Agency Problems Of The Controlling Shareholder, Financing Policy And Corporate Investment

In a world of perfect capital market, firms’ investment and growth do not rely on the way of financing but only relate to investment opportunity (Modigliani and Miller,1958). After release the premise of MM’s research, Jensen and Meckling (1976) suggest that conflicts between manager and shareholders affect corporate financing behavior and investment. Myers and Majluf (1984) also find out that information asymmetric between investors and firm raises the financing cost and leads under-investment. Examining dispersed ownership structures, previous literature finds that information asymmetric and agency problem affect corporate investment behavior.However, it has been widely documented that the ownership structure of most listed companies worldwide are concentrated. There is a controlling shareholder or multiple large shareholders in the firm. This controlling shareholder has incentive to divert corporate resources for his private benefit. Thus, corporate governance in this firm is how to mitigate the agency problem between the controlling shareholder and minority shareholders and protect outsider investors’ rights. Especially in China, ownership structure is concentrated. The controlling shareholder always expropriates other investors by related bargaining, embezzlement. Except this, the controlling shareholder also can realize private benefit of control by manipulating corporate financing and investment behavior.This dissertation examines how the controlling shareholder affects corporate financing and investment behavior in three aspects. First, we investigate the impact of the controlling shareholder on corporate cash holdings. Then we analyze how this cash policy of the controlling shareholder affects corporate investment. Second, we investigate the impact of the controlling shareholder on corporate debt financing. Then we analyze how debt ratio affects corporate investment. Third, we investigate the impact of the controlling shareholder on the probability of seasoned equity offering. Then we examine the efficiency of resource allocation in these SEO firms. Based on the theory of corporate financing and investment and previous research of controlling shareholders’divert behavior, this dissertation uses a model to explain how the controlling shareholder affects corporate financing. Then we examine the impact of the controlling shareholder’s financing policy on corporate investment behavior. Using a sample of Chinese listed companies in2003to2011, this study finds the following results:Firstly, all corporate governance mechanisms which are efficiency in American capital market such as board of directors, management ownership, and balance of power are inefficiency in China. These corporate governance mechanisms cannot decrease expropriation and tunneling of the controlling shareholder. The main reason is that directors and managers are controlled by the controlling shareholder. They make decision in the interest of the controlling shareholder not minority shareholders.Secondly, our model predicts that interest conflict between the controlling shareholder and minority shareholders affects corporate cash holdings. Firms with a wider divergence between the controlling shareholder’s control rights and cash flow rights hold more cash. State owned enterprise holds more cash than other firms. Furthermore, we find that the high cash holdings increase corporate investment in firms with more server agency problem. Our results indicate that firm holds high level of cash in the interest of the controlling shareholder, and these cash holdings are used for over-investment.Thirdly, the interest conflict between the controlling shareholder and creditors affects firm’s debt ratio. Firms with a wider divergence between the controlling shareholder’s control rights and cash flow rights will have a higher level of debt. Agency problem between the controlling shareholder and creditors leads a higher cash flow sensitivity of debt, which means firms rise financial leverage when cash flow decrease and repay debt when cash flow increase. Furthermore, we find that debt financing cannot mitigate over-investment in firms with agency problem between the controlling shareholder and creditors. In these firms, high level of debt ratio leads over-investment problems.Finally, the interest conflict between the controlling shareholder and potential shareholders increases the probability of seasoned equity offering. Our model shows that the decision of share issue is put forward to so long as the interests of the controlling shareholder increase, leads the probability of seasoned equity offering positively relate to divergence of control rights and cash flow rights of the controlling shareholder. Furthermore, we find that SEO firm’s capital expenditure is higher than no-SEO firms. In firms with more server agency problem, SEO leads a higher level of investment increasing and a lower asset return. These results indicate that the controlling shareholder expropriates potential shareholders by SEO and increases capital expenditure to realize benefit of control.To sum up, this dissertation examines the financing policy and investment behavior of firms on the background of concentrated ownership structure. We find that agency problem of the controlling shareholder leads distortion to firm’s financing and investment behavior. The controlling shareholder divert firm’s resource through over-financing and over-investment, thus he can realize private benefit of control. In order to monitor the controlling shareholder and protect other investors, we have to enhance corporate governance and mitigate the agency problem between controlling shareholders and minority shareholders. At the same time, we must protect investors’ rights and increase the efficient of resource allocation.