Previous studies have typically found a negative relation between pyramidal ownership and firm value, and have interpreted it as supporting evidence of the incentive problems created by pyramiding. Those studies, however, do not adequately control for the endogeneity of ownership to factors that also affect firm performance, leaving the agency problem indistinguishable from the unfavorable fundamental shock. Using a unique sample of privately owned listed enterprises in China, this paper examines the effect of pyramidal ownership on returns in response to the announcement of the Share Split Reform in China. This reform triggered zero fundamental shocks but resurrected entrepreneurial incentives in proportion to the separation of ownership and control. Estimates of agency cost of pyramidal ownership are significant and material, and are robust against a range of alternative hypotheses. Moreover, institutional investors appear to appreciate the reform more when a firm’s pyramidal ownership is less separated. The findings suggest that, despite the endogenous determinant of ownership choice, agency theory alone successfully explains the pyramidal discount.

Business groups organized by pyramids enable the ultimate shareholders to control a portfolio of firms with less cash requirement. Further, corporate pyramid induces an internal capital market and makes capital transfer more convenient within the pyramid. In China, the state and business groups control a large number of listed firms through pyramidal ownership structure. What role does the corporate pyramid play in firms’ investment decisions? What is its influence on firm performance? This paper investigates the capital investment and firm performance from the perspective of pyramidal ownership structure. We find that as the layers of corporate pyramid increases, the capital overinvestment declines. The negative relations between pyramid and overinvestment exist for both state-owned enterprises (SOEs) and non-state-owned enterprises (NSOEs), which indicate that increasing the layers within corporate pyramid reduces the likelihood of overinvestment of the listing firm and improving investment efficiency. Moreover, we show that the effects of increasing the layers of corporate pyramid on accounting performance are different for SOEs and NSOES. For SOEs, increasing the layers of pyramid results in less government interference on the listed firm and more flexibility in operate. Therefore, increasing pyramidal layers is positively related to accounting performance. While for NSOEs, pyramiding is to build an internal capital market for the ultimate shareholder’s capital investment. Although pyramid may reduce overinvestment of the listing firm, agency costs may offset the positive effect and induce a lower accounting performance.