This paper examines the interactive effect of private equity (PE) and excess control rights on the process of firms’ going public. We find that firms with high excess control rights have more earnings management before IPO, and they are more likely to seek PE investors especially when the earnings management is high. We further show that the involvement of PE investors increases the probability of the firms’ IPO application being approved by the regulators in firms with high excess control rights. However, PE backed firms with high excess control rights are found to have a higher IPO fee, lower initial returns and lower long term post-IPO performance. We argue that in emerging markets where the protection of minority shareholders is weak and the economy is dominated by relationship and networks, ultimate owners have a strong incentive to have PE investors help them access the IPO market at the expense of minority shareholders’ interests, especially when they have excess control rights. In fact, instead of playing a monitory role, PE investors actually conspire with the ultimate owners to exploit minority shareholders’ interests and both PE investors and controlling shareholders become big winners, while minority shareholders are the only losers in the IPO process.

This paper examines the effects of the agency costs on firm value in 156 Chinese publicly listed companies with individual ultimate owners between 2002 and 2007. The ultimate owners’ agency costs, as measured by the divergence between control rights and cash flow rights, are shown to negatively and significantly affect firm value, as measured by the market-to-book ratio of assets (an approximation of Tobin’s Q). As the agency costs grow, the stock returns decrease around the connected party transaction announcements, and firms are more likely to engage in value-destroying connected party transactions. These effects are particularly strong for some types of connected party transactions, notably loan guarantees and direct fund transfers. Further, as the agency costs grow, the firms violate laws more frequently and the nature of legal violations becomes more severe. Evidence from an exogenous policy shock, the non-tradable share reform confirms that higher agency costs cause more unfavorable stock market reactions to connected party transaction announcements.

This paper examines the effects of the agency costs on firm performance in 156 Chinese publicly listed companies with private ultimate owners between 2002 and 2007. The ultimate owners’ agency costs are measured by the divergence between cash flow rights and control rights. Agency costs are shown to negatively and significantly affect firm performance, as measured by Tobin’s Q. A major contribution of this paper is to identify connected party transactions as a channel through which such agency costs exert negative impact firm performance. Evidence from the public record of law violations of those firms lends further support to the “tunneling” view on the connected party transactions. The paper also shows that the larger the divergence, the less likely that firm managers will implement value-increasing industrial diversification. The last finding remains a puzzle.