Interlocks Of Executives Between Parent And Subsidiaries And Capital Allocation

The parent-subsidiary structure is an organizational form commonly adopted by listed companies in China.Under this structure,the proportion of the listed companies’ overall businesses undertaken by the subsidiaries has gradually increased,so have the authorized operations between the parent and the subsidiaries.The capital allocation has also shown the characteristics of stratification: the parent company mainly undertakes the overarching functions of strategy formulation and resource allocation for its subsidiaries across different business units;whereas subsidiaries are granted certain autonomy to carry out investment plans in their specialized fields,consistent with the strategies of the parent company.The parent-subsidiary capital authorization structure brings organizational flexibility to the capital allocation,and adds a more complex principal-agent relationship to the capital allocation mechanism of listed companies.Improving the parent-subsidiary governance becomes a key measure of the capital allocation efficiency of listed companies.The vertical interlocks of executives between parent and subsidiaries is one of the essential measures to improve government,as it solves the principal agent problem between parent and subsidiaries.In theory,it’s expected to improve the efficiency of capital allocation.However,the interests of vertical interlocks of executives who serve in both parent company and subsidiary company will be jointly determined by both sides,which means that vertical interlocks of executives may represent the interests of subsidiary,and would intensify the agency conflict between the parent and subsidiaries.The vertical interlocks of executives may represent the interests of parent company,supervising the subsidiary and achieving the governance goal between parent and subsidiary;however,when the personal interests of the executive are blended with the business arrangement of the subsidiary,the vertical interlocks of executives may represent the interests of the subsidiary.The existing research,from the perspective that vertical interlocks of executives and the entrusting party share the same interest and motivation,cannot fully explain the theoretical mechanism of how vertical interlocks of executives affect the capital allocation behavior and the efficiency of the parent company.With the complex interest relationship between the parent company and the subsidiary company,the vertical interlocks of executives,as the agent of the parent company,serve a delicate role in the decision of capital allocation.Therefore,when studying the effect of vertical interlocks of executives,it should be taken into consideration of the stakeholders and interests represented by the concurrent executives.Based on the above background,this paper discusses how the mechanism of vertical interlocks of executives between parent and subsidiaries affects capital allocation activities and efficiency,under the perspective of different interests of vertical interlocks of executives.The core research question of this paper is: How does the vertical interlocks of executives between parent and subsidiary companies affect the capital allocation activities and capital allocation efficiency of listed companies.The capital allocation behavior of listed companies mainly includes financial investment and operational investment.Generally speaking,these two types of investment have different effects on enterprise development.The incentives on the management level will affect the weight of capital allocation between financial investment and operating investment,and in turn affect the capital allocation efficiency of listed companies.With this in mind,this paper investigates the following three aspects: analysis of the effect and mechanism of the vertical interlocks of executives between the parent and subsidiary companies on the financial investment;on the operational investment;as well as on the efficiency of capital allocation of listed companies.The main findings of this research are as follows.First,the impact of vertical interlocks of executives between parent and subsidiary companies on financial investment is affected by the personal interests of the executives.When the vertical interlocks of executives represent the interests of the parent company,the executives will exert a supervisory effect by reducing the agency cost of the subsidiary company and restraining the financial investment at the subsidiary level,thereby inhibiting the financial investment of the listed company.However,when the vertical interlocks of executives represent the interests of subsidiaries,the executives have no significant inhibitory effect on financial investment.When there exist serious principal agent problems in the listed companies,it will weaken the inhibitory effect of vertical interlocks of executives between parent and subsidiaries on financial investment.Second,the vertical interlocks of executives between parent and subsidiaries increases the operational investment in general,but there are heterogeneities in the mechanisms.Regardless of whether the executives represent the interest of the parent company or the subsidiary company,the vertical interlocks of executives promote operational investment.However,when they represent the interests of the parent company,the executives will increase the debt of the subsidiary company,and through the introduction of external capital improves the operating investment of the listed company.As well as the crowding-out effect of financial investment diverts capital to operational investment.However,when the vertical interlocks of executives represent the interests of subsidiaries,the funds for increasing operating investment come from seeking excess cash directly from the parent company.Finally,the effect of vertical interlocks of executives on the efficiency of capital allocation depends on the interest represented by the executives.When the executives represent the interests of the parent company,the vertical interlocks of executives will exert a supervisory effect by reducing the agency costs of subsidiaries and improving investment consistency between parent and subsidiaries,thereby improving the capital allocation efficiency of listed companies.The vertical interlocks of executives representing the interests of the parent company can not only alleviate under-investment,but significantly inhibit over-investment.However,the vertical interlocks of executives represent the interests of subsidiaries,the executives will be alienated into a rent-seeking channel by fighting for excess capital,thereby reducing the capital allocation efficiency of listed companies.When concurrent executives receive salaries from the parent company or hold shares in listed companies,it can alleviate the distortion of capital allocation of listed companies to a certain extent.First,based on the different interests of vertical interlocks of executives,this paper provides evidence on the mechanism of the "supervision effect" and "rent-seeking effect" of vertical interlocks of executives.By doing so,I address the limitation of the assumption in the existing literature that the vertical interlocks of executives represent single interests of stakeholders,and provide an alternative theoretical explanation of vertically concurrent executives representing different interests.Based on the different positions of vertical interlocks of executives in subsidiaries,this paper explains the "supervisory effect" and "rent-seeking effect" of executives between parent and subsidiaries with the perspective of different personal interests of the executives.Based on the theoretical mechanism indicated by the different interest motives of vertical interlocks of executives,the perspective of the principal agent problem between the executives and the parent company enriches the theoretical understanding of the mechanism of vertical executive concurrent appointments.Second,based on the dual perspectives of supervision effect and rent-seeking effect,the paper provides explanation for the mechanism of the influence of vertical interlocks of executives between parent and subsidiaries on the company’s capital allocation behavior,which expands the relevant research on capital allocation decisions and the factors affecting capital allocation behavior under the parent-subsidiary structure.This paper indicates the differentiated decision mechanism of financial capital allocation and operating capital allocation of listed companies under the differentiated interest relationship determined by the vertical interlocks of executives between parent and subsidiaries,and finds that vertical interlocks of executives representing the interests of subsidiaries will turn the governance mechanism into rent-seeking behaviors between the parent company and the subsidiaries,which will result in differentiated consequences for the capital allocation behavior of listed companies.This finding further opens up the black box of capital allocation under the parent company structure,and provides opportunities for executives representing the interests of different entities.It also serves as a theoretical explanation for the differential impact mechanism of listed companies’ financial investment and operational investment,and also enriches the related research on the capital allocation decision mechanism of listed companies.Third,with the help of the background of the two-tier capital allocation decision-making mechanism formed by vertical interlocks of executives between the parent company and the subsidiaries,this paper looks into the decision mechanism of the two-tier capital allocation efficiency determined by the parent company’s dominant capital allocation and the subsidiary’s independent allocation.From the perspective of governance effects and rent-seeking effects,this paper concludes the differential impact of listed companies concurrently serving as executives under the parent-subsidiary structure under different interest tendencies on capital allocation efficiency,bypassing the existing research on the single governance effect.From the perspective of explaining the limitation of vertical interlocks of executives on capital allocation efficiency,this research expands the theoretical explanation of the determination mechanism of capital allocation efficiency of listed companies and internal capital market efficiency between parent and subsidiaries.