Institutional Environment, Corporate Governance And Expropriation

Since the 1997 East Asian financial crisis, corporate governance and investor protection have received much attention of researchers. The research of La Porta et al. suggests that the legal protection of minority shareholder is quite different among countries, and finally affects the development of capital markets, corporate governance and firm value. Their research says the first word of a new area-"law and finance", and also change the traditional corporate finance and accounting research to"new institutional accounting research". This perspective is very important for China, because China is currently in transition. On the one hand, controlling shareholder is very popular in China, and the decisions of listed companies are almost all made by their controlling shareholder. And on the other, the legal environment of China is quite weak, especially local governments may protect the listed companies in their regions. This institutional setting make the controlling shareholder have both ability and incentive to expropriate outside minority shareholders. Based on the theoretical framework of LLSV and the institutional background of today's China, this paper examines the monitoring effects of institutional environment and corporate governance for controlling shareholder's expropriation.In chapter 2, I describe some basic characters of the institutional background of current China. Since the transition of planned economy to market oriented economy in China has lasted only about 30 years, the overall legal protection of investors is very weak, the IPO and SEO of stock market is highly regulated, the operation of listed companies is much intervened by local government, the development of different regions is quite unbalanced and the corporate governance arrangement of listed companies is just in the beginning and needs a long way to go. These characters are the practical foundations of further theoretical and empirical analysis.In chapter 3, I review the related literature of institutional environment, corporate governance and expropriation. From these literatures, I get the following implications. First, the research of corporate finance and accounting has been opened to a deeper perspective, and the importance of institutional environment has been accepted by academia. Second, researchers have developed different measures of institutional environment, such as the legal origins of different countries and the development level of different regions in one country. Third, in traditional corporate finance and accounting research, the corporate governance arrangement, especially the ownership structure and board attributes are important for corporate behavior, and this relationship is also affected by institutional environment. Fourth, the stakeholder that has the residual control rights can make corporate decisions for their own benefits, not for the benefits of all shareholders. If the ownership is diffused, the management of the firm has the residual control rights, if there is a controlling shareholder, the residual control rights belong to the controlling shareholder. Fifth, expropriation is popular around the world and can take place by various means. If the legal protection of outside shareholders is much weaker, the means of expropriation is more obvious and the extent of expropriation is much greater.Based on institutional background of China and the theoretical framework of related literatures, I first describe the concept of expropriation and analyze its underlying reasons in chapter 4. A simple example is given to illustrate more directly the concept of expropriation. I also expand the basic LLSV model by separating the different effects of institutional environment and corporate governance, and analyze how these two factors would affect the expropriation by controlling shareholder. The expanded model gives two conclusions: (1) the better the institutional environment, the less the controlling shareholder would expropriate; (2) the better the corporate governance, the less the controlling shareholder would expropriate. These two conclusions constitute the foundation of further hypothesis development in empirical analysis chapters. The research design is also discussed in this chapter. I discuss the proxies for all the parameters in the above theoretical model and outline the research design of empirical analysis chapters. Particularly, based on the regulation environment, I argue that the balance of"other receivables"account is a better measure of the extent of expropriation by controlling shareholder in China.In chapter 5, I examine the expropriation by controlling shareholder of the listed companies in China's stock market, and test the above two theoretical conclusion in chapter 4. For Institutional environment, I focus both the cross-sectional and time-series differences of institutional environment. On the one hand, the cross-sectional difference is the difference of market development of all provinces. On the other, based on the regulatory changes of China's stock market, I divide the sample period into three different periods: weak regulation, strong regulation and non-tradable shares reform. This is the time-series difference of institutional environment. For corporate governance, I focus ownership structure and board attributes. The empirical results of this chapter give strong evidence to the theoretical conclusion: both better institutional environment and better corporate governance can limit the extent of expropriation by controlling shareholder of listed companies in China. Especially, the results suggest that in weak regulation period and non-tradable shares reform period, the effect of corporate governance is not significant, but in strong regulation period, the effect of corporate governance is quite significant. Based on this evidence, I argue that under the current institutional background of today's China, corporate governance is not the substitute of weak legal protection of investors. If the overall legal investor protection is weak, corporate can't limit the expropriation by controlling shareholder effectively. But when the regulation rules make the legal investor protection become strong, corporate governance do have a monitoring role in limiting the expropriation by controlling shareholder. In other words, under current China's overall weak legal protection of investors, corporate governance is not substitute but complement to institutional environment, and the monitoring role of corporate governance is dependent on institutional environment.In chapter 6, based on the Chinese companies that listed in the U.S.A., I choose compared Chinese companies that listed in China's own stock market, and further examine the monitoring effect of institutional environment and corporate governance by comparison of these two different samples. The results of this chapter suggest: (1) controlling shareholders of companies that listed in the U.S.A. expropriate less than companies that listed in mainland China; (2) companies that listed in the U.S.A. have better corporate governance that favor the protection of outside shareholders; (3) both the difference between institutional environment and corporate governance can explain the difference between the extent of expropriation of these two sample. So, the evidence of this chapter also supports the theoretical conclusions of chapter 4.In a word, this paper examines the monitoring role of institutional environment and corporate governance both theoretically and empirically, and gives strong evidence that in a transitional economy of China, these two factors can limit the expropriation by controlling shareholder effectively. Especially, the role of institutional environment is much more important. The results of this paper are important for limiting controlling shareholder's self-interest behavior and protecting outside minority shareholders. And the results of this paper suggest that the protection of minority shareholders in today's China requires strong regulation of central government, less intervention of local government and effective corporate governance arrangement.