Zhiwen Zhu - Multiple - Agent Relations

International Research Journal of Finance and Economics
ISSN 1450-2887 Issue 31 (2009)

EuroJournals Publishing, Inc. 2009
http://www.eurojournals.com/finance.htm
Multiple Principal-Agent Relationships, Corporate-Control

Mechanisms and Expropriation Through Related Party
Transactions: Evidence from China
Zhiwen Zhu
China Center for Economic Research, Peking University, Beijing, 100871, P.R. China
Room 301A, Section 1, Wanliu campus of Peking Univ., 29#
Wanliu Middle road, Haidian District, Beijing, China
E-mail: zhu_zhiwen@pku.edu.cn
Tel: +86-10-51604364; Fax: +86-10-62751474
Hao Ma
China Center for Economic Research, Peking University
Beijing, 100871, P.R. China
E-mail: ma@bimba.edu.cn
Tel: +86-10-62756573; Fax: +86-10-62751474
Abstract
This study investigated the intermediation of expropriation in the linkage between
corporate governance and firm value. We manifested the triple principal-agent relationships
among minority shareholders, majority shareholders and the board of directors, and
conceptualized the expropriation as rents demanded by majority shareholders to
compensate their agency function in a theoretical framework of internal and external
corporate-control mechanisms for firms with concentrated ownership structure. By using
related party transactions as a direct measure for expropriation, and the data of related party
transactions between 2002 and 2006 on Chinas stock market, we corroborated the negative
value effect of expropriation, and found that the controlling capability of controlling
shareholders, ownership balancing, identity of controlling shareholders, stock incentives for
the board/executives, and the proportion of tradable shares are significantly associated with
expropriation. Our work on expropriation would provide insight to understand the
relationship between corporate governance and firm value, and lay a basis for future theory
building on corporate governance.
Keywords: Corporate Control, Expropriation, Agency Theory, Related Party Transactions
JEL Classification Codes: G34
1. Introduction
With the recent myriads of corporate scandals, both in the industrial and financial sectors, the interests
in corporate governance has gained further momentum. As such, understanding the various specific
challenges faced by corporate governance is of both practical importance and theoretical significance.
This paper, grounded in literatures in finance (Cheung, Rau, and Stouraitis, 2006; Claessens, Djankov,
International Research Journal of Finance and Economics - Issue 31 (2009)
142
Fan, and Lang, 2002; La Porta, Lopez-De-Silanes, Shleifer, and Vishny, 2002; Lins, 2003) and
economics (Clarke, 2003; Johnson, La Porta, Lopez-de-Silanes, and Shleifer, 2000; Pagano and Roell,
1998), as well as a host of related disciplines, e.g. strategy and management (Chang, 2003; Daily and
Dalton, 1994; Eisenhardt, 1989; Hill and Snell, 1988; Thomsen and Pedersen, 2000; Walsh and
Seward, 1990), etc., tackles an important issue in corporate governance, namely the determinants of
expropriation, from a multiple principle-agent relationship (Arthurs, Hoskisson, Busenitz, and Johnson,
2008; Dharwadkar, George, and Brandes, 2000; Young, Peng, Ahlstrom, Bruton, and Jiang, 2003).
Early works in corporate governance concentrated mainly on the principal-agent conflicts due
to information asymmetry between boards of directors and executives and the ensuing opportunism of
executives on the Anglo-American capital markets (Eisenhardt, 1989; Finkelstein and Daveni, 1994;
Mallette and Fowler, 1992). Corporate governance is thus to control the internal and external
entrenchment practices of executives through the internal and external control mechanism which either
align the interest of executives with the boards or monitor them directly(Boyd, 1994; Gibbs, 1993; Hill
et al., 1988; Walsh et al., 1990; Zajac and Westphal, 1994). On the other hand, works on the corporate
governance of continental European and Japanese firms, which are characterized by concentrated
ownership structure, found that there exists interest conflicts between majority shareholders and
minority shareholders, and majority shareholders could expropriate minority shareholders for their
controlling advantage (Aguilera and Jackson, 2003; de Miguel, Pindado, and de la Torre, 2004;
Weinstein and Yafeh, 1994). Later studies found stronger evidence of expropriation in emerging
economies (Chang, 2003), for which some authors dubbed tunneling (Johnson et al., 2000).
In this paper, we use the related party transactions (RPTs) as a direct measure for expropriation,
investigating the intermediation of expropriation in the linkage between corporate governance and firm
value in the institutional settings of China. This paper will answer two questions: 1) Do expropriation
reduce firm value? 2) What factors of corporate governance are associated with expropriation?
2. Theory and Hypotheses

We first construct a conceptual model of multiple principal-agent relationships which underlies the
hypotheses from the perspectives of principal-agent theory in the institutional settings of China, and
the hypotheses are derived subsequently. Albeit some ethical attacks, agency theory is still among the
most persuasive and accepted theories to understand the corporate governance issues (Bohren, 1998;
Hendry, 2002).
2.1. Theoretical Framework
In institutional settings of China, the highly concentrated ownership structure1 coupled with nontradable shares and multiple objectives of majority shareholders lead to severer expropriation, which
offer a unique context for further theorizing the agency problem.
2.1.1. Triple Principal-Agent Relationships
In markets with disperse ownership structure, the conflicts of interest between disperse investors and
boards/executives are the principal conflicts. Because the costs to monitor boards/executives directly
are extremely high for disperse shareholders, they either align the interests of boards/executives with
them through incentive contracts or choose voting by foot through the market for corporate control.
In contrast, the costs to monitor board/executives for large shareholders are low thus they have enough
1
To reform and recapitalize its failing State-owned enterprises (SOEs), the Chinese government established two stock
exchanges the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE) in 1990 and 1991,
respectively. In order that the SOEs could be listed in priority, the China Securities Regulatory Commission (CSRC), the
regulator of the securities markets, imposed a strict quota system on which companies could be listed. Consequently, by
2006 the majority of the listed firms were State-controlled (over 70% in our sample), and the ownership structure was
highly concentrated (ownership of largest shareholder was 41% on average in our sample).
143
incentives to monitor board/executives directly and alleviate the opportunism problem thereby. So the
presence of a large shareholder would be beneficial to disperse minority shareholders in the respect of
monitoring boards/executives in that they could play as free riders they may entrust the large
shareholder to monitor boards/executives for them. However, there is no free lunch, large shareholders
self-interest and opportunism would lead to rent-seeking they would expropriate disperse investors
by their controlling and informational advantages.
So there exist triple principal-agent relationships in listed firms with concentrated ownership
structure (Figure 1). The first is the principal-agent relationship between minority shareholders and the
board of directors, which is also the fundamental principal-agent conflicts in markets with disperse
ownership structure, mostly referring to the Anglo-American capital markets. The board of directors
situates in a better position than minority shareholders in this duplet, because minority shareholders
actually can not monitor the board directly for the extremely high costs. The second is the principalagent relationship between majority shareholders and the board of directors. Majority shareholders
situates in a better position in this duplet, because the costs for them to monitor, assess or dismiss the
board are relatively low. So there are dual principals for the board, if the two principals have
conflicting objectives or decisions (Dharwadkar et al., 2000; Su, Xu, and Phan, 2008; Young et al.,
2003), the board would be in a dilemma, and it would have to choose an eclectic action. The third is
the principal-agent relationship between minority shareholders and majority shareholders. Also,
majority shareholders situates in a better position in this duplet because of their controlling and
informational advantages. Thus minority shareholders situates in the weakest position in the tripod
(Figure 1).
144
Figure 1: Triple Principal-agent Relationship and the Internal and External Control Mechanism
External control
mechanism
Markets for corporate

control; markets for
managers/directors;
rules, regulations and
laws
Non-tradable
shares
Minority
shareholders
Principal
Objective:
stock price
Agent
Rents
Ownership
structure;
information and
monitoring
Principal
Stock
incentives
Non-tradable
shares
Internal
control
mechanism
Incentive
contracts;
monitor;
assess; dismiss
Multiple objectives:
Cash flow; policy
burden (e.g.
employment)
Principal
Turnover
Non-tradable
shares
External control
mechanism

managers/directors;
laws
Majority
shareholders
External control
mechanism
Agent
Agent
Board of directors
Multiple
objectives:
income; effort;
turnover

managers/directors;
laws
Albeit unintentionally, minority shareholders can actually benefit from the alleviation of
opportunistic behavior of boards/executives by majority shareholders monitoring at the expense of
rents seized by majority shareholders. So we can deem this relationship as: minority shareholders
entrust majority shareholders to monitor the board/executives, as a cost, they are subject to the
expropriation (rents) by majority shareholders. The antecedents and consequence of the expropriation
(rents), which are measured directly by RPTs, are the thesis of this paper. Theoretically, whether
minority shareholders suffer loss from the expropriation (rents) depends on their benefits and expenses
from their agency contract with majority shareholders. On the other hand, rents are seized by majority
shareholders through the action of the board. Because there are two principals for the board, if the two
principals have conflicting objectives or decisions, the board would be in a dilemma, and it would have
to choose an eclectic action which makes majority shareholders seize reasonable rents. So theoretically,
majority shareholders could not expropriate minority shareholders discretionarily, the motivation and
capability for them to expropriate and the maximum rents they could seize depends on the objectives
and constraints of all the three players. Nevertheless, because rents can be deemed as the costs minority
shareholders pay to majority shareholders for their monitoring the board, we can infer that the more
effectively majority shareholders can monitor the board; the more rents they demand, and with the
higher motivation they are to expropriate.
145

Proposition 1: Among the three players the majority shareholders, the minority
shareholders and the board, majority shareholders situate in the strongest position,
minority shareholders situate in the weakest position, the board situate in the middle.
Proposition 2: Whether expropriation is value-destroying or value-creating depends on
the tradeoff between the benefit the minority shareholders could gain from and the rents
they must pay for the agency contract between minority shareholders and majority
shareholders.
Proposition 3: The more effectively majority shareholders can monitor the board; the
more rents they demand, and with the higher motivation they are to expropriate.
2.1.2. Non-Tradable Shares

A large portion outstanding share is non-tradable in China2. There are two types of non-tradable shares:
State shares and Legal-Person shares. State shares are held by government agencies3. Legal-Person
shares are held by non-individual legal persons4. Legal-Person and State shares are similar because
most legal persons are ultimately controlled by the State and both types of shares are not tradable.
However, Legal-Person shares can be held by both private and State-controlled entities and both
domestic and foreign entities, actually a large portion outstanding shares of private or foreign
controlled listed companies are also Legal-Person shares and thus not tradable (see Green, 2003 for an
extensive review regarding the development of China's stock market). In essence, the principalprincipal conflicts are between tradable share holders (social investors) and non-tradable share holders
(the State, State-owned enterprises, or legal persons) in China.
Proposition 4: Expropriation of minority shareholders by majority shareholders is
essentially expropriation of tradable share holders by non-tradable share holders in
China.
The market for corporate control serves as a discipline of last resort (Fama, 1980). However,
the split share structure in China affects the market for corporate control in two important ways. First,
because the State shares and/or Legal-Person shares held by the majority shareholders are non-tradable,
they will neither benefit nor suffer from the stock price change, besides, they also need not worry about
the competition for corporate control. This causes the majority shareholders no longer concerning
about stock prices and thus directly renders the market for corporate control dysfunctional. Second, the
existence of non-tradable shares attenuates the liquidity of a firms shares and the overall liquidity of
the market, thus impairing information efficiency, aggravating the information asymmetry of market,
and reducing the benefits of market monitoring (Holmstrom and Tirole, 1993).
Proposition 5: Under the split share structure, the market for corporate control is
failure.
2.1.3. Heterogeneity of Objectives
There are two sources of minority shareholders value: dividends and capital gains. However, the
minority shareholders is in the weakest position in the tripod (Figure 1), so they have no enough
strength to pressure corporate insiders to disgorge cash(La Porta, Lopez-de-Silanes, Shleifer, and
Vishny, 2000), as a result, dividends payout is pinchpenny in Chinas listed firms (Faccio, Lang, and
In order that the State ownership could not be transferred to the private sector, which was due to the intentionally
ideological aversion to capitalism, through future trading, and that the State could retain absolute majority ownership and
ultimate control towards listed firms, the Chinese government split shares into tradable and non-tradable. Tradable shares
can be freely traded on various stock exchanges and be further divided into tradable A shares, B shares and H shares.
Tradable A shares, which are most important and can be owned only by domestic individuals and organizations, are
traded on Chinas two stock exchanges. B shares and H shares are for foreign investors, B shares are traded on the SHSE
and the SZSE, whereas H shares are traded on the Hong Kong stock exchange.
Include the Bureau of State Property Management, the regional asset management bureaus, or the Solely State-Owned
Enterprises.
Include listed firms, unlisted private firms, non-bank financial institutions and some SOEs.
146
Young, 2001). Therefore, the only value for minority shareholders is capital gains, and their only
objective is the rise of stock price.
Proposition 6: The only objective of minority shareholders is the rise of stock prices.
Because the State shares and/or Legal-Person shares held by the majority shareholders are nontradable, they do not concern about the stock price thereby. However, majority shareholders have other
economic, social and political objectives. First, although majority shareholders could not obtain capital
gains, they could control the cash flow discretionarily, thus economically they wish to maximize the
cash flow of the listed firm. Second, majority shareholders, who are the government agencies or Stateowned enterprises (SOEs), have many social and political objectives5, and SOEs also undertake many
policy burdens (Lin, Cai, and Li, 1998). Even non-State controlled legal persons have close
connections with the government agencies or SOEs, thus have certain political objectives. But we
conjecture that for majority shareholders who are non-State controlled legal persons, their economic
objectives dominate their political objectives, whereas for majority shareholders who are the
government agencies or SOEs, their political objectives dominate their economic objectives.
Proposition 7: For majority shareholders who are non-State controlled legal persons,
their economic objectives dominate their political objectives, whereas for majority
shareholders who are the government agencies or the SOEs, their political objectives
dominate their economic objectives.
Directors also have multiple objectives in Chinas listed firms. As in the classical principalagent model, agent (director) makes decisions through tradeoff between his income and effort, so
directors have economic objectives. However, with an ownership structure dominated by State
institutions, it follows that the boards of most listed companies would be dominated by State
representatives, while board seats occupied by individual and corporate investors would be few. Most
of these State representatives are Communist Party officials; they could be promoted to a higher
position in the government or Party hierarchy in the future6. So these directors concern more about
their political future rather than merely income. Although economic performance is now an indicator
the Party assessing its officials, political performance plays a more important role. Because these State
representatives are appointed by majority shareholders - the government agencies or SOEs, majority
shareholders could use turnover as a means to directly control them.
Proposition 8: For directors of non-State controlled listed firms, their economic
objectives dominate their political objectives, whereas for directors of State controlled
listed firms, their political objectives dominate their economic objectives.
2.1.4. Internal and External Control Mechanism
The external control mechanism of corporate governance includes the market for corporate control, the
market for directors/managers and the derivative action of stockholders(Hill et al., 1988; Walsh et al.,
1990). We have demonstrated that under the split share structure, the market for corporate control is
failure (Proposition 5). Besides, because most directors/executives are appointed directly or indirectly
by the government or the Party, whereas the political rather than economic performance is the major
indicator the government or the Party assessing its officials, the market for directors/managers does not
work well in China. Furthermore, some researches on the apparent bias against private ownership in
property rights disputes suggests that Chinas political institutional norm resolves the conflict between
public and private interests in favor of the former (Nee, 1992; Peng and Luo, 2000). This is partially
due to lacking an independent judiciary and unclear laws governing private property rights, thus the
For example, a major objective of the Communist government since 1989 has been to maintain societal stability by
maintaining social equity, ensuring full employment and refraining from taking such profit enhancing measures as asset
divestiture and job cuts.
In fact, the leaders of the 50 largest Solely State-Owned Enterprises some being the parents of multiple listed firms
are directly appointed by the Politburo.
147
property rights are difficult to enforce (Su et al., 2008). In fact, there was no formal law protecting
private property until 2007.
Proposition 9: The external control mechanism is dysfunctional in China
There are two broad classes of internal control options: incentive contracts and monitoring
(Walsh et al., 1990). However, they are not equally effective on the governance of the triple principleagent relationships. For the minority shareholders board duplet, incentive contracts would be weakly
effective whereas monitoring is ineffective as the costs for minority shareholders to directly monitor
the board are unaffordable and directors even of the State controlled firms have certain economic
objectives. For the majority shareholders board duplet, monitoring would be in dominance as most
listed firms are State controlled (Proposition 8). For the minority shareholders majority shareholders
duplet, both incentive contracts and monitoring would be effective on the control of expropriation. The
ownership structure, which could be deemed as the incentive contract between the duplet, would affect
majority shareholders motivation to expropriate, whereas the information and monitoring system
inside the listed firms would affect their capability to expropriate.
2.2. Hypothesis
Given the theoretical framework, we can derive the hypotheses readily regarding related party
transactions (RPTs) in the institutional settings of China.
2.2.1. Related Party Transactions and Firm Value
RPTs being a direct measure for expropriation, whether they are value-destroying or value-creating
depend on the tradeoff between the benefits the minority shareholders could gain from and the rents
they must pay for the agency contract between minority shareholders and majority shareholders
(Proposition 2). However, because Chinas majority shareholders have multiple objectives rather than
purely economic objectives, they are likely to demand more rents than their counterparts in other
countries, other things being equal. As such, the rents are more likely to exceed the benefits in China.
Hypothesis 1: Related party transactions (RPTs) reduce firm value.
2.2.2. Corporate governance and related party transactions
The political objectives such as resolving the policy burden of the parent SOEs are the dominant
objectives for majority shareholders of State controlled listed firms, whereas the economic objectives
are the dominant objectives for the majority shareholders of non-State controlled listed firms
(Proposition 7). Thus the former would have stronger motivation to expropriate in order to resolve their
policy burden aside from achieving their economic goals. On the other hand, directors of State
controlled listed firms have no options other than being officials, they are more prone to be effectively
controlled and monitored by their superior institutions. So other things being equal, majority
shareholders of State controlled listed firms would have more controlling capability than their
counterparts of non-State controlled listed firms. Whereas the more effectively majority shareholders
can monitor the board; the more rents they demand, and with the higher motivation they are to
expropriate (Proposition 3).
Hypothesis 2: The likelihood, as well as frequency and intensity of RPTs are higher for
State controlled listed companies than for non-State controlled listed companies.
Hypothesis 3: The likelihood, as well as frequency and intensity of RPTs are positively
associated with the controlling capability of the controlling shareholders of listed
companies.
As we analyzed, rents are seized by majority shareholders through the action of the board,
whereas there are two principals for the board, if the two principals have conflicting objectives or
decisions, the board would be in a dilemma, and it would have to choose an eclectic action which
makes majority shareholders seize reasonable rents. To some extent tock incentives would
economically align interests of the board with minority shareholders, inducing them taking eclectic
148
actions through which majority shareholders could seize less rents. Therefore, despite
directors/executives ownership in China is very small (1% of total outstanding shares on average in our
sample), it would be beneficial to alleviate expropriation.
Hypothesis 4: The likelihood, as well as frequency and intensity of RPTs are negatively
associated with the directors/executives stock ownership.
Many researchers argued that the presence of multiple block holders could be an effective
mechanism for reducing expropriation, as multiple block holders would monitor one another in order
to protect their own interests, to the benefit of minority shareholders (Lins, 2003; Pagano et al., 1998).
Even in case of collusion between block holders, minority shareholders are likely to benefit as
coordination problems between block holders potentially increase the cost of tunneling. Also, the
presence of multiple block holders would attenuate the capability that individual block holders could
effectively control and monitor the board; as a result, they demand fewer rents (Proposition 3).
associated with the ownership balancing of multiple block holders.
With the increase of the proportion of tradable shares, which is either due to fewer non-tradable
shares held by majority shareholders in IPO thus they have weaker controlling capability and demand
less rents, or due to the conversion of non-tradable shares into tradable shares7 thus the market for
corporate control works and the majority shareholders are likely to concern more about stock prices,
the expropriation is expected to be alleviated. In addition, we expect the block holdings of tradable
shares by institutional investors, in spite of the 5% limitation, are beneficial for minority shareholders
to monitor and balance the power of majority shareholders.
associated with the proportion of tradable shares.
associated with the concentration degree of tradable shares.
It was not until 2001 that the China Securities Regulatory Commission (CSRC) the regulator
of the securities markets - established the requirement that each listed firms should have two
independent directors on its board. Independent directors are expected to represent the interests of
small shareholders and are considered an independent check on deviant managerial behaviors (Fama,
1980; Shleifer and Vishny, 1997), thus the presence of independent directors may be helpful to
alleviate expropriation.
associated with the proportion of independent directors in the board of directors.
The information and monitoring system inside listed firms is helpful for minority
shareholders to monitor majority shareholders. Thus we expect the presence of audit committee
in listed firms could alleviate the expropriation. Besides, firms issuing foreign shares have to
submit to stricter regulations than those issuing only A shares, and firms issuing H shares also
have to submit to regulations from Hong Kong regulators, so we expect listed firms offering
foreign shares would have more perfect information and monitoring system and thus fewer
RPTs.
Hypothesis 9: The likelihood, as well as frequency and intensity of RPTs are lower for
listed companies establishing the audit committee than for listed companies not
establishing the audit committee.
In IPO, Chinas regulators typically required that tradable A shares account for about one third of a firms total
outstanding shares. Until July 1999, the CSRC limited the maximum ownership of tradable A shares to 0.5%, when this
limitation was raised to 5.0%. This regulation effectively prohibited block holdings of tradable A shares. However, on
Aprial 29, 2005, the CSRC announced a program by which non-tradable shares would be converted into tradable shares.
By the end of 2006, the process was essentially complete, with more than 95 percent of the affected companies
completing the conversion.
149
listed companies offering both A shares and H shares than for listed companies not
offering H shares.
listed companies offering both A shares and B shares than for listed companies not
offering B shares.
Majority shareholders holding non-tradable shares do not concern about stock prices for their
holdings are not tradable, which also render the market for corporate control dysfunctional. So we can
expect the effects of the controlling capability of majority shareholders on expropriation are different
for listed firms with different proportions of tradable shares. One extreme case would be that RPTs are
more positively associated with the controlling capability for listed firms with non-tradable shares than
for listed firms without non-tradable shares, as the market for corporate control for the latter firms
would restrain majority shareholders from expropriating to some extent.
Hypothesis 12: The proportion of tradable shares and the controlling capability of the
controlling shareholders have an interaction effect on RPTs.
Hypothesis 12a: The frequency and intensity of RPTs are more positively associated
with the controlling capability of the controlling shareholders for the listed companies
with non-tradable shares than for the listed companies without non-tradable shares.
3. Research Methodology
3.1. Data and Sample
We collected all data from Sinofin, a database compiled by the China Center for Economics Research
(CCER) at Peking University. The Sinofin dataset provides RPTs, financial and corporate governance
information on companies listed on Chinese stock exchanges in Shanghai and Shenzhen. Our sample
includes 69045 RPTs announced by all listed firms between 2002 and 2006. The total number of listed
firms in China was 1459 by 2006, following Cheung et al. (2006), we excluded firms in financial
industry for their special capital structure. Sinofin classifies RPTs into 29 types; we summarized the
frequencies and ratios of RPTs for each type in Table 1, and the number and ratio of listed firms by
RPTs frequencies in Table 2. According to Table 1, the frequencies of RPTs increase significantly with
time whereas the ratio of each type is rather stable across years, actually the frequencies doubled in
2006 relative to 2002. According to Table 2, the number and ratio of listed firms without announcing
RPTs decrease with the time, whereas the number and ratio of listed firms announcing over ten RPTs
increase significantly with the time. After data merging, aggregating and excluding cases with missing
or unreasonable values (probably due to data input errors), the size of our company-year observations
ranged from 6203 to 6555 for the different regression models. We did not find systematic biases in our
estimates resulting from the treatment of missing values.
3.2. Measures
3.2.1. Dependent Variables
For robustness, we designed three measures for RPTs the likelihood of RPTs, the frequency of RPTs
and the intensity of RPTs. The likelihood of RPTs is a dichotomy variable: 0 for observations without
announcing RPTs; 1 for observations announcing at least one RPT. The frequency of RPTs is the de
facto frequencies of RPTs the observations announced. The intensity of RPTs is the average relative
scale of each RPT the scale of RPTs for each observation was divided by the total assets to obtain the
relative scale of RPTs, and then the relative scale was divided by the frequency of RPTs to obtain the
intensity of RPTs.
For the institutional settings of China, the minority shareholders only objective is the rise of
stock prices (Proposition 6). So the measure of firm value should also be market based. Thus, we
150
measured firm value as the Cumulative Abnormal Return (CAR) of its stock price, adjusted for splits
and dividend payouts. The measure is calculated as follows:
N
t =1
t =1
CARi ,t = ARi ,t = ( Ri ,t R j ,t ) ,
(1)
Where Ri ,t is the return on A shares of the listed firm i for day t, and R j ,t is the value-weighted
average return of industry j to which the listed firm i belong for day t.
Table 1:
Trans.
type a
1011
1012
1021
1022
1023
1031
1032
1041
1042
1051
1052
1061
1062
1071
1072
1081
1082
1091
1092
1101
1102
1111
1121
1122
1131
1141
1151
1991
1992
Sum
Frequencies and Ratio of RPTs (2002 - 2006)

2002
Ratio
Freq.
(%)
1938
20.27
2377
24.87
402
4.21
190
1.99
1
0.01
418
4.37
940
9.83
21
0.22
24
0.25
168
1.76
106
1.11
171
1.79
105
1.1
694
7.26
711
7.44
1
0.01
0
0
6
0.06
4
0.04
10
0.1
49
0.51
1
0.01
0
0
3
0.03
47
0.49
76
0.8
63
0.66
450
4.71
583
6.1
9559
100
2003
Ratio
Freq.
(%)
2485
20.55
2894
23.94
399
3.3
212
1.75
13
0.11
518
4.28
1360
11.25
49
0.41
32
0.26
46
0.38
35
0.29
179
1.48
89
0.74
674
5.57
989
8.18
10
0.08
7
0.06
0
0
7
0.06
9
0.07
75
0.62
107
0.89
0
0
2
0.02
34
0.28
34
0.28
71
0.59
755
6.24
1005
8.31
12090
100
2004
Ratio
Freq.
(%)
2797
22.85
3277
26.77
428
3.5
225
1.84
5
0.04
573
4.68
1221
9.97
21
0.17
31
0.25
164
1.34
124
1.01
145
1.18
107
0.87
604
4.93
918
7.5
1
0.01
0
0
5
0.04
4
0.03
11
0.09
58
0.47
16
0.13
1
0.01
0
0
15
0.12
36
0.29
69
0.56
549
4.48
838
6.84
12243
100
2005
Ratio
Freq.
(%)
2854
18.79
3507
23.08
435
2.86
236
1.55
0
0
668
4.4
1639
10.79
18
0.12
35
0.23
248
1.63
157
1.03
181
1.19
205
1.35
1062
6.99
1840
12.11
4
0.03
0
0
3
0.02
9
0.06
17
0.11
72
0.47
43
0.28
0
0
1
0.01
19
0.13
28
0.18
75
0.49
753
4.96
1083
7.13
15192
100
2006
Ratio
Freq.
(%)
3564
17.85
3938
19.73
568
2.85
271
1.36
0
0
1021
5.11
2171
10.88
6
0.03
15
0.08
33
0.17
16
0.08
361
1.81
465
2.33
1782
8.93
2950
14.78
0
0
4
0.02
7
0.04
6
0.03
16
0.08
74
0.37
209
1.05
3
0.02
3
0.02
106
0.53
63
0.32
76
0.38
870
4.36
1363
6.83
19961
100
Total
Ratio
Freq.
(%)
13638
19.75
15993
23.16
2232
3.23
1134
1.64
19
0.03
3198
4.63
7331
10.62
115
0.17
137
0.2
659
0.95
438
0.63
1037
1.5
971
1.41
4816
6.98
7408
10.73
16
0.02
11
0.02
21
0.03
30
0.04
63
0.09
328
0.48
376
0.54
4
0.01
9
0.01
221
0.32
237
0.34
354
0.51
3377
4.89
4872
7.06
69045
100
a 1011 listed firm buys commodities from related party;1012 listed firm sells commodities to related party;1021 listed
firm buys assets other than commodities from related party;1022 listed firm sells assets other than commodities to
related party;1023 assets replacement;1031 listed firm provides labor services for related party;1032 listed firm
receives labor services from related party;1041 listed firm acts as an agent of related partys products and
services;1042 related party acts as an agent of listed firms products and services;1051 related party leases out assets
to listed firm ;1052 listed firm leases out assets to related party;1061 listed firm provides capital for related
party;1062 related party provides capital for listed firm;1071 listed firm provides guarantees or mortgages for related
party;1072 related party provides guarantees or mortgages for listed firm;1081 listed firm provides management
contracts for related party (listed firm gets income);1082 related party provides management contracts for listed firm
(related party gets income);1091 listed firm transfers R&D projects to related party (listed firm gets income);1092
related party transfers R&D projects to listed firm (related party gets income);1101 listed firm provides licensing
agreements for related party;1102 related party provides licensing agreements for listed firm;1111 listed firm
provides remuneration for important directors/executives;1121 listed firm confers assets to related party;1122 related
party confers assets to listed firm;1131 debt restructuring between listed firm and related party;1141 non-monetary
151
transactions between listed firm and related party;1151 joint ventures between listed firm and related party;1991
other transactions from which listed firm gets income;1992 other transactions for which listed firm expends.
Table 2: Listed Firms' Number and Ratio by RPTs Frequencies (2002 - 2006)a
2002
Trans.
Ratio
Freq. number
(%)
0
157
13.17
1~10
717
60.15
>10
318
26.68
Sum
1192
100
2003
Ratio
number
(%)
110
8.76
727
57.88
419
33.36
1256
100
2004
Ratio
number
(%)
71
5.28
858
63.84
415
30.88
1344
100
2005
Ratio
number
(%)
104
7.75
744
55.44
494
36.81
1342
100
2006
Ratio
number
(%)
42
2.96
739
52.01
640
45.04
1421
100
Total
Ratio
number
(%)
484
7.38
3785
57.74
2286
34.87
6555
100
a listed firms in financial industry are excluded
Table 3:
Descriptive Statistics and Correlationsa
Variables
1. Likelihood of RPTs
2. Frequency of RPTs
3. Intensity of RPTs
4. Non-State controlled listed
firm
5. Proportion of tradable shares
6. Ownership of the largest
shareholder
7. Board/executives ownership
8. Ownership of 5 largest
tradable share holders
9. Herfindal index
10. Proportion of independent
directors
11. Audit committee
12. B share
13. H share
14. Abnormal transaction status
15. Logarithm of total assets
16. Industry-adjusted previous
year market-to-book ratio
17. Industry-adjusted previous
year debt ratio
mean s.d.
0.93
0.26
10.60 12.43
0.31 12.84
10
11
12
13
14
0.24
0.01
-0.01
0.29
0.45
-0.09
-0.15
-0.01
0.42
0.13
-0.05
-0.01
-0.01
0.09
0.41
0.17
0.16
0.25
0.02
-0.32
-0.51
0.01
0.05
-0.02
-0.04
-0.00
0.18
-0.03
-0.11
0.02
0.02
-0.09
-0.09
-0.01
0.18
0.11
-0.43
0.22
0.21
0.14
0.14
0.24
0.01
-0.30
-0.57
0.97
-0.09
-0.42
0.32
0.08
0.07
0.04
-0.02
0.12
0.06
-0.07
0.05
0.06
-0.08
0.41
0.07
0.02
0.09
9.21
0.49
0.25
0.15
0.29
0.45
0.03
-0.01
0.01
-0.09
0.15
0.06
0.04
0.05
-0.11
0.32
-0.01
-0.01
-0.00
0.02
-0.01
-0.04
-0.06
-0.08
0.14
-0.24
0.01
0.17
0.04
0.00
0.07
0.00
-0.05
0.07
-0.13
0.24
0.03
-0.03
-0.02
-0.04
-0.06
0.05
0.01
-0.04
0.05
-0.06
0.61
5.13
-0.00
-0.04
-0.00
0.06
-0.07
-0.03
-0.01
0.04
0.74
-0.07
-0.03
0.01
0.07
0.00
-0.04
-0.03
15
16
0.00
-0.07
0.13
-0.12
0.25
0.12
0.01
-0.16
0.03
-0.02
-0.04
0.05
-0.08
0.06
-0.04
0.07
0.10
-0.01
0.27
-0.34
0.04
-0.02
-0.02
-0.02
0.05
-0.01
0.15
-0.13
0.04
-0.04
0.01
-0.03
0.08
-0.01
0.28
-0.15 -0.02
a N=6186
3.2.2. Independent Variables

We measured the controlling shareholders identity by the dummy variable Non-State controlled listed
firm: 0 for observations that are State controlled; 1 for observations that are non-State controlled
(mostly private or foreign controlled). We follow La Porta et al. (2002) in assuming the ultimate owner
of the largest shareholders has effective control over a firm. Actually, the absence of cumulative voting
procedures in China reinforces the idea that the ultimate owner of the largest shareholder has effective
control. So we measured the controlling capability of the controlling shareholders by the variable
Ownership of the largest shareholder. Stock incentives were measured by the variable
Board/executives ownership. We measured the ownership balancing of multiple block holders by the
variable Herfindal index, which was calculated as the squared sum of the percentage of shares held by
the 10 largest shareholders. The larger the value of this variable is, the more concentrated the stocks are
in the hands of a few shareholders, and the less the ownership balancing is. Tradable shares were
divided by the total shares outstanding to calculate the variable Proportion of tradable shares, and we
measured the concentration degree of tradable shares by the variable Ownership of 5 largest tradable
share holders. The larger the value of this variable is, the more concentrated the tradable shares are in
the hands of a few investors. The number of independent directors was divided by the board size to
calculate the variable Proportion of independent directors. Three dummy variables - Audit committee,
B share and H share were used to measure whether an observation establishing an audit committee,
issuing B shares and H shares or not, respectively.
152
3.2.3. Control Variables

Following some relevant studies (Berkman, Cole, and Fu, 2009; Cheung et al., 2006), we set Abnormal
transaction status, Logarithm of total assets, Industry-adjusted previous year market-to-book ratio, and
Industry-adjusted previous year debt ratio as control variables. Abnormal transaction status is a dummy
variable indicating whether an observation is under normal transaction status or under abnormal
transaction status (0 for normal; 1 for abnormal). The transaction status is imposed by the CSRC,
alerting investors about the financial status of listed firms. Logarithm of total assets is used to measure
the size of listed firms. Industry-adjusted previous year market-to-book ratio and Industry-adjusted
previous year debt ratio are used to measure the growth prospect and leverage of listed firms,
respectively. Finally, 12 industry dummies (13 industries: A through M) according to Guidelines for
Classification of Listed Companies issued by the CSRC and 4 year dummies (5 years: 2002 - 2006)
were also included as control variables. We summarized variables in Table 3.
3.3. Estimation
3.3.1. Event Study
To explicate the causality between RPTs and firm value, we investigated the value effect through the
reactions of stock markets towards the announcement of RPTs. 9047 events of RPTs which were
announced during 2004 were analyzed. We first calculated the ex ante and ex post Cumulative
Abnormal Returns (CARs, see formula 1) in short-term, middle-term and long-term, then conducted
paired t tests between the CAR pairs to discover RPTs value effect in short-term, middle-term and
long-term respectively.
Concretely, we first set the announcement date be day 0, then calculated the CARs on days [-5,1] and days [1, 5] respectively for each event, after that we conducted paired t test between the CAR
pairs to get the short-term value effects. Similarly, we got the middle-term value effects between days
[-20,-1] and days [1, 20], and the long-term value effects between days [-250,-1] and days [1, 250].
3.3.2. Logit and OLS Regressions
For Likelihood of RPTs is a dichotomy variable, we used logit regressions to estimate models with it,
whereas we used Ordinary Least Squares (OLS) regressions to estimate models with Frequency of
RPTs or Intensity of RPTs being dependent variables. Besides, for models with Intensity of RPTs being
dependent variables, we excluded observations without announcing RPTs. The general form of
estimation models is:
y it = + X it + Z it + u it
(2)
Where y it - Likelihood of RPTs, Frequency of RPTs, Intensity of RPTs,
X it - Independent variables vector
Z it - Control variables vector
u it - Disturbance
Clearly, u it of the same company in different years are highly correlated. Furthermore, there
may also be a company specific error component and the variances of u it may vary across companies.
To address these problems, we computed Huber-White robust standard errors allowing for group errors
by companies(Greene, 1993). We reported both logit and OLS estimation results with t-ratios based on
Huber-White robust standard errors.
153
4. Results
4.1. Value Effects of RPTs
We conducted event analysis on 9047 RPTs which were announced during 2004 to discover the value
effects of RPTs, the results of paired t test are presented in Table 4. In general, RPTs reduce firm value
significantly (p<0.01), and the value effects are much more significant in long-term than in short-term
and middle-term. We also conducted event analysis on each type of RPTs, results also show most types
have significant negative value effects both in short-term and in middle-term and long-term. However,
in short-term, types 1041 listed firm acts as an agent of related partys products and services
(p<0.05), 1071 listed firm provides guarantees or mortgages for related party (p<0.01), and 1082
related party provides management contracts for listed firm (p<0.05) increase firm value
significantly; in middle-term, only type 1041 listed firm acts as an agent of related partys products
and services (p<0.05) increases firm value significantly; whereas in long-term, no type increases the
firm value. These results may imply that social investors could realize that those RPTs seeming likely
to benefit them in short-term were probably for more expropriation in long-term. In addition, in longterm, the value effects of 1041 listed firm acts as an agent of related partys products and services,
1082 related party provides management contracts for listed firm, 1092 related party transfers R&D
projects to listed firm and 1122 related party confers assets to listed firm are insignificant.
According to Table 4, we find that listed firms seldom pursue those RPTs with positive or insignificant
value effects.
4.2. Corporate Governance and RPTs
We reported the regression results based on logit and OLS models with Huber-White robust variance
in Table 5 and Table 6, respectively. The interaction effect between the proportion of tradable shares
and the controlling capability of the controlling shareholders was presented in Table 7. A correlation
analysis before regressions indicated acceptable correlations between independent variables except a
high correlation (Table 3, r=0.97) between Ownership of the largest shareholder and Herfindal index.
So we also estimated models including only one of the two variables.
4.2.1. Identity of the Controlling Shareholders
The hypothesis 2 is partially supported: the likelihood (Table 5, p<0.05) and frequency (Table 6,
p<0.01) of RPTs are all higher for State controlled than for non-State controlled listed firms, whereas
the intensity of RPTs is lower for State controlled than for non-State controlled listed firms(Table 6,
p<0.01). This may imply that the expropriating capability and chance of the non-State controlling
shareholders is lower than the State controlling shareholders (e.g. for stricter regulation imposed on the
former), so once an expropriating chance appears, the former would pursue heavier RPTs.
4.2.2. Controlling Capability of the Controlling Shareholders
The likelihood, frequency as well as intensity of RPTs are all positively associated with Ownership of
the largest shareholder (Table 5 and Table 6, p<0.01), so the hypothesis 3 is well supported.

Table 4:
154
Value Effects of RPTsb
Trans.
type a
All
1011
1012
1021
1022
1023
1031
1032
1041
1042
1051
1052
1061
1062
1071
1072
1081
1082
1091
1092
1101
1102
1111
1121
1122
1131
1141
1151
1991
1992
9047
1847
2203
302
142
11
399
1129
45
23
38
26
125
79
453
698
7
4
0
5
7
65
76
0
2
18
23
52
501
767
Industry-adjusted CAR (shortterm)

Days [Days
tc
5,-1]
[1,5]
0.0106
0.0079
4.40***
0.0108
0.0059
3.89***
0.0097
0.0057
3.26***
0.0208
0.0099
2.89***
0.0022
0.0106
-1.28
0.0168
0.0117
0.18
0.0184
0.0109
2.88***
0.0140
0.0074
4.25***
-0.0209
0.0127
-2.57**
0.0160
0.0016
1.00
0.0177
0.0276
-0.90
-0.0011
0.0128
-1.40
0.0112
0.0176
-1.40
0.0106
0.0175
-1.05
-0.0002
0.0145
-5.08***
0.0023
0.0028
-0.19
0.0319
0.0037
1.23
0.0177
0.0521
-5.23**
NA
NA
NA
0.0599
-0.0046
1.63
-0.0064
0.0062
-1.38
0.0169
0.0078
1.28
0.0074
0.0065
0.14
NA
NA
NA
0.0007
-0.0069
0.81
-0.0165
0.0052
-1.54
0.0150
0.0164
-0.11
0.0091
0.0155
-0.85
0.0128
0.0095
1.12
0.0150
0.0115
1.72*
Industry-adjusted CAR (middleterm)

Days [Days
tc
20,-1]
[1,20]
0.0342
0.0194
12.84***
0.0346
0.0195
6.28***
0.0342
0.0203
6.21***
0.0474
0.0077
5.50***
0.0228
0.0176
0.39
0.0224
0.0501
-0.47
0.0426
0.0258
3.19***
0.0362
0.0161
6.36***
0.0047
0.0845
-2.62**
0.0533
-0.0063
2.59**
0.0603
0.0712
-0.65
0.0302
0.0264
0.29
0.0305
0.0096
3.01***
0.0357
0.0122
2.01**
0.0222
0.0100
2.69***
0.0265
0.0150
2.28**
0.0926
0.0493
1.07
0.0159
0.0787
-1.75
NA
NA
NA
0.1570
-0.0005
3.18**
0.0482
0.0351
0.40
0.0427
0.0177
2.06**
0.0303
0.0136
1.61
NA
NA
NA
-0.0347
0.0537
-3.02
0.0120
-0.0130
1.04
0.0666
0.0181
1.78*
0.0367
0.0228
0.94
0.0347
0.0209
2.63***
0.0351
0.0276
1.96*
Industry-adjusted CAR (longterm)

Days [Days
tc
250,-1]
[1,250]
0.3114
0.1683
40.05***
0.3184
0.1760
18.13***
0.3087
0.1614
20.58***
0.3559
0.1889
7.82***
0.2893
0.1543
4.34***
0.3948
0.1454
2.25**
0.3076
0.1661
9.61***
0.3041
0.1838
12.01***
0.3332
0.3819
-1.29
0.3361
0.1386
2.47**
0.3288
0.2423
1.77*
0.3677
0.1479
3.98***
0.2748
0.0752
7.36***
0.3267
0.1925
3.58***
0.3258
0.1392
12.96***
0.2762
0.1234
11.54***
0.5716
0.1426
2.52**
0.5320
0.3617
1.69
NA
NA
NA
0.6334
0.5022
0.60
0.4091
0.0580
2.20*
0.3338
0.2193
2.53**
0.2569
0.1605
3.15***
NA
NA
NA
0.1892
-0.0574
1.71
0.3496
-0.0085
4.15***
0.3566
0.2461
1.90*
0.3271
0.1781
4.67***
0.3062
0.1873
7.28***
0.3210
0.1832
10.32***
a 1011 listed firm buys commodities from related party;1012 listed firm sells commodities to related party;1021 listed
firm buys assets other than commodities from related party;1022 listed firm sells assets other than commodities to
related party;1023 assets replacement;1031 listed firm provides labor services for related party;1032 listed firm
receives labor services from related party;1041 listed firm acts as an agent of related partys products and
services;1042 related party acts as an agent of listed firms products and services;1051 related party leases out assets
to listed firm ;1052 listed firm leases out assets to related party;1061 listed firm provides capital for related
party;1062 related party provides capital for listed firm;1071 listed firm provides guarantees or mortgages for related
party;1072 related party provides guarantees or mortgages for listed firm;1081 listed firm provides management
contracts for related party (listed firm gets income);1082 related party provides management contracts for listed firm
(related party gets income);1091 listed firm transfers R&D projects to related party (listed firm gets income);1092
related party transfers R&D projects to listed firm (related party gets income);1101 listed firm provides licensing
agreements for related party;1102 related party provides licensing agreements for listed firm;1111 listed firm
provides remuneration for important directors/executives;1121 listed firm confers assets to related party;1122 related
party confers assets to listed firm;1131 debt restructuring between listed firm and related party;1141 non-monetary
transactions between listed firm and related party;1151 joint ventures between listed firm and related party;1991
other transactions from which listed firm gets income;1992 other transactions for which listed firm expends.
b The significance level of 1%, 5% and 10% are noted by ***, ** and *.
c Paired t test is used.
155
4.2.3. Stock Incentives

Although Board/executives ownership is insignificant in predicting the likelihood of RPTs, it has
significantly negative effects on the frequency and intensity of RPTs (Table 6, p<0.01). Thus, the
hypothesis 4 is partially supported. This implies that although the tradeoff between economic and
political objectives by the directors could not let them deviate completely from majority shareholders
(i.e. choose between pursuing and not pursuing RPTs), it would be helpful to align their interest with
minority shareholders to some extent; in words, although stock incentives could not affect RPTs
qualitatively, it does affect RPTs quantitatively.
4.2.4. Ownership Balancing
We measured the ownership balancing by Herfindal index. The larger Herfindal index is, the less the
ownership is balanced. Table 5 and Table 6 indicate that the likelihood, frequency as well as intensity
of RPTs are all positively associated with Herfindal index (p<0.01). So the hypothesis 5 is supported.
4.2.5. Tradable Shares
The effects of Proportion of tradable shares are equivocal. On one hand, the likelihood of RPTs is
negatively associated with it (Table 5, p<0.05), on the other hand, the frequency of RPTs is positively
associated with it (Table 6, p<0.05), whereas its effect on the intensity of RPTs is insignificant. We
have argued that expropriation of minority shareholders by majority shareholders are essentially
expropriation of tradable share holders by non-tradable share holders in China (Proposition 4), so with
the increase of Proportion of tradable shares, the tradable share holders would have more strength to
balance the non-tradable share holders, thus the likelihood of expropriation is expected to decrease.
However, with the increase of Proportion of tradable share, there would be more resources for nontradable share holders to expropriate, so we conjecture that once tradable share holders fail to balance
non-tradable share holders and the latter could take actions to expropriate, instead they would likely to
expropriate more often.

Table 5:
156
LOGIT Resultsabc
Likelihood of RPTs (0: no; 1: yes)

(2)
(3)
(4)
3.441***
Ownership of the largest shareholder
(7.03)
4.118*** 4.267***
Herfindal index
(5.40)
(5.42)
-0.242**
-0.240**
-0.273**
-0.271**
Non-State controlled listed firm
(-2.20)
(-2.11)
(-2.48)
(-2.38)
-1.075**
-1.036**
-0.942**
-0.906*
Proportion of tradable shares
(-2.42)
(-2.26)
(-1.94)
(-1.80)
-0.915
-0.212
-1.072
-0.375
Board/executives ownership
(-1.25)
(-0.20)
(-1.47)
(-0.36)
-5.487**
-5.582**
-5.907**
-6.147**
Ownership of 5 largest tradable share holders
(-2.30)
(-2.23)
(-2.38)
(-2.37)
-0.041
0.364
-0.030
0.356
Proportion of independent directors
(-0.05)
(0.44)
(-0.04)
(0.43)
0.066
0.058
0.066
0.059
Audit committee
(0.61)
(0.53)
(0.61)
(0.54)
-0.226
-0.165
-0.245
-0.184
B share
(-1.17)
(-0.82)
(-1.28)
(-0.92)
-0.966**
-0.967** -1.206*** -1.205***
H share
(-2.35)
(-2.32)
(-2.86)
(-2.83)
-0.257*
-0.220
-0.261*
-0.222
Abnormal transaction status
(-1.66)
(-1.35)
(-1.69)
(-1.36)
1.107***
1.089***
1.114*** 1.096***
Logarithm of total assets
(7.04)
(6.63)
(7.10)
(6.68)
0.016**
0.015**
Industry-adjusted previous year market-to-book ratio
(2.26)
(2.26)
-0.064*
-0.068*
Industry-adjusted previous year debt ratio
(-1.66)
(-1.68)
-8.808
-8.883
-8.464
-8.504
Constant
(-6.17)
(-5.97)
(-5.96)
(-5.75)
N
6504
6181
6504
6181
Pseudo R2
0.14
0.14
0.13
0.14
a The significance level of 1%, 5% and 10% are noted by ***, ** and *.
b All regressions include the industry and year dummies.
c The numbers in parentheses are z value based on Huber-White robust standard errors.
(1)
3.296***
(6.96)
(5)
4.974***
(3.56)
-2.338
(-1.12)
-0.241**
(-2.11)
-1.283**
(-2.43)
-0.133
(-0.13)
-6.117**
(-2.42)
0.371
(0.45)
0.058
(0.52)
-0.154
(-0.76)
-0.814*
(-1.87)
-0.224
(-1.37)
1.106***
(6.63)
0.016**
(2.26)
-0.060
(-1.57)
-9.061
(-6.02)
6181
0.14
157
Table 6:
OLS Resultsabde
Ownership of the
largest shareholder
(1)
0.213***
(14.11)
Herfindal index
Non-State controlled
listed firm
Proportion of tradable
shares
Board/executives
ownership
Ownership of 5 largest
tradable share holders
Proportion of
independent directors
Audit committee
B share
H share
Abnormal transaction
status
Logarithm of total
assets
Industry-adjusted
previous year marketto-book ratio
Industry-adjusted
previous year debt ratio
Constant
N
R2
-0.046***
(-4.13)
0.033**
(2.37)
-0.024***
(-3.04)
0.002
(0.19)
-0.018
(-1.28)
0.014
(1.22)
0.009
(0.70)
-0.043***
(-2.71)
-0.008
(-0.83)
0.276***
(17.65)
-62.314
(-17.11)
6489
0.32
Panel A: frequencies of RPTs

(3)
(4)
(5)
0.183***
(3.69)
0.221***
0.220***
0.037
(12.83)
(12.38)
(0.67)
-0.047*** -0.051*** -0.052*** -0.047***
(-4.10)
(-4.57)
(-4.58)
(-4.12)
0.035**
0.052***
0.052***
0.040**
(2.42)
(3.48)
(3.37)
(2.47)
-0.020*** -0.027*** -0.023*** -0.021***
(-2.62)
(-3.38)
(-2.95)
(-2.66)
0.001
0.001
-0.001
0.002
(0.09)
(0.12)
(-0.10)
(0.15)
-0.020
-0.019
-0.021
-0.020
(-1.40)
(-1.34)
(-1.47)
(-1.41)
0.014
0.014
0.014
0.014
(1.23)
(1.20)
(1.23)
(1.23)
0.006
0.008
0.005
0.005
(0.42)
(0.62)
(0.34)
(0.41)
-0.047*** -0.058*** -0.061*** -0.049***
(-2.87)
(-3.69)
(-3.80)
(-2.96)
-0.017*
-0.009
-0.018*
-0.017*
(-1.67)
(-0.97)
(-1.74)
(-1.67)
0.279***
0.273***
0.277***
0.278***
(17.24)
(17.46)
(17.08)
(17.18)
0.020**
0.019**
0.020**
(2.41)
(2.35)
(2.41)
(2)
0.215***
(13.82)
0.029***
(3.24)
-64.790
(-17.33)
6167
0.32
-60.776
(-16.69)
6489
0.32
0.028***
(3.27)
-63.284
(-16.91)
6167
0.32
0.029***
(3.23)
-64.527
(-17.25)
6167
0.32
(6) c
0.148***
(2.82)
0.059
(1.00)
-0.045***
(-3.73)
0.048***
(2.81)
-0.018**
(-2.30)
0.005
(0.42)
-0.020
(-1.33)
0.016
(1.29)
0.009
(0.69)
-0.045***
(-2.61)
-0.017
(-1.55)
0.276***
(16.34)
0.017*
(1.89)
0.029***
(2.66)
-64.977
(-16.35)
5719
0.31
(1) c
0.070***
(3.79)
0.067***
(4.48)
0.012
(0.67)
-0.048***
(-2.83)
-0.031**
(-2.01)
0.025
(1.64)
-0.043***
(-3.28)
-0.019
(-1.49)
-0.018
(-1.31)
0.079***
(5.44)
-0.208***
(-12.62)
0.599
(2.25)
6014
0.15
Panel B: intensity of RPTs

(2) c
(3) c
(4) c
0.065***
(3.42)
0.084***
0.076***
(4.31)
(3.80)
0.064***
0.067***
0.063***
(4.20)
(4.51)
(4.21)
0.004
0.024
0.015
(0.22)
(1.29)
(0.76)
-0.035*
-0.048***
-0.036*
(-1.86)
(-2.86)
(-1.89)
-0.034**
-0.028*
-0.032**
(-2.16)
(-1.81)
(-2.03)
0.025
0.025
0.025
(1.62)
(1.62)
(1.61)
-0.053*** -0.043*** -0.053***
(-3.92)
(-3.28)
(-3.92)
-0.023*
-0.020
-0.023*
(-1.74)
(-1.52)
(-1.76)
-0.015
-0.024*
-0.020
(-1.05)
(-1.71)
(-1.40)
0.058***
0.079***
0.058***
(3.79)
(5.43)
(3.80)
-0.209*** -0.211*** -0.212***
(-12.56)
(-12.74)
(-12.66)
-0.001
-0.001
(-0.07)
(-0.08)
0.058**
(2.50)
0.627
(2.29)
5718
0.15
0.635
(2.39)
6014
0.15
0.057**
(2.49)
0.657
(2.40)
5718
0.15
(5) c
-0.017
(-0.29)
0.093
(1.52)
0.063***
(4.14)
0.016
(0.79)
-0.036*
(-1.90)
-0.032**
(-2.04)
0.025
(1.61)
-0.053***
(-3.93)
-0.023*
(-1.76)
-0.021
(-1.41)
0.058***
(3.80)
-0.212***
(-12.67)
-0.001
(-0.09)
0.057**
(2.49)
0.664
(2.43)
5718
0.15
c Observations without RPTs are not included in the estimations of equation 6 in panel A and all equations in panel B.
d The numbers in parentheses are t ratios based on Huber-White robust standard errors.
e Standardized coefficients.
As to the effect of concentration of tradable shares, the likelihood and intensity of RPTs are all
negatively associated with the Ownership of 5 largest tradable share holders (Table 5 and Table 6,
p<0.05), whereas the effect of Ownership of 5 largest tradable share holders on the frequency of RPTs
is insignificant. Thus, hypothesis 6 and 7 are partially supported.
4.2.6. Independent Directors
We found no evidence about the effect of independent directors, so hypothesis 8 can not be supported.
This result corroborates many findings that independent directors are invalid in protecting minority
shareholders in China, as majority shareholders board representatives will restrict the flow of
information needed by independent directors (Peng, 2004), and independent directors in China often
partner with the majority shareholder, even worse, some independent directors even believe that their
primary duty is to safeguard the interests of the controlling shareholder - the State (Clarke, 2003) .
Actually, some authors even consider independent directors as an extra burden and cost to listed firms
(Su et al., 2008).
4.2.7. Information and Monitoring System
Table 5 and Table 6 indicate that Audit committee is negatively associated with the intensity of RPTs
(p<0.01), whereas it has no significant effect on the likelihood and frequency of RPTs. Besides, B
share has no significant effect on both the likelihood and the frequency and intensity of RPTs, whereas
H share is negatively associated with the likelihood (p<0.05) and frequency (p<0.01) of RPTs. This is
158
because although B shares are also foreign shares, they are still under the regulation of the CSRC,
whereas H shares are subject to the regulation of Hong Kong. The stricter regulation and requirements
on corporate governance in Hong Kong capital markets would urge H share companies to ameliorate
their information and monitoring system. As a result, H share companies would have better
information and monitoring system than B share companies.
4.2.8. Control Variables
Among the control variables, the Abnormal transaction status is positively associated with the intensity
of RPTs (p<0.01); the Logarithm of total assets is positively associated with the likelihood and
frequency of RPTs (p<0.01), whereas it is negatively associated with the intensity of RPTs (p<0.01);
the Industry-adjusted previous year market-to-book ratio is positively associated with the likelihood
and frequency of RPTs (p<0.05); and the Industry-adjusted previous year debt ratio is positively
associated with the frequency (p<0.01) and intensity (p<0.05) of RPTs.
4.2.9. Interaction Effect
The result of interaction effect between the proportion of tradable shares and the controlling capability
of controlling shareholders was presented in Table 7. We divided observations into two groups, for
model 1 both in panel A and B, observations Proportion of tradable shares equal 1; for model 2 and 3
both in panel A and B, observations Proportion of tradable shares do not equal 1. By comparing OLS
regression results of model 1 and 2 both in panel A and B, we found the coefficient on the variable
Ownership of the largest shareholder is significantly positive for model 2 (p<0.01), whereas the
coefficient is insignificant for model 1. So the hypothesis 12a is supported. In view of the small sample
in model 1, we also compared other model pairs with Proportion of tradable shares equal 0.75 and
0.85 instead of 1 as the grouping thresholds, the result was unchanged qualitatively. However,
considering these choices of grouping threshold are rather arbitrary, we only reported the result here
with 1 as the grouping threshold.
To further explicate the interaction effect, we added a cross-term Proportion of tradable
share*Ownership of the largest shareholder in model 3, the results of OLS regression with robust
variance show the coefficient on the cross-term is significant for model 3 in panel A (p<0.01), and is
marginally significant for model 3 in panel B (p<0.1). The marginal effects of Proportion of tradable
share on RPTs are:
(frequency)
>0ownership>0.24
= 4.828+ 20.535* ownership {
(3)
<0ownership<0.24
(proportion)
and
(int ensity)
= 0.303 + 0.780 * ownership
proportion
>0ownership>0.39
{<0ownership<0.39
(4)
where frequency the frequency of RPTs
intensity the intensity of RPTs

proportion Proportion of tradable shares
ownership Ownership of the largest shareholders
Formula (3) and (4) state that the marginal effects of Proportion of tradable shares on RPTs are
subject to the Ownership of the largest shareholders. If the Ownership of the largest shareholders is
over a certain threshold, there would be a positively marginal effect; otherwise, the marginal effect
would be negative.
We have argued that expropriation of minority shareholders by majority shareholders are
essentially expropriation of tradable share holders by non-tradable share holders in China (Proposition
4), so with the increase of Proportion of tradable shares, the tradable share holders would have more
strength to balance the non-tradable share holders, thus the frequency and intensity of RPTs were
expected to decrease. However, provided that the ownership of the largest shareholder was beyond a
159
certain level (0.24 and 0.39 for the frequency and intensity of RPTs respectively in our estimation) thus
the controlling shareholders could exert an absolute control towards a firm, with the increase of
Proportion of tradable share, as there would be more resources for controlling shareholders to
expropriate, contrary they would expropriate more often and heavily.
Table 7:
Interaction Effectabc
Ownership of the largest shareholder

Non-State controlled listed firm
Proportion of tradable shares
Proportion of tradable shares* Ownership of
the largest shareholder
Board/executives ownership
Ownership of 5 largest tradable share holders
Proportion of independent directors
Audit committee
B share
H share
Abnormal transaction status
Logarithm of total assets
Industry-adjusted previous year market-to-book
ratio
Industry-adjusted previous year debt ratio
Constant
N
R2
Panel A: frequencies of RPTs

Proportion of
tradable shares =1
shares1
(1)
(2)
(3) d
0.215
0.213***
6.387**
(1.14)
(13.73)
(2.14)
-0.148
-0.046***
-1.061***
(-0.77)
(-4.00)
(-3.87)
0.022
-4.828*
(1.53)
(-1.76)
20.535***
(2.65)
-0.056
-0.021***
-5.109***
(-0.42)
(-2.74)
(-2.87)
0.004
0.001
1.930
(0.04)
(0.12)
(0.30)
0.818***
-0.021
-2.864
(4.70)
(-1.45)
(-1.44)
-0.166
0.013
0.302
(-0.85)
(1.15)
(1.15)
0.008
0.417
(0.62)
(0.73)
-0.047***
-3.660***
(-2.84)
(-3.12)
-0.018*
-0.649*
(-1.76)
(-1.70)
-0.027
0.279***
6.960***
(-0.06)
(17.25)
(17.29)
0.561*
0.020**
0.041**
(2.08)
(2.36)
(2.31)
-1.091***
0.026***
0.402***
(-3.67)
(3.25)
(3.37)
7.774
-64.599
-62.953
(0.15)
(-17.22)
(-16.77)
24
6143
6143
0.95
0.31
0.33
Panel B: intensity of RPTs

Proportion of
tradable shares =1
shares1
(1)
(2)
(3) d
-0.025
0.063***
-0.038
(-0.13)
(3.33)
(-0.23)
-0.627**
0.067***
0.098***
(-3.76)
(4.40)
(4.45)
-0.008
-0.303*
(-0.45)
(-1.76)
0.780*
(1.87)
-0.516**
-0.037*
-0.531**
(-3.55)
(-1.94)
(-1.97)
-0.084
-0.033**
-1.017**
(-0.68)
(-2.07)
(-1.98)
0.346*
0.025
0.211
(2.31)
(1.60)
(1.60)
0.525
-0.055***
-0.071***
(1.94)
(-4.05)
(-4.03)
-0.020
-0.048
(-1.50)
(-1.44)
-0.015
-0.074
(-1.03)
(-1.24)
0.056***
0.133***
(3.76)
(3.77)
0.612
-0.206***
-0.301***
(0.93)
(-12.40)
(-12.19)
-0.474*
-0.001
-0.000
(-2.37)
(-0.04)
(-0.05)
1.014**
0.049***
0.047***
(4.32)
(2.71)
(2.75)
-13.913
0.605
0.668
(-1.24)
(2.21)
(2.39)
20
5698
5698
0.98
0.15
0.15
c The numbers in parentheses are t ratios based on Huber-White robust standard errors.
d Coefficients of equation 1 and 2 both in Panel A and B are standardized; Coefficients of equation 3 both in Panel A and B
are not standardized in order for marginal analysis.
5. Discussion
5.1. Implications
China is the largest and fastest growing emerging economy in the world. By 2007, it has ranked among
the five largest economies in the world. So understanding the specific challenges faced by corporate
governance of its firms per se are of both practical importance and theoretical significance. Especially
for those multi-national corporations (MNCs) which are considering to entry the Chinese market and
thus seeking partners for their strategic alliances (e.g. joint venture, licensing), our study on RPTs
provides them the immediate information and evidence about their potential partners corporate
governance, whereas other reliable information are extraordinarily difficult for MNCs to obtain as the
controlling shareholders of these firms are prone to hide the true information for their private interest.
Our study also has practical implications for other emerging economies with concentrated ownership
160
structure and weak investor protection. We suggested that in such economies the external control
mechanism were dysfunctional, thus the internal control mechanism were more important. Our study
indicated the expropriation is associated with ownership structure, incentive contracts, and the
information and monitoring system. By using these instruments appropriately, firms may mitigate
agency problems in the context of weak investor protection.
Moreover, extant works in the field of corporate governance considered the expropriation to be
the result of principal-principal conflicts(Su et al., 2008; Young et al., 2003), thus implicitly
regarding expropriation as value destroying. However, our theoretical framework suggested minority
shareholders and majority shareholders is essentially principal-agent rather than purely principalprincipal relationship, and the expropriation in essence is the rent seized by majority shareholders to
compensate their agency function. Thus expropriation is indefinitely value-destroying if their benefits
from majority shareholders agency function exceed the expropriation, minority shareholders may
instead benefit. So a future research implication could be under what conditions minority shareholders
benefits would exceed the expropriation.
Another implication concerns the ongoing debates between the agency theory and the
stewardship theory of corporate governance. Agency theory suggests that the interests of opportunistic,
self-interested agents conflict with those of principals, whereas stewardship theory suggests instead
that executives' interests are aligned with company interests and that executives are thus more
intrinsically motivated than agency theory implies (Sundaramurthy and Lewis, 2003; Wasserman,
2006). These two contrasting theories imply two contrasting approaches for corporate governance
control or collaboration. In view of the fact that the theoretical framework of this study was established
in line with the agency theory, and it predicted results well, we are confident that the agency theory is
also robust to underlie corporate governance for other emerging economies with similar institutional
settings. Thus monitoring and control instead of empowerment should be the major approaches for
corporate governance in these emerging economies.
Finally, although this study did not concern corporate strategy directly, it may have indirect
implications to the relationship between ownership structure and corporate strategy which had been
debated among several authors (Amihud and Lev, 1981; Amihud and Lev, 1999; Denis, Denis, and
Sarin, 1999; Lane, Cannella, and Lubatkin, 1999). A firm with high frequency of RPTs may, to some
extent, implication of many related parties, which is more likely to be diversified. So the result that the
frequency of RPTs is positively associated with the ownership concentration may imply the
diversification of a firm is positively associated with its ownership concentration. Amihud and Lev
(1981; 1999) claimed that companies with greater ownership concentration are less diversified, as
managers, unless closely monitored by large block shareholders, will attempt to reduce their
employment risk through unrelated mergers and diversification. Following the same logic, in spite of
different conclusion, the positive association between diversification and ownership concentration
could be explained as follows: the corporate strategy is de facto formulated by the controlling
shareholder as the board is tightly monitored and controlled by it in firms with concentrated ownership
structure; in addition, minority shareholders may diversify their portfolios, whereas the controlling
shareholder is locked in one firm, so the controlling shareholder, unless closely monitored by minority
shareholders, will attempt to reduce their risk through unrelated mergers and diversification; obviously,
the more concentration of ownership is, the more stake the controlling shareholder is locked in one
firm, and the less minority shareholders can monitor the controlling shareholder, further, the more
diversification the controlling shareholder would choose.
5.2. Limitations
An important limitation of the study is about the causality. While our hypotheses were stated in
associational terms, the logic behind implies that corporate governance "causes" RPTs. Unfortunately,
even with panel data it is not possible to completely disentangle causal direction.
Another limitation of this study concerns the generalizability of its results. Specifically, to what
extent do our results generalize outside of China? Actually, even China is unique as to its split share
161
structure (tradable/non-tradable shares) and Party control, as the largest emerging economy, it has
many commonalities in corporate governance with other developing countries or transitional
economies. So we believe our results would not be changed qualitatively when generalizing to these
economies with concentrated ownership structure.
Finally, our research objective was to link corporate governance to firm value through the
intermediary expropriation which was measured by RPTs. For robustness, we designed three measures
for RPTs: the likelihood, the frequency and the intensity. However, by conducting event analysis, we
could only illustrate the value effect of the likelihood of RPTs, but could not explicate the causality
between the frequency or intensity of RPTs and firm value. In addition, although we have showed
RPTs are value-destroying in overall, we ignored several RPTs types which were identified as valuecreating or value-neutral in the event study.
6. Conclusion
This study investigated the intermediation of expropriation in the relationship between corporate
governance and firm value. Based on extant works on principal-principal conflicts, we manifested
the triple principal-agent relationships among minority shareholders, majority shareholders and the
board of directors. We also conceptualized the expropriation as rents demanded by majority
shareholders to compensate their agency function in a theoretical framework of corporate governance
for economies with concentrated ownership structure. In institutional settings of China, the highly
concentrated ownership structure coupled with non-tradable shares and multiple objectives of majority
shareholders would lead to more rents demanded and thus severer expropriation by majority
shareholders. So it offers a unique context for further theorizing and empirical testing of the agency
problem. By using related party transactions as a direct measure for expropriation, we corroborated the
negative value effect of expropriation, and found that the controlling capability of controlling
shareholders, ownership balancing, identity of controlling shareholders, stock incentives for the
board/executives, and the proportion of tradable shares are significantly associated with related party
transactions. All these factors but the proportion of tradable shares had already been directly linked to
firm performance or value in literatures on corporate governance, corporate strategy, value creation,
accounting as well as finance and economics. We hope our work on related party transactions would
provide insight to understand the relationship between corporate governance and firm value or
performance, and lay a basis for future theory building on corporate governance.
162
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Zhiwen Zhu - Multiple - Agent Relations

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International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 31 (2009)

Multiple Principal-Agent Relationships, Corporate-Control

International Research Journal of Finance and Economics - Issue 31 (2009)

2. Theory and Hypotheses

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

Markets for corporate

Markets for corporate

Markets for corporate

International Research Journal of Finance and Economics - Issue 31 (2009)

2.1.2. Non-Tradable Shares

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

Frequencies and Ratio of RPTs (2002 - 2006)

International Research Journal of Finance and Economics - Issue 31 (2009)

a listed firms in financial industry are excluded

Descriptive Statistics and Correlationsa

3.2.2. Independent Variables

International Research Journal of Finance and Economics - Issue 31 (2009)

3.2.3. Control Variables

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

Value Effects of RPTsb

Industry-adjusted CAR (shortterm)

Industry-adjusted CAR (middleterm)

Industry-adjusted CAR (longterm)

International Research Journal of Finance and Economics - Issue 31 (2009)

4.2.3. Stock Incentives

International Research Journal of Finance and Economics - Issue 31 (2009)

Likelihood of RPTs (0: no; 1: yes)

International Research Journal of Finance and Economics - Issue 31 (2009)

Panel A: frequencies of RPTs

Panel B: intensity of RPTs

International Research Journal of Finance and Economics - Issue 31 (2009)

where frequency the frequency of RPTs

intensity the intensity of RPTs

International Research Journal of Finance and Economics - Issue 31 (2009)

Ownership of the largest shareholder

Panel A: frequencies of RPTs

Panel B: intensity of RPTs

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

International Research Journal of Finance and Economics - Issue 31 (2009)

Aguilera, R. V. and G. Jackson. 2003. "The cross-national diversity of corporate governance:

International Research Journal of Finance and Economics - Issue 31 (2009)

Hill, C. W. L. and S. A. Snell. 1988. "External Control, Corporate-Strategy, and Firm

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