Corporate Pyramids Research Articles

Rent‐seeking or value‐creating? The impact of managerial autonomy from state‐built corporate pyramids on M&A performance

AbstractHow to give managers autonomy to improve organisational performance has long been a focus of business practice. In this paper, we use a unique Chinese context to investigate the effect of managerial autonomy arising from state‐built corporate pyramids on mergers and acquisitions (M&A) performance. We find that the number of pyramidal layers between the government and the state‐owned enterprise (SOE) is positively associated with M&A performance. This relationship is stronger when the SOE managers possess professional M&A abilities but weaker when the SOE management team and the government are politically connected. We attribute the positive association to the career path incentives of SOE managers. Additionally, we address the role of managerial autonomy in the M&A process and integration. We also analyse this effect in contexts where managerial autonomy is crucial in some investment decisions. Taken together, our study fills a critical gap on managerial discretion within internal organisational contexts.

Intervention of large shareholders and corporate fraud – evidence from vertical interlock in corporate pyramids in an emerging economy

AbstractThrough using 17,995 firm‐year observations of all the Chinese A‐share listed firms from 2008 to 2016 as a sample, we document that firms with vertical interlock have a lower likelihood of committing corporate fraud. We further test the underlying mechanisms, and we find that the effect of vertical interlock on the occurrence of corporate fraud is more pronounced when firms operate in a region with poor legal protection; with the legal environment being enhanced in China, the effect of vertical interlock has become less significant; and the effect of vertical interlock is also more pronounced when firms exhibit poor information environment at the firm level. Our results in this paper imply that the role of large shareholders and legal protection are substitutes in an emerging economy, and even with rapid economic and legal development in China, large shareholders keep playing a positive role in controlling fraudulent behaviours in Chinese listed firms.

More Human Than Human: The Exile in Blade Runner

More Human Than Human: The Exile in <i>Blade Runner</i>

Corporate Pyramids and SOE Innovations

Why do some state-owned enterprises (SOEs) embrace innovations during economic transitions, when institutional logics move from state socialism to market capitalism? The rise of a market capitalism logic espousing competition and innovations challenges traditional SOEs’ state socialism logic that prioritizes central planning. We posit that these challenges, stemming from the grip of the state as the ultimate owner, may be mitigated for some SOEs in corporate pyramids. A pyramid features SOEs being organized into chains of firms, creating indirect ownership and control through pyramidal layers. Such layers insulate government intervention in lower-tier SOEs, loosening the grip of the state socialism logic and facilitating the transition towards the market capitalism logic, as reflected in more SOE innovations. Leveraging a sample of SOEs in China, we find that SOEs innovate more when the number of pyramidal layers between them and the state increases. Additionally, the innovation-facilitating role of pyramids hinges on industry regulations and institutional development. Overall, this paper integrates research on institutional logics and corporate pyramids to deepen our understanding of SOE innovations.

Political Influence and Corporate Governance: Evidence from Party-Building Reform in China

We focus on the recent Dangjian (“party-building”) reform, a major measure taken by the Chinese Communist Party (CCP) to strengthen its leadership position in Chinese state-owned enterprises (SOEs). We hypothesize that, given the unique governance and ownership structure of Chinese firms, there is a trade-off between the political costs and benefits of the mitigated agency problems. We report negative investor reactions to privately-owned enterprises (POEs) after the Dangjian reform announcements, consistent with the hypothesis that strengthening party control over business is harmful to business efficacy and firm value. We also find evidence that the increased risks of political influence due to the reform undermine the value of SOEs that are considered more independent of political power (i.e., those under corporate pyramids or cross-listed on a foreign market). In addition, the market reacted negatively when firms incorporated the provision to adopt the party’s cadre management principle, which allows the CCP to intervene in firm management.

Corporate pyramids, geographical distance, and investment efficiency of Chinese state-owned enterprises

Abstract We investigate how the state's intervention in the investment decisions of Chinese local SOEs is affected by corporate control distance in the form of pyramidal layers and the geographical distance between the SOEs and their government controllers. Although both the corporate control distance and the geographical distance affect the state's costs of acquiring information about the SOEs, the former is created intentionally by the state to delegate decision rights, and the latter is largely exogenous. We find that local SOEs’ investment efficiency is positively associated with the extensiveness of pyramids but negatively related to the geographical distance. The positive impact of pyramid-building on investment efficiency remains strong even when information costs captured by the geographical distance are low. However, the two distance measures lose their impact on investment efficiency when local governments reclaim control through a vertical interlock of chairman. Our results indicate that the credibility of the government's intention to delegate decision rights is vital to the SOEs’ efficiency when government intervention is the norm in China.

Corporate Pyramids, Geographical Distance, and Investment Efficiency of Chinese State-Owned Enterprises

We investigate how the state’s intervention in the investment decisions of Chinese local SOEs is affected by corporate control distance in the form of pyramidal layers and the geographical distance between the SOEs and their government controllers. Although both the corporate control distance and the geographical distance affect the state’s costs of acquiring information about the SOEs, the former is created intentionally by the state to delegate decision rights, and the latter is largely exogenous. We find that local SOEs’ investment efficiency is positively associated with the extensiveness of pyramids but negatively related to the geographical distance. The positive impact of pyramid-building on investment efficiency remains strong even when information costs captured by the geographical distance are low. However, the two distance measures lose their impact on investment efficiency when local governments reclaim control through a vertical interlock of chairman. Our results indicate that the credibility of the government’s intention to delegate decision rights is vital to the SOEs’ efficiency when government intervention is the norm in China.

Corporate Pyramids and Stock Price Crash Risk: Evidence from China

Abstract This paper examines the impact of corporate pyramids on the stock price crash risk of listed firms in China. Our results show that, first, the pyramidal layer of state-owned enterprises (SOEs) can reduce stock price crash risk through the three channels of improving financial statement transparency, increasing accounting conservatism, and decreasing overinvestment. Second, the greater the related party transactions, the weaker the negative relation between the pyramidal layer and crash risk, while this negative relation is strengthened by Hong Kong cross-listing. Further analysis shows that the corporate pyramidal layer of SOEs can also decrease stock price synchronicity. For non-state-owned enterprises (NSOEs), we find that there is an inverse U-shaped relationship between the corporate pyramidal layer, crash risk, and stock price synchronicity. These findings have important policy implications in promoting the sound and stable development of the capital market in China.

The Impact of Shareholding Structure on Firmss Dividend Decisions: Evidence from Chinese Listed Companies

Investigating the impact of three types of state ownership on firms’ dividend pay-out decisions for the first time, this study focuses on the differences in dividend pay-out behavior among various state ultimate owners. It has been found that the state enterprises supervised by lower level state agencies, as well as those affiliated to local governments are more likely to pay a dividend than the firms controlled by private ultimate owners. Central enterprises are no more likely to instigate a dividend pay-out as ultimate owners than the firms controlled by private ultimate owners. Similar patterns are found regarding the impact of ultimate owners’ cash rights and voting rights on dividend pay-out decisions. To a certain extent, central enterprises behave more similarly to private firms than other types of government controlled firms. No expropriation is detected in all kinds of firms controlled by the state as ultimate controlling shareholders via corporate pyramids, although weak evidence is found for firms owned by private investors. It is also inferred that paying dividends is no longer a necessary condition to get permissions of rights issues.

The Costs of Control-enhancing Mechanisms: How Regulatory Dualism Can Create Value in the Privatisation of State-owned Firms in Europe

Empirical studies show that ownership structures that separate control and cash flow rights create agency problems and are associated with reduced value for minority shareholders. Institutional investors recognise these inefficiencies and expect a discount on the share price of companies with control-enhancing mechanisms like multiple voting rights shares or pyramidal ownership structures. In the US, corporate pyramids are discouraged through the taxation of intercompany dividends, whereas multiple voting rights shares are allowed but have to be issued before the firm goes public. Therefore, controlling shareholders who want to entrench themselves in control by retaining multiple voting rights shares pay the costs of this inefficient capital structure when the firm initially goes public at a discounted price. Some European countries — including Spain, Portugal, Greece and, until very recently, Italy — have adopted a diametrically opposite solution. Multiple voting rights shares have been expressly prohibited by the legislator, but corporate pyramids are commonly used by listed companies and can be created following the IPO of the firm without approval from the shareholders. In this situation, if institutional investors expect that a pyramidal ownership structure will be created in the future, they will discount the price of the shares when the firm goes public. Therefore, if Italy, Spain, Portugal and Greece are willing to privatise some of their state-owned companies and want to maximise the price of their stocks, they should create the conditions to assure the market that these companies will not be controlled through pyramids in the future. Because of strong opposition from national business elites which control the largest corporate groups, it is very difficult to adopt strict regulations aimed at prohibiting — or at least limiting — the use of pyramidal ownership structures in a relatively short period of time. In order to solve this Olson problem, I suggest that Italy, Spain, Portugal and Greece should use regulatory dualism to create new markets with enhanced corporate governance rules that prevent shareholders’ control through pyramids.

Corporate Pyramids, Conservatism and Cost of Debt: Evidence From Taiwan

This study investigates the extent to which the span of corporate pyramids (as measured by the number of ownership layers) is associated with higher agency costs of debt, and whether conservatism can moderate the agency cost. Consistent with corporate pyramids generating higher agency costs and information asymmetries between corporate insiders and outside creditors, we find a positive association between the number of investment layers and cost of debt. However, we also find that multi-layered firms mitigate organizational opaqueness through increased financial reporting conservatism, which results in lower cost of debt capital. These findings provide new insights into the relationship between organizational structure and financial reporting quality.

Cash dividend policy, corporate pyramids, and ownership structure: Evidence from China

This paper investigates how the state-controlling ownership and the ownership through corporate pyramid structures affect the dividend policies of publicly listed firms in China. We find that the state-controlled firms in China pay higher dividends (measured by the dividend yield and the dividend payout ratio) than the privately controlled firms. We also find that as the control chain of the firm lengthens, the firm pays lower dividends. We conclude that the privately controlled firms in China pay lower dividends than the state-controlled firms because the former are more capital-constrained in obtaining external equity and long-term debt, other things being equal, and depend more on internal equity to finance growth. The negative association between the length of the control chain and dividends comes from a greater use of investable funds among Chinese firms under corporate pyramids, which is one of the features of the internal capital markets for firms under pyramid structures.

Institutions and Organizational Structure: The Case of State-Owned Corporate Pyramids

Pyramidal organizational structures are common throughout the world. This article considers an explanation for pyramids built by the state: separating firms from political interference. Although intermediate pyramidal layers insulate managers from a pyramid's top owners and hence induce agency costs, they also minimize political costs of state intervention. All else equal, the optimal division of power between the government and the managers should be the point at which the marginal agency costs are equal to the marginal political costs. Our empirical results, based on hand-collected data for 742 local government-owned Chinese business groups are generally in line with this hypothesis. (JEL: D21, D23, G32, L22, L32, P31). The Author 2012. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oup.com, Oxford University Press.

Investor Protection and the Mode of Acquisition: Implications for Ownership Dilution and Formation of Pyramids

This paper examines the influence of investor protection on the form of M&A transaction and its subsequent impact on ownership dilution and creation of corporate pyramids. In a large sample of acquisitions around the world, I find that (stock-based) mergers are more likely in countries with good investor protection, while (cash-based) control transactions are more prevalent in countries with low investor protection. Repeated acquisitions in common law countries results in substantial dilution of proportional ownership especially in U.S. but not in civil law countries. In contrast, series of acquisitions in civil law countries linked through firms that are bidders in one acquisition but targets in another tend to generate a corresponding series of inter-corporate control links, while this correspondence is much weaker in common law countries. These results suggest that differences in acquisition modes could be one potential channel through which investor protection affects corporate control structures around the world.

Government Banking in Russia: Magnitude and New Features

State-controlled banks are currently at the core of financial intermediation in Russia. This paper aims to assess the magnitude of government banking, reveal some of its special features and arrangements. We distinguish between directly- and indirectly state-controlled banks and construct a set of bank-level statistical data covering between 2000 and 2011. By January 2011 the market share of state-controlled banks reached almost 54 percent of all bank assets, putting Russia in the same league with China and India and widening the gap from typical European emerging markets. We show that direct state ownership is gradually substituted by indirect ownership and control. It tends to be organized in corporate pyramids that dilute public property, take control away from government bodies, and underpin managerial opportunism. State-controlled banks blur the borderline between commercial banking and development banking. Dominance of public banks has a bearing on empirical studies whose result might suggest state-owned banks’ greater (or lesser) efficiency or competitiveness compared to other forms of ownership. We tend to interpret such results as influenced by the choice of indicator, period of observations, sample selection, etc., in the absence of an equal playing field for all groups of players. We suggest that the government’s planned retreat from the banking sector will involve non-core assets mainly, whereas control over core institutions will just become more subtle.

The Corporate Pyramid Fable

Although corporate pyramids are currently commonplace world-wide and although there have been “noteworthy pyramiders” in American business history, this controversial form of corporate organization is now a rarity in the United States. The conventional wisdom is that corporate pyramids disappeared in the U.S. when New Deal policymakers began taxing dividends paid to corporate shareholders. This version of events is more fable than truth. The introduction of the intercorporate dividend tax did not foster a rapid dismantling of corporate pyramids. Instead, pyramidal arrangements were already rare in the U.S., other than in the utilities sector, and the demise of utility pyramids was prompted by the Public Util- ities Holding Company Act of 1935 rather than by tax reform.

Organizational Structure as a Decentralization Device: Evidence from Corporate Pyramids

This paper examines the pyramidal organizational structure of newly listed local-government-controlled firms in China. These controlling owners are constrained by the Chinese laws prohibiting free transfer of state ownership. Pyramiding allows them to credibly decentralize decision rights to firm management without selling off their ownership. Our empirical results support this conjecture. State controlling owners build more extensive corporate pyramids when they are less burdened with fiscal or unemployment problems, when they have more long-term goals, and when their firms' decisions are more subject to market and legal disciplines. The more extensive pyramids are also associated with higher Tobin's Q, better labor and investment efficiency and greater total factor productivity. This relation between pyramidal structure and firm operating efficiency however is found to be endogenous to the local government incentives and the regional institutional environment faced by the firms.

The Emergence of Corporate Pyramids in China

We examine the pyramidal ownership structure of a large sample of newly listed Chinese companies controlled by local governments or private entrepreneurs. Both types of the owners use layers of intermediate companies to control their firms. However, their pyramiding behaviors are likely affected by different property rights constraints. Local governments are constrained by the Chinese laws prohibiting free transfer of state ownership. Pyramiding allows them to credibly decentralize their firm decision rights to firm management without selling off their ownership. Private entrepreneurs are constrained by their lack of access to external funds. Pyramiding creates internal capital markets that help relieving their external financing constraints. Our empirical results support these conjectures. Local governments build more extensive corporate pyramids when they are less burdened with fiscal or unemployment problems, when they have more long-term goals, and when their firm decisions are more subject to market and legal disciplines. The more extensive pyramids are also associated with smaller underpricing when the firms go public. Entrepreneur owners construct more complex corporate pyramids when they do not have a very deep pocket - as indicated by whether they are among the top-100 richest people in China.