WORKING PAPER SERIES

Transcription

1 College of Business Administration University of Rhode Island William A. Orme WORKING PAPER SERIES encouraging creative research Full Privatization, Expropriation, and Firm Performance: Evidence from China Liansheng Wu, Yaping Wang, Bing-Xuan Lin, Yunxia Bai 2009/2010 No. 3 This working paper series is intended to facilitate discussion and encourage the exchange of ideas. Inclusion here does not preclude publication elsewhere. It is the original work of the author(s) and subject to copyright regulations. Office of the Dean College of Business Administration Ballentine Hall 7 Lippitt Road Kingston, RI

2 Full Privatization, Expropriation, and Firm Performance: Evidence from China Liansheng Wu Guanghua School of Management Peking University Beijing, China Tel: Yaping Wang Guanghua School of Management Peking University Beijing, China Tel: Bing-Xuan Lin College of Business Administration University of Rhode Island Kingston, RI 02881, USA Tel: Yunxia Bai Guanghua School of Management Peking University Beijing, China Tel: Corresponding author.

3 Full Privatization, Expropriation, and Firm Performance: Evidence from China Abstract The paper investigates the effects of full privatization through controlling rights transfer (CRT). It shows that performance deteriorates significantly owing to excessive expropriation by controlling shareholders after privatization. In particular, it finds that fully privatized firms perform worse than state-controlled enterprises. Expropriation by private block shareholders is greater than expropriation by state block shareholders. Furthermore, increase in expropriation is negatively related to performance change. The results suggest that full privatization may not yield the expected efficiency gains in transition economies. They also emphasize the importance of preventing private block shareholders from exploiting minority shareholders in the process of full privatization. JEL classification: G32; G34; L33; M21 Keywords: Privatization; Controlling rights transfer; Expropriation; China. 1

4 1. Introduction For decades, academics have supported the sale of state-owned enterprises (SOE) to private parties as the key to greater efficiency and superior performance. Many governments also view privatization as a method of injecting new energy into financial systems, reducing government interference in the market and promoting economic efficiency. Privatization s benefits are thought to significantly outweigh its costs and it is seen as providing an opportunity for transition economies to compete globally. Unfortunately, it is not a panacea. Privatization has not been successful in the former Soviet Union, and both Argentina and Malaysia have turned to re-nationalization. Meanwhile, the 2008 global financial crisis has greatly compromised the continuing privatization of SOEs. In some extreme cases (e.g., American International Group), private firms have been nationalized by governments in developed nations. Partly because of the complex ownership structure of Chinese stock companies, the privatization of SOEs in China took multiple stages, starting with partial privatization through share issues. The subsequent full privatization was achieved through controlling rights transfer (CRT) from the government to private parties. Unlike many other countries, China has not encouraged universal privatization. Instead it has undertaken case-by-case privatization of selected firms. However, the scale of privatization is massive and unprecedented. The number of SOEs in China fell by 40% between 1996 and 2001, and most of the remaining SOEs were scheduled to be privatized within a short period (Garnaut et al., 2003). The uniqueness of its political environment and organizational structure has made privatization in China a distinctive case. 2

5 It is perhaps surprising that there is little research that examines the outcome of privatization in China, 1 the second largest economy on a purchasing-power-parity basis. In this paper, we take on the task to investigate firm performance after full privatization in China. We analyze 194 cases of CRTs between 1996 and 2001 to determine the performance of firms before and after full privatization. Contrary to popular belief, it shows that owing to excessive expropriation by major shareholders after full privatization, performance deteriorates significantly. In particular, it finds that fully privatized firms perform worse than partially-privatized firms. Expropriation by private block shareholders is greater than that by state block shareholders, and is negatively related to performance change. The findings suggest that privatization may not yield the expected efficiency gains in transition economies and may open the door to more corruption (Martimort and Straub, 2006). The remainder of the paper is structured as follows. Section 2 describes the institutional background for privatization in China. Section 3 reviews the literature on privatization and expropriation by controlling shareholders. It also discusses the hypotheses of the study. Section 4 describes the models and variable definitions, and Section 5 reports the data and descriptive statistics. Section 6 provides regression results, and Section 7 concludes. 2. Institutional Background The major economic reforms in China took place in the late 1970s. However the overall impact of privatization was limited until the establishment of the Shanghai Stock Exchange in In an attempt to revitalize inefficient SOEs, the Chinese 1 Most of the extant studies only examine partial privatization, which is very different from full privatization. This is discussed in more detail in the review of the institutional background and literature. 3

6 government partially privatized over a thousand SOEs through share issue privatization. Sun and Tong (2003) suggest that almost all of the firms listed on China s two stock exchanges (the Shenzhen Stock Exchange and the Shanghai Stock Exchange) at the end of 2000 are former SOEs. Partial privatization freed about one third of a company s shares, while the remaining two-thirds were owned by the state and by legal persons. State shares were held by government agencies such as the Bureau of State Property Administration or other non-privatized SOEs. Legal person shares were often held by representatives of the original SOEs who retained close ties with local governments (Qian, 1995). Finally, the remaining shares were sold to mainland China investors (A shares), Hong Kong investors (H shares) and foreign investors (B shares). 2 The initial stage of privatization allowed a more diversified ownership. However complete privatization was not achieved until the controlling rights were transferred to private entities at a later stage. Only individual shares could be traded on the exchanges and they accounted for merely one third of the total shares before 2006, when the Chinese stock market started a large-scale reform to convert all of the non-tradable shares into tradable shares. Green and House (2004) refer to privatization in China as a two-step approach. First an SOE sold a minority stake to obtain an exchange listing. An off-exchange transfer of non-tradable shares from state or legal person to private entities then took place to complete the privatization. Prior to 1996, there were very few transfers of non-tradable shares. After 1996 the number of transfers continued to increase as the government aggressively encouraged full privatization. Although the 2 Sun and Tong (2003) and Guo and Yao (2005) discuss the history and development of Chinese economic reform, SOE ownership structure and institutional arrangements. 4

7 government is still the controlling shareholder, partial privatization is a huge improvement on 100% state ownership. However, if the central or local government decides to pursue political or social objectives at the expense of a firm s performance, then public shareholders have little power to interfere with these decisions. To fully understand the impact of privatization in China on SOE performance, it is necessary to examine full privatization through CRT. The exchange of state shares and legal person shares can only be conducted in two ways: by free transfer and agreed sale. Free transfer does not require cash payments to the target block shareholder and it is often between one government agency and another. It is often referred to as administrative transfer because the state or local government makes the administrative decision regarding the new ownership of a firm. Another way to transfer controlling rights is an agreed sale, where an acquirer pays the shareholder a certain amount of cash and gains control of the target company (this is also referred to as a cash transaction). Green and Black (2003) show that agreed sale is a very common form of transferring control in China and is often done through private negotiations between the acquirer and a state agency. 3. Literature Review and Hypotheses There are two strands of literature pertinent to this study. One deals with the effect of privatization on a firm s performance and the other with the expropriation of minority shareholders by block shareholders. They will be examined separately. 5

8 3.1. The impact of privatization on a firm s performance Privatization has been argued to mitigate the agency problem between management and stakeholders, as managers become subject to the pressures of financial markets (Jensen and Ruback, 1983; Easterbrook and Fischel, 1991), and the monitoring of profit-oriented investors (Vickers and Yarrow, 1991; Lin et al., 1998). Privatization also helps to align corporate objectives with shareholder interests, as the firm is no longer burdened with the social and political considerations of SOEs (Shleifer and Vishny, 1994; Boycko et al., 1996). The extant literature seems to overwhelmingly support privatization as a means of improving SOEs performance. Studies have looked into privatization in OECD countries (Megginson and Netter, 2001), in some developing countries (Boubakri and Cosset, 1998), in Mexico (La Porta and López-de-Silanes, 1999), in Egypt (Khattab, 1998), and in Central and Eastern Europe (Nellis, 1999; Claessens and Djankov, 2002; Domadenik et al., 2008) and found positive financial and operating results of privatization. However, doubts remain and are growing. Djankov and Murrell (2002) suggest that privatization can be detrimental in countries such as Russia and Mongolia. Aussenegg and Jelic (2006) found that the operating performance of privatized firms in three Central European transition economies between 1990 and 1998 showed no signs of improvement for the first six years after privatization. Considering the conflicting outcomes of privatization, some (Cragg and Dyck, 2003; World Bank, 1995) argue that reform of the institutional environment should precede privatization. Indeed, the privatization and re-nationalization in Argentina (Baer and Montes-Rojas, 2008) and Malaysia (Jomo and Tan, 2003) are classic cases where privatization failed because of weak and inefficient institutional environments. 6

9 Privatization in China is sometimes considered to be an exception. First of all, the process of privatization in China differs greatly from that in other nations, yet it seems to achieve striking results. Secondly, institutional infrastructure is relatively weak in China, and yet privatization has been achieved in an orderly manner. There are a number of studies that examine the effects of partial privatization in China on firms performance. Sun and Tong (2003) collect data for 634 SOEs and study their performance after share issue privatization. They find that SOEs earnings, real sales and workers productivity increase, but profit returns and leverage fail to improve. Wei et al. (2003) find that real output, assets and sales improve significantly after partial privatization. In addition, they find that firms with lower state ownership perform better than firms with higher state ownership. Similarly, Zou and Adams (2008) find that companies with more state ownership tend to have lower stock returns; whereas companies with more legal-person ownership tend to have higher stock returns. Tian and Estrin (2008) find a U-shaped relationship between state holdings and a firm s value after partial privatization. The relationship between Tobin s q and state ownership is negative for ownership levels below 30%, and positive for ownership levels above 30%. Jia et al. (2005) look at a different sample of SOEs that were privatized through listing in Hong Kong and find that real net profits are unchanged and the returns on sales decline significantly after partial privatization. However, Huang and Song (2005) document a positive effect of privatization for firms listed in Hong Kong by showing that their relative performance compared to a matched sample is less negative. The studies listed above examine only the effect of partial privatization on firms performance. However, none of them examines performance after full privatization through CRT. 7

10 Boycko et al. (1996) argue that privatization will work only if both cash-flow rights and controlling rights are passed into private hands. To gain a clearer understanding of privatization in China, it is important to explore the outcome of full privatization through CRT. Chen et al. (2008) investigate full privatization in China and find positive effects on performance. Like many extant studies (e.g., Megginson et al., 1994; Boubakri et al., 2005), they use a three year period to examine performance after privatization. However Aussenegg and Jelic (2006) suggest that the impact of privatization should be measured over a longer period because reaching maximum potential performance takes some time. Moreover, if the new block shareholder tries to expropriate wealth from minority shareholders, then the negative impact on firm performance will also take time to materialize. Thus, the results found using the three year period may not be robust, especially in transition economies Expropriation of minority shareholders by block shareholders Expropriation of minority shareholder wealth by block shareholders is widely documented in the literature, even in competitive market economies. For example, Holderness and Sheehan (1988, 2000), Bates et al. (2006), and Atanasov et al. (2008) find evidence of shareholder expropriation in the U.S. In emerging markets where investor protection is weak, the problem of expropriation is even more striking. Claessens et al. (2002), Johnson et al. (2000a), Nenova (2003), Lemmon and Lins (2003), Dyck and Zingales (2004), Atanasov (2005) and Cheung et al. (2008) document significant wealth expropriation, or tunneling, from minority shareholders to the controlling shareholder. Most of the studies on China also confirm the frequent 3 Based on the data used in this paper, if a 3-year period is used there is a significant increase in performance for fully privatized firms, which is consistent with that in Chen et al. (2008). But if the time period is extended to five years, then a significantly decreased performance is observed after full privatization. 8

11 occurrence of tunneling by corporate block shareholders. For example, Deng et al. (2008) study large shareholders expropriations after China s share issue privatization. They find that large shareholders expropriate resources through related-party transactions and through dividend policy after partial privatization. However extant studies do not examine how state block shareholders and private block shareholders may differ in the extent of their expropriation of resources from minority shareholders. Additionally, they fail to establish the link between expropriation and firms subsequent performance The dark side of privatization is rarely put under the public spotlight. Nevertheless, bribery, abuse of political connections, price manipulation and expropriation of minority shareholders accompany the process of privatization in many countries (Clarke and Xu, 2004). The World Bank (1995) uses five different performance measures and studies 12 countries to determine what measures were successful in the process of privatization. One important initiative found in successful privatization is the effort to improve corporate governance by changing the contractual relationship between the firm and the state. This initiative is important because it provides a more effective management contract and may prevent excessive expropriation by managers or controlling shareholders. In addition, the report shows that political connections play crucial roles in ensuring the feasibility of the reform. The exchange of political favors and the sacrifice of minority shareholders interests may be undesirable outcomes in some cases. Using the event study approach, Calomiris et al. (forthcoming) find negative abnormal return when government stake in the firm is sold due to loss of political connections. However, their sample includes only firms selling state ownership and they do not examine the firm performance after privatization. Weiss and Nikitin (1998) show that, after privatization, firms held by 9

12 investment funds are likely to perform less well. One possible explanation may be the involvement of management in share dealing. Cull et al. (2002) suggest that the poor performance of firms in the Czech Republic after privatization is related to excessive tunneling and expropriation by block shareholders. However, none of the prior studies provides direct evidence of expropriation or tunneling to support their arguments Hypotheses Prior studies (La Porta et al., 1999; Faccio and Lang, 2002; Claessens et al. 2002; Masulis et al., 2009) show that the tunneling or expropriation activities by large shareholder often take place in firms with huge divergence between cash-flow rights and control rights (i.e., the largest shareholder is often able to control a firm's operations with a relatively small direct stake in its cash-flow rights). However, this incentive might be different between the state owner and the private owner. The state owner representing the largest shareholder in an SOE might not have a strong incentive to exploit company wealth, since they often share different goals from those of private block shareholders. The state shareholder would put more weight on the maximization of social welfare rather than maximizing the wealth for block shareholders. On the personal level, managers of SOE are frequently reviewed by government agencies and their political advancement might depend on their performance. For example, the Chinese State Council has an explicit policy guideline to remove managers from SOEs if they are responsible for losses over three consecutive years. The potential loss of political reputation and forced demotion due to poor performance discouraged management from aggressively exploiting the company and expropriating minority shareholders. 10

13 Meanwhile, privatization may intensify conflicts between the private block shareholders and other stakeholders. The process of privatization in China often produces one single large private shareholder who has significant control over management and company. The goal for these private block shareholder is simply the maximization of personal wealth, and the mismatch of controlling rights and cash flow rights further aggregates the agency problem between the block shareholder and the minority shareholder. Additionally, managers of privatized firms are more likely to collude with private block shareholders and expropriate wealth from minority shareholders to protect their jobs. The weak legal system and lack of protection aggravate the situation for minority investors. Hence, we have our first hypothesis: H1: The degree of expropriation is greater for a private block shareholder than for a state block shareholder. Following Hypothesis 1, we also expect privatized firms to perform worse than the state-controlled firms. Private controlling shareholders may engage in either propping or tunneling to support or extract resources from the target companies after gaining controlling rights. Propping benefits the controlling shareholder in the long run if investors value the target company at a premium. Tunneling results in a quick profit for block shareholders, especially when the legal system is weak and minority shareholder protection is inadequate. If private block shareholders are driven mainly by self-serving incentives, then we expect tunneling to dominate and expropriation of minority shareholder to be widespread. Thus, our second hypothesis is as follows: H2: A fully-privatized company performs worse than a state-controlled company owing to the higher level of wealth expropriation by the private block shareholder. 11

14 4. Models and Variable Definitions To mitigate the endogeneity problem associated with CRT and potential biases in measurement errors, we follow Barber and Lyon (1996) and Ghosh (2001) and measure performance after privatization with the matched sample adjusted performance (MSAP). Specifically, we identify a matched sample for each CRT firm in our sample. The matched sample includes five state-controlled firms that have not gone through CRT transactions during the period between year t-2 and year t+5, where year t is the year of CRT for the sample firm. Following Wang et al. (2008) and Berkman et al. (2009), the ownership of a firm is classified as state or private. A firm is defined as state-owned if its ultimate owner is a state or local government agency. It is considered to be a private company if its ultimate owner is a non-government unit such as entrepreneurs or foreign companies. The matched firms are in the same industry as the sample CRT firm with closest size and performance prior to the CRT 4. The MSAP is then computed as the performance difference between the sample firm and the median of the matched sample. Performance is measured by operating income divided by total assets. To figure out the impact of privatization on performance we can then compute the change in performance by the difference in MSAP before and after CRT as following. ΔPerf = ( Perf - MPerf ) post - ( Perf MPerf ) prior. Post denotes the five year average MSAP after CRT and prior is the two year average MSAP before CRT. Perf represents the performances of CRT firm and MPerf is the median performance for the corresponding matched sample. According to Ghosh 4 Size is the mean total assets over two years prior to CRT (in billions). Performance is the mean operating income divided by total assets over two years prior to CRT. 12

15 (2001), this approach will remove the potential performance trend in the sample and mitigate the measurement error. The following ordinary least square (OLS) regression model is used to determine whether the coefficient for privatization variable (PRI) is significant: Δ Perf = α + αpri + αcash+ αgap + α Pre_ Perf + α Pre_ Size + α Pre_ Lev + ε. (1) ΔPerf is the change in performance defined earlier. The key variable of the study is PRI. It is a dummy variable that equals 1 if CRT was from a state owner to a private owner, and 0 if CRT was between two state owners. To control for the incentive and entrenchment effects of large ownership, the approach in Claessens et al. (2002) is used to construct a measure Cash to represent the cash flow rights to the ultimate owner of the firm, and a measure Gap to proxy the gap between cash flow rights and control rights. 5 Following the extant literature (Sun and Tong, 2003; Fong and Lam, 2004), we control for firm size (Pre_Size), leverage (Pre_Lev) and performance (Pre_Perf) prior to the transfer. They are measured by the two year average of the logarithm of year-end total assets, total debt over total assets and operating income over total assets, respectively. To examine the relationship between privatization and expropriation, we run the following OLS regression: Δ Expro = β0+ β1pri + β2cash + β3gap + β4pre _ Expro + β5size + β6bdebt. (2) + β Growth + β OCF + η These measures are computed using the data from the year of the CRT, as ownership structure stays roughly the same during the period of the analysis. La Porta et al. (1999), Bajaj et al. (1998), and Driffield et al. (2007) also assume ownership structure to be stable for their analyses. 13

16 ΔExpro is the dependent variable, which is a measure of expropriation by block shareholders. Given the complexity of expropriation approaches, it is difficult to come up with a direct measure. Although some indirect measures of expropriation have been proposed in the literature, 6 Ma et al. (2005), Jiang et al. (2005) and Huang (2006) propose a more direct measure of expropriation, defined as corporate loans to the block shareholders. It is measured as other receivables over total assets. However, other receivables include transactions with block shareholders and others. This study extends their measure and classifies other receivables to different sources. We are able to construct this measure since China Securities Regulatory Commission (CSRC) issued a reporting guideline 7 in 1993 that required detail explanations of every annotation in the financial report. Hence for every transaction that affects a firm s accounts receivable, the company needs to reveal the counter-party of the transaction, the amount, and etc. We carefully read through the annual report and examine if the counter-party of the transaction is the largest block shareholder or an entity controlled by the largest block shareholder. The measure of expropriation (Expro) is thus equal to other receivables owed by the block shareholder normalized by total assets. ΔExpro is the average expropriation between year 0 and year 5 minus the average expropriation between year -2 and -1 (Pre_Expro). As in Model (1), the cash flow rights to the ultimate owner of the firm (Cash) and the gap between cash flow rights and control rights (Gap) are used to control for the incentive and entrenchment effects 6 La Porta et al. (2002) and Claessens et al. (2002) suggest that Tobin s Q is negatively related to the likelihood of expropriation and Berkman et al. (2003) adopt this approach and interpret industry-adjusted Tobin s Q as a measure of expropriation. The second approach used in Berkman et al. (2003) is the association between event-related abnormal return and ownership variables that proxy for the extent of expropriation. However, these two approaches are only applicable to studies with clearly identified event dates. Other studies (Jian and Wong, 2003; Berkman et al., 2009) argue that related party transactions between the listed company and its block shareholder can serve as a proxy for minority shareholder expropriation. Berkman et al. (2009) show that many related party transactions represent loan guarantees to related parties (usually the controlling block shareholders). 7 Content and Format of Corporate Disclosure by Publicly Traded Company: Guidelines No. 2,

17 of large ownership in Model (2). Based on the studies by Cheung et al. (2006), Johnson et al. (2000b) and Fan et al. (2008), firm size (Size), operating cash flow (OCF) and growth (Growth) are also included. They are measured by the average logarithm of total assets, operating cash flow over total assets, and the average annual growth rate in sales between year 0 and year 5. Cull et al. (2002) suggest a direct relationship between bank debt and expropriation; hence, the average amount of bank debt owed by the firm over total assets (Bdebt) between year 0 and year 5 is also controlled for. To ensure consistency in our measures, all of the aforementioned variables are computed using the year-end values. To determine whether higher expropriation by private block shareholders is related to inferior performance, the variable of changes in expropriation by block shareholder is added to Model (1) and we rerun the test using the following equation: 8 Δ Perf = γ 0+ γ1pri + γ2δ Expro + γ3cash + γ4gap + γ5pre _ Perf + γ6pre _ Size. (3) + γ Pre _ Lev + μ 7 5. Data and Descriptive Statistics The sample covers transfers of controlling rights between 1996 and 2001, as there were few cases of transfers before Information with respect to CRT and expropriation are manually collected from companies annual reports. Company financial data come from the China Stock Market and Accounting Research Database (CSMAR). The full sample of CRTs includes 418 cases. Following the suggestion in Aussenegg and Jelic (2006), the five years after transfers were used to measure long run performance after privatization. To be included in the final sample, a firm is 8 We control for industry and CTR year in Models (1) to (3). 15

18 required to have performance information available for five years after CRT. 9 Firms that experienced multiple rounds of CRT during the sample period were rejected because it is difficult to isolate the impact of different transfers. The final sample includes 198 transfers, of which 71 represent full privatization with controlling rights transferred to private investors (PRI firms). The remaining 127 were between two state owners, and the companies remained in state ownership (NPRI firms). Table 1 reports the sample distribution by year and industry. The annual trend of CRT suggests that the number of firms transferring the controlling rights increased throughout our sample period from five in 1996 to 55 in Another interesting phenomenon is the increasing level of full privatization. There were two full privatizations in 1996 and 26 in Between 1996 and 1999, full privatization accounted for about 26% of CRTs. However between 2000 and 2001, over 44% of CRTs resulted in full privatization. A careful examination of Table 1 also reveals that full privatization tended to take place in more competitive industries. For monopolies or regulated industries such as utilities, mining, and petroleum, there were fewer full privatizations. This is consistent with the state s strategy of withdrawing from competitive industries and retaining monopoly control in key industries that are critical to economic growth. Insert Table 1 Here Table 2 shows the statistics for the test sample and the matched sample. For the fully privatized firms, the mean and median Size are and 0.523, respectively. For the matched sample, the mean and median Size are and No statistical 9 It is likely that the sample will suffer survivorship bias in which poorly performing firms are removed from the analysis. The results reported in this paper are thus actually biased upwards. The actual performance is lower than that shown in this analysis. 16

19 differences in mean and median are found between the two samples. Similarly, there is no significant difference in performance prior to CRT between them. For firms that are still controlled by the state after CRTs, the matched sample also appears to be similar to the test sample. Insert Table 2 Here Table 3 reports the descriptive statistics. Panel A provides the data for the entire sample. Panels B and C report the data for privatized and non-privatized firms. Panel D reports the difference between the two groups. In the whole sample, mean and median changes in firms performance (ΔPerf) are and For privatized firms the mean is and for non-privatized firms it is The difference between the two groups is significant. This result suggests that non-privatized firms appear to perform better than privatized firms after CRTs. The opposite is true for changes in expropriation (ΔExpro). On average, ΔExpro has a positive mean, suggesting the average level of expropriation increases after CRTs. However, the mean ΔExpro is for privatized firms and for non-privatized firms. On average, privatized firms engage in more expropriation activities than non-privatized firms. Gap, Growth and OCF measures appear to have large variations, as indicated by the large standard deviation. Bdebt has a mean of and a median of 0.290, suggesting that bank loans are a key financing source for Chinese companies. Finally, significant differences in size and performance between privatized firms and non-privatized firms are seen prior to CTRs (Pre_Perf and Pre_Size). These are consistent with state policy to control large SOEs and privatize small SOEs. Insert Table 3 Here 17

20 Table 4 presents the performance difference between privatized firms and non-privatized firms. During the year of CRT, performance improves for both groups. Consistent with Chen et al. (2008), privatized firms continue to experience performance improvements in years 1 and 2 after CRTs, whereas non-privatized firms realize no performance changes. However, performance starts to decline from year 3 to year 5 after CRTs for privatized firms, whereas there are no performance changes for non-privatized firms. Using the average performance between year 0 and year 5, it can be seen that performance declines significantly for privatized firms. For non-privatized firms, performance changes are insignificant after CRTs. Insert Table 4 Here Table 5 describes the level of expropriation by block shareholders after CRTs. In Panel A, it is evident that the mean and median expropriation measures are significantly different from 0 for both privatized and non-privatized firms. Mean and median expropriation measures are significantly higher for privatized firms than for non-privatized firms in all years. Because expropriation may have taken place before privatization, it is necessary to examine the incremental change in expropriation after transfers of controlling rights. Panel B reports the change in expropriation (ΔExpro) between the year of study and the two-year average prior to CRT. We see that ΔExpro is positive and significant in all of the years for privatized firms and insignificant for non-privatized firms. These findings suggest that block shareholders become more aggressive in exploiting minority shareholders after privatization. Insert Table 5 Here Table 6 classifies expropriation activities for the CRT sample equally into low, medium and high groups by the magnitude of expropriation and examines the 18

21 percentage of privatized and non-privatized firms that falls into each group. Average Expro between year 0 and year 5 is used in Panel A. Over 50% of privatized companies fall into the category of high expropriation, whereas less than 25% of non-privatized (state-owned) companies fall into this category. Moreover, the percentage of firms that falls into the category of low expropriation is much higher for non-privatized firms than for privatized firms. The same results can be found in Panel B, which deals with average ΔExpro between year 0 and year 5. More than 40% of privatized firms are classified as high, but less than 30% of non-privatized firms fall into this category. Insert Table 6 Here 6. Regression results Table 7 reports the regression results. Model 1 addresses the effect of privatization on firm performance. The dependent variable is the change in the matched sample adjusted performance (ΔPerf), and the key independent variable is the dummy variable for privatization (PRI). The results show that the coefficient for PRI is significant and negative, suggesting that privatized firms perform less well than non-privatized firms. Insert Table 7 Here Model 2 deals with the impact of privatization on wealth expropriation by large shareholders. The dependent variable is the change in expropriation by the block shareholder (ΔExpro), and the key independent variable is the dummy variable for privatization (PRI). Privatization is found to be positively related to expropriation by the block shareholders. Furthermore, the coefficient for Pre-Expro is significantly 19

22 negative, showing firms that suffered higher levels of expropriation prior to privatization suffered less expropriation afterwards. The coefficient for Bdebt is significantly positive for Model 2, consistent with the view that block shareholders may use bank loans to continue their expropriation activities after they have depleted the internal resources in the firm. Finally, whether expropriation results in performance decline in privatized firms is explored. The variable change in expropriation by block shareholder (ΔExpro) is added to Model (1) and the test is rerun using Model (3). Interestingly, the coefficient for privatization (PRI) is no longer significant. Instead the coefficient for ΔExpro is both negative and significant. It seems that the negative impact of privatization on firm performance is explained by the increasing levels of expropriation by block shareholders. Overall, the results suggest that privatization itself does not cause firms to lose value. However, expropriations by block shareholders escalate greatly after privatization, and cause a decline in long term performance. The matched-sample approach has been used thus far to measure performance changes. To ensure the results are robust, we repeat the foregoing analyses using raw performance change and industry-adjusted performance change. The raw performance change is measured as the average operating income over total assets between year 0 and year 5, minus the average operating income over total assets between years -2 and -1, where year 0 is the year of CRT. The industry adjusted performance change is measured as the raw performance change minus the average of the industry median performance for the corresponding years. The results using alternative measures of performance are consistent both in magnitude and level of significance with those reported in the paper. 20

23 In the above regression, we have controlled for the separation of control and cash flow rights. In our robustness check, we also include the ratio of state shares sold to the total shares, since it is a main contributor to the separation of control and cash flow rights. Results in Table 8 confirm our earlier findings that privatized firms have poorer performance and higher magnitude of expropriation in different model specifications. Insert Table 8 Here 7. Conclusion Focusing on the long-term performance of a sample of firms that went through complete privatization, the paper suggests that excessive expropriation by major shareholders after privatization causes firms performance to deteriorate significantly. Expropriation by private block shareholders is more severe than that by state block shareholders. The findings suggest privatization may not yield the expected efficiency gains in transition economies. They also emphasize the importance of curbing the private block shareholders from exploiting minority shareholders in the process of privatization. The paper differs from previous studies in several ways. Most of the extant studies examine partial privatization, whereas this study focuses on full privatization. Other studies have looked at medium-term performance, whereas this one considers long-term performance. Most importantly, the study of privatization is advanced by empirically showing how expropriation by block shareholders becomes more severe after privatization. Although many papers have examined tunneling by block shareholders, none has looked at how expropriation impairs firms performance or the difference between state block shareholders and private block shareholders. The 21

24 findings of this paper thus complement the existing literature on partial privatization in China and the role of block shareholders in transition economies. 22

25 References Atanasov, V., How much value can blockholders tunnel? Evidence from the Bulgarian mass privatization auctions. Journal of Financial Economics 76 (1), Atanasov, V., Boone, A., Haushalter, D., Is there shareholder expropriation in the United States? An analysis of publicly-traded subsidiaries. Journal of Financial and Quantitative Analysis, forthcoming. Aussenegg, W., Jelic, R., Operating performance of newly privatized firms in central European transition economies. Working paper, Vienna University of Technology, Austria, and University of Birmingham, U.K. Baer, W., Montes-Rojas, G., From privatization to re-nationalization: What went wrong with privatizations in Argentina? Oxford Development Studies 36 (3), Bajaj, M., Chan, Y.-S., Dasgupta, S., The Relationship between ownership, financing decisions and firm performance: A signaling model. International Economic Review 39 (3), Barber, B.M., Lyon, J.D., Detecting abnormal operating performance: The empirical power and specification of test statistics. Journal of Financial Economics 41 (3), Bates, T.W., Lemmon, M.L., Linck, J.S., Shareholder wealth effects and bid negotiation in freeze-out deals: Are minority shareholders left out in the cold? Journal of Financial Economics 81 (3), Berkman, H., Cole, R.A., Fu, J.L., Expropriation, regulation and firm value: Evidence from events in China. Working paper, Massey University-Albany, Auckland, New Zealand. Berkman, H., Cole, R.A., Fu, L.J., Expropriation through loan guarantees to related parties: Evidence from China. Journal of Banking and Finance 33 (1), Boubakri, N., Cosset, J.-C., The financial and operating performance of newlyprivatized firms: Evidence from developing Countries. The Journal of Finance 53 (3), Boubakri, N., Cosset, J.-C., Guedhami, O., Liberalization, corporate governance, and the performance of newly privatized firms. Journal of Corporate Finance 11 (5), Boycko, M., Shleifer, A., Vishny, R.W., A theory of privatization. Economic Journal 106 (435), Calomiris, W. C., R. Fishman, Y. Wang, forthcoming, Profiting from government stakes in a command economy: Evidence from Chinese asset sales, Journal of Financial Economics. 23

26 Chen, G., Firth, M., Xin, Y., Xu, L., Control transfers, privatization, and corporate performance: Efficiency gains in China's listed companies. Journal of Financial & Quantitative Analysis 43 (1), Cheung, Y.-L., Rau, P.R., Stouraitis, A., Tunneling, propping and expropriation: Evidence from connected party transactions in Hong Kong. Journal of Financial Economics 82 (2), Cheung, Y.-L., Rau, P.R., Stouraitis, A., The helping hand, the lazy hand, or the grabbing hand? Central vs. local government shareholders in publicly listed firms in China. Working Paper, City University of Hong Kong, Hong Kong, China. Claessens, S., Djankov, S., Privatization benefits in Eastern Europe. Journal of Public Economics 83 (3): Claessens, S., Djankov, S., Fan, J.P.H., Lang, L.H.P., Disentangling the incentive and entrenchment effects of large shareholdings. The Journal of Finance 57 (6), Clarke, G. R. C., L. C. Xu, Privatization, competition, and corruption: How characteristics of bribe takers and payers affect bribes to utilities. Journal of Public Economics 88 (9-10): Cragg, M., Dyck, A., Privatization, compensation and management incentives: Evidence from the United Kingdom. Journal of Law, Economics, and Organization 19 (1), Cull, R., Matesova, J., Shirley, M., Ownership and the temptation to loot: Evidence from privatized firms in the Czech Republic. Journal of Comparative Economics 30 (1), Deng, J., Gan, J., He, J., Privatization, large shareholders' incentive to expropriate, and firm performance. Working paper, University of Electronic Science and Technology of China, Hong Kong University of Science & Technology, and Chinese University of Hong Kong. Djankov, S., Murrell, P., Enterprise restructuring in transition: A quantitative survey. CEPR Discussion Paper No Domadenik, P., Prašnikar, J., Svejnar, J., Restructuring of firms in transition: Ownership, institutions and openness to trade. Journal of International Business Studies 39 (4), Driffield, N., Mahambare, V., Pal, S., How does ownership structure affect capital structure and firm value? Recent evidence from East Asia. Economics of Transition 15 (3), Dyck, A., Zingales, L., Private benefits of control: An international comparison. The Journal of Finance 59 (2), Easterbrook, F.H., Fischel, D.R., The Economic Structure of Corporate Law. Cambridge: Harvard University Press. 24

27 Faccio, M., Lang, L.H.P., The ultimate ownership of Western European corporations. Journal of Financial Economics 65 (3), Fan, J.P.H., Jin, L., Zheng, G., Internal capital market in emerging markets: Expropriation and mitigating financing constraints. Working paper, Chinese University of Hong Kong, Hong Kong, China. Fong, W.-M., Lam, K.C.K., Privatization and performance. The Chinese Economy 37 (4), Garnaut, R., Song, L., Tenev, S., Yao, Y., A study of firm restructuring in China. The World Bank, Washington, D.C. Ghosh, A., Does operating performance really improve following corporate acquisitions? Journal of Corporate Finance 7 (2), Green, S., Black, A., A market in control: Non-tradable shares deals in companies listed at the Shenzhen stock exchange. Working paper, London Royal Institute of International Affairs, London, United Kingdom. Green, S., House, C., The privatization two-step at China's listed firms. Working paper, Chatham House, London, United Kingdom. Guo, K., Yao, Y., Causes of privatization in China: Testing several hypotheses. Economics of Transition 13 (2), Holderness, C.G., Sheehan, D.P., The role of majority shareholders in publicly held corporations. Journal of Financial Economics 20, Holderness, C.G., Sheehan, D.P., Constraints on large-block shareholders. Concentrated Corporate Ownership, Edited by Randall A. Morck, National Bureau of Economic Research, University of Chicago Press. Huang, G., Song, F.M., The financial and operating performance of China s newly listed H-firms. Pacific-Basin Finance Journal 13 (1), Huang, Z., 2006, Share-holding Ratio, Tunneling strategy and totally circulating. Nankai Business Review, 9(1), Jensen, M.C., Ruback, R.S., The market for corporate control: The scientific evidence. Journal of Financial Economics 11 (1-4), Jia, J., Sun, Q., Tong, W.H.S., Privatization through an overseas listing: Evidence from China's H-share firms. Financial Management 34 (3), Jian, M., Wong, T.J., Earnings management and tunneling through related party transactions: Evidence from Chinese corporate groups. Working Paper, University of Hong Kong, Hong Kong, China. Jiang, G., Lee, C.M.C., Yue, H., Tunneling in China: The surprisingly pervasive use of corporate loans to extract funds from Chinese listed companies. Working paper, Cornell University, New York, United States, and Peking University, Beijing, China. Johnson, S., Boone, P., Breach, A., Friedman, E., 2000b. Corporate governance in the Asian financial crisis. Journal of Financial Economics 58 (1-2),

28 Johnson, S., La Porta, R., Lopez-de-silanes, F., Shleifer, A., 2000a. Tunneling. American Economic Review 90 (2), Jomo, K. S., Tan, W. S., Privatization and re-nationalization in Malaysia: A survey. Working paper, University of Malaya, Kuala Lumpur, Malaysia. Khattab, M., Constraints of privatization in the Egyptian experience. Working paper, The World Bank Group. La Porta, R., López-de-Silanes, F., The benefits of privatization: Evidence from Mexico. Quarterly Journal of Economics 114 (4), La Porta, R., López-de-Silanes, F., Shleifer, A., Corporate ownership around the world. The Journal of Finance 54 (2), La Porta, R., López-de-Silanes, F., Shleifer, A., Vishny, R., Investor protection and corporate valuation. The Journal of Finance 57 (3), Lemmon, M.L., Lins, K.V., Ownership structure, corporate governance, and firm value: Evidence from the East Asian financial crisis. The Journal of Finance 58 (4), Lin, J.Y., Cai, F., Li, Z., Competition, policy burdens, and state-owned enterprise reform. American Economic Review (Papers and Proceedings) 88 (2), Ma, S., Huang, Z., Xue, Y., Resource predation under deferent controlling shareholder and cash dividend policy. Accounting Research 9, (in Chinese). Martimort, D., Straub, S., Privatization and changes in corruption patterns: The roots of public discontent. Working Paper, University of Toulouse, Toulouse, France. Masulis, R., Wang, C., Xie, F., Agency problems at dual-class companies. Journal of Finance 64 (4), Megginson, W.L., Nash, R.C., van Randenborgh, M., The financial and operating performance of newly privatized firms: An international empirical analysis. The Journal of Finance 49 (2), Megginson, W.L., Netter, J.M., From state to market: A survey of empirical studies on privatization. Journal of Economic Literature 39 (2), Nellis, J., Time to rethink privatization in transition economies? IFC discussion paper No. 38. Nenova, T., The value of corporate voting rights and control: A cross-country analysis. Journal of Financial Economics 68 (3), Qian, Y., Enterprise governance structure and financial reform. Economic Research Journal 1, (in Chinese). Shleifer, A., Vishny, R.W., Politicians and firms. Quarterly Journal of Economics 109 (4),

29 Sun, Q., Tong, W.H.S., China share issue privatization: The extent of its success. Journal of Financial Economics 70 (2), Tian, L., Estrin, S., Retained state shareholding in Chinese PLCs: Does government ownership always reduce corporate value? Journal of Comparative Economics 36 (1), Vickers, J., Yarrow, G., Economic perspectives on privatization. Journal of Economic Perspectives 5 (2), Wang, Q., Wong, T.J., Xia, L., State ownership, the institutional environment, and auditor choice: Evidence from China. Journal of Accounting and Economics 46 (1), Wei, Z., Varela, O., D Souza, J., Hassen, M.K., The financial and operating performance of China s newly privatized firms. Financial Management 32 (2), Weiss, A., Nitikin, G., Performance of Czech companies by ownership structure. Working Paper, Boston University, Boston, United States. World Bank, Bureaucrats in Business. New York, Oxford University Press. Zou, H., Adams, M. B., Corporate ownership, equity risk and returns in the People s Republic of China. Journal of International Business Studies 39 (7),

30 Table 1: Sample distribution PRI firms are firms whose controlling rights are transferred from state shareholder to private shareholder. NPRI firms are firms whose controlling rights are transferred from one state shareholder to other state shareholder. Panel A: Distribution by year Total PRI firms NPRI firms Total Panel B: Distribution by industry PRI firms NPRI firms Total Agriculture Mining Food Textile Paper/printing Petroleum Electronics Metal/non-metal Equipment Pharmaceutical Utilities Construction Transport Information technology Retailing Property Services Media Multi-industry Total

31 Table 2: Comparison between testing sample and matched sample PRI firms are firms whose controlling rights are transferred from state shareholder to private shareholder. NPRI firms are firms whose controlling rights are transferred from one state shareholder to other state shareholder. Size is measured as the mean total assets over two years prior to CRTs (in billions). Raw performance is the mean operating profits divided by total assets over two years prior to CRTs. Mean/Median Diff of size (raw performance) is the mean/median size (raw performance) difference between testing sample and matched sample. The test for mean difference is the student s t-test, and the test for median difference is Wilcoxon test. Testing Sample Matched Sample Mean Median Mean Median Mean Diff t value Median diff Signed rank Panel A: PRI firms Size (in billions) Raw Performance Panel B: NPRI firms Size (in billions) Raw Performance

32 Table 3: Descriptive statistics ΔPerf is the average match-sample adjusted Perf between year 0 and year 5 minus Pre_Perf. Perf is operating income over total assets. Pre_Perf is the average performance between year -2 and -1. ΔExpro is the average Expro between year 0 and year 5 minus Pre_Expro. Expro is measured by other receivables owed by the block shareholders normalized by total assets. Pre_Expro is the average Expro between year -2 and -1. Cash is the measure constructed as that in Claessens et al. (2002) to capture the cash flow rights to the ultimate owner of the firm. Gap is the measure constructed as that in Claessens et al. (2002) to proxy the gap between cash flow rights and control rights. Pre_Size is measured by the average logarithm of year-end total assets between year -2 and -1. Pre_Lev is measured by the average of total debt over total assets between year -2 and -1. Size, Bdebt, Growth, OCF are all measured as the average value between year 0 and year 5. Specifically, Size is defined as logarithm of total assets; Bdebt is the amount of the bank debt taken by the firm over total assets; Growth is the annual growth rate in sales and OCF is operating cash flow over total assets. PRI firms are firms whose controlling rights are transferred from state shareholder to private shareholder. NPRI firms are firms whose controlling rights are transferred from one state shareholder to other state shareholder. Mean/Median Diff is the mean/median difference between PRI firms and NPRI firms. The test for mean difference is student s t-test, and the test for median difference is Wilcoxon test. Mean Median Standard Deviation Minimum Maximum Panel A: Full sample(n=198) ΔPerf ΔExpro Cash GAP Pre_Expro Pre_Perf Pre_Size Pre_Lev Size Bdebt Growth OCF Panel B: PRI firms (n=71) ΔPerf ΔExpro Cash GAP Pre_Expro Pre_Perf Pre_Size Pre_Lev Size

33 Bdebt Growth OCF Panel C: NPRI firms (n=127) ΔPerf ΔExpro Cash GAP Pre_Expro Pre_Perf Pre_Size Pre_Lev Size Bdebt Growth OCF Panel D: PRI firms- NPRI firms Mean diff t value Median diff Z value ΔPerf *** *** ΔExpro *** *** Cash *** *** GAP *** *** Pre_Expro * *** Pre_Perf *** *** Pre_Size *** *** Pre_Lev Size *** *** Bdebt *** *** Growth OCF *** *** ***: significant at the level of 1%; **: significant at the level of 5%; *: significant at the level of 10% 31

34 Table 4: Performance change after controlling rights transfers Performance change is the difference in match-sample adjusted performance between the current year and that of the two year average prior to the transfer. Performance is operating income over total assets. PRI firms are firms whose controlling rights are transferred from state shareholder to private shareholder. NPRI firms are firms whose controlling rights are transferred from one state shareholder to other state shareholder. Year 0 is the year of CRT. Mean/Median Difference is the mean/median difference between PRI firms and NPRI firms. The test for mean is student s t-test. The test for median is Wilcoxon test Mean Median PRI firms NPRI firms difference PRI firms NPRI firms difference (1.94*) (2.68***) (1.69*) (-2.43**) (-4.34***) (-3.96***) (2.05**) (0.89) (1.32) (0.09) (0.38) (0.17) (0.53) (1.11) (0.31) (2.31**) (-4.25***) (-3.83***) (431**) (522***) (379**) (-301*) (-793***) (-875***) (724*) (570) (632) (305) (793*) (885**) (1.09) (1.29*) (0.77) (-1.97**) *** (-5.05***) (-5.62***) Avg. (-4.53***) (0.77) (-4.39***) (-674***) (611) (-4.19***) ***: significant at the level of 1%; **: significant at the level of 5%; *: significant at the level of 10% 32

35 Table 5: Expropriation by controlling shareholders for CRTs firms Expropriation (Expro) is measured by other receivables owed by the block shareholders normalized by total assets. ΔExpro is the difference between expropriation at the end of the current year and that of the two year average prior to the transfer. PRI firms are firms whose controlling rights are transferred from state shareholder to private shareholder. NPRI firms are firms whose controlling rights are transferred from one state shareholder to other state shareholder. Year 0 is the year of CRT. Mean/Median Difference is the mean/median difference between PRI firms and NPRI firms. The test for mean is student s t-test. The test for median is Wilcoxon test. Mean Median PRI firms NPRI firms Difference PRI firms NPRI firms Difference Panel A: Expropriation (Expro) (4.85***) (4.48***) (5.42***) (5.44***) (5.93***) (4.48***) (5.52***) (4.82***) (4.42***) (3.51***) (4.57***) (2.67***) (3.17***) (2.81***) (3.19***) (3.87***) (4.95***) (3.62***) Avg. (6.15***) (5.10***) (4.65***) Panel B: Expropriation change (ΔExpro) (2.37**) (1.88*) (2.67***) (3.30***) (4.58***) (3.98***) (-0.08) (-0.01) (0.53) (0.01) (0.48) (1.27) (2.22**) (1.74*) (2.09**) (2.97***) (4.34***) (3.46***) (451.5***) (370.5***) (517.5***) (588***) (637.5***) (540.5***) (945.5***) (210**) (152) (240.5**) (315***) (505.5***) (493.5***) (663***) (1008***) (1207.5***) (798***) (915***) (689***) (2730***) (123.5) (143.5) (292.5) (11) (240) (43.5) (3.05***) (1.80*) (2.64***) (4.43***) (4.94***) (4.79***) (4.40***) (1.30) (0.50) (0.68) (1.65*) (2.87***) (2.90***) Avg. (4.47***) (0.68) (3.96***) (613***) (846.5***) (3.00***) ***: significant at the level of 1%; **: significant at the level of 5%; *: significant at the level of 10% 33

36 Table 6: Sample distribution by expropriation In Panel A, we classify the sample equally into three groups: high, medium and low by the average Expro between year 0 and year 5. In Panel B, we classify the sample by the average ΔExpro between year 0 and year 5. Year 0 is the year of CRT. Expropriation (Expro) is measured by other receivables owed by the block shareholders normalized by total assets. ΔExpro is the difference between expropriation at the end of the current year and that of the two year average prior to the transfer. PRI firms are those of which controlling rights were transferred from state to private. NPRI firms are those of which controlling rights were transferred from state to state. Z-statistics for the two sample tests of proportions are reported in the last column. PRI firms Panel A: Expropriation (Expro) NPRI firms n Percentage (%) n Percentage (%) Z value High *** Medium *** Low Panel B: Expropriation change (ΔExpro) High *** Medium Low ** ***: significant at the level of 1%; **: significant at the level of 5%; *: significant at the level of 10% 34

37 Table 7: Regression results The dependent variables of models (1), (2) and (3) are ΔPerf, ΔExpro and ΔPerf, respectively. ΔPerf is the average match-sample adjusted Perf between year 0 and year 5 minus Pre_Perf. Perf is operating income over total assets. Pre_Perf is the average performance between year -2 and -1. ΔExpro is the average Expro between year 0 and year 5 minus Pre_Expro. Expro is measured by other receivables owed by the block shareholders normalized by total assets. Pre_Expro is the average Expro between year -2 and -1. PRI equals 1 if CRT was from a state owner to a private owner, and 0 if CRT was between two state owners. Cash is the measure constructed as that in Claessens et al. (2002) to capture the cash flow rights to the ultimate owner of the firm. Gap is the measure constructed as that in Claessens et al. (2002) to proxy the gap between cash flow rights and control rights. Pre_Size is measured by the average logarithm of year-end total assets between year -2 and -1. Pre_Lev is measured by the average of total debt over total assets between year -2 and -1. Size, Bdebt, Growth, OCF are all measured as the average value between year 0 and year 5. Specifically, Size is defined as logarithm of total assets; Bdebt is the amount of the bank debt taken by the firm over total assets; Growth is the annual growth rate in sales and OCF is operating cash flow over total assets. Model 1: ΔPerf Model 2: ΔExpro Model 3: ΔPerf Estimate t value Estimate t value Estimate t value Intercept PRI *** *** ΔExpro *** Cash GAP Pre_Perf Pre_Size Pre_Lev Pre_Expro *** Size Bdebt *** Growth *** OCF Industry controlled controlled controlled Year controlled controlled controlled Adj. R N ***: significant at the level of 1%; **: significant at the level of 5%; *: significant at the level of 10% 35

38 Table 8: Regression results The dependent variables of models (1), (2) and (3) are ΔPerf, ΔExpro and ΔPerf, respectively. ΔPerf is the average match-sample adjusted Perf between year 0 and year 5 minus Pre_Perf. Perf is operating income over total assets. Pre_Perf is the average performance between year -2 and -1. ΔExpro is the average Expro between year 0 and year 5 minus Pre_Expro. Expro is measured by other receivables owed by the block shareholders normalized by total assets. Pre_Expro is the average Expro between year -2 and -1. PRI equals 1 if CRT was from a state owner to a private owner, and 0 if CRT was between two state owners. Cash is the measure constructed as that in Claessens et al. (2002) to capture the cash flow rights to the ultimate owner of the firm. Gap is the measure constructed as that in Claessens et al. (2002) to proxy the gap between cash flow rights and control rights. Pre_Size is measured by the average logarithm of year-end total assets between year -2 and -1. Pre_Lev is measured by the average of total debt over total assets between year -2 and -1. Size, Bdebt, Growth, OCF are all measured as the average value between year 0 and year 5. Specifically, Size is defined as logarithm of total assets; Bdebt is the amount of the bank debt taken by the firm over total assets; Growth is the annual growth rate in sales and OCF is operating cash flow over total assets. Model 1: ΔPerf Model 2: ΔExpro Model 3: ΔPerf Model 4: ΔPerf Model 5: ΔExpro Model 6: ΔPerf Estimate t value Estimate t value Estimate t value Estimate t value Estimate t value Estimate t value Intercept PRI *** *** *** *** ΔExpro *** *** Cash GAP TRSF * Pre_Perf Pre_Size Pre_Lev Pre_Expro *** *** Size Bdebt *** *** Growth *

39 OCF Industry controlled controlled controlled controlled controlled controlled Year controlled controlled controlled controlled controlled controlled Adj. R N ***: significant at the level of 1%; **: significant at the level of 5%; *: significant at the level of 10% 37

40 Founded in 1892, the University of Rhode Island is one of eight land, urban, and sea grant universities in the United States. The 1,200-acre rural campus is less than ten miles from Narragansett Bay and highlights its traditions of natural resource, marine and urban related research. There are over 14,000 undergraduate and graduate students enrolled in seven degreegranting colleges representing 48 states and the District of Columbia. More than 500 international students represent 59 different countries. Eighteen percent of the freshman class graduated in the top ten percent of their high school classes. The teaching and research faculty numbers over 600 and the University offers 101 undergraduate programs and 86 advanced degree programs. URI students have received Rhodes, Fulbright, Truman, Goldwater, and Udall scholarships. There are over 80,000 active alumnae. The University of Rhode Island started to offer undergraduate business administration courses in In 1962, the MBA program was introduced and the PhD program began in the mid 1980s. The College of Business Administration is accredited by The AACSB International - The Association to Advance Collegiate Schools of Business in The College of Business enrolls over 1400 undergraduate students and more than 300 graduate students. Mission Our responsibility is to provide strong academic programs that instill excellence, confidence and strong leadership skills in our graduates. Our aim is to (1) promote critical and independent thinking, (2) foster personal responsibility and (3) develop students whose performance and commitment mark them as leaders contributing to the business community and society. The College will serve as a center for business scholarship, creative research and outreach activities to the citizens and institutions of the State of Rhode Island as well as the regional, national and international communities. The creation of this working paper series has been funded by an endowment established by William A. Orme, URI College of Business Administration, Class of 1949 and former head of the General Electric Foundation. This working paper series is intended to permit faculty members to obtain feedback on research activities before the research is submitted to academic and professional journals and professional associations for presentations. An award is presented annually for the most outstanding paper submitted. Ballentine Hall Quadrangle Univ. of Rhode Island Kingston, Rhode Island