Two Essays on Shareholder Base, Firm Behavior, and Firm Value

TWO ESSAYS ON SHAREHOLDER BASE, FIRM BEHAVIOR, AND FIRM VALUE Yi Jian Old Dominion University, 2016 Director: Kenneth Yung Most companies spend significant time and attention to managing their shareholder base out of the belief that significant stock market benefits can be reaped if they can identify and attract the right shareholders. Consistent with the opinion of practitioners, many financial economists suggest that the shareholder base is an important determinant of firm value and corporate policies (Lins and Warnock 2004; Brav, Graham, Harvey, and Michaley 2005; Bodnaruk and Ostberg 2013). Despite the importance of the shareholder base, research on the topic has been scant. What’s more, previous studies have reported conflicting results regarding the effect of the shareholder base on firm behavior and firm value. Thus, I want to add to the literature by exploring the effects of the shareholder base on firm behavior and firm value in a foreign setting. This dissertation explores the effect of shareholder base on firm behavior and firm value in China. It seeks to answer the following research questions: 1) what is the effect of shareholder base on risk-taking and dividend payout? 2) What is the impact of shareholder base on earnings management? And 3) what is the direct effect of shareholder base on firm value? Essay 1 examines the effects of the shareholder base on firm behavior and firm value. Contrary to popular belief, the results show that a large shareholder base does not benefit firms in China, suggesting that a large shareholder base in China implies elevated agency conflicts between insiders and outsiders. We find that a larger shareholder base is associated with lower levels of capital expenditures, a lower standard deviation of return on assets, a lower standard deviation of return on equity, and higher dividend payouts in China. Researchers have concluded that high dividend payouts in China are expropriations by insiders. Our results therefore imply that insiders increase the expropriation of outsiders by diverting resources for private motives as the conflict between the two parties escalates. Our finding of a negative impact of the shareholder base on firm value in China further suggests that investors are concerned about the motives of insiders as agency conflicts intensify. Consistent with the view of Rozeff (1982), our results imply that the shareholder base in China serves as a proxy for the agency conflict between insiders and outsiders of firms. Essay 2 focuses on the effect of shareholder base on earnings management. Consistent with popular belief, we find that a larger shareholder base provides a monitoring effect on earnings management in China. However, investors in China are still relatively inexperienced and fail to see the link between earnings management and tunneling. Specifically, we find a negative relation between discretionary accruals and the shareholder base. In addition, we find some weak evidence that the shareholder base provides a controlling effect on real activities manipulation. Our results also show a positive relation between the shareholder base and tunneling activities in China. The rapid rise of the shareholder base in China provides insiders with more opportunities to extract private benefits at the expense of the minority shareholders. Both essays suggest that improvements to the legal system and corporate governance are important before an expanding shareholder base can have positive effects on firm behavior and firm value for countries that have a poor record of investor protection and where firms are heavily controlled by the state. This dissertation adds to the scant literature on the shareholder base by examining the effects of the shareholder base on firm behavior and firm value in China. Given that China is in the process of developing its capital markets, the findings on the shareholder base of firms in China may have significant policy implications.