Transcript Does Legal Protection of Minority Shareholders Affect the

Does Legal Protection of Minority
Shareholders Affect the Variation of
Ownership Concentration in China?
Nianhang Xu and Shinong Wu
Discussed by Oliver Rui
Chinese University of Hong Kong
Corporate Governance Research Incubator
2005 Shanghai
1
What does this paper study?
 This paper examines the effect of legal
protection of minority investors on the
ownership concentration of listed
companies in China for the period from
1990 to 2003.
 The legal protection of minority investors is
measured by legal score and ownership
legal score based on laws and regulations.
Corporate Governance Research Incubator 2005
Shanghai
2
What are the main findings?
 Both legal enforcement and legal rules do
not affect initial ownership concentration
and the variation of ownership concentration
after listing.
 In the well-developed stage of legal
protection of minority investors, the relation
between legal rules and the initial ownership
concentration is significantly negative.
Corporate Governance Research Incubator 2005
Shanghai
3
Law and Finance Approach
 The “law and finance” theory stresses the importance
of legal protection of investors for the development of
capital markets, and argues that legal protection is
ultimately a by-product of the country’s legal origin.
 The intuition is that investors are not willing to provide
equity to finance a firm unless they are confident of
receiving a fair return from their investment. If
shareholder protection is low, minority shareholders
require a high return from their investment to
compensate them for the high risk of expropriation by
the management/controlling shareholder.
Corporate Governance Research Incubator 2005
Shanghai
4
Law and Finance Approach
 The “law and finance” approach predicts that
companies in countries with lower investor
protection and civil law are characterized by
greater ownership concentration and more
pyramidal groups than companies in countries with
common law and higher investor protection.
 La Porta et al. (1998) find that the quality of legal
protection of shareholders helps determine
ownership concentration: in countries with
relatively poor legal protection of investors, publicly
listed companies are likely to have large blockholders.
Corporate Governance Research Incubator 2005
Shanghai
5
Law and Finance Approach
 Coffee (2001b) ponders whether La Porta et
al’s empirical findings of a link between legal
and protection of investors and ownership
structure may actually reflect the reverse
causal relationship: that strong markets
came first and created a demand for
stronger laws to protect the constituency of
investors who had entered those markets.
Corporate Governance Research Incubator 2005
Shanghai
6
Law and Finance Approach
 The classification of countries based on
the legal rules for protecting minority
shareholders may be endogenous. In
particular, countries with economically
and politically powerful controlling
shareholders may enact laws that
entrench such shareholders and reduce
minority rights.
Corporate Governance Research Incubator 2005
Shanghai
7
Law and Finance Approach
 The results might be a spurious consequence of an
association between minority shareholder protection
and the more general structure of financial system.
Thus, firms in bank-centered financial systems might
rely on debt finance, making it unnecessary for
controlling shareholders to sell their equity to raise
funds, but also making legal rules protecting minority
shareholders less essential. In contrast, firms in
market-centered financial systems rely on equity
finance, forcing founders to give up control to raise
capital, as well as making the protection of minority
shareholders necessary.
Corporate Governance Research Incubator 2005
Shanghai
8
Time-series approach
 Ownership of corporation in the UK is dispersed
among large number of individual and institutional
investors. Consistent with the law and finance view,
dispersed ownership in the UK today is associated with
a high level of investor protection.
 Recent work by Franks, Mayer and Rossi (2004) has
provided some insights into how this occurred in the
UK. They record that dispersed ownership emerged in
20th century Britain when insider and family share
ownership was rapidly diluted by share issuance to
fund growth through acquisitions. Regulation on its
own is unlikely to be an adequate explanation for
dispersed ownership in the UK.
Corporate Governance Research Incubator 2005
Shanghai
9
Time-series approach
 Ownership of corporation in Germany is today highly
concentrated in the hands of families and other
companies. By international standards investor
protection is weak in Germany today. According to
the law and finance theory, that is consistent with
current high levels of concentration of ownership.
 Franks, Mayer and Wagner (2005) provides the longrun study of ownership and control of German
corporations by assembling data on the ownership
and financing of firms from samples spanning almost
a century from 1860 to 1950.
Corporate Governance Research Incubator 2005
Shanghai
10
Time-series approach
 At first sight, German financial markets look very
similar to their UK counterparts. There were a
large number of firms listed on German stock
markets and firms raised large amounts of equity
finance. This runs counter to the conventional
view of Germany as a bank oriented financial
system. Firms raised little finance from banks
and surprisingly large amounts from stock
markets.
Corporate Governance Research Incubator 2005
Shanghai
11
Institutional setting in China
 In China, ownership concentration is a choice by
the government, not a voluntary choice by private
owners.
 Most of listed firms in China are those that have
been carved out from existing state-owned
enterprises. To maintain the state’s control on the
listed firms, Chinese Company Law regulates that
shares subscribed by parent SOEs cannot be less
than 35% of their outstanding shares when the
companies went public. To prevent the sales off of
state-owned assets, all state shareholdings are
non-tradable.
Corporate Governance Research Incubator 2005
Shanghai
12
Methodology
 The paper finds that the relation between
legal rules and the initial ownership
concentration is significantly negative
between 1999 and 2003. Since the legal
scores is constant each year and there are
only 4-year data, I am not sure how to
interpret the coefficient and how reliable the
finding is.
Corporate Governance Research Incubator 2005
Shanghai
13
Methodology
 The dependent variables (H5, CR5 and CR1)
are bounded between 0 and 1. I suggest use
fractional response variable technique described
by Papke and Wooldridge (1996). The quasilikelihood estimation suggested by Papke and
Wooldridge has the advantage over the more
common logistic transformation.
 Papke, L.E. and J.M. Wooldridge (1996),
Econometric methods for fractional response
variables with an application to 401(K) plan
participation rates, Journal of Applied
Econometrics, 11, 619-632.
Corporate Governance Research Incubator 2005
Shanghai
14
Methodology
 Table 6 examines how the nature of the
controlling shareholders affects the relation
between legal protection of minority investors
and ownership concentration after listing. I think
the interactive terms between types of
controlling shareholders and ownership
concentration should be included in the
analysis.
Corporate Governance Research Incubator 2005
Shanghai
15
Methodology
 I think the sub-sample of non-state-controlled
companies studied in table 7 deserves further
research because the ownership concentration
of private firms is less subject to the
government’s restrictions.
Corporate Governance Research Incubator 2005
Shanghai
16
Political Economy Approach
 The “political economy” view posits that financial
development is the outcome of political decisions. If
compared with the law and finance approach, this
theory is very dynamic in nature, since changes of the
political power of different constituencies can alter the
disposition of a country towards financial development.
As with any political decision, financial development is
the outcome of ideology and the economic interests of
voters and pressure groups. Rajan and Zingales (2002)
argue that the stock market can be fostered or
hampered by government action depend upon the
balance of powers between pressure groups.
Corporate Governance Research Incubator 2005
Shanghai
17
Political Economy Approach
 The “political economy” view predicts that
ownership should be more concentrated and
companies should be organized into groups in
countries where the government has a big role
in the economy. The intuition is in Pagano and
Volpin (2001). When the state has a great
involvement in the economy, firms need political
support to grow. Hence, to maximize their
political clout, businessmen need to maximize
the value of assets under their control. With
concentrated ownership and pyramidal groups,
both goals are attained.
Corporate Governance Research Incubator 2005
Shanghai
18