The controlling shareholder of a firm may suffer as a result of its right to control the firm due to unfavorable market reactions associated with concerns on private benefit extraction by the controlling shareholder. Thus, the controlling shareholder has an incentive to build a good governance mechanism as a commitment device in order to discipline itself, which allows it to sell shares at a higher price in the initial public offering (IPO). An improvement in pricing efficiency will give the controlling shareholder more incentive to limit its private benefits from controlling the firm. Therefore, we propose that, besides improving the efficiency of capital allocation, the development of the financial market can shape the corporate governance of firms in an economy, thus improving firm operation efficiency. A model of IPO is constructed to demonstrate this mechanism of market discipline. Using data from China stock market on the regulatory changes in IPO pricing and firm ownership structure, we find evidence consistent with the model’s implications.

Friedman et al. (2003) developed a model in which, in equilibrium, controlling shareholders may choose either tunneling or propping depending on the magnitude of an adverse shock and the magnitude of the private benefits of control. In this paper, we employ connected transaction data from China to test the implications of their model. We hypothesize that, when listed companies are financially healthy (in financial distress), their controlling shareholders are more likely to conduct connected transactions to tunnel (prop up) their listed companies and the market reacts unfavorably (favorably) to the announcement of these transactions. Our empirical findings strongly support our hypotheses. Our analysis supports Friedman et al.’s (2003) model by furnishing clear evidence that it is possible that propping and tunneling might occur in the same company but at different times.

Recent researches suggest that private benefits of control of managers are a key predictor of acquisition performance and that there exists a negative correlation between measures of private benefits and acquirer announcement returns. However, empirical evidence has not confirmed such a negative relationship. The study in this paper shows that this relationship between private benefits of control of managers and acquisition performance may depend on the level of government shareholding. The study is based on an analysis of a sample of 246 M&A events from the listed companies of Chinese state-controlled enterprises, during the period 2001-2006 and it reveals that, under a low level of government shareholding, private benefits of control are positively correlated with the performance of acquiring firm; but private benefits of control are negatively correlated with the performance of acquiring firm under high government shareholding. Results also indicate that the private benefits of control of managers are important determinants of the acquiring firm performance. These findings sharpen the current understanding of the relationship between private benefits of control of managers and acquiring firm performance.

This paper examines the relationship between private benefits and the discount of private equity offerings. Measuring private benefits in terms of both control rights and cash flow, we find that private benefits are primarily attributed to control right rather than ownership. By using a measure, the Banzhaf power index, that could better reflects the largest shareholder’s relative influence over the firm. We find that the largest shareholder’s control power decreases, even though her ownership increases after private placement. It indicates that the largest shareholder is willing to give up some control power in private placement. In addition, we find that motivation and the type of investors in private placements significantly influences price discount.

Based on the brief analysis of the theory, we analyze the governance effect of the dynamic allocation of control rights and contingent transfer mechanism through an experiment and show that the dynamic allocation of control rights and contingent transfer mechanism are benefit for limiting the manager’s private benefits and protecting the investors’ return. While, the more the control transfers, the less effort the manager spends in private benefits and the more in the firm’s value. We also show that given more perfect external information revealed and monitoring mechanism, the governance effect of the dynamic allocation of control rights and contingent transfer mechanism will be improved more notable.

Like other major countries in the world, Chinese listed firms have recently experienced a dramatic rise in executive compensation. However, the arguments that could explain the same phenomena in developed countries can not be extended to the case in China. First, most Chinese listed firms are controlled by the state, thus management cannot set their own compensations through captured boards as suggested by Bebchuk and Fried (2004). Second, very few listed firms in China granted stock options and/or common stocks as part of executive compensations prior to 2005. There is little possibility that executives increased their own compensations by offering stock-option plans implied by Bolton et al. (2006). Based on the facts that the legal investor protection has been improved in China, we argue theoretically and empirically in this paper that the rise in executive compensation of Chinese listed firms can be attributed to the enhancement of legal investor protection. Since the management has to give up part of their private benefit with the improvement of legal investor protection, some private benefits extracted by management before have to be paid in an explicit way in order to make management incentive compatible. This finding partially leads to the increasing trend in executive compensations. It therefore provides a new perspective to explain why executive compensations keep rising in this emerging market where legal investor protection has been improving.

Using a sample of China’s partially privatized state-owned enterprises (SOEs) that have emerged in the global equity markets, this paper examines the decision to list overseas and its consequences. We find that overseas listing of Chinese SOEs is primarily determined by political needs, not by firms’ desire to fund growth and expand foreign sales. In addition, we find that overseas listed SOEs have more professional boards of directors, use greater accounting conservatism, exhibit higher investment efficiency, and have better one-year and two-year post-listing stock performance than their domestically listed counterparts. Additional analysis exploring the impact of political relations on overseas listing effects finds that strong political connections weaken the overseas listing effect on investment efficiency and post-listing stock performance, consistent with the positive overseas listing effect on investment efficiency being attenuated by government influence to satisfy state objectives such as excess employment. Taken together, our study suggests that overseas listing provides a mechanism for constraining politicians’ pursuit of private benefits and improving efficiency for partially privatized Chinese SOEs. However, the effectiveness of this mechanism is limited for SOEs with strong ties to the government.

This paper generalizes the Myers and Majluf (1984) model by introducing an agency cost structure based on private benefits of control. This new model predicts that many corporate finance variables each have opposing effects on under- and overinvestment. Private benefits exacerbate overinvestment but, interestingly, a small amount of private benefits can enhance firm value by alleviating underinvestment. Likewise, an increase in insider ownership alleviates overinvestment but aggravates underinvestment. When private benefits are small, the adverse effect of insider ownership on underinvestment tends to dominate. When there are considerable private benefits, the incentive-alignment effect of insider ownership is pronounced. Additionally, this model reconciles existing equity financing theories on announcement effects. It helps resolve the puzzle that small-growth firms do not seem to have an asymmetric information disadvantage when they issue new equity.

This paper hypothesizes that the threat of losing listing status in China’s distressed ST (specialtreatment) firms kick starts a corporate control market that does not exist otherwise. The incumbent controlling shareholder, facing the possibility of losing control right, will have to“tunnel back” the value he has extracted from the firm before to boost the distressed firm’s accounting performance. This part of value is captured by the cumulative abnormal returns (CARs) surrounding ST event. We further argue that ST CARs present themselves as alternative measure of private benefits of control, distinguished from the ones used in Barclay and Holderness (1989) and Nenova (2000). Studying 66 listing companies that had become ST between 1998 and 2000 in China’s stock market, we find that the 22-month cumulative abnormal returns run as high as 29% on average. Based on a game theoretic model, we find that the control value released through the contest for corporate control right is positively related the largest shareholder’s shareholding, concentration of shares held by other largest shareholders, but negatively correlated with the firm’s leverage ratio. Our empirical evidence confirms these hypotheses.