Does External Monitoring Substitute for or Complement Internal Monitoring by Corporate Board?–Evidence From Korean State-owned Enterprises

Numerous studies have investigated whether regulation substitutes for or complements internal governance. The results have been inconclusive due to their over reliance on agency theory and extensive use of demographic proxy variables to real board activities. We empirically investigate the relationship between government performance evaluation (GPEs) and internal monitoring by SOE boards in the context of Korean state-owned enterprises (SOEs), overcoming the limitations of existing empirical studies. This analysis is enabled by data collected from the 1,525 board minutes of 170 Korean SOEs. Our prior expectation is a substitutive relationship. First, the similarity of GPE and internal monitoring by the board makes the relative cost of internal monitoring more expensive. Second, GPEs only reward managers, leaving outside directors unpaid. The empirical results are consistent with our expectation, and indicate that even in heavily regulated SOEs, internal imperatives outweigh institutional pressure. Hence, policy makers should carefully design GPEs so as not to crowd-out the potential benefit of internal monitoring by SOE boards.