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.

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.

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.