When Will the Controlling Shareholder Expropriate Investors? Cash Flow Right and Investment Opportunity Perspectives

Abstract

In this paper, we examine how investment opportunities influence the impact of cash flow rights on a firm value. Previous papers argue that cash flow rights serve as the incentives of a controlling shareholder to expropriate outside investors, and document that cash flow rights increase firm value. We find that when firms have opportunities to invest in positive NPV projects, cash flow rights do not increase firm value. However, when there exist investment opportunities and cash flow rights are relatively low, cash flow rights still increase firm value. Only when cash flow rights are relatively high, will firm value not be affected by cash flow rights, given the potential investment gains. Hence, in the presence of profitable projects, whether cash flow rights increase firm value depends on the level of cash flow rights. These results suggest a non-linear relationship between cash flow right of the controlling shareholder and firm valuation.