Research On The Influence Of Ultimate Controlling Shareholders On The Overinvestment Of China's Listed Companies

Concentrated ownership structure and pyramidal structure are very common in China, so under the circumstances of concentrated ownership structure and separation of control right from cash flow right, it is of great practical significance to analyze the problems caused by ultimate controlling shareholders. So this paper aims to study the agency problems between large and medium-and-small shareholders from the perspectives of overinvestment and ultimate controlling shareholder.Theoretically this paper builds up a two-period dynamic model to analyze the influence of ultimate controlling shareholders on the investment decisions of the bottom-layer corporation. In the design of the model, I involve the influence of the nature of the ultimate controlling shareholder in the benefits of expropriation, and the level of control right in the cost of expropriation. The deductions of the model suggest that the concentration of ownership and the existence of an ultimate controlling shareholder result in the overinvestment of the bottom-layer corporation. Specifically, the larger of the size of free cash flow, the higher of the extent of the separation of control right from cash flow right, the more serious of the overinvestment problem. Furthermore, the state-owned nature of the ultimate controlling shareholder aggravates the problem. In contrast, the improvement of cash flow right of the ultimate shareholder and the internal governance mechanisms effectively mitigate the overinvestment problem.Empirically I build up a panel sample of China's listed companies which covers 982 firms and the fiscal years of 2006-2008. First of all, I utilize the expected investment model of Richardson(2006) to get the data of unexpected investment, overinvestment and free cash flow, then based on the data I test the hypotheses of the theoretical model. The first test is the link between overinvestment and the existence of an ultimate shareholder, to do so I use t-test, ranksum test and a logit model, and all the results show that there indeed is a significant link between the two. Then I extract a subsample of firms who have both an ultimate controlling shareholder and an overinvestment phenomenon to analyze the influence of free cash flow, the level of separation, the nature of ultimate controlling shareholder, the cash flow right and internal governance mechanisms on overinvestment. The empirical results here show that the size of free cash flow and the extent of separation have significantly positive effects on overinvestment, besides that, the state-owned nature of the ultimate shareholder intensifies the problem. As for the governance mechanisms, the checks and balances between shareholders can effectively constrain overinvestment, but cash flow right of the ultimate controlling shareholder and the governance mechanisms, such like board of directors and board of supervisors, seem to have no effect on overinvestment. In short, the empirical results provide evidence for most of the hypotheses except for the governance effect of cash flow right,In a nutshell, this paper examines the agency problem between large and medium-and-small shareholders from the perspectives of overinvestment and ultimate controlling shareholder both theoretically and empirically. The results find new evidence for the expropriation of controlling shareholders from the perspective of investment and prove the existence of agency costs of ultimate controlling shareholders. As for the governance mechanisms, the checks and balances between shareholders are effective, but the others are no longer the case.