Ebook Cash Dividends in China: Liquidating, Expropriation and Earnings Management
The Miller-Modigliani Dividend Theorem was derived from the no-arbitrage condition of perfect market. Numerous researches since then have indicated that the market is less than perfect and cash dividends around the world are associated with transaction costs and institutional constraints. China’s stock market, born out of socialist planned system in 1990, should be one of the least perfect markets in the world. The extraordinary case of China may provide new insight to Black’s (1976) puzzle of “why pay dividend.” The common explanations of cash dividends in the literature, the clientele effect theory, the signaling theory, and the agency theory, are mostly irrelevant in China. The cash dividend policies in China are primarily driven by the motives of liquidating, expropriation, and earnings management as a result of majority ownership and tight control by state-owned enterprises (SOE). This paper provides an illustration on the importance of institutional setting in analyzing issues of corporate finance in China.
Analyzing China data reveals several puzzling patterns of cash dividend. Despite large transaction costs of cash dividend and severe shortage of working capital in listed firms, the frequency of cash dividend payment in China is quite similar to that in the US. Moreover, we observe stable dividend payment policy for one group of firms and stable payout ratio policy for the other. The stock market in China shows no significant reaction to cash dividend increase, but positive reaction to cash dividend decline, especially for firms with high concentration of shareholding by the state. We find no significant correlation between free cash flow and the probability of paying dividend. Piecing all these observations together, we suggest that market imperfection and non-negotiable shareholding by the SOE are important factors behind cash dividend policies in China.
To assure smooth birth of stock market and out of big-daddy role in socialism, Chinese government sets very stringent quota on IPO and regulated every detail of the IPO process, such as the volume of offering, the asset valuation, and the P/E multiple for IPO pricing. To maximize capitalization for a given quota of shares, the SOE carved out its most valuable part for IPO. The parent-SOE holds the non-negotiable state shares of newly listed firm. The new shareholders in wake of IPO hold negotiable shares. “The market” in the American/European literature refers to the market for negotiable share. Non-negotiable shares can be traded only with private placement between institutions under special permission. Lack of open market for liquidating its holdings, the parent-SOE uses cash dividend to retrieve cash from the listed firm. In shortage of funds, the listed firm initiated rights offering to raise cash and uses part of receipts to pay cash dividends.
We find that all negotiable shareholders subscribe rights offering, but only less than 30% of non-negotiable shareholders do. When the listed firm uses part of rights offering receipts to pay cash dividends to all shareholders, it is a form of expropriating small shareholders on the behalf of controlling shareholders. The negative market reaction to cash dividend announcement reflects the dismay of negotiable shareholders. Moreover, the listed firm can use cash dividends to boost the returned of equity (ROE) for meeting the rights offering threshold. Under the current accounting standard in China, dividend payment is recognized in the year when the profit is earned, not at the time of payment. As a result, paying cash dividend can reduce the book value of equity and hence increase the ROE, which in turn raises the chance of rights offering approval and the ability of paying cash dividends in the future. Paying cash dividends now can increase the chance of paying cash dividends in the future.
Although literally all listed firms were carved out from SOEs, some become quite independent from their parent SOEs as the concentration of state shareholding declines. For these independent listed firms, building reputation for good performance becomes a more important reason for paying cash dividends. The independence from the direct control of state-shareholders requires the management to use stable cash dividends payment to convey information about future performance. Therefore, the listed firms under tight control and dominating shareholding by the parent SOE tend to adopt stable payout ratio policy as a way to liquidate the non-negotiable shares. The listed firms with no controlling non-negotiable shareholder tend to adopt stable dividend payment policy as a way to signal future performance.
Jensen & Meckling (1976) admitted that the conflict between majority shareholder and minority shareholders may be more important than that between shareholders and managers analyzed in their article. Bennedsen and Wolfenzon (2000) pointed out the common conflict between controlling shareholder and other shareholders. La Porta et. al (1999) argued that the existence of other large shareholders reduces controlling shareholder expropriation by monitoring. The literature provides little understanding on the empirical significance of agency problem between large shareholders and between small shareholders and controlling shareholders. China provides us a unique institutional setting and data set to explore these issues. Our result indicates that firms with different shareholding concentration have different cash dividend behavior. We also find that monitoring from other large shareholders does not necessarily help small shareholders. It depends on whether other large shareholders’ interests are closer to that of small shareholders or that of controlling shareholder. La Porta et. al (2000) argue that paying cash dividend can protect minority shareholders. The case in China shows that cash dividend may be used as a tool of expropriating minority shareholders. The institutional setting affects the players’ trade-off matrix. Paying cash dividend for earnings management and expropriation, quite bizarre immoral acts in many people’s eyes, reflects the player’s institutional constraints.
The remaining of this paper is organized as follows. Section 2 documents cash dividend behavior in China. We discover three puzzling empirical regularities. Analyses of institutional setting in China suggest that these puzzles may be related to governance and ownership of listed firms. Section 3 develops hypotheses to explain the puzzles. Section 4 describes research design and sample. Section 5 reports empirical tests, and section 6 concludes.
Download
PDF Ebook Cash Dividends in China: Liquidating, Expropriation and Earnings Management
Posted in :
