Investors’ perception of corporate governance: cessation of trading and order strategies around Taiwan corporate scandals

Despite being the twelfth largest financial market in the world, approximately 90 per cent of the entire trading volume in the Taiwan stock market is accounted for by only a small, but widely dispersed, group of local investors actively participating in the local market during the 1995-1999 period (Barber, Lee, Liu and Odean, 2007); it is, however, also the case that these investors suffer from low levels of investor protection (La Porta, Lopez-de-Silances, Shleifer and Vishny, 1998). The discovery of a series of corporate scandals in Taiwan, between 16 June and 15 September 2004 (the event period), offers a unique opportunity to investigate the perceptions of investors on the value of corporate governance. The main line of reasoning in this study is that at times when news of scandals flows into the market, the perceptions of certain types of investors, particularly uniformed outsiders, will lead to a systematic change in their trading habits; thus, they may avoid trading in certain firms altogether, or their incentives to place aggressive orders may be considerably weakened, particularly where there is a likelihood of expropriation by controlling insiders. This dissertation undertakes a comprehensive analysis of trade and quote (TAQ) data for all investors on a sample of 94 firms listed on the Taiwan Stock Exchange (TSE), and provides evidence of extreme variations in the investment behavior of different types of investors. It is clear that during the event period, a substantial proportion of investors did cease trading altogether, with such cessation of trading even affecting their original non-scandal portfolios. This response was particularly discernible amongst small and medium-sized individual investors, who may often incur losses in firms with high cash-flow rights leverage. It seems that even the better-performed small-sized individual investors, who had previously enjoyed larger positive excess returns, tended to discard their previous trading strategy involving firms with no clear deviation between control rights and cash-flow rights. An examination of this deviation in trading behavior shows that most investors, with the exceptions of foreign institutions and large-sized individual investors, began to enter the market more passively during the event period, particularly in firms in which the ultimate controllers had separate control and cash-flow ownership. However, throughout the event period, the trading strategies of foreign institutions and large-sized individual investors involved more aggressive submission of orders for stocks in firms with strong cash-flow rights leverage. Finally, a direct test of the informativeness of aggressive orders placed by each category of investors, under different ownership structure portfolios, regardless of any order strategy, reveals that small-sized individual investors invariably performed badly during both the pre-event and event periods examined in this dissertation. Each line of our analysis shows that only foreign institutions and large-sized individual investors maintained acceptable returns; in comparative terms, these two groups of investors performed relatively well in portfolios with higher cash-flow rights leverage