Cash Flow Rights Research Articles

Ultimate ownership, risk-taking and firm value: evidence from China

This article investigates the relationship among ultimate ownership, risk-taking and firm value using firm-level data from Chinese companies. The results indicate that dominant ultimate controlling shareholders exacerbate the agency problem. The larger the divergence between ultimate shareholder’s control rights and cash flow rights, the stronger motivation is to reduce corporate risk-taking (CRT) to safeguard private benefits. Furthermore, the presence of a dominant ultimate controlling shareholder is harmful to firm value, and the divergence between its control right and cash flow right has a significantly negative effect on firm value. Corporate risk-taking plays a significant mediating effect between ultimate controlling shareholder and firm value. Based on these results based on theory and practice, we propose a number of practical implications for managers.

Organizational structure, agency costs, and accrual quality

Our study investigates whether a firm's organizational structure as measured by the number of investment layers connecting the parent firm and the lowest-tiered subsidiaries is negatively associated with earnings quality when the investment structure has high agency costs as measured by high deviation between voting rights and cash flow rights. We find that in firms with high deviation, information asymmetry as measured by bid-ask spread and share turnover increases with the number of layers, and earnings quality declines as the number of layers increases. The findings are more pronounced in family firms than in other firms, supporting the theory that agency problems between controlling and non-controlling shareholders are more severe in family firms. In additional analyses, we also find that high deviation and long investment chains increase expropriation, which can be covered up by manipulating earnings.

Why do family firms switch between family CEOs and non-family professional CEO?

Purpose – This study aims to examine whether a switching decision between a family CEO and a non-family professional CEO has a different effect on firm performance and what determines such a decision by family firms. Design/methodology/approach – This study uses multiple regressions, Probit and univariate analyses, based the sample of family-controlled Chaebol firms in Korea for the 11-year period from 2001 to 2011. Findings – Evidence found was consistent with the family entrenchment hypothesis: firms experiencing declining Q value are more likely to replace family CEOs with non-family CEOs, and that these firms, having switched to non-family CEOs, exhibit an improvement in firm performance as measured by the change in Q value. On the other hand, for those firms that replace non-family CEOs with family member CEOs, no evidence was found that the switching decision either decreases or increases firm performance. The results of Probit and univariate analyses suggest that firms switching to family CEOs tend to be larger, stock-exchange listed and more “central”, with more cash flow rights held by the controlling families and with relatively more equity holdings in the other affiliated firms of the same Chaebol group. In contrast, firms switching to non-family CEOs tend to be smaller, unlisted and less “central”, with less equity holdings in the other affiliated firms of the same Chaebol group. Originality/value – This study sheds light on the different value implications and determinants of a decision between “family CEO” and “non-family CEO”.

Ultimate ownership structure and capital structure: evidence from Chinese listed companies

This study investigates the impact of the ultimate corporate ownership structure, particularly the divergence of ultimate controlling shareholder’s control rights and cash flow rights, on the capital structure decisions among firms listed in Chinese market where the legal protection for creditors and minority shareholders is weak. I find that firms with a wider divergence between the ultimate controlling shareholder’s control rights and cash flow rights have significantly higher leverage level of capital structure. I also identify factors that affect this relation, including state ownership, institutional ownership, the presence of large tradable shareholders and NTS reform. My results suggest that leverage-increasing motivation of ultimate controlling shareholders with the risk of expropriation dominates in Chinese market and raising debt is a tool for them to maintain control over resources and corporate decisions to facilitate their self-dealing expropriation

现金流权和控制权分离对上市中小板企业成长性的影响研究——基于托宾Q值指标

本文以2014年我国上市中小板企业为样本，研究终极控股股东现金流权、控制权、两权分离度对企业成长性的影响。研究发现，现金流权与企业成长性正相关；控制权与企业成长性正相关；现金流权和控制权分离程度越大，终极控股股东对公司价值的侵蚀就越大，越会对企业的成长性造成负面影响。 This paper, based on a convenience sample of 2014 listed small and medium-sized enterprise board in China, studied the influence of cash flow rights, control power and two rights separation degree of the ultimate controlling shareholders on the enterprise growth. The findings show that cash flow rights and corporate growth are positive related; control power and enterprise growth are positive related; the greater the degree of separation of cash flow and control rights is, the greater the erosion of ultimate controlling shareholder to the company’s value is, resulting in the more negative impact on the growth of enterprises.

Excesso de controle acionário: um estudo do seu reflexo sobre o custo da dívida das empresas brasileiras de capital aberto

This study analyzes the effect of excess control on the cost of debt in publicly traded Brazilian companies. Its objective is to determine whether a higher misalignment between voting rights and cash flow rights held by controlling shareholder causes an increase in agency cost of debt. For the analysis of the research problem, it was used panel data regression with random effects, in which was compared the level of excess control and the firms cost of debt. The results indicate that there is a positive and statistically significant association between excess control and the cost of debt. This suggests that creditors interpret this misalignment as a control entrenchment, which increases the credit risk, and thereby, increases the cost of debt. From the scientific point of view, the contribution to the literature provided by this study is the finding that ownership structure bears an impact in the creditor perceptions of risk, and thus, the cost of debt. These results can assist in developing actions to reduce the cost of debt, which implies the maximization of the economic performance of firms that have third-party capital in its capital structure. Its social contribution is the distinction of the firms exposed to a higher level of cost of debt, identifying ways to maximize resources, that is a relevant aspect especially in times of crisis whose effects can be very varied, such as bankruptcies, massive layoffs and default.

Corporate governance and market valuation of R&D-based firms: the effect of controlling shareholders and ownership-control discrepancy

This paper aims to investigate the relationship between ownership structure and the valuation of R&D-based firms by focusing on two mechanisms in a concentrated ownership setting: large controlling shareholders (LCSs) and ownership-control discrepancy. Examining a sample of 143 R&D-companies, this study provides evidence that the market value depends critically on the identity of controllers and excess control. Specifically, our results show that when the LCS is a family that uses a democratic voting rule, the firm value increases; consistent with the incentive effect hypothesis. However, when the family maintains control while holding fewer cash flow rights, the firm value decreases; consistent with the entrenchment effect hypothesis. Additional results provide evidence that, in a concentrated ownership setting, internal and external means of governance have a subordinate role of control. Specifically, our results show a second-order effect of board composition, compensation policy and analysts coverage on the valuation of R&D-based firms.

Corporate governance and market valuation of R&D-based firms: the effect of controlling shareholders and ownership-control discrepancy

This paper aims to investigate the relationship between ownership structure and the valuation of R&D-based firms by focusing on two mechanisms in a concentrated ownership setting: large controlling shareholders (LCSs) and ownership-control discrepancy. Examining a sample of 143 R&D-companies, this study provides evidence that the market value depends critically on the identity of controllers and excess control. Specifically, our results show that when the LCS is a family that uses a democratic voting rule, the firm value increases; consistent with the incentive effect hypothesis. However, when the family maintains control while holding fewer cash flow rights, the firm value decreases; consistent with the entrenchment effect hypothesis. Additional results provide evidence that, in a concentrated ownership setting, internal and external means of governance have a subordinate role of control. Specifically, our results show a second-order effect of board composition, compensation policy and analysts coverage on the valuation of R&D-based firms.

The Research on the Psychological Motivation of the Encroach Behavior of the Ultimate Controlling Shareholder

Under the pyramid shareholding structure, the departure of the control right and the cash flow right of the ultimate controlling shareholder has enhanced the desire of the ultimate controlling shareholders of the listed companies to occupy, weighing the pros and cons, when the ultimate controlling shareholders think that the income of the encroach behavior is much more than the cost, he will encroach the listed company. The ultimate controlling shareholders’ embezzlement infringes the interests of small and medium-sized shareholders seriously, at the same time, it brings serious negative effects on the long-term development of the listed companies, it even produces negative effect on the healthy development of capital market in China, so the study on the encroach behavior of the ultimate controlling shareholders is extremely essential. Based on the theory of psychological ownership, this paper conducts an in-depth study on the psychological motivation of the encroach behavior of the ultimate controlling shareholder. The study found that: under the pyramid shareholding structure, the control right of the ultimate controlling shareholder and the cash flow right depart, consequently, the control right of the ultimate controlling shareholders of the listed companies is greater than the cash flow right. The control right will influence the individual’s psychological ownership right by three ways of information, assets and influence, and the ultimate controlling shareholder himself will produce psychological ownership via efficiency, self-recognition, having space and social exchange. The psychological ownership will lead to the expected earnings of ultimate controlling shareholders in the psychological level, but the real return of the ultimate controlling shareholder is determined by the cash flow right aka the corresponding proportion of share bonus, in the case of the separation of two rights, the expected income and actual income of the ultimate controlling shareholder will be misplaced, in order to compensate the income gap, the ultimate controlling shareholder will take encroach behavior to get more profit.

State Contract Law and the Use of Accounting Information in Debt Contracts

We study the relation between state contract law and the use of balance-sheet and income-statement based covenants in debt contracts. Incomplete contract theory suggests that balance-sheet based covenants ex ante resolve debtholder-shareholder conflicts, whereas income-statement based covenants serve as trip wires that trigger the switch of control rights ex post. Importantly, it is more difficult for lenders to exert their control rights ex post if the contract law is more favorable to debtors (i.e., the law is pro-debtor). We therefore ask whether lenders using pro-debtor law are more likely to rely on balance-sheet based covenants, and our evidence provides an affirmative answer to this question. Pro-debtor state contract law is positively associated with the weight given to balance-sheet based covenants (vs. income-statement based covenants) in the debt contract. Moreover, we extend our inquiry beyond financial covenants and find additional evidence that lenders using the law of pro-debtor states are more likely to rely on contractual features that align cash flow rights ex ante, rather than allocating control rights ex post through enforcement. In particular, we document that borrowing base restrictions, which limit the amount a lender provides to the borrower based on the borrower’s working capital assets, are more common in contracts that are governed by pro-debtor state contract law.

Does Family Control Shape Corporate Capital Structure? An Empirical Analysis of Eurozone Firms

AbstractThis study investigates the relationship between family control and corporate capital structure considering the dynamic nature of the debt policy and the ownership structure of family firms. Our results show that the sensitivity of debt to fluctuations in cash flow is less pronounced in family firms and highlight that family control increases the speed of adjustment toward target debt. Four dimensions of the family business model explain these results: deviations of voting from cash flow rights, the presence of a second blockholder in the company, involvement of family members in management, and the generation in charge of the business. The weaker negative impact of cash flow on debt is driven by family firms with no control‐enhancing mechanisms, companies with active family participation in management and family businesses that are still controlled by the first generation. By contrast, the more severe agency conflicts between owners and creditors in family firms with a second blockholder lead to more pronounced pecking order behaviour. Furthermore, the higher flexibility in corporate decision‐making of family firms managed by the family and under the influence of the first generation explains why family companies are able to rebalance their capital structure faster.

An optimization approach to resolving circular shareholding in large business groups

Circular shareholding refers to a situation where a series of capital contributions made by companies in a family business group establish a chain of shareholdings. For example, a circular shareholding is formed when company A owns stock in company B, company B owns stock in company C, and company C owns stock in company A. In Korea, the practice of circular shareholding in large family-controlled business groups may give the principal families higher control over member firms and more opportunities to pursue their own interest at the expense of other shareholders. For this reason, the government of Korea has encouraged large conglomerates to gradually eliminate their circular shareholdings. However, there has been no research as to which shareholdings out of the complicated ownership structure should be cleared in order to resolve the issue of circular shareholding. In this paper, we propose optimization models to address the problem. Of the proposed integer programming models that can eliminate circular shareholding, one maximizes the sum of cash-flow rights while another maximizes the sum of voting rights. The proposed models have been applied to Korean family-controlled business groups, and the results are included herein. To the best knowledge of the authors, this research is the first study to apply optimization theory to the problem of resolving circular shareholding.

Bank ownership and connected lending

Bank ownership concentration may not only induce banks’ controlling owners to become involved in connected lending but also deter them from doing so. This paper examines how the cash flow rights of the banks’ controlling owners are associated with the need for special connections with banks, which is a proxy measure of connected lending. Using data from more than 2,600 firms across 25 countries, this study finds that the cash flow rights increase the need for special connections, but the increase becomes smaller as the cash flow rights increase. No evidence is found that the cash flow rights result in a decrease in the need for special connections.

Disproportionate insider control and board of director characteristics

We comprehensively examine the characteristics of the board of directors in firms characterized by disproportionate insider control. Specifically, we investigate whether board of director characteristics contribute to, or attenuate, the known negative association between a divergence of insider voting and cash flow rights and firm value. Using a new hand-collected sample of U.S. dual-class firms between 2000 and 2012, we find that disproportionate insider control is negatively associated with board experience, independence, and the tenure/age of directors. These findings support an entrenchment, rather than a substitution explanation, which would require stronger board monitoring as the extent of agency conflicts increases. Moreover, mediation analyses reveal that negative board characteristics act as one channel for the previously established negative association between disproportionate insider control and firm value.

Growth options effect on leverage: Evidence from China

Using the market-to-book assets (MB) ratio and its inverse exponential transformation as proxies for growth options, we find that the growth options effect on leverage is negative and highly convex in China, consistent with the U.S. evidence from Ogden and Wu (2013). Of particular importance, using a nonlinear transformed rather than a linear MB ratio yields stronger explanatory power for the growth options effect on leverage in tests of both static and dynamic trade-off theories. Moreover, we show that the growth options effect on leverage is stronger among firms characterized by wider divergence between control rights and cash-flow rights of the largest ultimate owner and firms that face more severe financial constraints.

Does minority shareholder protection matter? Evidence from open-market share repurchases

This study examines the impact of minority shareholder protection on the signaling effect of open-market share repurchases, the post-repurchase operating performance, and the subsequent investment decisions. When controlling owners retain tight control of their firms by insufficient equity investment, the discrepancy between voting rights and cash flow rights induces an entrenchment problem and undermines minority shareholder protection. This study finds that the market reaction to share repurchase announcements is contingent on minority shareholder protection. The signaling effect of repurchase announcements is weak for firms subjected to poor minority shareholder protection, especially for the repurchase purposes of converting debt to equity and signaling undervaluation. Moreover, the results show that poor minority shareholder protection is negatively associated with the long-term operating performance following repurchase announcements. We also find that repurchasing firms with poor minority shareholder protection experience notably declines in R&D expenses, cash holdings, and inventory when they repurchase shares to convey undervaluation.

Corporate control and credible commitment

The separation of control and ownership – the ability of a small group effectively to control a company though holding a minority of its cash flow rights – is common throughout the world, but also is commonly decried. The control group, it is thought, will use its position to consume excessive amounts of the firm's returns, and this injures minority shareholders in two ways: there is less money and the controllers are not maximizing firm value. To the contrary, we argue here that there is an optimal share of the firm that induces the control group to maximize shareholder value while inducing investors to fund the firm's projects. The concern that controlled companies raise is that the controlling group cannot easily commit not to consume more than the optimal share. A firm's cost of capital is increasing in the controllers’ inability to solve this credibility problem because potential investors will charge the firm for later consuming private benefits. Today, accurate judicial review of controlled transactions under mandatory fiduciary rules helps controllers to commit not to take more than the optimal share. Private contracting and judicial review are strong complements, however. Therefore, our principal normative recommendation is to open up the contracting space by reducing the fiduciary rules to defaults. This reform would be less helpful in developing countries that lack effective legal systems. The public corporations in such countries, however, also have controlling shareholders. We explore various non-legal methods by which these shareholders credibly commit to cap private benefits, although we also show that these methods are less efficient in a mature legal system than contracting would be.

Pricing the Value of Cash Flow Rights in Crowdinvesting: An Analysis of Innovestment Backers

We analyze the pricing of cash flow rights in start-up companies using a unique data set of 44 equity crowdfunding campaigns. Our sample consists of 499 backers who invested during the period from November 6, 2011, to March 25, 2014, on the German equity crowdfunding portal Innovestment. In contrast with all other European equity crowdfunding portals, Innovestment runs a multi-unit second-price auction in which backers themselves can specify the price of an investment ticket. We exploit this unique auction mechanism to analyze backers’ willingness to pay for cash flow rights. We find that campaign characteristics, investor sophistication, progress in funding, herding, and stock market volatility influence backers’ willingness to pay in an economically meaningful manner while geographic distance, learning effects, and sniping at the end of an auction have no effect.

Ownership Concentration and Corporate Disclosure Choice in Bangladesh

This paper investigates empirically the effect of ownership concentration on corporate disclosure choice in Bangladesh. In an environment of weak enforceability of laws, corporate culture in Bangladesh is characterized by family control and concentrated ownership. Controlling shareholders exercise nearly full control over a firm’s operating and financial policies, including disclosure policies, while maintaining low cash flow rights relative to voting rights. The paper shows that management’s choice of disclosure across key financial elements is discriminatory against external shareholders and bondholders. The findings show that controlling for factors such as age, size, profitability and financial leverage, ownership concentration reduces corporate disclosure. The findings validate the hypothesis of La Porta et al. (1999) that an increasing ownership concentration leads corporate management to adopt a disclosure regime which is biased against external shareholders and creditors.

Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts

AbstractWe study the evolution and renegotiation of the cash-flow rights that venture capitalists (VCs) obtain in their portfolio companies. When company performance between financing rounds is poor, subsequent contracts contain stronger VC cash-flow rights, and existing VCs tend to either give new VCs senior claims or forfeit their existing rights altogether. These results are consistent with the importance of financing problems between different VCs and with theory predicting that financing frictions worsen with poor performance. A consequence is that VC cash-flow rights are frequently significantly diluted before exit, implying that VC investments are riskier than previously estimated.