Ebook Ownership Structure, Share Transferability, and Corporate Risk Taking: Evidence from China
A central theme in property rights studies is how constraints on shareholders’ property rights will shape shareholder’s incentive and, hence their firm value maximizing behavior. In this paper, exploiting the unique ownership characteristics of Chinese listed state-owned enterprises (SOEs) and family firms for the period 1998 to 2008, we empirically explore the effect of cash flow rights and transferable rights on corporate risk choices in corporate investment decisions.
As argued by Alchian (1969), “the capitalization of future effects into present values, combined with the ability to capture that market wealth by selling to a second party, provides an effective stimulus to the control of actions that affect present capital values.” Capitalizing future profits and realizing the benefits through capital market provides a different reward or punishment for present actions than is the case in the absence of capitalization and realization possibilities. If the stockholders’ rights to capture profits are restricted, the absence of property rights to capitalize future events into present market values and realizing the benefits by exiting through market will distort the shareholders’ behavior and thus, they will have less incentive to be concerned with potential capital value effects.
Chinese listed firms, like listed firms in other non-US countries around the world, are typically controlled by the State or the families, which is in contrast to Berle and Mean’s image of widely held ownership of the modern corporation (La Porta, Lopez-de-Silane, and Shleifer, 1998; Claessens, Djankov, and Lang, 2000; Faccio and Lang, 2002). In these firms, the nature of agency problems shifts away from the conflicts of interest between managers and shareholders to the conflicts of interest between controlling owners or large shareholders (who happen to be managers in most cases) and minority shareholders. Nonetheless, SOEs and family firms are also different in that the residual cash flow claims of SOEs are not actually in the hands of the government bureaucrats who really control the listed SOEs but belong to the Treasury (Shleifer and Vishny, 1994), while the family firms’ controlling shareholders hold the cash flow claims.
Beyond these typical ownership characteristics of non-US firms, most of the shares held by the controlling shareholders of Chinese listed firms cannot be traded in the capital market before the Split Share Reform (the Reform hereafter) launched in 2005 by the Chinese central government, and the prohibition is removed thereafter. When the property rights of major shareholders who have controlling power over the company are restricted, the agency problem will become severer. The most important conflict arises from the fact that as the owner’s property rights are restricted, his incentive to devote significant effort to creative activities such as searching out new profitable ventures falls (Jensen and Meckling, 1976). It has been said that profits accrue to those who bear risks and make innovative decisions, the flip side of which is if the profits cannot be accrued to the risk bearer, i.e., under the asymmetric condition of risk taking and rewards, the incentive to take risk and perform innovative activity would be attenuated. In this study, we try to show how the restrictions on cash flow rights and share transferability affect the corporate risk taking behavior.
Past research finds that the divergence of cash flow rights and control rights has great negative effects on corporate value (Claessens et al., 2002; Lins, 2003; Lemmon and Lins, 2003), dividend policy (Faccio et al., 2001), and accounting quality (Fan and Wong, 2002), especially for non-US firms. Moreover, the rights to transfer the shares the shareholders hold is also vital to the incentives of the controlling shareholders and management and hence, the corporate performance (Furobotyn and Pejovich, 1973; Karpoff and Rice, 1989). The most closely resembling study to ours is the paper by John, Litov, and Yeung (2008), where they find that better investor protection could lead corporations to undertake riskier but value enhancing investments. A complementary study done by Acharya, Amihud, and Litov (2008) finds that stronger creditor rights in bankruptcy reduce corporate risk-taking since strong creditor rights are associated with a greater propensity of firms to engage in diversifying mergers. Moreover, there are also some studies investigating ownership and risk taking in banks (e.g., Laeven and Levine, 2009; Gonzalez, 2005), ownership and risk taking for non-financial firms (Gadhoum and Ayadi, 2003; Paligorova, 2009; Wright et al., 1996), and the effect of managerial incentives on corporate risk taking (Coles, Daniel, Naveen, 2006; Forssback, 2007; Low, 2009). We, however, go a further step to investigate a more fundamental question, i.e., the effects of constraints on property rights, more specifically, cash flow rights and transferability rights, on corporate risk taking.
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