The role of managerial ownership in dividend tunneling: Evidence from China

• Published date: 01 March 2023
• Author: Huan Bian,Jing‐Ming Kuo,Hui Pan,Zhuang Zhang
• Date: 01 March 2023
• DOI: http://doi.org/10.1111/corg.12478

ORIGINAL ARTICLE

The role of managerial ownership in dividend tunneling:

Evidence from China

Huan Bian

1

| Jing-Ming Kuo

2

| Hui Pan

3

| Zhuang Zhang

4

1

Huarong Fund Management Co. Ltd., Beijing,

China

2

Birmingham Business School, University of

Birmingham, Birmingham, UK

3

Coventry Business School, Coventry

University, Coventry, UK

4

Southampton Business School, University of

Southampton, Southampton, UK

Correspondence

Jing-Ming Kuo, Birmingham Business School,

University of Birmingham, Birmingham B15

2TT, UK.

Email: j.kuo.2@bham.ac.uk

Abstract

Research Question/Issue: We examine the role of corporate executives in dividend

tunneling activity by controlling shareholders and whether the correlation between

executive ownership and dividend tunneling is influenced by internal and external

governance mechanisms.

Research Findings/Insights: We find increased executive ownership may lead to a

higher level of dividend tunneling. This is further strengthened by our finding that

the positive effect of executive ownership on dividend tunneling is more pronounced

for firms with weaker minority shareholder protection. In addition, our results show

that higher degrees of state ownership may further intensify this positive association.

Finally, we find that analyst coverage has a moderating effect and constrains the collu-

sion between controlling shareholders and executives in dividend tunneling activity.

Theoretical/Academic Implications: Our study contributes to the literature on the

role of managerial ownership in controlling shareholders' dividend tunneling activity.

We fill a gap in the literature on the corporate agency problem by providing evidence

that dividends have been employed by controlling shareholders as a means of tunnel-

ing and that executives with higher ownership are more likely to collude with control-

ling shareholders in dividend tunneling activities.

Practitioner/Policy Implications: This study contributes to the debates around the

promotion of the cash dividend policy in China, as our findings show that cash divi-

dends are used as a tunneling vehicle. Providing important evidence to regulators,

our findings support the argument that external monitoring by financial analysts can

effectively constrain dividend tunneling by dominant shareholders, especially in the

context of emerging stock markets with high ownership concentration, weak minor-

ity shareholder protection, and an underdeveloped legal system.

KEYWORDS

corporate governance, dividend tunneling, managerial ownership, state ownership, financial

analysts

Received: 3 March 2021 Revised: 11 April 2022 Accepted: 7 June 2022

DOI: 10.1111/corg.12478

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium,

provided the original work is properly cited.

© 2022 The Authors. Corporate Governance: An International Review published by John Wiley & Sons Ltd.

Corp Govern Int Rev. 2023;31:307–333. wileyonlinelibrary.com/journal/corg 307

1|INTRODUCTION

Tunneling, a specific type of financial fraud, is a phenomenon by

which controlling shareholders use their power to expropriate minor-

ity shareholders (Johnson et al., 2000). Although tunneling cannot be

directly observed, prior studies have found activities associated with

tunneling behavior by controlling shareholders, such as advantageous

transfer pricing to parties related to controlling shareholders, execu-

tive perquisites, excessive compensation, loan guarantees, directed

equity issuance, favorable lending terms, and outright theft of corpo-

rate assets (Faccio et al., 2001; Johnson et al., 2000; La Porta

et al., 2000; Shleifer & Vishny, 1997). Jiang et al. (2010) point out that

the salient institutional features of Chinese stock markets, including

high ownership concentration, weak minority shareholder protection,

and the under-developed legal system, facilitate tunneling activities

by controlling shareholders. In particular, they revealed that the scale

of the tunneling in China is astonishing, based on evidence that over

one-third of Chinese listed firms had suffered expropriation via inter-

corporate loans. In 2006, the China Securities Regulatory Commission

(CSRC) developed regulations to completely ban controlling share-

holders from making intercorporate loans. Given that the motivators

behind tunneling activity in China, being deeply rooted within the

nature of the institutional settings, were not eradicated, we expect

that controlling shareholders will seek alternative vehicles for tunnel-

ing, and dividend tunneling may have become the prevailing form of

expropriation especially after the intercorporate loan ban of 2006.

Due to the distinctive features of the institutional landscape of

Chinese listed firms, prior studies indicate that tunneling behavior has

not been eliminated in China after the introduction of the intercorpo-

rate loan regulations in 2006 (Allen et al., 2005; Bai et al., 2004;

Braendle et al., 2005; Fan et al., 2007; Kuo et al., 2014). Huang (2016)

finds that the balance of outstanding related-party loan guarantees, as

a measure of tunneling, even increased after China's 2008 enterprise

income tax reform. More importantly, prior studies indicate that con-

trolling shareholders in Chinese listed firms routinely enjoy absolute

control over the decision-making of executive appointments, remu-

neration, and dismissals (Conyon & He, 2011; Firth et al., 2006b). In

the same vein, Zhang et al. (2014) find that concentrated ownership

reduces executives' performance-based incentives, so managers may

be driven to collude with controlling shareholders in tunneling activi-

ties. Although the direct impact of ownership and identities of con-

trolling shareholders on tunneling activity have been addressed in the

literature, the understanding of the influence of executive ownership

remains limited, particularly in the context of emerging markets.

In addition, dividends may have been used as a means of tunnel-

ing by controlling shareholders. Atanassov and Mandell (2018) indi-

cate that master limited partnerships (MLPs) with weaker corporate

governance mechanisms tend to have more dividend tunneling. Chen

et al. (2009) find evidence of dividend tunneling by controlling share-

holders through investigating the relationship between IPO price dis-

counts of non-tradable shares and firms' dividend payouts in China.

Lv et al. (2012) indicate that dividend tunneling increases in firms with

weaker minority shareholder protection in the Chinese stock markets.

Moreover, in October 2008, the CSRC issued new regulations govern-

ing dividend payments, which specify that total cash dividend in the

previous 3 years should be above 30% of the average annual distribu-

table profits during the same period, with the intention of protecting

the interests of minority shareholders in China.

1

In November 2013,

further guidance was issued to protect minority shareholders and

request that they should be sufficiently consulted before any changes

to a current dividend policy. It was also designed to encourage firms

to adopt cash dividends in rewarding shareholders so long as the con-

ditions are met for this.

2

These previous findings in dividend tunneling and the promotion

of cash dividend policy have inspired us to conduct further investiga-

tion into dividend tunneling in the Chinese stock markets. We aim to

fill a gap in the literature on the corporate agency problem by examin-

ing the role of corporate executives in dividend tunneling activities by

controlling shareholders and whether the correlation between execu-

tive ownership and dividend tunneling is influenced by internal and

external governance mechanisms.

In this study, we investigate the impact of managerial ownership

on divided tunneling using firm-year observations of Chinese listed

firms between 2003 and 2020. Prior literature suggests that the Type

I agency problem can be partly resolved by increasing executive own-

ership in firms when the ownership is low (Claessens &

Djankov, 1999; Core & Larcker, 2002; Denis et al., 1997a,1997b;

McConnell et al., 2008; Morck et al., 1988; Shuto & Takada, 2010;

Zhou, 2001; among many). However, the role of executive ownership

in the Type II agency problem regarding the conflicts of interests

between controlling and minority shareholders has not been fully

addressed.

3

Our results show that dividend tunneling is positively

related to executive ownership. The finding implies that executives

may collude with controlling shareholders and extract resources

through dividend payouts for the interests of controlling shareholders

under the institutional settings of Chinese stock markets.

Lv et al. (2012) claim that dividend payment may be used as a

vehicle for tunneling by controlling shareholders to extract corporate

resources for their own benefit when the level of minority shareholder

protection, measured by the shareholder balancing mechanism (SBM),

is lower. In line with this argument, our results further show that the

positive correlation between executive ownership and dividend

tunneling is more pronounced for firms with weaker minority share-

holder protection. Our results offer further support to the finding that

a more balanced ownership structure can limit expropriation from

majority shareholders (Berkman et al., 2009; Maury & Pajuste, 2005).

We also examine whether dividend tunneling has been employed

as a substitute for the major tunneling activity, intercorporate loans,

in the Chinese stock markets. In particular, it is noteworthy that inter-

corporate loans have been restricted by the CSRC since 2006. Jiang

et al. (2010) provide evidence of tunneling via intercorporate loans,

but they believe the magnitude of the overall problem to be certainly

greater. Given that the incentives of controlling shareholders to

expropriate from minority shareholders are not eliminated, controlling

shareholders may use dividends as new means of tunneling. Our

results suggest that dividend tunneling has been used as a substitute

308 BIAN ET AL.