Buying gold at the price of silver? Controlling shareholders and real estate transactions in korean listed firms

• Author: Dong‐Ryung Yang
• Date: 01 May 2017
• Published date: 01 May 2017
• DOI: http://doi.org/10.1111/corg.12193

SPECIAL ISSUE ARTICLE

Buying gold at the price of silver? Controlling shareholders and

real estate transactions in korean listed firms

Dong‐Ryung Yang

Seojeong College, Eunhyun‐myeon, Yangju,

Kyunggi 11429, South Korea

Correspondence

Dong‐Ryung Yang, Seojeong College,

Eunhyun‐myeon, Yangju, Kyunggi, 11429,

South Korea.

Email: dongryung.yang@gmail.com

Abstract

Manuscript Type: Empirical

Research Question/Issue: This paper examines real estate transactions among Korean

listed firms, their affiliated companies and controlling shareholders from 1999 to 2011. The goal

of this study is to test whether the controlling individuals gain higher returns from the trades than

the other parties in a persistent manner.

Research Findings/Insights: Investigating price changes across the transactions reveals

that the controlling shareholders consistently earn higher returns than the listed firms, while this

is not the case for the affiliated firms. The listed firms, in expectation of bleak potential in value

growth, acquire real estate properties from their controlling shareholders while disposingof prop-

erties with promising prospect of growth in value. When the listed firms either buy or lease a

property from controlling shareholders, the market value of the acquired property increases less

than the leased.

Theoretical/Academic Implications: All of the findings confirm a tunneling nature of the

listed firms’real estate transactions with their controlling shareholders.

Practitioner/Policy Implications: The findings show a possibility that listed firms and the

controlling shareholders can plot property transactions so as to offer biased profits for the indi-

viduals at the expense of minority shareholders. Such profitability becomes viable by manipulat-

ing transaction timing and does not necessitate predatory pricing of the assets transferred.

KEYWORDS

corporate governance, real estate, relatedparty transaction, tunneling

1|INTRODUCTION

Tunneling is the transfer of resources out of a company to its control-

ling shareholders (Johnson, La Porta, Lopez‐de‐Silanes, & Shleifer,

2000). Therefore, to show that a certain transaction type should be

considered as tunneling, it is essential to demonstrate that the control-

ling shareholder, as an individual, benefits from the transaction.

The existing literature selects related party transactions (RPT)

1

as

one of the possible tunneling channels shareholders use to extract cor-

porate resources. The literature uncovers the tunneling nature of RPTs

mostly in two ways. First, minority shareholders are reported to lose

their value of equity holdings upon the negative market reaction

against RPTs (Cheung, Raghavendra Rau, & Stouraitis, 2006; Kohlbeck

& Mayhew, 2010). The other stream of articles shows that transaction

terms are set to be biased in favor of related parties, as opposed to

comparable arm's length transactions (Cheung, Qi, Raghavendra Rau,

& Stouraitis, 2009).

Although the two empirical methodologies find convincing, sys-

temic evidence of the tunneling nature of RPTs, the practices involve

assumptions that are indispensable for their arguments. To link the neg-

ative market reaction to the tunneling requires an assumption that the

stock market can accurately differentiate deals beneficial to a firm from

those that are not. Existing literature reports instantaneous negative

market reaction to prospective tunneling transactions. However, the

immediate unfavorable market reaction does not guarantee the long‐

term value destruction of the firm conducting the transactions. It is still

probable that a deal regarded as hazardous upon initial announcement

might turn into a value‐creating transaction in the long run.

Empirical studies focusing on the fairness of transaction price

show biased price conditions embedded in RPT relative to arm's length

Received: 9 September 2015 Revised: 2 November 2016 Accepted: 18 December 2016

DOI: 10.1111/corg.12193

200 © 2016 John Wiley & Sons Ltd Corp Govern Int Rev. 2017;25:200–218.wileyonlinelibrary.com/journal/corg

deals of a similar kind. The rationale behind the inference is that firms

pay more for the acquisition from related parties while receiving less

for the disposition than in arm's length transactions. The rationale

assumes that the rate of return on the assets transferred should be

identical, or similar, between the buyer and the seller in the transac-

tions. Skeptics may argue that the underpaid disposals are not value‐

destructive when the selling party does not make the most out of

the assets. In other words, a new owner may be able to enhance the

value of the disposed‐of assets and create a higher return on invest-

ment. In that case, the prospective tunneling activities through the

asset transactions turn out efficient asset reallocation within a busi-

ness group (Gordon, Henry, & Palia, 2004). Likewise, overpaid asset

acquisition is justified by the possibility that the acquired asset would

be better used and, hence, yields a higher rate of return under the con-

trol of a new owner.

The reason tunneling inferred from the biased price conditions

becomes vulnerable is that measuring the returns on assets, depending

on who operates them, is neither possible nor accurate. When a trans-

action is about trading a corporate entity, subsequent value changes are

not guaranteed to result from tunneling, because operational improve-

ment or additional acquisition might have brought the changes. In

another case, when specific fixed assets, such as high‐priced machinery

or production facilities, are traded, ex post price changes are neither

obtainable nor reliable due to the different level of care taken and the

depreciation of which magnitude varies depending on the care.

This paper proposes to study real estate transactions between

public firms and their related parties as a new way of investigating

expropriation mechanisms by RPT and argues that the new method

is more immune to the understandable criticism of the current litera-

ture linking RPT to the tunneling framework. The new method delivers

immunity because the real estate asset class contains several desirable

characteristics useful in studying the mechanism. First, the real estate

asset exists as a pure, stand‐alone entity, and any subsequent price

change cannot be caused by additional mergers or acquisitions. Sec-

ond, real estate property is the only asset class whose value does not

depreciate over time, which eliminates the concern that unbalanced

price changes among two real estate properties are the result of differ-

ent levels of care and ensuing depreciation. Finally, unlike other fixed

assets, real estate items allow pricing per comparable unit; for example,

pricing per square meter enables the comparison of prices of different

items in a standardized manner.

For a regional consideration in this paper, Korea is selected

because it is one of the countries where a handful of controlling share-

holders manage multiple firms with minimal cash flow rights, leaving

significant incentives to expropriate their firms (La Porta, Lopez‐de‐

Silanes, & Shleifer, 1999). More importantly, the Korean government

authorities make public historical price change data for all registered

real estate properties, dating back to 1990, which provides significant

data advantage for an empirical study of this kind. In this paper, the

officially assessed land price (OALP) announced annually by the

Korean Ministry of Land, Infrastructure and Transport (MOLIT) is used

in tracking price changes. Although the way the OALP is constructed is

presented in more detail in later sections, previous real estate literature

(Geltner, MacGregor, & Schwann, 2003) also asserts that the changes

in OALP can be used for market tracking.

For most of the empirical studies in this paper, comparisons are

conducted between the affiliated companies of public firms and the

firms’controlling shareholders. This setting offers a more intensive test

protocol than a study focusing on arm's length transactions, because

the affiliated companies are somehow related to the controlling indi-

viduals and are less likely to become scapegoats for the tunneling moti-

vation than an unrelated third party.

Prices of real estate assets can vary, depending on how efficiently

asset owners operate the properties like other asset classes. This is the

issue that previous literature, finding biased price conditions within the

RPT, does not examine and the prospect that implicitly assumes that

the operational efficiency is equal among counterparties. In this sense,

different levels of returns between the controlling shareholders and

the public firms may stem from the fact that either the shareholders

or the firms are superior in real estate development. Although it seems

reasonable that corporations in general are superior to (controlling)

individuals in developing properties due to greater resources and bet-

ter financing capacity, this paper actually tests and confirms that com-

panies indeed excel in such development. This finding refutes a

plausible counterargument that a real estate property is disposed of

to a controlling shareholder because the individual is better at using

assets. Likewise, it becomes no longer valid to argue that companies

take over unpromising assets from the controlling shareholders

because the firms are more capable of handling the properties. If this

is the case, the returns on assets should be higher under the control

of the firms than under the individuals’supervision. The empirical stud-

ies in Table 6 report the opposite findings.

The main attribute that this paper uncovers about real estate

transactions between public firms and their controlling individuals is

that the individuals become consistent winners from the trades. The

individuals dispose of assets only after realizing decent returns,

whereas the assets record poorer returns when the firms take control

of the properties. In the same vein, the assets rise more in price only

after they are transferred to the individuals, whereas the properties

do not rise much in value before the trades. As already noted by the

existing literature (Cheung et al., 2009), preferential price conditions

toward the controlling shareholders may deliver different returns

between the firms and the individuals.

Another possibility first raised by this paper is the timing of the

trades. Controlling shareholders and the firms under their supervision

cautiously set up the timing of the transactions so that the controlling

individuals maximize their returns. For the individuals’acquisitions of

assets, which later turn out to be “crown jewels,”trades are executed

in advance of price‐boosting news, whereas the individuals sell their

properties late enough for the market to reflect the news fully. With

ill‐judged real estate investments showing no potential for imminent

value appreciation, the controlling shareholders execute their escape

plan by dumping the properties on the firms under their control. All

of the cases help the controlling shareholders become inevitable win-

ners even without favorable price conditions. Although the price con-

ditions set to benefit the controlling shareholders are easier to detect

at the point of each transaction, the use of transaction timing keeps

the shareholders’motivation clandestine for a while because the

trades do not turn out to be beneficial to the individuals until a few

years later. The possibility that public firms and their controlling

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