The Relationship Between Ownership Concentration and Investor Protection: from an Endogenous Perspective

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1 554 The Relaionship Beween Ownership Concenraion and Invesor Proecion: from an Endogenous Perspecive Chen Chaohui, Zhang Jian School of Business Adminisraion, Souh China Universiy of Technology, Guangzhou, P.R. China, Absrac: Based on panel daa of Chinese A share lised companies in , his paper empirically analyzes he relaionship beween ownership concenraion and invesor proecion by consrucing simulaneous equaions of dynamic panel daa, which overcomes he endogeneiy problem and considers he ineracion of ownership concenraion and invesor proecion. The findings show he exisence of wo-way negaive correlaion beween hem, which furher validae and enrich Ownership Concenraion and invesor proecion alernaive hypohesis presened by he LLSV (1998). Based on empirical resuls, we hink ha he promoion of full circulaion and decenralizaion of equiy should be accompanied wih srenghening invesor proecion. Key words: Ownership concenraion; Invesor proecion; Dynamic panel daa; Simulaneous equaions; Endogeneiy 1 Inroducion Modern corporae governance heories poin ou ha separaion of corporae ownership and conrol exiss (Berle and Mesns, 1932), which ineviably resuls o agency coss (Jensen and Mecklin, 1976). In Berle and Means view, corporae ownership is decenralized around he world, and none of shareholders can have an impac on professional managers decisions. I s real in U.S. corporaions a ha ime and nowadays. However, a large of sudy found ha in many counries ownership is concenraed disribued(llsv,1998,1999,2000), such as Greece, Ialy, Indonesia and Brazil, in which he hree larges shareholders hold abou 60% of all shares, while he percenage was lower han 20% 1 in U.S., Unied Kingdom, Japan and Taiwan. Why are shares disribued scaered in some counries and regions? LLSV argues ha his is due o differen invesor proecion in differen counries, and proposes Ownership Concenraion and invesor proecion alernaive hypohesis. LLSV provides a new angle o he quesion, causing a large number of domesic and foreign scholars o invesigae he relaionship beween ownership concenraion and invesor proecion, which resuls o a wealh of research resuls. However, he endogeneiy problem exiss in mos of hese sudies. Tha s o say, hey rea invesor proecion as exogenous variables, and only consider he impac of invesor proecion on ownership concenraion. Bu, ownership concenraion may have an impac on invesor proecion in urn, i.e. a wo-way ineracion, no jus one-way relaionship as mos scholars defaul, may exis beween hem. This paper consrucs simulaneous equaions o overcome he endogenous problem, and consider heir possible ineracion in order o deermine heir relaionship more accuraely. This paper is organized as follows: firsly, inroducion; secondly, lieraure review; hirdly, he sudy design; he fourh par is resuls of empirical research, and he las is conclusions and recommendaions. 2 Lieraure Review The mos classical researchers on ownership concenraion and invesor proecion are La pora, Lopez-de-Silanes, Shleifer and Vishny (LLSV, 1998, 1999, 2000). LLSV (1998) analyses he ownership disribuion of en larges non-financial corporaions in 49 counries and regions around he world. They arrange hese counries ino four groups according o heir law origin, and find ha he French law counries, which offers he wors invesor proecion, has he mos concenraed ownership. Then hey use he sum percenages of shares held in he op hree shareholders o represen ownership concenraion, and muliply he law degree wih exen of implemenaion of he law o represen invesor proecion. Regression shows a significan negaive correlaion beween hem, i.e. ownership in counries wih weak invesor proecion are ofen more concenraed, and on he conrary he widely dispersed share is common in he common law counries in which invesors are srongly proeced. Inspired by LLSV (1998), domesic and foreign scholars have made a series of sudies on he relaionship beween ownership concenraion and invesor proecion using secional daa, ime series

2 555 daa or panel daa, mos of which suppor LLSV (1998) s hypohesis (Himmelberg. e. al, 2002). Bu here are also some sudies find ha ownership concenraion and invesor proecion is no always monoonic negaive relaed. There may be non-linear relaionship beween hem (Aganin and Volpin, 2003; Sepanov, 2003;Casillo and Skaperdas, 2005), or boh posiive and negaive correlaion are possible(burkar and Panunzi, 2006). A major limiaion of LLSV and oher scholars sudies is endogeneiy. LLSV (1998) admied ha some of he independen variables hey used, in paricular, accouning sandards may be endogenous. For hose counries wih concenraed ownership, hey may be less willing o adop wih beer accouning sandards and improve hem. Thus, he causaliy would go from ownership concenraion o invesor proecion raher han he oher way around. Wha hey can guaranee exogenous among all variables is he legal origin. In addiion o foreign sudy, domesic scholars also make a lo of research on his opic. However, mos of hem explore he role of ownership concenraion or invesor proecion in improving corporae performance and corporae governance. Par of he research resuls are also consisen wih he hypohesis proposed by LLSV(1998) (Wang Kemin and Chen Jingyong, 2004; Shen Yifeng, 2007). Direc analysis on he relaionship beween ownership concenraion and invesor proecion is rare. Xu Nianhang and Wu Shinong (2006) find ha he decline of ownership concenraion does no enirely resul from legal proecion for minoriy invesors, i may also be due o oher facors. However, Xu and Wu (2006) also do no solve he problem of endogenous. Differen from previous research, Hou Yu and Wang Yuao (2010) use conrol ransfer evens in sock markes as samples o overcome he endogeneiy. They hink ha when he ransfers occur, he company faces he opporuniy o redefine he ownership srucure. Given he level of invesor proecion, companies deermine heir own shares o maximize conrol benefis. In his process ownership srucure does no affec he level of invesor proecion, and hus o overcome he endogeneiy problem. Therefore, Hou Yu, Wang Yuao (2010) avoids he problem of endogeneiy by choosing paricular samples. Bu i can be applied universally because conrol marke in China is no developed. The previous sudies summarized above show ha i should be seriously considered how o research companies in general and resolve endogeneiy. By building simulaneous equaions including boh invesor proecion and ownership concenraion, we consider hem as endogenous variables o solve he endogeneiy problem. Besides, i can be observed wheher invesor proecion influences ownership concenraion, or he oher way around, or boh inerac. In addiion, he panel daa we use make i possible o invesigae how vasly ownership disribues in differen areas and how ownership in an individual corporae changes along wih increase in he level of invesor proecion. 3 The Sudy Design 3.1 Daa sources and sample selecion We selec China's A-share lised companies in as samples. We filer hem as follows: (1) excluding finance and insurance indusry because of heir special naure; (2) removing he ST, PT companies; (3) excluding companies wih incomplee daa. Finally we ge samples of 905 lised companies, of which 387 are from Shenzhen Securiy Exchange and 518 are from Shanghai Securiy Exchange. Excep daa abou invesor proecion from he Chinese marke index esablished by Fan Gang and Wang Xiaolu, he oher daa is from Juyuan daabase. We use Eviews 6.0 for daa processing. 3.2 Model design and variable definiion Taking ino consideraion he endogeneiy, we rea boh ownership concenraion and invesor proecion as endogenous variables, and consruc simulaneous equaions of dynamic panel daa o esimae he relaionship beween hem: share10i, = α 0 1share10i, -1 2 proecioni, 3sizei, 4roei, (1) proecioni, = β 0 + β1 proecioni, 1 + β 2share10i, + β 3gdpi, (2) share10, on behalf of ownership concenraion, is he sum percenage of share held by he op en shareholders, which is similar o LLSV (1998) and Xu and Wu (2006). Referring o he previous approach (Chen Shenglan and Wei Minghai, 2006; Hou Yu and Wang Yuao, 2010), we quoe he developmen of marke and inermediary organizaions and he legal insiuional environmen indicaor esablished by Fan Gang and Wang Xiaolu. In addiion, we use company's size and performance, which are adoped in previous research (Xu Nianhang and Wu Shinong, 2006; Hou Yu and Wang Yuao, 2010), as conrol variables. The definiion of variables is showed in Table1.

3 556 Table 1 Variable Definiion Variable Code Descripion ownership concenraion share10 Proporion of shares held by op en shareholders invesor Proecion proecion developmen of inermediary organizaions and he legal environmen indicaor score of corresponding province size size Logarihm of oal asses performance roe Ne profi / oal asses regional economic power gdp Logarihm of GDP 3.3 Descripive saisics Descripive saisics for variables is shown in Table 2. Table 2 Descripive Saisics (Mean) Variable Obs Share % 60.02% 60.22% 59.08% 53.76% 52.22% Proecion Size Roe % 4.31% 4.19% 3.30% 5.25% 16.49% Gdp The descripive saisics shows ha he degree of invesor proecion is increasing in , while ownership concenraion is decreasing. The changes show a negaive correlaion beween hem. 4 Empirical Resuls 4.1 Granger causaliy es Table 3 Resul of Granger Causaliy Tes Null Hypohesis: Obs F-Saisic PROTECTION does no Granger Cause SHARE *** 3620 SHARE10 does no Granger Cause PROTECTION 5.52*** Noe: ***represen he significance level a 1% The Granger causaliy es resul shows boh of he original hypoheses are rejeced, which means here is wo-way Granger causaliy beween ownership concenraion and invesor proecion. The resul verifies he speculaion of he wo-way relaionship beween hem. Also, he following esimaion of simulaneous equaions provides heoreical suppor. 4.2 Esimaion of simulaneous equaions We use simulaneous equaions of dynamic panel daa esablished previously o esimae. Taking ino accoun he exisence of lagged values of explanaory variables, and heeroscedasiciy and auocorrelaion if possible, we choose GMM. Table 4 shows regression resuls. Table 4 shows wo GMM mehods obain similar resuls. Also he symbol of each variable is consisen wih forecasing. R-sq and adjused R-sq is and respecively, showing regression equaion fis he daa well. Discussion for esimaion resuls in deails is as following The discussion of equaion 1 ( 1) Ownership concenraion (share10 (-1)). The coefficien of ownership concenraion is , and i s significan a he level of 1%, indicaing ha curren ownership concenraion is grealy influenced by previous one. The acual siuaion in our counry can be a good explanaion. As marke economy sared lae in China, capial markes and he conrol marke are far from maure o forma large-scale mergers and acquisiions, so equiy ransfers relaively difficully, which resuls o slow change of ownership srucure. However, we find he coefficien of he lagged erm is less han 1, indicaing ha ownership concenraion ends o decrease consanly, and his is due o he improvemen of relevan mechanisms. (2) Invesor proecion (proecion). In regression equaion he coefficien of proecion is , indicaing ha ownership concenraion decreases by 0.08% if invesor proecion increases by one uni. The coefficien is significan a he level of 1%, indicaing ha here is a significan negaive correlaion beween invesor proecion and ownership concenraion. The resul verifies Ownership Concenraion and invesor proecion alernaive hypohesis. We can make a good explanaion for his from he view of agency heory and conrol heory. From he poin of agency heory, shareholders in provinces wih weak invesor proecion such as Gansu, Guizhou and Qinghai of China choose o hold he

4 557 larege shares and hus have full access o company informaion, and avoid being deceived by managers. From he view of conrol heory, socks offer shareholders some special powers, e.g. arrangeing people in he board and managemen o represen heir ineress, or influencing he company's business plans and invesmen programs. Therefore in he case of weak invesor proecion, shareholders focus on invesing in individual company, which leads o concenraed ownership [16]. Conversely, if exernal markes such as he legal sysem, capial markes, conrol markes, produc markes and manager markes are complee, and sronger invesor proecion is provided, invesors have more confidence and end o diversify he invesmen, hereby resuling o relaively dispersed equiy. Table 4 Resul of Simulaneous Esimaion Equaion 1 Regression Resuls Variable GMM-cross secion (Whie cov.) GMM-ime series (HAC) consan * ** ( ) ( ) share10 (-1) *** *** ( ) ( ) proecion *** *** ( ) ( ) size ** *** (2.4001) (2.6865) roe 3.60E-06 *** 3.65E-06 *** (5.2469) (5.7181) Equaion 2 regression resuls consan *** *** ( ) ( ) proecion (-1) *** *** ( ) ( ) Share *** *** ( ) ( ) gdp *** *** ( ) ( ) adjused R 2 = 0.97 DW = 2.15 adjused R 2 = 0.97 DW = Noe: Brackes values are -saisics for he esimaed coefficiens, ***, **, *represen he significance level a 1%, 5%, 10% respecively. (3) Conrol variables. Ownership concenraion is significanly posiively correlaed o firm size, indicaing ha larger companies end o have more dispersed equiy srucure. One inerpreaion is ha wih he expansion, he companies require sronger conrol, and herefore leads o a higher degree of ownership concenraion. Ownership concenraion and corporae performance (roe) also showed a significan posiive correlaion The discussion of equaion 2 (1) Invesor proecion (proecion (-1)). The coefficien of invesor proecion is , and is significan a he level of 1%, indicaing here is a significan posiive correlaion beween previous and curren invesor proecion. Because inpus on he legal sysem and relevan exernal marke come wih lag effecs. The coefficien of greaer han 1, indicaing ha China coninues o srenghen invesor proecion, which is consisen wih he resuls showed in able 2. (2) Ownership concenraion (share10). The esimaed coefficien of ownership concenraion is , which is significan a he leve of 1%. The reason may be as following: in he region wih dispersed ownership, he governmen acceleraes he improvemen of he legal sysem and he exernal marke mechanism in order o proec he ineress of invesors, which leads o srong invesor proecion; when ownership is concenraed, block shareholders are able o monior managers and influence corporae decision making, which resuls o less agency problems agains he ineress of invesors. Therefore, he governmen is less pressed o speed up legislaion, srenghen law enforcemen and improve he exernal marke, leading o weaker invesor proecion. (3) Region economic power (GDP). The greaer economic power of a region is, he more money can be spen o proec he ineress of invesors. As ransacions increase, relaed governmen deparmens also have he abiliy and moivaion o enhance invesor proecion, and hus invesor proecion in his region is srenghened, which is refleced by significan posiive regression coefficien.

5 558 5 Conclusion In his paper, by using Chinese A-share lised companies in and building simulaneous equaions of dynamic panel daa including ownership concenraion and invesor proecion, we empirically analyze he relaionship beween hem afer solving he problem of endogeneiy. The resuls show ha invesor proecion and ownership concenraion are significanly negaive correlaed, and he negaive relaionship is wo-way, i.e., lower invesor proecion leads o higher ownership concenraion, and i leads o a lower degree of invesor proecion. Wih he improvemen of invesor proecion, ownership concenraion ends o decrease, while he dispersed ownership srucure furher promoes he demand for high invesor proecion, leading o furher enhance invesor proecion. Therefore, his paper provides more evidence o furher validae and enrich Ownership Concenraion and invesor proecion alernaive hypohesis proposed by LLSV (1998). As can be seen from he above analysis, here are wo ways for invesors o proec heir own ineress: o increase heir shares and increase he level of proecion. The former approach can be achieved on heir own, bu hey mus pay he corresponding coss; he laer one, such as speeding up legislaion, improving law enforcemen and exernal markes, is he responsibiliy of he governmen. I can be seen from he ownership concenraion decreases year by year, and share spli reform in 2005 also furher promoes circulaion and dispersion of equiy. During he process, he governmen mus enhance invesor proecion, which is good for healhy developmen of capial markes in China. References [1] Berle A., Means G. The Modern Corporaion and Privae Propery[M]. NewYork, 1932 [2] Jensen M. C, Mecklin W. H. Theory of he Firm: Managerial Behavior, Agency Coss and Ownership Srucure[J]. Journal of Financial Economics, 1976, (3): [3] La Pora R., Lopez-de-Silanes F., Shleifer A., Vishny R.W. Law and Finance[J]. Journal of Poliical Economy, 1998, (106): [4] La Pora R., Lopez-de-Silanes F., Shleifer A., Vishny R.W. Corporae Ownership around he World [J]. Journal of Finance, 1999, (54): [5] La Pora R., Lopez-de-Silanes F., Shleifer A., Vishny R.W. Invesor Proecion and Corporae Governance[J]. Journal of Financial Economics, 2000, (58): 3-27 [6] Himmelberg C.P., Hubbard R.G., Love I. Invesor Proecion, Ownership, and he Cos of Capial [J]. World Bank, Developmen Research Group, Public Service Finance, 2002 [7] Aganin A., Volpin P. Hisory of Corporae Ownership in laly [Z]. Working paper, 2003, ECGI [8] Sepanov S. Invesor Proecion, Ownership Srucure, and Separaing Conorl from Cash Flow Righs [Z]. Wokring paper, 2003, ECARES [9] Casillo R., Skaperdas S. All in he Family or Public? Law and Appropriae Coss as Deerminans of Ownership Srucure [J]. Economics of Governance, 2005, (6): [10] Burkar M, Panunzi F. Agency conflics, Ownership Concenraion, and Legal Shareholder Proecion [J]. Journal of Financial inermediaion, 2006, (15): 1-31 [11] Wang Kemin, Chen Jingyong. Ownership Srucure, Invesor Proecion and Corporae Performance [J]. Managemen World, 2004, (7): (In Chinese) [12] Shen Yifeng, Chen Shuyu, Huang Juanjuan. Invesor Proecion, Ownership Srucure and Managemen Turnover in Disressed Firms[J]. China Indusrial Economy, 2007, (1): (In Chinese) [13] Xu Nianhang, Wu Shinong. Does Legal Proecion of Minoriy Shareholders Affec Ownership Concenraion in Chinese Sock Marke?[J]. China Economic Quarerly, 2006, (2): (In Chinese) [14] Hou Yu, Wang Yuao. Invesor Proecion and Ownership Concenraion: New Empirical Evidence from Conrol Righ Transfer[J]. Journal of Financial Research, 2010, (3): (In Chinese) Chen Shenglan, Wei Minghai. Invesor Proecion and he Qualiy of Financial Accouning Informaion [J]. Accouning Research, 2006, (10): (In Chinese)