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How to curtail controlling shareholders' capital expropriation: evidence from IT firms in economy.

1. Introduction

Given the bursting growth of IT industry in emerging economies such as China, governance scholars attached increasing research attention to them. The principal-principal conflict is increasingly central consideration of corporate governance design. Due to the goal incongruence and information asymmetry, controlling shareholders often exploit minority shareholders (e.g., expropriating capital from the firm, excess salary for the controlling shareholder, controlling director board). Especially in transition economy where legal system protecting the minority shareholders is not well developed (Young et al., 2008). Previous literature mainly investigates how to curtail controlling shareholders' capital expropriation from Principal-Principal theory, which views expropriation as the results of formal institution void, ownership concentration, and informal institutions (Young et al., 2008; Dharwadkar et al., 2000; Sa and Rocha, 2012).

Although principal-principal theory dominates the extant literature, it is still difficult to explain the shareholders' capital expropriation in developed countries with well established institutions. Extending this line of literature, this research argues that the expropriation is viewed as the result of entrepreneurial shareholders' psychological ownership. Based on psychological ownership theory, we propose that formal ownership of entrepreneur, Pre-IPO age promote psychological ownership and then lead to capital expropriation. However, we find that these effects decrease when ratio of independent directors and ownership disparity increase.

This research contributes to extant literature by offering alternative theoretical explanation and solution for Principal-Principal conflict. Although previous literature suggests that the essence of PP conflict is goal incongruence, psychological ownership theory further explain why and when the controlling shareholders has incongruent goals with minority shareholders. To our knowledge, this article is the first try to explore how to curtail controlling shareholders' expropriation from psychological ownership perspective. Our findings suggest that even if formal institution protecting minority shareholders is well established, it is not enough to remove controlling shareholders' motivation to expropriate minority shareholders.

2. Theoretical framework

Principal-Principal (PP) theory suggests that controlling shareholders have different goal from minority shareholders, which motivate controlling shareholders to expropriate minority shareholders when formal institution is absent (Su et al., 2007; Chen and Young, 2010). However, this theory does not offer explain why goal congruence exists and offer partial explanation for the motivation to expropriate minority shareholders (Jiang and Peng, 2010; Li and Qian, 2013).

Psychological ownership theory complement with PP theory to explain these issues. Psychological ownership refers to the feeling of possession toward some target. The individual controlling the target, investing in the target, and being familiar with the target often develop intense psychological ownership toward target. For IT firms established usually by an entrepreneurial team, controlling entrepreneurial shareholder sets up their firms and often invests in huge energy during the entrepreneurial process (Pierce et al., 2001). Furthermore, during the entrepreneurial process, controlling shareholders often are more familiar with their firms than the other minority shareholders. Therefore, the controlling shareholders often develop higher level of psychological ownership toward their firm. This feeling of possession often makes controlling shareholders refuse to share their firm with other shareholders (Sieger et al., 2013). Therefore, previous developed psychological ownership creates psychological inertia, which promotes the controlling shareholder continue to put tight control on the listed firm and less attention on the minority shareholder interest. When the firm is publicly listed, controlling shareholders often maintain this feeling of possession and thus leads to capital expropriation of minority shareholders from the listed firm.

This psychological ownership grows with the controlling shareholders' previous linkage with the firm. When ratio of entrepreneurial share is high, the controlling shareholder invested more financial, effective, and other resources to the previous firm. Therefore, when firms are listed, the controlling owner with high ratio of previous ownership may hold higher level of psychological ownership. In this case, controlling shareholders may attach less attention to the interest of minority shareholders, which promotes the capital expropriation.

Following this logic, we also argue that if the Pre-IPO age is high, controlling shareholders often develop higher level of psychological ownership toward the listed firm. In this case, controlling shareholder also attach less attention to the interest of minority shareholders, which thus increases capital expropriation. Therefore, we propose that:

H1a: Ratio of entrepreneurial share has positive effect on controlling shareholders' capital expropriation

H1b: Pre-IPO age has positive effect on controlling shareholders' capital expropriation

However, we argue that when ownership of the listed firm is disperse, the controlling shareholders may experience more challenges from other shareholders. In this case, the controlling shareholders attach more attention to other shareholders' benefits and therefore ownership disparity reduces the controlling shareholders' feeling of psychological ownership (Sieger et al., 2013). Furthermore, when ownership disparityis high, controlling shareholders has less power to expropriate other shareholders. According to principal-principal theory, independent directors also can constrain the power of controlling shareholders' power to expropriate minority shareholders (North, 1990). Therefore, we propose that:

H2a: Ownership Disparity weakens the positive effects of Ratio of entrepreneurial share on controlling shareholders' capital expropriation

H2b: Ownership Disparity weakens the positive effects of Pre-IPO age on controlling shareholders' capital expropriation

Based on above analysis, we build a model to explain the controlling shareholders' capital exploitation by integrating both principal-principal theory and also psychological ownership theory.

3. Methodology

3.1. Data collection

We collected the data on firms listed in Growth Enterprise Market (GEM) of China. The data is from Stock Market Accounting Database (CSMAR) which is one of the most famous databases in China. To test causality, we collected data on independents variables from the IPO to 2012. Accordingly, we also focus on our sampling in software and internet industry. We also excluded the firms without complete information. Finally, Data from 169 firms established by natural entrepreneurs rather than company are collected.

3.2. Measures

a. Dependent variable

Capital expropriation. The annual reports provide the information on how controlling shareholders extract capital from listed firms. In China, controlling shareholders extract capital through accounts receivable. Following Su et al., (2007), we measure capital expropriation by yearly averaging the accounts receivable.

b. Independent and moderating variables

1. Ratio of entrepreneurial share: We measure ratio of entrepreneurial share by calculating the percentage of entrepreneurial share.

2. Pre-IPO age: We measure Pre-IPO age by calculating the natural logarithm transform of the number of year from which the firm is established to the IPO year.

3. Ownership disparity: This research measures ownership disparity with ownership variation coefficient.

4. Ratio of independent directors: We measure it by calculating the percentage of independent directors.

c. Control variables

We controlled the firm size, industry, and location. We measure firm size by calculating the natural logarithm transform of the employee number. We measure industry by coding 1 when a firm is operating in high technology industry while 0 if else. We measure location by coding 1 when a firm locates in provinces in eastern China while 0 if else.

3.3. Analysis and results

Descriptive statistics and correlations analysis indicate that no correlation coefficient is above the 0.6 threshold, suggesting that our estimations are not likely to be biased by multicollinearity problems (table 1). Multivariate regression analysis and the moderated method were employed to test our hypotheses (Baron and Kenny, 1986). Table 2 presents the steps performed to test the hypotheses, and the results for each steps.

To test H1a and H1b, we ran mode1 and model2. In model1 we entered control variables. Model2 includes the ratio of entrepreneurial share and also firm Pre-IPO age. Model2 shows that the ratio of entrepreneurial share and Pre-IPO age have significant positive effects on capital expropriation. Therefore, H1a and H1b are both supported.

To test H2a and H2b, we included the interactions to model3. The model3 shows that the coefficients of two interactions with ownership disparity have significant negative effects on capital expropriation. This indicates that ownership disparity significantly reduces the effects of both the ratio of entrepreneurial share and Pre-IPO age on capital expropriation. To further test this moderating effects. According to the recommendation of Aiken and West (1991), we plotted the relationships in Figure 2a and Figure 2b. As the Figure 2 a shows, the effect of ratio of entrepreneurial share increases slower when ownership disparity increases. As the figure 2b shows, the effect of Pre-IPO age increases slower when ownership disparity increases. These results indicate that ownership disparity weakens the positive effects of the ratio of entrepreneurial share and Pre-IPO age on capital expropriation. Therefore, H2a and H2b are both supported.

3.4. Discussion

This paper aims to explain the capital expropriation from psychological ownership perspective beyond principal-principal theory. The results support the prediction of psychological ownership theory. We find pre-IPO age and the entrepreneur share both promote capital expropriation post-IPO. Besides, their effects are contingent on the ownership disparity. This paper extends previous literature by offering an alternative theoretical explanation for controlling shareholder's capital expropriation.

Our results also bear important managerial implications. First, according to our results we should reduce the psychological ownership of entrepreneur to reduce the controlling shareholder capital expropriation. The principal-principal theory suggests that we should rely on well-established institutions to remove controlling shareholder's capital expropriation. However, our results show that the controlling shareholder's capital expropriation should be also the results of psychological ownership inertia, especially for firms with short Pre-IPO age, and concentrated ownership. Therefore, well-established institutions are not enough to remove the minority expropriation. Second, because we find that ownership disparity can reduce the influence of psychological ownership inertia, we should set standards for ownership disparity during IPO process.

This research also has some limitations, which should be addressed in future research. First, future research should explore other moderating effects. This paper just finds the moderating effects of ownership disparity. Other factors such as share of venture capital, director board composition, and also on may also have moderating effects. Second, more empirical sample is needed to extend the empirical context. This research just narrows the empirical context in software and internet industries to remove the industrial variance. However, this may limit the generalization validity of our results. Therefore, future research should find data from other industries to examine our model.

4. Conclusion

Aiming to extend our understanding on principal-principal conflicts and controlling shareholders' capital expropriation in transition economy, this study introduces psychological ownership theory to extant literature. This research argues that the expropriation is viewed as the result of entrepreneurial shareholders' psychological ownership. We find that ratio of entrepreneurial share and Pre-IPO age has positive effects on controlling shareholders' capital expropriation. Ownership Disparity and weakens the positive effects of ratio of entrepreneurial share and Pre-IPO age on controlling shareholders' capital expropriation.

Recebido/Submission: 08/05/2016

Aceitacao/Acceptance: 26/08/2016

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Lin Quan (1), Jun Zhou (2)

zhoujun601@sina.com

School of economics, Wuhan University of Technology, 430070, Hubei, China.

Table 1--Provides descriptive statistics and correlations

                                    1       2       3       4

1. Firm Size                        1.00
2. Industry                         0.05    1.00
3. Location                         -0.01   0.05    1.00
4. Ratio of entrepreneurial share   -0.05   0.04    0.04    1.00
5. Firm Pre-IPO age                 -0.05   0.06    0.04    -0.03
6. Ownership disparity              0.07    -0.02   0.03    0.207 **
7. Ratio of independent director    -0.01   -0.02   0.06    0.145 *
8. Capital expropriation            0.04    0.02    -0.01   0.147 *
Mean                                6.09    N/A     N/A     20.92
S.D                                 0.77    N/A     N/A     17.96

                                    5        6         7        8

1. Firm Size
2. Industry
3. Location
4. Ratio of entrepreneurial share
5. Firm Pre-IPO age                 1.00
6. Ownership disparity              0.00     1.00
7. Ratio of independent director    0.00     0.130 *   1.00
8. Capital expropriation            0.15 *   -0.01     -0.01    1.00
Mean                                2.19     1.54      0.37     15.42
S.D                                 0.52     0.51      0.0.05   17.33

Notes: * (p<0.05), ** (p<0.01)

Table 2--Indicates that the results support the four hypotheses

                                      Capital expropriation (N=234)

Variables                         Model1      Model2      Model3

1. Firm Size                      0.263 ***   0.270 ***   0.343 ***
2. Industry                       -0.218 *    -0.215 *    -0.126
3. Location                       -0.075      -0.064      0.019
4. Ratio of entrepreneurial                   0.177 *     0.675 ***
  share
5. Firm Pre-IPO age                           0.264 **    0.257 **
6. Ownership disparity                                    -0.471 **
7. Ratio of entrepreneurial                               -0.260 (+)
  share x Ownership disparity
8. Firm Pre-IPO age x Ownership                           -0.282 **
  disparity
R-square                          0.118       0.189       0.325
F-value                           2.127 *     1.902 *     2.203 *

Note: (+) p<0.10; * p<0.05; ** p<0.01; *** p<0.001
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Author:Quan, Lin; Zhou, Jun
Publication:RISTI (Revista Iberica de Sistemas e Tecnologias de Informacao)
Date:Oct 15, 2016
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