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Keywords:

  • private benefits of managerial control;
  • M&As;
  • government shareholding;
  • China;
  • Chinese state-controlled listed companies (CSCLCs)
  • bénéfices privés du contrôle de gestion;
  • M&A;
  • participation du gouvernement;
  • entreprises étatiques chinoises cotées en bourse

Abstract

  1. Top of page
  2. AbstractRésumé
  3. Institutional Background and Hypothesis Development
  4. Methodology and Data
  5. Results
  6. Discussion
  7. References

This article examines how government ownership affects the relationship between private benefits of managerial control, measured as excessive overhead expenses, and profitability of acquirers. A total of 246 merger and acquisition (M&A) events from Chinese state-controlled listed companies (CSCLCs) between 2001 and 2006 constitutes the analytical sample. Under a low level of government shareholding, private benefits of managerial control positively correlated with acquirer announcement returns. However, there was no relationship between private benefits of managerial control and acquirer announcement returns under a high level of government shareholding. The implications of these findings for scholarship and practice are discussed. Copyright © 2011 ASAC. Published by John Wiley & Sons, Ltd.

Résumé

Cet article examine comment la propriété de l'État influence la relation entre les bénéfices privés du contrôle de gestion, évalués en frais généraux excessifs, et la rentabilité des acquéreurs. L'échantillon analytique est constitué d'un total de 246 évènements de fusions et d'acquisitions (M&A) d'entreprises étatiques chinoises cotées en bourse (CSCLCs) de 2001 à 2006. Les résultats empiriques démontrent que lorsque le niveau de participation du gouvernement est bas, les bénéfices privés du contrôle de gestion sont positivement corrélés aux retours d'annonce des acquéreurs. Mais lorsque le niveau de participation du gouvernement est élevé, il n'y a aucune relation entre les bénéfices privés du contrôle de gestion et les retours d'annonce des acquéreurs. Copyright © 2011 ASAC. Published by John Wiley & Sons, Ltd.

Over the last several years, merger and acquisition (M&A) events have attracted considerable attention. In particular, how managerial incentives affect shareholder wealth has become a popular research topic. To date, however, little research has been done on M&A events in China's state-owned enterprises (SOEs) despite the rapid development of the Chinese M&A market over the past two decades. Since the institutional environment in China differs greatly from that in the West, the underlying factors that drive M&A processes and shareholder wealth in China are likely to differ greatly from those in developed countries.

When addressing the issue of managerial incentives and shareholder values, private benefits are particularly important. A stream of research has documented that private benefits of managerial control are key predictors of acquirer returns. Morck, Shleifer, and Vishny (1990) provided empirical evidence that managerial self-interest has a negative correlation with acquirer returns. Hubbard and Palia (1995) examined how the benefits enjoyed by corporate managers affect the relationship between managerial ownership and the stock returns of acquirers, determining that managerial agency costs (such as perquisite consumption) reduce the stock returns of acquirers when managerial ownership is low. Masulis, Wang, and Xie (2007) found that M&A deals involving firms with strong managerial rights are associated with poor market reactions. They argued that this may be driven by the empire building of managers who are subject to weak monitoring from the corporate control market. Gorton, Kahl, and Rosen (2009) constructed a model dealing with the relationship between managerial private benefits and merger outcomes, predicting that larger-sized firms with higher managerial private benefits would be inclined to engage in an unprofitable defensive acquisition, and thus conjectured a negative correlation between managerial private benefits and acquirer announcement returns. However, they did not develop a measure of managerial private benefits (Gorton et al., 2009).

The above-mentioned studies were conducted within the context of developed economies. However, M&A events among China's SOEs in recent years do not appear to be entirely consistent with the conclusions from these studies, perhaps because the forms of private benefits for managers and government controls of SOEs are different from those in many developed economies. Thus, a large gap in empirical implementation still persists in the context of the research question discussed above.

It is well-known that the government tends to be the controlling shareholder in SOEs in China (Tian & Estrin, 2008). On the one hand, Shleifer and Vishny (1998) showed that government ownership is likely to be detrimental to corporate value because the government often extorts firms for the private benefits of politicians and bureaucrats. A number of studies have shown that the government usually intervenes in the M&A activities of China's SOEs and may use them to attain the political objectives of bureaucrats (Kam, Citron, & Muradoglu, 2008; Li, Yu, & Wang, 2005). On the other hand, recent research has highlighted the important role of the government shareholder as a factor that affects managerial control rights (Liu & Lu, 2007). In some cases, the government as the controlling shareholder entrusts the management of SOEs to managers as “real controllers” (Li & Zhu, 2006). Due to owner absence in these companies, a former party secretary or a retired bureaucrat is usually the chairman of the board (Liu, 2006) and thus manipulates M&A activities.

In view of these phenomena, this paper aims to offer a more comprehensive study of the links among private benefits of managerial control, government shareholding, and acquirer returns in Chinese state-controlled listed companies (CSCLCs). We investigate what roles government and managers are playing, what relationship exists between private benefits of managerial control and acquirer returns, and how the level of government shareholding affects this relationship. We argue, in the case of CSCLCs, that private benefits of managerial control are key predictors of acquirer returns, and that the relationship is contingent upon the level of government shareholding. More specifically, we suggest that, under a low level of government shareholding, private benefits of managerial control acting as incentives may enhance acquirer returns. Conversely, when the level of government ownership is high, the government shareholder can exert more control over M&A activities, thus weakening the role of managerial control. In this instance, no relationship should be expected between private benefits and acquirer returns. By analyzing a sample of 246 M&A events in CSCLCs between 2001 and 2006, we found strong empirical support for our hypothesis.

In this study, how to measure the extent of private benefits of managerial control is a key question. Based on the Chinese institutional setting, we have assumed that managers gain private benefits by consuming nonpecuniary compensation.

Institutional Background and Hypothesis Development

  1. Top of page
  2. AbstractRésumé
  3. Institutional Background and Hypothesis Development
  4. Methodology and Data
  5. Results
  6. Discussion
  7. References

The Institutional Setting and the Role of Government Shareholders in M&As

After 1949, all business entities in mainland China were created and owned by the government. Following the economic reform program in the late 1980s, the government began to reform SOEs, and during the 1990s and 2000s many mid-sized and small-sized SOEs were privatized and went public. They were usually “carve-outs” or “spin-offs” from SOEs (Firth, Fung, & Rui, 2006). Prior to split-share structure reform,1 the ownership structure was unique in these listed companies. There remain three major classes of shares in a firm: shares owned by the state, shares owned by legal entities (also called legal-person shares, indirectly owned by the government), and tradable shares owned by individuals and private institutions. A major characteristic in China is that share ownership is still dominated by the state or legal-person shareholders. Liu (2006) reported that, on average, state-owned shares and legal-person shares account for 70% of the total shares in China's listed companies and these shares cannot be traded on the stock exchange.

The above practice shows that the government is playing two roles simultaneously: the regulator and the controlling shareholder (Liu & Lu, 2007), which leads to the fact that the M&A activities in these companies were usually controlled by the government. Since the late 1980s, the government has aimed to release itself from the burden of supporting loss-making SOEs by merging them with “well-performing” firms. In many cases, the government would force firms with good performance to acquire financially distressed SOEs and improve their performance; local officials are also often keen to facilitate M&As among enterprises because the performance of SOEs is a strong indication of their own administrative performance. Thus, during the early and mid-1990s, merger waves took place in the capital market in China. As the controlling shareholder, however, the government can dominate the listed firm's decisions and expropriate some of the shareholder value of minority investors (Shleifer & Vishny, 1998). Several recent pieces of research have clearly illustrated that the controlling shareholders harm the interests of minority shareholders through “tunneling” activities (Gao & Kling, 2008) such as providing loan guarantees to related parties (Berkman, Cole, & Fu, 2009), taking related-party transactions with listed companies (Cheung, Jing, Rau, & Stouraitis, 2005), and extracting funds from the listed companies (Jiang, Lee, Yue, Wong, & Jian, 2005). Particularly, with the increasing size of its shareholding, the government can exert more control over the firm and hence divert more corporate wealth to official political uses (Tian & Estrin, 2008).

Why Managers Consume Perks as Private Benefits of Control in CSCLCs

The Chinese institutional set-up in the reform of SOEs results in the pervasive pursuit of private benefits of managerial control (Tong, 2005). Benos and Weisbach (2004, p. 219) defined private benefits of control as “benefits that accrue to managers or shareholders that have control of the corporation, but not to minority shareholders.” Hwang (2004) argued that much of the literature on private benefits of managerial control is vague about who is actually enjoying these private benefits of control—owners or managers? To avoid this concept confusion, Hwang (2004, p. 2) divided private benefits of managerial control into two components: “benefits accruing to managers and benefits accruing to owners.” In CSCLCs, the initial top managers of administration and the members of the directorate were designated by the government (Chang & Wong, 2004), which gave managers specific control rights over corporate operation. Given the absence of owners, the real control rights are in the hands of these inside managers, which leads to managers providing themselves with fringe benefits.

How do managers extract these private benefits? Prior research has noted that managers may maximize their personal benefits through either consuming perquisites (Jensen & Meckling, 1976) or enjoying high compensation and subsidies (Harris & Raviv, 1988). In CSCLCs, the main source of managerial compensation is salary, but because the government imposes stringent restrictions on managerial pay levels, salaries for different levels of managers are very low and not greatly differentiated. In addition, stock-based incentives are weak because of low managerial shareholding (Chang & Wong, 2004). As a result, most CSCLCs lack compensation schemes and hence have a poor incentive structure. Though cash- and stock-based compensation are low in these firms, managers still choose to stay because they have control rights to generate private benefits for themselves that may compensate for their inadequate basic pay (Tong, 2005). Hubbard and Palia (1995) pointed out that managers may indulge in any nonvalue maximizing transaction, such as excessive consumption of perquisites, when they do not have a significant ownership stake in the firm. On-the-job perks for managers in Chinese SOEs can be substantial (Qian, 1996). Furthermore, Chen, Chen, and Wan (2005) documented that invisible income from excessive nonpecuniary compensation is a manager's major income and can include personal communications, travelling, and even car use.

Therefore, we conclude that unless there is prevailing government intervention, it is the private benefits of control that accrue to managers and not those that accrue to shareholders or owners that serve as the main incentive in M&As; this is so not only because managers seek private benefits outside their usually low regular pay, but because such a motive is facilitated by the Chinese institutional setting where real owners are absent from the Chinese SOEs and managers are entrusted by, and act on behalf of, the government, which is usually the dominant shareholder. This motivates us to use perks as the proper measure of private benefits of managerial control in the Chinese environment.

Acquirer Returns in the Chinese Stock Market

Recent research has suggested two opposite views on whether M&A activities create value. Some have argued that M&As add value (Gonzales, Vasconcellos, & Kish, 1998; Lewellen, 1971; Moeller, Schlingemann, & Stulz, 2005; Rossi & Volpin, 2004; Shahrur, 2005) whereas others have argued that M&A activities reduce value (Hubbard & Palia, 1995).

Some empirical results indicate that Chinese M&As are usually beneficial to the shareholders of the target firms, but the wealth effects on the acquirers are inconclusive. Yu and Yang (2000) examined the wealth effects of M&A activities between 1993 and 1995 in Chinese listed companies and found positive gains for the target firms but insignificant gains for acquirers after announcements of M&A events. Zhang, He, and Zhou (2003) used 1,216 samples from Chinese listed companies between 1993 and 2002 to show that both the stock prices and the financial performance of target companies improved significantly after M&A deals, and the reverse effect was found for acquirers. Xu's (2006) empirical results, which used 330 samples from Chinese listed companies between 1997 and 2001, showed positive wealth gains for targets but negative wealth gains for acquirers. Chi, Sun, and Young (2009) investigated the performance of acquirers in 1,148 M&As on the two Chinese stock markets between 1998 and 2003 and found that M&As do not improve the short-run abnormal returns of acquirers. Wang and Boateng (2007), however, studied the performance of Chinese cross-border M&A activities of 27 deals between 2000 and 2004 and found that cross-border M&As create value for Chinese acquirers.

It should be noted that the above research concerns only the outcomes of acquisition and not the factors that lead to, or affect, these outcomes or the interplay among these factors themselves, which is the goal of this paper.

Hypothesis Development

We studied the relationships among three key factors of M&As: namely, private benefits of managerial control, roles of government, and acquirer returns. There are different approaches to exploring this question, but below we focus on how the level of government ownership affects the relationship between private benefits of managerial control and acquirer returns.

As indicated above, on one hand the government designates managers and gives them specific control rights in corporate decision making. In this case, managers can exert more control over M&A activities. On the other hand, M&As are possible tools used by government shareholders to facilitate tunneling which benefits them at the expense of minority shareholders (Bae, Kang, & Kim, 2002; Bigelli & Mengoli, 2004). Most importantly, as Tian and Estrin (2008) noted, in Chinese public listed companies, the higher the government shareholding, the more control it has over the firms.

Accordingly, we hypothesize that the combination of government ownership level and private benefits of managerial control will have an important effect on acquirer returns. Under a low level of government shareholding in CSCLCs, there are weak shareholder rights, which cause higher agency costs and perquisites consumption by managers (Hwang, 2004). As the state representatives, managers without significant ownership of the firm hold residual rights of control and can exert more control over the M&A activities. Because of low managerial pay-for-performance, private benefits of managerial control might replace income stemming from managerial ownership as an incentive to undertake acquisition, and thus may help explain improved acquirer returns.

As argued earlier, in the Chinese institutional setting, perks should be the proper measure of private benefits of control; the relationship between private benefits of control and acquirer returns is reduced to one between acquirer returns and perks. From this, expected questions arise: What factors determine perks in China? Do they depend on the government ownership level of the SOEs? To answer these questions, we cite Chen, Chen, and Wan (2005) who showed that perks are determined by firm size, position, administrative grade of managers, local standard of living, the general financial status of enterprises, and so on. We emphasize that none of these are directly related to government ownership level; in other words, there is no reason to believe that the government tends to assign less perks to managers under lower-level government ownership. On the contrary, the opposite could be happening (Hwang, 2004). Since such low levels of perks in the context of less government control can be associated with a better acquisition decision, the above argument precludes a possible negative correlation between perks and acquirer returns.

Perks could be related to managerial skills, however, and this could take place in several ways. On one hand, perks increase as a direct result of the improvement of an enterprise's financial state and the promotion of a manager (within or interenterprise) to a higher position or administrative rank as a result of his/her persistent good management performance. This led us to predict that the correlation between perks and acquirer returns would be positive but not as strong as expected in a market economy setting. That is, in the Chinese setting, it may not be appropriate to simply assume that perks are an ideal proxy of managerial skills. In fact, for quite a while under the “big pot” (for a detailed account, see Leung, 2003, 2004) policy, perks for managers in China had been relatively independent of managerial skills; the situation began to change only after the introduction of economic reform, which has clearly been gradual. This explains why we have refrained from making the assumption that perks are a pure proxy of skills; we have assumed, however, that perks are somehow a reflection of managerial skills.

On the other hand, when government ownership is high, government intervention dominates and the government shareholder can exert more control over these companies than under low government ownership levels. Apparently, such roles of government overrun not only the rules of market economy but also managers' concern for their own interests or the general interests of their enterprise. In particular, M&As may be used by the government to facilitate tunneling activities that expropriate minority shareholders or to attain officials' specific political objectives in which case managerial control over M&A activities is seriously weakened. Thus, no relationship should be expected between private benefits of managerial control and acquirer returns.

In sum, the relationship between private benefits of managerial control and acquirer returns may depend on the level of government shareholding, and therefore we formulate the following hypothesis:

H 1. The relationship between private benefits of managerial control and acquirer announcement returns is contingent upon the level of government shareholding, with private benefits of managerial control having a positive impact on acquirer announcement returns at low levels of government shareholding and no significant impact at high levels of government shareholding.

Methodology and Data

  1. Top of page
  2. AbstractRésumé
  3. Institutional Background and Hypothesis Development
  4. Methodology and Data
  5. Results
  6. Discussion
  7. References

Variables

Acquirer announcement returns. Standard event study methodology (Brown & Warner, 1985) was employed to measure the abnormal returns around the announcement. The method has been used in developed as well as developing countries including China (Kam et al., 2008). All stock price data were obtained from the China Stock Market & Accounting Research (CSMAR) database. Following Walters, Kroll, and Wright (2007) and Wang and Whyte (2010), we computed 7-day cumulative abnormal returns (CAR) during the window encompassing the event day (−3, 3) for all acquirers.

Private benefits of managerial control. There has been surprisingly little empirical research on how to measure private benefits of managerial control. Most empirical studies try to measure private benefits accruing to the controlling shareholders (Dyck & Zingales, 2004). Benos and Weisbach (2004) documented two standard measures of private benefits of control in the literature2 and pointed out that private benefits vary in different countries with different legal environments.

Among the few studies on measuring the private benefits of managerial control, Hwang (2004) quantified the level of managerial control exercised by owners by the probability of top executive turnover within one year following block trades. The study explained that a larger shareholder is both an owner and a manager, as blockholders have the power to replace the top executive. However, Hwang's approach is still aimed at larger shareholders rather than on “pure” managers. As noted earlier, effective control is in the hands of these inside managers of companies in which owners do not exert power. Private benefits of managerial control may arise from consuming excessive perquisites in CSCLCs in the absence of executive stock-option schemes and other incentive-based pay. In view of this, we quantified unobservable perquisite consumption to measure the private benefits of managerial control. Tian (2005) pointed out that excessive overhead expenses, which are defined to be overhead expenses divided by revenue, are the most suitable indicator of unobservable perquisite consumption among all possible candidates in accounting. According to China's accounting rules, overhead expenses include many elements, and it is not practical to cover them all in this study. Following Tian (2005) and Chen et al. (2005), the overhead expenses related to on-the job perks for managers include eight categories: expenses for office operations, travelling, business entertainment, communication, professional training, personal car use, conferences, and board of directors' fees. These expenses can be easy ways for managers to obtain private benefits, in which case managers' personal spending is legalized and covered by their companies' budget (Chen et al., 2005).

Government shareholding. SOEs can be fully owned or partially owned by the government. As a practical matter, it is difficult to definitively determine what level of state ownership would qualify an entity as “state-owned” since the government can also own regular stock without implying any special interference. In this study, we considered the government as the controlling shareholder if it owned more than 10% of equity, which is the controlling threshold used by Claessens, Djankov, and Lang (2000) and Faccio and Lang (2002).3 We employed the estimation methodology of Tian and Estrin (2008) to compute the size of government shareholding. This was calculated as the state-owned shares over the total common shares in state-controlled listed companies.

Control variables. We controlled for various other factors that have been found to influence acquisition outcomes. First, we controlled for acquirer characteristics, including growth opportunities, leverage, firm size, and fixed assets (Moeller, Schlingemann & Stulz, 2004). Prior studies have found that an acquirer's growth opportunities measured by the market-to-book ratio has an ambiguous effect on CAR. In this study, however, we employed the average revenue growth ratio in the three years proceeding the year of M&As instead of the market-to-book ratio to capture this measure in China. Leverage is also an important characteristic to take into account, since higher debt levels could provide incentives for managers to improve performance particularly when managers may lose their jobs if their firms enter financial distress (Masulis et al., 2007). We expected leverage to have a positive effect on CAR. Moeller et al. (2004) found that an acquirer's size is negatively correlated with its announcement-period CAR. Thus, we expected managers of larger firms to be more entrenched and more likely to make value-reducing M&As. We defined firm size as the natural log of an acquirer's total assets. On the other hand, the fixed asset rate of an acquirer would also have an effect on CAR and we controlled for this.

Second, we controlled for industry characteristics. Some special industries such as weapons manufacturing are usually controlled by the central government, and therefore M&A activities in these industries are limited. Finally, we controlled for board characteristics. For example, board members may induce more responsible acquisition decisions (Walters et al., 2007). We controlled for this using the number of independent directors over the total number of directors.

The Regression Model

We used the following regression model to investigate the relationship among the variables we identified.

  • display math(1)

where CAR is the cumulative abnormal return over the (−3, 3) window, and other variables are as defined in Table 1. Our primary interest was to test whether the coefficients in front of State and Perk (State * Perk) are significant.

Table 1. Variables' Definitions
VariablesDefinitions
CARThe acquirer's cumulative abnormal returns for three days surrounding the M&A announcement.
PerkA measure of private benefits of control (unobservable perk consumption). It is calculated as overhead expenses divided by revenue at the fiscal year-end prior to the M&A announcement. The overhead expenses include office operations, travelling, business entertainment, communication, professional training, personal car use, conferences, and board of directors' fees.
StateThe size of government shareholding. It is calculated as the state-owned shares over total common shares at the fiscal year-end prior to the M&A announcement.
GrowthThe average revenue growth ratio in the three years preceding the year of the M&A.
DebtIt is calculated as the total debt over total assets at the fiscal year-end prior to the M&A announcement.
LnsizeFirm size. It is calculated as the log form of total assets at the fiscal year-end prior to the M&A announcement.
FixedassetThe fixed asset ratio. It is calculated as the fixed assets over total assets at the fiscal year-end prior to the M&A announcement.
IndustryA dummy variable of industry. If the company belongs to a nonregulated industry, it is 0; otherwise, 1.
IndependentA measure of board independence. It is calculated as the number of independent directors over the total number of directors at the fiscal year-end prior to the M&A announcement.

Sample

The data for this study were obtained from the CSMAR database, commercially available from Shenzhen GTA Information Technology Company Ltd. Our initial sample included all the firms traded on either of China's two stock exchanges between 2001 and 2006. We adjusted the sample by deleting financial firms, firms with less than six months of trading data, firms with negative book equity value, nonstate-controlled listed acquirers, and firms with missing data. We also required that all events were state-controlled listed firms acquiring nonlisted firms or other listed firms.4 Our final sample includes 246 firms.

Results

  1. Top of page
  2. AbstractRésumé
  3. Institutional Background and Hypothesis Development
  4. Methodology and Data
  5. Results
  6. Discussion
  7. References

Descriptive Statistics

Table 2 provides descriptive statistics of the variables involved. The mean (median) total CAR is 0.012 (0.006), with a standard deviation of 0.050. The mean (median) total Perk is 0.005 (0.003). The mean (median) total State is 0.408 (0.443), which demonstrates a high average level of government control.

Table 2. Descriptive Statistics of Cumulative Abnormal Returns and Explanatory Variables of Chinese State-Controlled Listed Companies between 2001 and 2006.
VariablesMeanMedianMinimumMaximumSt. d.
CAR0.0120.006−0.1000.3600.050
Perk0.0050.003−0.1720.3800.047
State0.4080.4330.1000.8380.216
Growth0.3300.227−0.7034.2520.560
Debt0.4970.5090.0122.3410.216
Lnsize21.36121.28817.53626.6321.037
Fixedasset0.3930.3670.0013.7740.308
Industry0.1710010.377
Independent0.3410.3330.0830.5560.049

Table 3 presents the Pearson correlation coefficients between the measure of private benefits of managerial control and acquirer announcement returns, which shows that these two variables are significantly correlated with each other. This is suggestive evidence that firms with strong managerial rights may be more likely to make profitable M&As. In addition, there is an insignificant correlation between Perk and State (−0.068, p > 0.1), which demonstrates that government ownership has no impact on perks, consistent with our hypothesis.

Table 3. Pearson Correlation Coefficients of Cumulative Abnormal Returns and Explanatory Variables of Chinese State-Controlled Listed Companies between 2001 and 2006
 CARPerkStateGrowthDebtLnsizeFixed assetIndustryIndependent
  1. Notes: 1. “*,” “**,” and “***” represent 0.1, 0.05, and 0.01 levels of significance respectively.

  2. 2. The sample size is 246.

CAR1.000        
Perk0.166***1.000
State−0.068−0.0291.000
Growth−0.081−0.157**0.0661.000
Debt−0.0460.1260.0740.0821.000
Lnsize−0.068−0.226***−0.0820.0010.151**1.000
Fixedasset−0.121*−0.159**0.0580.0790.0860.127*1.000
Industry−0.0650.016−0.0310.035−0.152**0.279***0.236***1.000
Independent0.136**0.0110.004−0.096−0.0300.022−0.056−0.0471.000

Test of Hypothesis

We estimated the regression model with STATA 9.0. The regression results are shown in Table 4. Control variables, including Growth, Debt, Lnsize, Fixedasset, Industry, and Independent, were entered in Model 1, followed by adding the Perk variable in Model 2, the State variable in Model 3, and placing the interaction term between the Perk variable and the State variable in Model 4.

Table 4. Regression Results of Perks and the Size of Government Shareholding on Cumulative Abnormal Returns of Chinese State-Controlled Listed Companies between 2001 and 2006
VariablesModel 1Model 2Model 3Model 4
  1. Notes: 1. The dependent variable reported in this table is “CAR,” which denotes the acquirer's cumulative abnormal returns for three days surrounding the M&A announcement. The two key explanatory variables are “Perk” and “State,” which respectively represent perks measured as overhead expenses divided by revenue at the fiscal year-end prior to the M&A announcement, and the size of government shareholding measured as the state-owned shares over total common shares at the fiscal year-end prior to the M&A announcement.

  2. 2. “*,” “**,” and “***” represent the 0.1, 0.05, and 0.01 levels of significance respectively.

Intercept0.026−0.0180.0140.012
(0.36)(−0.24)(0.19)(0.17)
Perk 0.165**0.167**0.625***
(2.29)(2.34)(3.84)
State −0.014−0.003
(−0.96)(−0.19)
Perk*State −1.145***
(−3.11)
Growth−0.005−0.003−0.003−0.003
(−0.91)(−0.50)(−0.55)(−0.53)
Debt−0.006−0.140−0.008−0.014
(−0.38)(−0.89)(−0.52)(−0.91)
Lnsize−0.0020.000−0.001−0.000
(−0.62)(0.02)(−0.28)(−0.01)
Fixedasset−0.018*−0.112−0.014−0.015*
(−1.45)(−1.03)(−1.27)(−1.39)
Industry−0.003−0.007−0.009−0.006
(−0.37)(−0.76)(−0.97)(−0.63)
Independent0.121**0.120**0.093*0.127**
(1.85)(1.85)(1.43)(1.99)
N246246246246
AdjR20.0120.0300.0560.063
F1.502.06**2.62***2.83***

The variable of interest is the sign of the regression coefficient for the Perk variable, capturing the direct effect of managerial private benefit of control on CAR. In other words, the regression-coefficient estimate tells us whether there is a significant relationship. The coefficient on the interaction term between the Perk variable and the State variable describes how the linear relationship between Perk and CAR is influenced by State. Regression Model 2 in Table 4 shows that private benefits of managerial control have a significant positive impact on the acquirer's return. The coefficient estimate on Perk is 0.165 (p < .05). The result for Model 2 confirms that managerial rights increase the acquirer's announcement returns. Regression Model 3 reveals that government shareholding does not impact the acquirer's returns (r = −0.014, p. > 0.1).

Model 4 adds the interaction effect of government shareholding and private benefits of managerial control. The coefficient estimate on Perk*State is −1.145 (p. < .01), implying that the impact of private benefits of managerial control on acquirer announcement returns varies with the level of government shareholding. An F-test shows that adding the interaction effect results in a significant increase in explanatory power (p. < 0.01). Although the statistically significant interaction effect indicates that the effect of private benefits of managerial control on acquirer announcement returns varies with the level of government shareholding, it is not clear at this stage how this effect exactly varies. So we plot, in Figure 1, the relationship between private benefits of managerial control and acquirer announcement returns for both low (i.e., one standard deviation below the mean) and high (i.e., one standard deviation above the mean) government ownership. Figure 1 shows that private benefits of managerial control have a positive effect on acquirer announcement returns for low government shareholding (r = 0.367, p. < 0.01) and a negative (but insignificant) effect for high-level government shareholding (r = −0.021, p. > 0.1). This is in-line with our hypothesis.

image

Figure 1. The impact of private benefits of control on acquirer announcement returns for low and high levels of government shareholding

Download figure to PowerPoint

Table 4 also shows that the variable Independent significantly and positively affects acquirer announcement returns, suggesting that an independent director can help monitor managers, causing them to be more careful in their M&A decisions and thus leading to greater shareholder wealth. Growth opportunities, leverage, and firm size have no significant effect on CAR.

A Re-estimate of the Results Using an Alternative Private Benefits Measure

We used Perk as the measure of private benefits of managerial control and next used control premiums (CP)5 paid in large block sales as an alternative independent variable to re-estimate the main results.

The results using CP are displayed in Table 5. We found an increased adjusted R square in all the regressions (comparing Tables 4 and 5). CP related negatively to CAR (r = −0.017, p. > 0.1) and the relationship of CP*State was nonsignificant (r = 0.001, p. > 0.1), which demonstrates that government shareholding has no significant impact on the relationship between CP and CAR.

Table 5. Regression Results of Control Premiums and the Size of Government Shareholding on Cumulative Abnormal Returns of Chinese State-Controlled Listed Companies between 2001 and 2006
VariablesModel 1Model 2Model 3Model 4
  1. Notes: 1. The dependent variable reported in this table is “CAR,” which denotes the acquirer's cumulative abnormal returns for three days surrounding the M&A announcement. The two key explanatory variables are “CP” and “State,” which respectively represent control premiums measured as the difference between the price per share paid for large-percentage blocks of common stock and the market price of the shares after the block transaction, divided by the market price of the shares after the block transaction, and the size of government shareholding measured as the state-owned shares over total common shares at the fiscal year-end prior to the M&A announcement.

  2. 2. “*,” “**,” and “***” represent the 0.1, 0.05, and 0.01 levels of significance respectively.

Intercept0.0260.0070.0110.011
(0.36)(0.21)(0.35)(0.33)
CP −0.017***−0.017***−0.018***
(−31.43)(−31.36)(−14.96)
State −0.007−0.006
(−0.99)(−0.89)
CP*State 0.001
(0.22)
Growth−0.005−0.001−0.001−0.001
(−0.91)(−0.26)(−0.21)(−0.22)
Debt−0.0060.0000.0010.001
(−0.38)(0.03)(0.11)(0.13)
Lnsize−0.002−0.000−0.000−0.000
(−0.62)(−0.12)(−0.20)(−0.20)
Fixedasset−0.018*−0.001−0.001−0.001*
(−1.45)(−0.21)(−0.15)(−1.20)
Industry−0.0030.0030.0030.002
(−0.37)(−0.76)(0.66)(0.68)
Independent0.121**−0.002−0.002−0.001
(1.85)(−0.07)(−0.06)(−0.04)
N246246246246
AdjR20.0120.8080.8080.807
F1.50147.72**129.37***114.54***

The result demonstrates a difference between our measure and the standard measure. It suggests that: (a) the inclusion of the control premium captured by the controlling shareholder enhances the explanatory power of the model and indicates that the control premium is also an important determinant of CAR, and (b) the impact of government shareholding on the relationship between CP and CAR is minimal. Also, regardless of the level of government shareholding, the control premium is always negatively correlated with CAR. One probable explanation for this finding is that firms with high CP have poor governance (Dyck & Zingales, 2004) and thus experience significantly lower CAR. By comparison, the perk consumption by managers might act as an incentive to undertake acquisitions and thus experience higher CAR at the low level of government shareholding.

We prefer perks over CP as a measure of private benefits of managerial control in the Chinese setting for several reasons. First, in the absence of an owner, private benefits accruing to managers are the closest Chinese counterpart to the Western concept of private benefits accruing to controlling (or large) shareholders, which in turn forms the theoretical basis for the standard measure of Dyck and Zingales (2004). Perks, not CP, provide the more appropriate accurate measure of these managerial private benefits. Second, managers can immediately receive on-the-job perks and thus are motivated; they tend to be less sensitive to any change in CP because of CP's minor relevancy to their interests. Finally, the empirical evidence in this paper does show that perks play a more effective incentive role than CP, as can be seen from the fact that while CP is usually negatively correlated with CAR, there are contexts in which perks and CAR are positively correlated.

In short, perks as a measure of private benefits of managerial control is a better measure than CP in the Chinese institutional setting.

Discussion

  1. Top of page
  2. AbstractRésumé
  3. Institutional Background and Hypothesis Development
  4. Methodology and Data
  5. Results
  6. Discussion
  7. References

Summary

In this article we address the managerial incentive issue in the merger and acquisition activities of Chinese state-controlled listed companies. We argued that this incentive is rooted in private benefits of managerial control, which in turn affects the stock returns of acquirers. Our empirical evidence suggests a positive correlation between the measure of private benefits of managerial control and acquirer announcement returns. We further demonstrated that government shareholding has an impact on the relationship between private benefits of managerial control and acquirer announcement returns. Under a low level of government shareholding, private benefits of managerial control are positively correlated with acquirer announcement returns; yet private benefits of managerial control are negatively but insignificantly correlated with acquirer announcement returns under a high level of government shareholding. We believe that the above research advances knowledge of managerial incentives, enhances understanding of M&A activities and government's roles in them, and, provides insight into the relationships among them.

Contributions to Scholarship

This research broadens our understanding of private benefits of managerial control and acquirer returns by linking them to government shareholding. In fact, this is the first study to explore the relationship between private benefits of managerial control and acquirer returns in CSCLCs in the context of government shareholding. Specifically, our contribution lies in the following aspects.

First, although research has focused mainly on how bidder characteristics, such as firm size (Moeller et al., 2004), ownership structure (Ben-Amar & André, 2006), and corporate governance (Masulis et al., 2007), affect acquirers' returns, little attention has been paid to the managerial incentives view. Gorton et al.'s (2009) model suggests a negative correlation between private benefits of managerial control and acquirers' returns. Yet our results show that the opposite could happen—that is, under a low level of government shareholding, private benefits of managerial control, as proxied by perks, might act as incentives to enhance acquirer returns.

Second, the argument that perks should be a proper measure of private benefits of managerial control is new, and it helps explain how managerial incentives effect M&A deals of CSCLCs, which to some extent enriches the literature on M&As.

Third, the paper contributes to the literature on ownership structure and M&As by using large data sets to confirm various relationships, such as those among government ownership, private benefits of managerial control, and acquirers' returns in the Chinese institutional setting

Applied Implications

Our research has important implications for M&A practice in China. Since lower government ownership or less administrative intervention is usually conducive to a healthier relation between private benefits of managerial control and acquirer announcement returns, whenever possible the government should refrain from intervening in the management affairs of SOEs in general and M&A activities in particular—that is, leave the managers alone and let the rules of the market do their job. Given the enormous success of the market economy in both the Western and Chinese environments, our finding is in no way surprising. On the other hand, one may ask, “How bad could the role of government get?” Could, for example, as a manifestation of bad governance, the government tend to assign less perks to managers under lower levels of government shareholding, resulting in managers likely making better acquisition decisions? If this were true, then we would expect a negative relationship between perks and acquirer announcement returns; but our hypothesis development and regression analysis do not support this scenario. In fact, the positive correlation we found between perks and acquirer announcement returns implies that perks are skill-related. Note that we are not suggesting that perks are a pure proxy of skills, but given our results and the determining factors of perks (Chen et al., 2005), we consider perks to be skill-dependent.

It's ironic to point out that many of the pay-related policies (such as those regarding perks) in China are also made and put into practice by the government. Therefore, as noted above, our message to the Chinese government is clear: in firms with low government ownership, appropriate perks should be rewarded to managers—particularly those involved in M&A activities. Conversely, in firms with high government ownership, perks should be minimally granted.

Limitations and Future Research Directions

Despite its many strengths, our research has a number of limitations. First, how to measure the private benefits of managerial control is a key question. Due to the lack of well-constructed measures, we used perks as a proxy. This raises a serious question about the robustness of the results. Empirically, it is very difficult to find ideal proxies for private benefits of managerial control. Much in-depth research is needed on this front. Second, though we re-estimated the empirical result by using an alternative measure of private benefits accruing to shareholders, we did not, in this case, provide a convincing explanation as to why government shareholding has no impact on the relationship between such private benefits and acquirers' returns. This is a topic to be investigated in the future. Third, we did not include the managerial ownership variable in the regression model. This is because managerial ownership in the CSCLCs was very low before the split-share structure in 2005. After the reform, however, the Chinese government allowed incentives such as stock options and other incentive-based pay in state-controlled listed firms. Therefore, the form taken by private benefits are expected to change in the next decade. Our future research will account for this.

Finally, our sample was limited to CSCLCs; in particular, we limited M&As to bidders where the government has an ownership level of 10% and above, which may limit the generalizability of the results. Hence, the results should be viewed cautiously, especially when extended to other cultural contexts. A broader, more interesting, and also more challenging avenue of research would attempt to understand the behaviours of private, collective enterprises or SOEs where there are no constraints on government ownership.

Endnotes
  • 1

    The split-share structure reform started in 2005 and ended in 2008.

  • 2

    Standard approaches to estimating private benefits of managerial control include (a) the control block approach, measured by the difference between the price per share paid for large-percentage blocks of common stock and the market price of the shares after the block transaction (Barclay & Holderness, 1989; Dyck & Zingales, 2004), and (b) the voting approach, measured by comparing prices of shares with identical dividend rights but with different voting rights (Zingales, 1995; Nenova, 2003).

  • 3

    Since the goal of our research is to study the behaviour of SOEs in M&As and, in particular, to understand how government ownership in SOEs affects the relationship between private benefits of managerial control and acquirer returns, we need to define what firms are considered “state-owned.” Following Claessens et al. (2000), we adopted the “10% of equity” owned by the government as our judging criterion. In other words, the selection of our sample is largely determined by our research goals, hence the inclusion of nonstate-owned enterprises does not serve our purpose well. We do hope, however, that a more general research, where the restriction on government ownership is removed, can be conducted in the future.

  • 4

    We limited ourselves to M&As where the government is a controlling shareholder in the bidder (as opposed to the target) not because we are uninterested in other scenarios, but because we lack the necessary data to conduct a more extensive research; in particular, we point out the fact that the situation where state-owned enterprises are acquired by nonstate-owned enterprises is extremely rare, if it exists at all. The reason for this is twofold: First, the marketization level of Chinese economy is not high and there is a lack of large enough private or collective companies that can afford an acquisition of SOEs. Second, the transfer of government ownership is restricted in China and requires the approval of the state-owned Assets Supervision and Administration Commission of the State Council (SASAC).

  • 5

    CP has been considered by some as a standard measure in the literature. For a more detailed calculating process see Dyck and Zingales (2004).

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  3. Institutional Background and Hypothesis Development
  4. Methodology and Data
  5. Results
  6. Discussion
  7. References
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