Prejudicial related-party transactions of listed companies in China: evidence of motivating and enabling influences

Williams, M 2014, Prejudicial related-party transactions of listed companies in China: evidence of motivating and enabling influences, Doctor of Philosophy (PhD), Accounting, RMIT University.

Document type: Thesis
Collection: Theses

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Title Prejudicial related-party transactions of listed companies in China: evidence of motivating and enabling influences
Author(s) Williams, M
Year 2014
Abstract There is emerging corporate governance research on the problem of conflict of interest between shareholders (i.e., the principal-principal problem). This problem concerns the phenomenon of the ultimate controlling shareholder expropriating (Tunneling) or injecting (propping) funds through related-party transactions (RPTs) in a way that prejudices the rights of minority shareholders. The area of corporate governance that deals with minority shareholder protection is under-researched. Most corporate governance research treats shareholders as a homogeneous party (i.e., the principal) whose common rights are to be served by the agent (management and the board). However, the protection of minority shareholders’ interests, in balance with all shareholders of the firm, is one of the key corporate governance principles. Ways in which this study seeks to contribute to the literature concerning the principal-principal problem are threefold: (a) extend the evidence and understanding of governance problems in the context of developing and transitioning countries where the protection of minority shareholders from prejudicial actions by an ultimate controlling shareholder or set of block-holders and the executive management team has been identified as the primary problem (Shleifer and Vishny 1997; Johnson, Lopez-de-silanes, La Porta and Shleifer 2000); (b) develop stronger theoretical underpinning for the specification of models when empirically investigating relationships between corporate governance practices, ownership concentration, regulatory systems and the actions of controlling shareholders in developing and transitioning countries; and (c) establish improved measures used as proxies for the prejudicial proportion of total RPTs and for theory-driven concepts that can explain the extent of Tunneling and propping phenomena as manifest in prejudicial RPTs.

The main aim of this study, therefore, is to test theory-driven models of motivating and enabling influences on the extent of prejudicial RPTs. A supplementary aim is to update the descriptive evidence on the incidence and categorisation of RPTs in China. In respect of the main aim, the following lines of investigation are pursued: (a) the ultimate controlling shareholder’s motivation for undertaking Tunneling from the perspective of Bebchuk’s (1999) rent-protection theory of corporate ownership structure; (b) the ultimate controlling shareholder’s motivation for undertaking propping from the perspective of Jensen and Ruback’s (1983) ‘market for ownership control’ theory; and (c) the enabling influences of corporate governance practices on Tunneling and propping in a transitional economy with high government ownership from the perspectives of reverse bonding theory between controlling shareholders and agents, and the theory of markets in transition (Nee 1989) where power and privilege is perpetuated into the private sector from former State regimes.

This study is set in the context of contemporary China. A background review is provided to the context of corporations, shareholders and capital markets in China. This includes a brief history of economic and accounting changes, the development of securities markets and shares classifications, and the establishment of a corporate governance code including aspect of minority shareholders protection in China.

Hypotheses and models are constructed to test the extent to which motivating and enabling/inhibiting factors can explain or predict the extent of Tunneling and propping, respectively. A positivist epistemology is adopted. China is chosen as the context because it is a major transitional economy, has a large share market, high State-ownership and questionable implementation of securities regulations. Data is sourced mainly from the China Securities Market and Accounting Research (CSMAR) database on listed companies in China. The sample is drawn from a census of all companies listed on the Shenzhen and Shanghai Stock Exchanges in 2010. After making various exclusions, the sample size is 1,967 listed companies. Data is collected for 2010, which means that cross-sectional analysis is undertaken. Correlations and regressions are the main form of data analysis. Apart from analysing data for the sample as a whole, comparisons are made between groupings of State versus non-State controlled companies, and larger versus smaller companies.

The results reveal several significant determinants of prejudicial RPTs. The influences from the findings are briefly discussed. First, in terms of the motivating conditions for Tunneling, results suggests that when ultimate controlling shareholders can not satisfy their cashflow rights through non-prejudicial means (i.e., voting rights high relative to cashflow rights or low dividend payout), they tend to resort to Tunneling. This provides evidence in support of Bebchuk’s (1999) rent-protection theory of ownership control. Alternatively, in terms of motivating conditions for propping, the reporting of prior net losses by the company, which can lead to the CSRC imposing ‘special status’ penalty, thereby triggering the emergence of a market for ownership control, is the primary motivator for propping. This provides support for Jensen and Ruback’s (1983) market for ownership control theory.

Second, in terms of enabling mechanisms for Tunneling results reveal that Tunneling is higher when the controlling shareholder is a ‘cadre entrepreneur’ (i.e, a person with high status in the former State-owned regime who has become a successful entrepreneur in the current market-based regime) and the Chair of the Board has high ‘path dependency’ on the ultimate controlling shareholder. This supports both Nee’s (1989) theory of market transition in which power and privilege is perpetuated in cadre entrepreneurs’ and the notion of reverse bonding in which the board is bonded by the controlling shareholder. Alternatively, significant enabling mechanisms for propping are revealed as a high level of emoluments of the top executive team and a high ‘path dependency’ of the CEO on the ultimate controlling shareholder. This adds further support for the notion of bonding to the ultimate controlling shareholder which cuts out protection of minority shareholders’ interests.

These results are discussed, not only in terms of their support for underlying theories, but also in terms of their practical implications for securities regulations and governance practices in China concerning the principal-principal problem. In particular, China’s securities regulations concerning special listing treatment when losses are reported and also the holding of non-tradable shares have the side-effect of motivating controlling shareholders to engage in propping. These CSRC regulations on listed companies, therefore, need to be reviewed in order to address the principal-principal shareholder problem. In the broader area of implementing corporate governance guidelines, the issue of independence of directors needs to be reviewed if better protection of all shareholders rights is to be achieved. Limitations arise from the difficulty of measuring the concept of prejudicial RPTs, the restricting of the evidence to the context of China only and a single year, and the potential for endogeniety in some elements of the models.
Degree Doctor of Philosophy (PhD)
Institution RMIT University
School, Department or Centre Accounting
Keyword(s) related-party transactions
corporate governance
controlling shareholders
cadre entrepreneurs
ownership control theory
market transition theory
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Created: Fri, 06 Jun 2014, 09:55:55 EST by Denise Paciocco
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