Controlling Shareholders, Corporate Diversification And Market Valuation

The relationship between corporate diversification and firm value has alwaysbeen one controversial topic in financial field. Research conclusions about it is farfrom agreement in the developed countries. On the other hand, corporatediversification will help to promote its value through replacement of external capitalmarket in the transition country where lacking of high credibility of the legal systemand effective operation of the factor market. On the other hand, corporatediversification make the controlling shareholders or managers for grabbing gain moreeasily under the background of underdeveloped capital markets and investors legalprotection system of low levels. Therefore, corporate diversification may not be ableto overcome the low efficiency of external market and agency cost problem causedwill offset the advantages of corporate diversification. The influence of corporatediversification on firm value in the transition countries also remains unclear. Now, theconflict of interest between controlling shareholders and outside minorityshareholders is the main contradiction of corporate governance on condition that thelisted companies in China which is generally controlled by large shareholders anddominated by state-controlled firms. That means, agency cost between controllingshareholders and outside minority shareholders will have an important effect on therelationship between corporate diversification and firm value.Based on the preliminary analysis about the influence of controlling shareholderson corporate diversification, the paper studied the influence of controllingshareholders on the relationship between corporate diversification and firm value.Specifically, we studied the impact of the controlling shareholder’s feature of equitystructure on the relationship between corporate diversification and firm value andexplored the impact way how corporate diversification controlled by controllingshareholder affects the firm value. Our goal is to provide evidence whether thecontrolling shareholder engaged in diversified business for the purpose of grabbingselfish and further analyse the inner mechanism of the impact of corporatediversification controlled by large shareholders on firm value so that we can enrichtheoretical reseach on the relationship between corporate diversification and firmvalue.We find that:(1)The controlling shareholders with a separation of control andcash flow right engaged in diversified business behavior to obtain private benefits.The agency cost caused corporate diversification is greater than the benefits broughtby the alternative function of internal market and diversification destroys value.Further, we found the degree of corporate diversification discount is higher in the areawhere the factor market is undeveloped. The findings provide the abundant evidence that the agency cost problems caused by the controlling shareholders plays a leadingrole on the relationship between corporate diversification and firm value.(2) The separation of control and cash flow rights strengthen the negative effectof corporate diversification on firm value to some extent. In the companies wherecontrolling shareholder has absolute control power and which has abundant free cashflow and which is controlled by local government, the separation of control and cashflow rights obviously strengthen the negative effect of corporate diversification onfirm value.(3)The government control quality strengthen the negative effect of corporatediversification on firm value. Neverthless, the relation between the governmentintervention and insider control play a different role on corporate diversification andfirm value within the government controlled companies. That is, although thegovernment intervention is harmful to some extent, It may restrain the insider’sopportunism behavior in the transition countries. So, the stronger of the governmentintervention, the weaker of the degree of corporate diversification discount is.(4) The actual grabbing behavior of the controlling shareholder has negativeinfluence on the corporate diversification and firm value. The government controlquality strengthen the controlling shareholder’s actual grabbing behavior on thecorporate diversification and firm value. The slower of marketization process, thestronger of the controlling shareholder’s actual grabbing behavior on the corporatediversification and firm value. With the process of rule of law accelerating, it improvethe relationship between corporate diversification and firm value and also inhibit thecontrolling shareholder’s actual grabbing behavior on the corporate diversificationand firm value.(5) The internal capital markets formed in the diversified companies has apositive impact on the ease of financing constraint. But, the proxy conflict betweenthe controlling shareholders and minority shareholders, such as occupation by themajor shareholders, may make the role of diversified companies’ alleviating financingconstraint weaken, to have a negative impact on the value of the company.