Equity Refinancing Call Option, The Government-controlled Listed Companies Escalation Behavior

Capital investment is critical whether to the success of an enterprise or to a country's economic growth. China's fixed assets investment has been increasing continuously in the past few years.In this context, it is very important to investigate how to improve the efficiency of fixed assets investment, and how to avoid the occurrence of escalation of commitment.By far, there are two weak points on the study of escalation of commitment in investment. Firstly, most studies are based on the practice of enterprises in market economy, and few studies related to enterprises of transition economy have been made. Secondly, most studies are carried out from the perspective of decision-maker's judgment bias and irrationality, and only a few studies are made from the perspective of decision-maker rationality. This is because of that the earliest researchers of escalation of commitment are the psychologist. At present, studying abroad in this field there is still half of the psychologists or behavior economists, and they are mainly from countries in market economy.It is undeniable that study on the escalation of commitment from the perspective of irrationality is very important. However, the rational perspective is equally important in China, because the governance structure and internal and external monitoring system of Chinese listed companies are not as effective as those in market economy of developed countries. Besides, the cost of selfish investment decision is lower and the there is more leeway in such behavior in China than in developed countries. Therefore, it is not complete for studying escalation of commitment in China only from the irrational perspective, and neglecting the rational perspective will cause theoretical research in escalation of commitment to be deficient.Currently, the research conducted from the rational perspective is mainly based on agency theory, and most of it only deals with the conflict at the general level, for example: conflict between managers and shareholders, or between major shareholders and minority shareholders.We believe that Chinese listed companies in transition economy are unique in two ways: (1) there is a two-tier principal-agent relationship in these companies characterized by state ownership. The first-tier principal-agent relationship is the one between the initial clients (all citizens) and the government, and the second-tier principal-agent relationship is the one between the government and managers, and the government represents the core connection of the two-tier principal-agent relationship. The second-tier principal-agent relationship is the one actually effective due to the problem of the final owner absence, government officials' strong residual right of control and weak residual right of claiming. The rent-seeking collusion by the principal and agent in the second-tier principal-agent relationship leads to the problem of corruption in state owned enterprises and affects enterprise investment decision. In addition, the decentralized administration, the financial contract system and the promotion system of government officials in China also cause local governments to encourage enterprises' over-investment in pursuit of GDP growth and promotion opportunities; (2) Chinese listed companies have a strong preference for seasoned equity offering, and the major shareholders generally give up the subscription right In the Chinese institutional system, these will greatly reduce the financing cost and investment risk of major shareholders, and reduce the enterprise investment efficiency. Therefore, the causes and formation mechanism of escalation of commitment in Chinese listed companies should have its own unique aspects.This paper proposes an analytical framework of the escalation of commitment from decision maker's rationality perspective, based on China's institutional background in transition economy, focusing on the principal-agent relationship in listed companies, and elaborated to include the subscription selection of seasoned equity offering and government control in the framework. Subsequently, the paper analyzes theoretically the effect of major shareholder's subscription selection and government control on escalation of commitment, and conducts an empirical research based on data of Chinese listed companies from 2003 to 2006.The results show that: (1) Regardless of the existence of government control, there may be escalation of commitment in listed companies when the major shareholder takes part in the subscription, and the relationship between the probability of escalation of commitment and the major shareholder's shareholding proportion is negative. But the relationship becomes non-linear when the major shareholder gives up the subscription; (2) Compared with the case when the major shareholder takes part in the subscription, their giving up the subscription will increase the probability of escalation of commitment; (3) Regardless of the major shareholder's subscription choice, compared with the case when there is no government control, government control will increase the degree of escalation of commitment. Moreover, the relationship between government control and the degree of escalation of commitment is negative.When we further divide the government-controlled enterprises into three categories: ultimately controlled by state asset-management bureaus(SAMBs),state-owned enterprises affiliated to the central government(SOECGs),state-owned enterprises affiliated to the local government (SOELGs), we find that: (1) both the probability and degree of escalation of commitment are higher in state-owned listed enterprises than private listed companies;(2) in terms of the probability of escalation of commitment, SOELG listed firms are highest, followed by SAMB-controlled listed firms, and SOECGs listed firms are the lowest. The three types of state-owned listed companies do not differ significantly in the degree of escalation of commitment.The contributions of this paper are: (1) Tracing down the principal-agent relationship of Chinese listed companies, we propose an analytical framework based on China's institutional background and from the rational perspective; (2) We study the effect of major shareholder's subscription selection of seasoned equity offering on escalation of commitment. This helps us understand the economic consequences of the subscription selection by major shareholder, and sets up theoretical foundation for managing and supervising the investment and financing behavior of listed companies; (3) We study the effect of government control on escalation of commitment, which provides a new perspective for government control research, and improves our understanding of the economic consequences of government control; (4) We place the escalation of commitment and over-investment into the same research framework, which enriches and advances the study of inefficient investment and escalation of commitment...