Study On Large Shareholders' Private Benefits Of Control And Earnings Management

Private benefits of control (PBC) are sub-topic of principal-agent theory. Shleiferand Vishny (1997) clearly pointed out that the conflict between large and smallshareholders dominates company's agent problem in market without perfect legalprotection of investors. Chinese securities market is a newly emerging marketdeveloped in the process of a transitional economy. The pervasive existence of largeshareholders and lack of full legal protection of minor investors make PBC deservedmuch attention. Managers of listed companies act as the shadow and agent of largeshareholders under the latter's strong control, which transform the contracts betweenthem into contracts between large and small shareholders. Using contract theory, Iestablish an analytical framework and try to offer an interpretation of PBC fromtransaction costs and incompleteness of contract, information asymmetry, largeshareholders' control, opportunistic motive, and regulation.The author further expands the thesis to study the impact of PBC on earningsmanagement, which intends to display a complete picture of principal-agent problembetween large and small shareholders. Fan and Wong (2002) found that once the largeshareholders can control listed companies' operation, the same control could beexerted on accounting information. PBC cause damages to the interests of otherinvestors, and retard the healthy development of capital market. Facing great pressurefrom regulatory authorities, small shareholders and others, the large shareholders canextended their control to accounting information, and manage earnings to conceal andmaintain PBC. In other words, they will excuse themselves from being blamed usingaccounting language.Based on the above analytical framework, this dissertation choese cashexpropriation and private placement discount as typical tunneling ante and postreform on split share structure, and studies PBC and PBC based earnings managementempirically. Split share structure distort large shareholders' manner of obtain interests,and cash expropriation is an example. Conflicts between large and small shareholdersalleviated after the reform, but new type of tunneling such as unfair private offeringemerges. Based on principal-agent theory I find that manipulation of offering discountis one of the ways of tunneling. Empirical study on the two typical kinds of tunnelingshows that large shareholders select the manner of PBC contingently with the changeof market environment, as long as large shareholder's control, opportunistic motivation, information asymmetry etc. justify PBC. Reform on split share structureis a necessary but not sufficient condition for constraint of PBC. The dissertationfurther finds that large shareholders drive listed companies to manage earnings inorder to conceal and maintain PBC. After controlling for the effects of loss, SEO andscale etc. on earnings management, I find that the more cash expropriation the moreearnings management upwardly; compared with other companies, companies thatoffer securities privately show higher degree of earnings management. Using privateoffering sample it further shows that companies offer securities to major shareholdersdemonstrate even more earnings management although the empirical results can't tellthe direction of earnings management. This corroborates the argument that earningsmanagement is reflection of agency problems on accounting (Lei and Liu, 2006).Earnings management plays a part to facilitate PBC.Possible contributions of this dissertation are: First, combines PBC and earningsmanagement into the same topic, and studys their relationship through contractanalysis under principal-agency framework; Second, extends research of the mannerof PBC using theoretical analysis and empirical test, and points out that the reform ofsplit share struture (full circulation) is a necessary but not sufficient condition forinterests synergy of different type of shareholders. Third, extends the topic of PBC toearnings management phenomena and investigate how large shareholders get listedcompanies to manage earnings in order to conceal and maintain PBC.