Does ownership structure matter? Evidence from firms’ excess cash in China

Abstract

We examine the effect of corporate ownership structure on the market value of excess cash in Chinese listed firms. We find that state ownership has a positive effect, as the market value of excess cash is greater in state-owned firms (SOEs) than in privately controlled firms. Furthermore, we show that expropriation by controlling shareholders is significantly higher in privately controlled firms than in SOEs and increases with excess cash. The evidence is consistent with the view that the market believes private controlling shareholders are more likely to extract the private benefits associated with cash reserves.

Keywords:

• cash holdings
• ownership structure
• controlling shareholders
• expropriation

JEL Classification:

• G31
• G34
• G32

Acknowledgements

We appreciate detailed comments from Chris Adcock (the editor) and two anonymous referees that significantly improved the paper. We are also grateful to Tong Yu, Wenxuan Hou, Yawen Jiao, Liu Yang, Zhen Wang, and session participants at the 2011 China International Finance Conference, and the second EJF special issue on Chinese capital market conference for many valuable suggestions. Financial supports from Summer Faculty Research Fellowship at Siena College and National Natural Science Foundation of China (No. 71272037) are gratefully acknowledged.

Notes

1. In recent years, the exploitation of minority shareholders by large shareholders has attracted widespread attention. Johnson et al. (2000) coined the term ‘tunneling’ to describe asset appropriation by large shareholders, who legally or illegally transfer assets and profits to themselves. They found that unrestrained tunneling was the main reason for the 1997–1999 Asian financial crisis. Tunneling not only hurts the interests of small shareholders, but also seriously hinders stock market development.

2. Pinkowitz, Stulz, and Williamson (2006) use the Fama and French methodology in their cross-country study of cash, dividends, and governance. Dittmar and Mahrt-Smith (2007) use the same methodology in their study of the value effect of governance and cash resources. Both find that the effect of governance on the value of cash is of a similar order of magnitude as we find in our study.

3. For example, Atanasov (2005) estimates tunneling from the premiums paid for controlling shares. Cheung et al. (2006) estimate tunneling from a sample of connected transactions between Hong Kong listed companies and their controlling shareholders.

4. A freeze-out describes a situation where a firm is delisted due to a tender offer that is relatively low compared with the actual market value of the company, and thus negatively affects the interests of minority shareholders (Bates, Lemmon, and Linck 2006). As there is no effective delisting mechanism in China, freeze-outs are not essential. However, so-called uncompensated transactions in the case of mergers and acquisitions mainly occur when the state restructures state-owned enterprises and other related SOEs are not fully compensated for acquisitions. Dilution describes a considerable increase in equity capital (Black and Kraakman 1996). This situation is also less likely in China because the state tries to keep control of publicly listed companies and the issuance of new shares is not easily absorbed by the market.

5. The financial statements data-set of the PACAP-CCER Greater China database covers all Chinese listed firms on domestic stock exchanges since 1993 and provides a comprehensive set of financial data composed of data in balance sheets, income statements, and cash flow statements. The corporate governance data-set presents several characteristics of Chinese firms’ corporate governance, such as the type of ultimate controlling shareholder, the types of shares (such as state, legal person, and employee shares), and the percentage of shares held by the top 10 shareholders, respectively.

6. SAMBs, SOELGs, and SOECGs are directly or indirectly affiliated with the government. For example, SOECGs are state-owned enterprises directly controlled by the central government under the state-owned assets supervision and administration commission (SASAC) in China, such as Sinopec Corp. and the China Merchants Group. The number of SOECGs has been reduced from 196 in 2003, when it was first established, to 150, according to the statistics posted on the SASAC website in China. SOELGs are state-owned enterprises that are subject either directly to the supervision and management of the local government, or to the state asset management bureaus at the local government level. In terms of the number of firms, SOELGs constitute the largest group compared with firms with other types of ultimate controllers in our sample. SAMBs, such as Harbin Pharmaceutical Group and Peking University, are indirectly affiliated with the government. The managers of these firms are under threat of being replaced or suffering even worse consequences in the event of illegal or bad performance. If investors view the government as more effective than other controlling shareholders in preventing managers from extracting private benefits, then with all else held constant, the value of government-controlled firms should be higher.

7. Some firms are initially controlled by the state and then transferred to private investors. Such a transfer of ownership to a private entity is referred to as a private transfer. It is one of the three types of control transfers observed in China, as discussed in Chen et al. (2008). The other two types of ownership transfer are from state to private entity and from one unit of the state to another. The first type of transfer is rare in our sample. The second type of transfer usually represents an administrative arrangement and is not expected to have any significant effect on the market value of a firm.

8. We use the cash-to-assets ratio rather than the logarithm of the cash-to-assets ratio because cash-to-asset ratios in China are not very skewed (the mean and median of the cash-to-assets ratio are 15.49% and 12.91%, respectively, as reported in Table 2). Our results do not change significantly when we use the logarithm of the cash-to-assets ratio.

9. Dittmar and Mahrt-Smith (2007) estimate the value regression on all firms with positive excess cash. They argue that the role of governance is likely to differ for negative excess cash firms and that theories of governance and capital constraints are not as well developed as theories of governance and excess cash. Fresard and Salva (2010) claim that predictions about the roles of incentive and governance mechanisms in firms with negative excess cash are still a theoretical issue and are difficult to establish. In Section 4.4, we use all excess cash and the excess cash that exceeds the median level as alternative measures of excess cash and re-estimate the models in Table 8. The main results are largely the same as those in Table 5.

10. Sun, Tong, and Tong (2002) use the natural logarithm of annual sales revenue to proxy for firm size as a factor for the market value of the firm. We obtain similar results using this measure rather than firm size.

11. This finding contradicts Megginson and Wei (2010), who argue that the marginal value of cash declines as state ownership increases, due to the sampling difference generated by the exclusion of all dual-listed firms from our sample. Our results are consistent with those in Megginson and Wei (2010) when we include dual-listed firms. Furthermore, when we exclusively consider dual-listed firms, the negative effect is much larger. These results are provided in the appendix. We appreciate the suggestion from the referee.

12. Two types of agency problems arise due to the ownership structure in China: managers versus owners, and largest/controlling shareholder versus minority shareholders. The market valuation of excess cash mainly reflects the agency problem between the largest shareholder and minority shareholders. B/M measures the overall efficiency. In terms of B/M, SOEs are not as efficient as privately controlled firms and have severe agency problems between managers and owners. This is not in conflict with our finding that the agency problem between the largest/controlling shareholder and minority shareholders is more severe in privately controlled firms.

13. Jiang, Lee, and Yue (2010) report that the average other receivables are 8.1% with an interquartile range from 1.7% to 10.8%. Our sample shows that the interquartile range for other receivables is between 0.73% and 5.51%. This suggests that other receivables are highly skewed. In untabulated analysis, we use the logarithm of other receivables as the dependent variable in Equation (4) and find similar results.

14. Jiang, Lee, and Yue (2006) pointed out that eight government ministries issued a joint announcement, making it clear that the top management of controlling entities will face disciplinary punishment if the deadline for repayment is not met. This means, it may not be appropriate to use other receivables as the proxy of tunneling. To make sure the robustness of our results, we also perform analysis up to 2006 and find similar results.

15. The regressions of NOI are also conducted with the additional control variables suggested by Ding, Zhang, and Zhang (2007). These variables include the logarithm of the annual sales from firms’ main operations and leverage estimated as the total debt over total assets. The regressions using these variables yield similar conclusions. We do not report them because these variables are insignificant across different model specifications.