. This figure is comparable

to that documented in Wang and Chin (2004) but is significantly higher compared to that in the U.S

market, which is, for example, about 4% in Lee and Swaminathan (2000). The Amihud ratio that is

multiplied by 1,000 has a mean of 46.79, and appears highly volatile, with a standard deviation of

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126.81.

Logarithm of total assets is used as a proxy for the firm size (Morck, Shleifer, and Vishny, 1988;

McConnell and Servaes, 1990). The mean SIZE of our sample is 21.05. The average leverage and

book to market ratio are 0.51 and 0.35 respectively over the sample period. The mean monthly return

volatility (VOL) is about 24.95%.The right-hand-side panel of Table 3 shows the contemporaneous

correlations between the dependent and independent variables.

<Insert Table 3 about here>

The results of estimating equation (1) are reported in Table 4. The key finding in Table 4 is that

corporate governance index is significantly associated with liquidity. For the turnover regression, the

estimated coefficient for CGI is 0.097 (t= 3.28) when all control variables are included. This implies

that an increase of 1 CGI point (out of 100), the monthly (annual) turnover ratio of a firm will be

increased by 0.1% per month (1.2% per year) in the subsequent year, on average. For the Amihud

(illiquidity) ratio regression, the estimated coefficient for CGI is –0.972 (t= -2.26) when all control

variables are included. The results in Table 4 are consistent with extant findings that better governed

firms are associated with higher financial and operational transparency, less information asymmetry,

and thus higher liquidity (Botosan, 1997; Bhattacharya and Daouk, 2002; Brockman and Chung,

2003; Chen et al., 2007, Chung et al., 2010). Consistent with the literature, firm size is positively

related to liquidity (Amihud and Mendelson, 1986), leverage and book-to-market are negatively

related to liquidity (Perotti and von Thadden, 2003; Lang and Lundholm, 1999). These results hold

true when both the turnover and the Amihud ratios are employed as the dependent variables. There

appears to be a positive relation between turnover and volatility, however, the positive liquidity –

volatility relation does not exist when the Amihud ratio is used as a measure of illiquidity. The

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estimated coefficients for AMIHUD are of wrong signs, although they are insignificantly different

from zero.

<Insert Table 4 about here>

We also explore the relation between subindices of corporate governance and firm liquidity. An

examination of subindices of corporate governance serves as a robustness test of the relation between

overall governance and liquidity because one may concern that some of governance variables

themselves may be the determinants of liquidity, for example, ownership and ownership

concentration.3 We construct two subindices: the board of directors-based index and the ownership

structure-based index. The subindex is constructed by first summing the scores of individual

variables and then scaling the scores using the number of non-missing variables for each group. The

governance provisions related to board of directors are less likely to be the determinants of or

affected by liquidity than those related to ownership structure. The results of regressing liquidity on

lagged subindices of corporate governance are reported in Table 5. To contain space, we only report

the regression results using turnover as the liquidity measure.4 Consistent with the results in Table 4,

the coefficient estimates for subindices of corporate governance are positive and significant at the 5%

level or higher for all regressions, and the estimated coefficients for control variables are all of

expected signs and statistically significant.

<Insert Table 5 about here>

5. Conclusions

3 Although we focus on the relationship between liquidity and lagged corporate governance index, one may

argue that some governance provisions at the firm level vary a little across years, and the positive

governance-liquidity relationship may arise from those governance provisions that determine liquidity. 4 The results of regressions using Amihud ratio as the liquidity measure are similar to those in Table 4, which

are in general less significant than those using turnover as the liquidity measure.

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In this paper, we examine the cross-sectional relation between overall corporate governance and

firm liquidity in the Chinese stock market. We employ a corporate governance index to measure

overall quality of corporate governance for each firm traded on the Shanghai and the Shenzhen stock

exchanges over the 1999-2004 interval. The index contains 17 governance elements, which uses, to

our best knowledge, the most information available publicly in the construction of corporate

governance index in the Chinese stock market. We find a positive and significant relation between

corporate governance and firm liquidity after accounting for factors influencing firm liquidity. An

increase of 1% in corporate governance index is associated with a 1.2% increase in a firm‟s annual

turnover in the subsequent year. We also examine the relation between subindices of corporate

governance and liquidity and between individual corporate governance elements and liquidity. We

report that both ownership structure-based and board of directors-based governance indices are

positively related to firm liquidity; 12 out of 17 corporate governance elements are positively

associated with firm liquidity.

This paper appears to be the first study to investigate the relation between overall corporate

governance quality and firm liquidity. Our results have important implications for academics to better

understand the benefits and costs of corporate governance. Extant literature has documented that the

level of corporate governance is positively associated with firm value or stock returns. Our findings

on the positive relation between corporate governance and firm liquidity imply that the value creation

effect of corporate governance reported in the extant literature tends to be underestimated. Our

findings also have implications for stock market regulators to actively promote corporate governance

reform. The positive relation between overall corporate governance and liquidity relieves the concern

that enhancing corporate governance dampens liquidity (Coffee, 1991; Bhide, 1993; Bolton and

15

Thadden, 1998).

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Table 1

Descriptive statistics

The sample period is from 1999 to 2004. The number of firms is computed at the end of each year. The SHSE and the SZSE

denote the Shanghai and the Shenzhen stock exchanges respectively.

1999 2000 2001 2002 2003 2004

Sample

firms

SHSE 469 556 633 700 764 820

SZSE 449 498 497 491 488 523

Total 918 1054 1130 1191 1252 1343

No. of listed firms 923 1060 1139 1206 1266 1362

18

Table 2

Measuring overall corporate governance

Name of variable Type of variable Criteria

Panel A: Expropriation of minority interests

1 RELATEDPARTY Dummy If a company has tunneling-intended related party

transaction, 0; otherwise 1.

2 PARENT Dummy If a company has a parent, 0; otherwise 1.

Panel B: Board of directors

3 INDD Dummy If at least one third of the board is independent directors, 1;

otherwise 0.

4 CEOCHAIR Dummy If the CEO is also the Chairman or Vice-chairman of

board, 0; otherwise 1.

5 PAIDDIR Continuous 0-1 The number of paid outside directors divided by the total

number of board of directors.

6 ASUC Dummy If the successor had previously acted as a director,

supervisor, or executive for the controlling shareholder and

selected by the controlling shareholder, 0; otherwise 1.

7 BODSIZE Continuous 0-1 The number of directors sitting on the board scaled by the

largest board size in the year

Panel C: Supervisory board structure and process

8 SUPER Dummy If directors, managers, and CFO are appointed as

supervisors in that firm, 0; otherwise 1.

9 PAIDSUPER Continuous 0-1 The number of paid supervisors divided by the total

number of supervisors

Panel D: Ownership structure

10 INSIDER Continuous 0-1 The percentage shareholdings of chairman, directors, and

senior managers of the company.

11 TOP2_10 Continuous 0-1 The sum of squares of percentage shareholdings by 2nd to

10th largest shareholders divided by 10000

12 TOPSTATE Dummy If the controlling shareholder is the government, 0;

otherwise 1.

13 TOP_1 Continuous 0-1 The percentage shareholdings of the largest shareholder.

14 INSTITUTION Continuous 0-1 Institutions‟ tradable shareholdings divided by the firm‟s

tradable shares outstanding.

Panel E. Financial transparency and disclosure

15 HBSHARE Dummy If a firm has either H or B shares, 1; otherwise 0.

16 SGM Continuous 0-1 The attendance rate of annual Shareholders‟ General

Meeting.

17 AUDIT Dummy If a auditing firm expresses a standard non- retention report

of audit opinion, 1; otherwise 0

19

Table 3

Summary statistics (1999-2004)

CGI denotes the corporate governance index. AMIHUD is the Amihud ratio that is computed based on Equation (2), which

is multiplied by 1,000. TURNOVER denotes monthly turnover ratio that is the number of shares traded in the month

divided by total tradable A-shares outstanding. SIZE is the logarithm of the firm‟s total assets at the end of year.

LEVERAGE denotes the leverage ratio that is computed as the total debt scaled by total assets. MB is market to book ratio.

VOL is the monthly return standard deviation in a year. **, and *** indicate the significance at the 5% and 1% levels

respectively.

Mean Median Std dev CORRELATION MATRIX

CGI TURNOVER AMIHUD SIZE LEVEARGE BM VOL

CGI 0.460 0.459 0.070 1.000 TURNOVER 0.274 0.209 0.213 0.007 1.000 AMIHUD 46.789 31.500 126.813 0.010 -0.123*** 1.000 SIZE 21.047 20.975 0.932 0.189** -0.155*** -0.145** 1.000 LEVERAGE 0.514 0.461 0.672 -0.023 -0.066** 0.060** 0.128** 1.000 BM 0.347 0.310 0.202 0.039 -0.216** 0.006 0.326** -0.128** 1.000 VOL 24.954 0.092 88.770 -0.013 0.296** -0.066 -0.094 -0.185** -0.051 1.000

20

Table 4

Corporate governance and firm liquidity

This table shows the （fixed effects） panel regression result of firm liquidity in year t on corporate governance index in

year t-1. The sample period is from 1999 to 2004. The dependent variables are the turnover ratio (TURNOVER) and the

Amihud ratio (AMIHUD) respectively. Turnover is defined as the average of monthly turnover ratios for a firm in year t,

and monthly turnover ratio is the number of shares traded in a month divided by total tradable A-shares outstanding at the

end of year t-1. CGI is the corporate governance index of a firm. SIZE is the logarithm of the firm‟s total assets at the end of

year t-1. BM is the book to market ratio where the market value is measured using the share price at the end of year t-1

multiplied by total shares outstanding. Leverage is measured as the total debt over the total assets at the end of year t-1.

VOL is the monthly return standard deviation in year t. EX and INDUSTRY are dummies variables for two stock exchanges

and 12 industries respectively. The numbers in parentheses are the z-statistics computed based on the White's

heteroskedasticity- consistent standard errors. *, **, and *** indicate significance at the 10%, 5% and 1% levels

respectively.

TURNOVER AMIHUD

Model 1 Model 2 Model 3 Model 4 Model 1 Model 2 Model 3 Model 4

Intercept 0.040** 0.279*** 0.021 0.001 1.131*** 10.79*** 11.401*** 11.910***

(1.98) (5.42) (0.38) (0.01) 2.91 8.93 9.45 10.05

CGI 0.091*** 0.113*** 0.098*** 0.097*** -1.286** -1.031** -0.932* -0.972**

(3.08) (3.81) (3.31) (3.28) (-2.45) (-2.32) (-1.92) (-2.26)

VOL 1.680*** 1.643*** 1.535*** 0.006** 1.662 2.251 1.351 1.051

(16.77) (16.39) (15.1) (2.48) (1.67) (1.73) (1.26) (1.03)

SIZE 0.012*** 0.015** 1.549*** -0.480*** -0.511*** -0.552***

(5.28) (2.39) (14.86) (-10.7) (-11.78) (-13.33)

BM -0.1763*** -0.181*** 0.312*** 0.472***

(-18.43) (-18.8) (2.63) (3.74)

LEVERAGE -0.032*** 0.852***

(-2.58) (9.11)

EX Yes Yes Yes Yes Yes Yes Yes Yes

INDUSTRY Yes Yes Yes Yes Yes Yes Yes Yes

Adjusted R2 0.208 0.212 0.245 0.246 0.024 0.0369 0.0386 0.0396

No. of Obs. 5519 5519 5519 5519 5503 5502 5385 5384

21

Table 5

Subindices of corporate governance and firm liquidity

This table shows the (fixed effects) panel regression results of turnover in year t on the board of directors-based and

ownership structure-based subindices of corporate governance in year t-1 respectively. The sample period is from 1999 to

2004. Turnover is defined as the average of monthly turnover ratios for a firm in year t, and monthly turnover ratio is the

number of shares traded in the month divided by total tradable A-shares outstanding at the end of year t-1. SIZE is the

logarithm of the firm‟s total assets at the end of year t-1. VOL is the monthly return standard deviation in year t. BM is the

book to market ratio where the market value is measured using the share price at the end of year t-1 multiplied by total

shares outstanding. Leverage is measured as the total debt over total assets at the end of year t-1. EX and INDUSTRY are

dummies variables for the 2 stock exchanges and 12 industries respectively. The numbers in parentheses are the

z-statistics computed based on the White's heteroskedasticity- consistent standard errors. *, **, and *** indicate

significance at the 10%, 5% and 1% significance levels respectively.

Board Based CGI Ownership Based CGI

Model 1 Model 2 Model 3 Model 4 Model 1 Model 2 Model 3 Model 4

Intercept 0.102*** 0.311*** 0.033 0.011 0.082*** 0.313*** 0.044 0.024 (6.27) (6.01) (0.55) (0.10) (5.17) (6.06) (0.81) (0.41) CGI 0.040*** 0.033** 0.032** 0.031** 0.033* 0.042** 0.043** 0.043** (2.72) (2.45) (2.33) (2.34) (1.76) (2.25) (2.39) (2.29) VOL 1.682*** 1.652*** 1.531*** 1.554*** 1.682*** 1.642*** 1.532*** 1.552***

(16.68) (16.33) (15.11) (14.90) (16.72) (16.35) (15.07) (14.84) SIZE 0.012*** 0.011** 0.012*** 0.011*** 0.012** 0.011*** (4.46) (2.43) (3.05) (4.87) (2.14) (2.72) BM -0.182*** -0.193*** -0.181*** -0.181*** (-18.16) (-18.70) (-18.51) (-18.88) LEVERAGE -0.043*** -0.032*** (2.89) (-2.64) EX Yes Yes Yes Yes Yes Yes Yes Yes

INDUSTRY Yes Yes Yes Yes Yes Yes Yes Yes

Adjusted R2 0.2065 0.2092 0.2428 0.2435 0.2064 0.2096 0.2432 0.2436

No. of Obs. 5503 5502 5385 5384 5503 5502 5385 5384