Insider Ownership, Subsidiary Cash Holdings, and Economic Consequences: Evidence from Listed Chinese Companies

ABSTRACT

Using a large sample of listed Chinese companies, we investigate how the equity ownership of business group insiders affects subsidiary cash holdings. We find that ownership by the largest shareholders and senior managers in the listed parent firm is negatively related to its subsidiaries’ cash holdings, whereas there is a positive relationship with minority equity in subsidiaries. We also find that the market places a more significant value discount on listed firms whose cash holdings are more located in the affiliated subsidiaries. Our evidence demonstrates how cash policy inside business groups is influenced by insider ownership, and it reveals to what extent cash allocated in subsidiaries may suffer from losses in efficiency.

KEY WORDS:

• cash holdings
• economic consequences
• efficiency loss
• insider ownership
• internal capital market

Notes

1. In our random selection of 100 firms, of all A shares in the Chinese stock market in 2006, only one subsidiary of one firm is not in the form of limited liability company.

2. Compared with an M-formed conglomerate, the internal capital market inside the pyramid organizational groups in our study should endure more conflicts of interest because various legally independent entities are involved.

3. In Chinese SOEs, the ownership of managers is significantly less than their counterpart in non-SOEs. Even in non-SOEs, senior managers’ ownership is relatively very low (with a mean of 4.4 percent). Thus, our definitions of CONT and MANA are not supposed to have severe collinearity problems. We also test the variance inflation factor (VIF) in our regression. The largest factor equals 1.908, indicating our results are not driven by collinearity issues.

4. Admittedly, the way we measure SAS would underestimate the size of the total subsidiaries’ assets. Because very few subsidiaries of listed firms in China are publicly traded, accurately estimating their size is difficult. However, this underestimation should not systematically bias our conclusion.

5. All variables in Model 2 are calculated using financial figures from the listed firms’ consolidated financial statements, except for cashdisp. According to Yang et al. (2008), the value of nontradable shares in China approximates 45 percent of the value of their publicly traded counterparts. We also follow Bai et al. (2004) in our robustness checks, using a value discount of 70 percent; the results remain qualitatively unchanged.

6. Collective parent financial statement data are available only in this database, whereas other data sources in China, such as CCER Sinofin and CSMAR (China Security Market Accounting Research), offer only consolidated figures.

7. The Sinofin database is widely used in Chinese finance and accounting research. We also use the CSMAR database to test our main results and reach similar conclusions.

8. Model 2 involves observations for a leading year and a following year, and thus, the observations adopted in this section actually involve the period 2002–7.

9. The reason for the insignificance of MANA for SOE may likely be that only a few SOEs offer stock to their senior managers.

Additional information

Funding

The authors appreciate financial support from National Natural Science Foundation of China (Approval No. 71202030, and 71132004), and the Fundamental Research Funds for the Central Universities-China.