Multiple Large Shareholders, Excess Leverage and Tunneling: Evidence from an Emerging Market

• Published date: 01 January 2017
• Date: 01 January 2017
• Author: Agyenim Boateng,Wei Huang
• DOI: http://doi.org/10.1111/corg.12184

Multiple Large Shareholders, Excess Leverage and

Tunneling: Evidence from an Emerging Market

Agyenim Boateng*and Wei Huang*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Past empirical efforts in corporate governance have examined the effects of large shareholders with

excess control rights on tunneling activities. However, no study has systematically investigated the effects of multiple large

shareholders on excess leverage policies and tunneling in an emerging country environment where minority rights protection

is weak. In this study, we examine the role of multiple large shareholders and the effects of control contestability of multiple

large shareholders on f‌irm excess leverage decision and tunneling by controlling shareholders.

Research Findings/Insights: Using a sample of 2,341 Chinese f‌irms for the years 2001 to 2013, we document that the

contestabilityof multiple non-controlling large shareholders relative to controllingshareholders reduces the adoption of excess

leveragepolicies, tunneling and enhancescapital investment. Anotherintriguing f‌inding is that the government, as a c ontrolling

shareholder, exerts signif‌icant inf‌luence and reduces the monitoring effectiveness of multiple larger shareholders.

Theoretical/Academic Implications: By addressing the role of multiple large shareholders on excess leverage decisions, this

study makes an important contribution to the corporate governance literature. We extend the recent developments in agency

theory regarding the role of multiple large shareholders in constraining expropriation of controlling shareholders with excess

controlrights and their effect on f‌irm leverage decisions. Our resultssupport the theoretical modelswhich indicate that the pres-

ence of multiple largeshareholders is an important and eff‌icientinternal governance mechanism that mitigates a f‌irm’sagency

costs, particularly,in an emerging market environment where corporategovernance is weak and inadequateto curb the tunnel-

ing problem.

Keywords: Corporate Governance, Multiple Large Shareholders, Excess Leverage, Tunneling, Control and Cash Flow

Rights

INTRODUCTION

One importantaspect of the governance characteristicsof a

f‌irm is the ownership concentration. The importance

stems from the fact that concentrated ownership creates

agency problems, affects the behavior of shareholders with

implications for f‌irmvalue. In the context of emerging econo-

mies, systematic research evidence indicates that emerging

country f‌irms have concentrated ownership structures unlike

f‌irms in the United States, which are widely dispersed (see

Dharwadkar, George & Brandes, 2000; Kumar and Zattoni,

2014; La Porta, Lopez-de-Silanes & Shleifer, 1999; Morck,

Wolfenzon & Yeung, 2005). Many f‌irms across the globe, par-

ticularly those in East Asia, predominantly have single large

shareholders who exercise ultimate control, despite owning

few cash f‌low rights(Claessens, Djankov & Lang,2000; Faccio

& Lang, 2002; Young, Peng, Ahlstrom, Bruton & Jiang, 2008).

Researchers such as Laeven and Levine (2008) and Pagano

and Roell (1998) argue that ownership structure comprising

shareholders with large stakes in the company can benef‌it

minority shareholders by improving monitoring over man-

agers. However, Casado, Burkert, Davila and Oyon (2016),

Li, Lu, Mittoo and Zhang (2015), and Shleifer and Vishny

(1997) note that large shareholders can also be harmful and

create principal-principal conf‌licts (i.e. goal incongruence

among shareholder groups in a f‌irm, particularly bet ween

the controllingand minority shareholders).For example, large

shareholders with excess control rights provide large control-

ling shareholderswith incentives to extractprivate benef‌its for

themselves at the expense of other shareholders, popularly

referred to as tunneling (Young et al., 2008). Recent corporate

governance studies, such as Faccio, Lang and Young (2010)

and Liu and Tian (2012) have therefore focused on the effects

*Addressfor correspondence:Agyenim Boateng, GlasgowSchool of Business & Society,

Glasgow Caledonian University, Cowcaddens,Glasgow G4 0BA, UK.

E-mail: agyenim.boateng@gcu.ac.uk

WeiHuang, Nottingham UniversityBusiness School China

E-mail: wei.huang@nottingham.edu.cn

© 2016 JohnWiley & Sons Ltd

doi:10.1111/corg.12184

58

Corporate Governance: An International Review, 2017, 25(1): 58–74

of ownership concentration involving large controlling share-

holders on tunneling activities and f‌irms’leverage decisions.

The predominantresearch evidence is thatemerging economy

f‌irms withexcess control rights vestedin the controlling share-

holders use highexcess leverage as a channel toplace more re-

sources at their disposal to facilitate tunneling activities

(Buchuk, Larrain, Muñoz & Urzúa, 2014; Claessens et al.,

2000; Claessens, Djankov, Fan & Lang, 2002; Faccio & Lang,

2002; Jiang, Lee & Yue, 2010; Liu & Tian, 2012; Paligorova &

Xu, 2012; Qian & Yeung, 2015).

The prevalence and severity of tunneling activities, as mea-

sured through intercorporate loans, of controlling share-

holders (Cheung, Rau & Stouraitis, 2006; Peng, Wei & Yang,

2011),and the inadequacy of existinglaws to curb the problem

are well documentedin many emerging countries(see Buchuk

et al., 2014and Jiang et al., 2010 for reviews).Thus, it is not sur-

prising that a number of studies have sought to explain the

potential corporate governance role of multiple large

shareholders in curbing the expropriations of controlling

shareholders (Attig, Guedhami & Mishra, 2008; Casado

et al., 2016; Laeven & Levine, 2008; Maury & Pajuste, 2005).

However, notable contributions in the recent literature have

focused on the presence and effects of multiple (non-control-

ling) large shareholders with respect to two issues: the cost

of capital and corporate valuation (see Attig et al., 2008;

Laeven & Levine,2008; Maury & Pajuste, 2005).To our knowl-

edge, no study has systematically investigated the direct

effects of multiple large shareholders on excess leverage deci-

sions and the effect of their role in constraining the extraction

of private benef‌its by controlling shareholders. However, it is

argued that multiple large shareholders constitute the extent

of ownership dispersal and their presence may engender con-

trol contestability relativeto the controlling shareholders, a sit-

uation that maylead to eff‌icient monitoring (Attig,El Ghoul &

Guedhami, 2013; Maury & Pajuste, 2005; Pagano & Roell,

1998). The theoretical view regarding the benef‌its of multiple

large shareholders indicates that they play a vital monitoring

role in curbing the extraction of private benef‌its (Attig, El

Ghoul & Guedhami, 2009, 2013). For example, Pagano and

Roell (1998) note that multiple large shareholders increase

the contestabilityof the largest shareholder’s control and that

they are more likely to reduce the potential to extract private

benef‌its fromthe f‌irm at the expense of minority shareholders.

This articledeparts from prior studies, whichhave either fo-

cused on the effects of multiple large shareholders on corpo-

rate value or the general economic benef‌its of multiple large

shareholders,by examining the effects of multiplelarge share-

holders on f‌irms’excess leverage decisions and how their

contestability relative to controlling shareholders may miti-

gate tunneling activities. Specif‌ically, we attempt to answer

the following question: Can the excess leverage policy often

adopted as a vehicle for tunneling through intercorporate

loans be alleviated by multiple (non-controlling) large share-

holders? We focus on excess leverage because prior studies

such as Lin, Ma, Malatesta and Xuan (2011), Paligorova and

Xu (2012), and Qian and Yeung (2015) note that the adoption

of excess leverage policies provides a primary vehicle for con-

trolling shareholders with excess control to divert resources

from the f‌irm for their private benef‌it rather than investing

in projects withpositive net present value. Moreover, in an en-

vironment where corporate governance is weak, excess

leverage is more likely to be used in a discretionary manner

(Luo, Wan & Cai, 2012; Paligorova & Xu, 2012).

China is selected for this study for two reasons. One,

concentrated ownership, which is the root cause of principal-

principal conf‌licts, is common among publicly traded

companies in most Asian countries (Djankov, La Porta,

Lopez-de-Silanes & Shleifer, 2008; Gedajlovic, Lubatkin &

Schulze, 2004). Moreover, ownership concentration in public

companies is pronounced, and all Chinese listed f‌irms have

controlling shareholders and multiple non-controlling large

shareholders (Jiang et al., 2010). Two, the poor market-based

institutional framework for internal and external governance

such as the weak nature of the board of directors, the ineffec-

tive market for corporate control and the weak legal system,

which offers less institutional protection for minority share-

holders and provides them with relatively few avenues for

private enforcement, make tunneling a frequent occurrence

(Allen, Qian & Qian, 2005; Cheung et al., 2006; Jiang et al.,

2010; La Porta, Lopez-de-Silanes, Shleifer & Vishny, 2002;

Qian & Yeung, 201 5).

This study makes an important contribution to the corpo-

rate governance literature in the following way. We extend

the recent literature regarding the role of multiple large

shareholders in constraining expropriation of controlling

shareholderswith excess control rights and theireffect on f‌irm

leverage decisions. In particular, we provide one of the f‌irst

attempts to examine the effects of contestability of multiple

large shareholders on excess leveragedecisions and tunneling

activities, thereby extending the evidence of Jiang et al. (2010)

and Liu and Tian (2012), who examined the role of controlling

shareholders on excess leverage and tunneling through inter-

corporate loans.We document that thecontestability of multi-

ple (non-controlling) large shareholders relative to controlling

shareholders reduces the adoption of excess leverage and

tunneling. Our f‌indings appear robust in all modelsafter con-

sidering excess control rights and the type of controlling

shareholder. Our results support the theoretical models,

which contend that the presence of multiple large share-

holders is an important internal governance mechanism that

mitigates a f‌irm’s agency costs, particularly, in an emerging

market environment where corporate governance is weak

and inadequate to curb the problem of tunneling.

This paper is structured as follows. The next section

presents background information on ownership structure in

China, reviews the related literature and develops the

hypotheses of the study. The third section presents the data

and methodologyof the study,and this is followed by analysis

and discussions of our results in the fourth section. The f‌inal

section presents the paper’s conclusions.

LITERATURE REVIEW AND HYPOTHESES

DEVELOPMENT

Firm Ownership Structure in China

Prior to the inception of enterprise reforms in the mid-1980s,

state ownership was the main form of f‌irm ownership in

China. The reforms started gradually and accelerated in the

1990s, following the establishment of the Shanghai and

Shenzhen Stock Exchanges in 1990 and 1991. The stock

59LARGE SHAREHOLDERS, EXCESS LEVERAGE,AND TUNNELING

© 2016 JohnWiley & Sons Ltd Volume 25 Number 1 January 2017