The Twin Agency Problems in Corporate Finance - On the basis of Stulz s theory -

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1 The Twin Agency Problem in Corporae Finance - On he bai of Sulz heory - Von der Fakulä für Machinenbau, Elekroechnik und Wirchafingenieurween der Brandenburgichen Technichen Univeriä Cobu zur Erlangung de akademichen Grade eine Dokor der Wirchafwienchafen genehmige Dieraion vorgeleg von Maer of Science Juan Du Geboren am 28. März 978 in Hunan, China Vorizender: Prof. Dr. rer. pol. A. Piouli Guacher: Prof. Dr. rer. pol. K. Serfling Guacherin: Prof. Dr. rer.pol.k. Schimmelpfeng Tag der mündlichen Prüfung: 27. Mai 2009

2 Conen Li of Figure...IV Li of Table... V Li of Appendixe... VII Li of Abbreviaion...VIII Li of Symbol...IX Inroducion.... The ae of financial globalizaion....2 Three puzzle in financial globalizaion Twin Agency Problem propoed by Sulz o explain he puzzle Objecive of he Sudy Developing he model of Sulz heory and looking for heoreical oluion Reearching he Chinee financial marke and looking for empirical oluion The rucure of he udy Expropriaor Deciion on Expropriaing he Exiing Company Aumpion and decripion of he model Firm value and expropriaion by corporae inider and ae ruler Expropriaion by corporae inider Opimal fracion of expropriaion by corporae inider Imporan facor deermining he fracion expropriaed by corporae inider Impac of ownerhip concenraion on expropriaion by corporae inider Impac of expropriaion by ae ruler on expropriaion by corporae inider Impac of inveor proecion on expropriaion by corporae inider Impac of fuure profiabiliy and capial co on expropriaion by corporae inider Expropriaion by ae ruler Opimal fracion of expropriaion by ae ruler Impac of inveor proecion on expropriaion by ae ruler Imporan facor deermining firm value Impac of inveor proecion on expropriaor benefi Impac of inveor proecion on corporae inider benefi Impac of inveor proecion on ae ruler benefi Impac of fuure profiabiliy and capial co on corporae inider benefi Summary Expropriaor and Ouide Inveor Deciion on Eablihing New Company Corporae inider deciion Corporae inider financing deciion Corporae inider invemen deciion I

3 3..2. Impac of inveor proecion on corporae inider invemen deciion Impac of fuure profiabiliy and capial co on corporae inider invemen deciion Ouide inveor invemen deciion Impac of inveor proecion on ouide inveor invemen deciion Impac of fuure profiabiliy and capial co on ouide inveor deciion Sae ruler deciion Summary Poible Soluion Propoed by he Model o he Twin Agency Problem Wha hould be done o olve he Twin Agency Problem? Wha could be done o olve he Twin Agency Problem? Sraegie hould be aken by he ae Summary Pracical Inveigaion in China General decripion of financial marke in China Developmen of Chinee financial marke Comparion of Chinee ock marke o oher main ock marke Siuaion of ownerhip concenraion in China Conrucion of daa Proporion of ownerhip concenraed companie in China Average degree of ownerhip concenraion in China Mo ownerhip-concenraed companie in China Mo ownerhip-dipered companie in China I liing abroad a good way for Chinee companie o become more ownerhipdipered? Comparion of ownerhip concenraion beween Chinee corporaion lied in mainland and hoe lied abroad Influence of ae holding companie on he ownerhip concenraion of companie lied abroad Effec of he liing-abroad-age on ownerhip concenraion of companie lied abroad Influence of grea capial cale on ownerhip concenraion of companie lied abroad Difference of ownerhip concenraion beween op 50 and boom 50 companie Comparion of ownerhip concenraion beween companie lied abroad and inland wih he ame capial cale Concluion Relaionhip beween profiabiliy and ownerhip concenraion Relaionhip beween ROE and ownerhip concenraion for companie in differen indurie Relaionhip beween profiabiliy and ownerhip concenraion for ae holding companie and non-ae holding companie Relaionhip beween profiabiliy and ownerhip concenraion for companie lied abroad and lied inland II

4 5.5 Meaure aken by he ownerhip-dipered corporaion o olve he agency problem Effecive ownerhip rucure Ownerhip rucure aken by he ownerhip-dipered companie The effec of differen ownerhip rucure on profiabiliy Lower eparaion of voing righ from cah flow righ Ownerhip encouragemen o more op manager and employee Suggeion indicaed by he empirical daa Summary Concluion and Recommendaion Concluion Recommendaion Appendix Reference III

5 Li of Figure Figure : Relaionhip beween deermining facor and he fracion of profi expropriaed by corporae inider and ae ruler Figure 2: Number of companie lied in China Mainland ( ) Figure 3: Number of ecuriie lied in China Mainland ( ) Figure 4: Toal ock iued capial in China Mainland ( ) Figure 5: Sock marke value in China Mainland ( ) Figure 6: Average marke value of companie lied in China Mainland ( ) Figure 7: Sock and non-ock ecuriie lied in China Mainland ( )... 7 Figure 8: Number of companie lied on main ock exchange (2007) Figure 9: Marke value of main ock exchange (2007) Figure 0: Average marke value of companie lied on main ock exchange (2007) Figure : Number of lied companie on main ock exchange ( ) Figure 2: Marke capializaion of main ock exchange ( ) Figure 3: Average marke value of lied companie on main ock exchange ( ) 78 Figure 4: China v. USA, Marke capializaion / GDP ( ) Figure 5: Ownerhip rucure of Zhejiang Yankon Group Co. Ld Figure 6: Ownerhip rucure of Shanghai Broadband Technology Co. Ld Figure 7: Ownerhip rucure of Jilin AoDong Medicine Indury Group Co. Ld Figure 8: Ownerhip rucure of Tianjin Taly Pharmaceuical Co. Ld Figure 9: Ownerhip rucure of Zhuhai Zhongfu Enerprie Co. Ld IV

6 Li of Table Table : Relaiviy beween deerminan facor and benefi of expropriaor Table 2: Overview of Financial Marke in China ( ) Table 3: Number of lied companie on main ock exchange ( ) Table 4: Marke capializaion of main ock exchange ( ) (US$ Mil.) Table 5: Average marke value of companie lied on main ock exchange ( ) (US$ Mil.)... 8 Table 6: China v. USA, Marke capializaion / GDP ( )... 8 Table 7: Proporion of ownerhip concenraed companie in China (20% Cuoff) Table 8: Proporion of ownerhip concenraed companie in China (0% Cuoff) Table 9: Comparion of proporion of ownerhip concenraed companie beween differen ock exchange Table 0: Proporion of ownerhip concenraed companie on Shanghai Sock Exchange (20% Cuoff) Table : Proporion of ownerhip concenraed companie on Shanghai Sock Exchange (0% Cuoff)... 9 Table 2: Proporion of ownerhip concenraed companie on Shenzhen Sock Exchange (20% Cuoff) Table 3: Proporion of ownerhip concenraed companie on Shenzhen Sock Exchange (0% Cuoff) Table 4: Average ownerhip concenraion in China Table 5: Cah-flow concenraion in Ea Aia Table 6: Comparion of average ownerhip concenraion beween differen ock exchange Table 7: Average ownerhip concenraion on Shanghai Sock Exchange Table 8: Average ownerhip concenraion on Shenzhen Sock Exchange Table 9: Top 20 mo ownerhip concenraed companie in China Table 20: 9 mo ownerhip dipered companie in China Table 2: Comparion of ownerhip concenraion beween companie lied abroad and in China Mainland Table 22: Difference of ownerhip concenraion beween companie conrolled by ae and by family Table 23: Effec of liing-abroad- age on ownerhip concenraion of companie lied on NYSE V

7 Table 24: Comparion of ownerhip concenraion beween op 50 companie... Table 25: Comparion of ownerhip concenraion beween boom 50 companie... Table 26: Comparion of ownerhip concenraion beween financial corporaion... 4 Table 27: Comparion of ownerhip concenraion beween op 50 non-financial companie4 Table 28: Comparion of ownerhip concenraion beween financial companie lied in mainland and lied abroad... 7 Table 29: Comparion of ownerhip concenraion beween non-financial companie lied in mainland and lied abroad... 7 Table 30: Comparion of ROE beween companie ownerhip-concenraed and -dipered (20% cuoff) Table 3: Comparion of ROE beween companie ownerhip-concenraed and -dipered (0% Cuoff) Table 32: Comparion of CR beween companie ownerhip-concenraed and -dipered (20% Cuoff) Table 33: Comparion of CR beween companie ownerhip-concenraed and -dipered (0% Cuoff) Table 34: Comparion of CR beween companie wih differen ownerhip concenraion Table 35: Comparion of CR beween companie lied abroad and lied inland (20% Cuoff) Table 36: Comparion of CR beween companie lied abroad and lied inland (0% Cuoff)... 3 Table 37: Comparion of CR beween companie lied abroad and lied inland wih differen ownerhip concenraion... 3 Table 38: Comparion of profiabiliy beween differen ownerhip rucure of ownerhipdipered companie in China Table 39: Comparion of ownerhip rucure beween effecive and ineffecive companie 4 Table 40: Separaion of voing righ from cah flow righ for differen ownerhip rucure Table 4: Comparion of eparaion of voing righ from cah flow righ beween effecive and ineffecive companie Table 42: Comparion of ownerhip encouragemen on op manager beween differen ownerhip rucure Table 43: Comparion of ownerhip encouragemen on op manager beween effecive and ineffecive companie VI

8 Li of Appendice Appendix : Yearly Marke Overview of Shanghai Sock Exchange ( ) Appendix 2: Yearly Marke Overview of Shenzhen Sock Exchange ( ) Appendix 3: Ownerhip concenraion of public raded financial companie in China Appendix 4: Ownerhip concenraion of op 50 public raded non-financial companie in China Appendix 5: Daa of 52 ownerhip-dipered public raded companie in China VII

9 Li of Abbreviaion ASX CEO CFO GDP HKEx KRX LSE NASDAQ NSE India NYSE OECD OLS ROE SBT SET SGX SHSE SZSE TSE TSEC TSX WACC Auralian Securiie Exchange Chief Execuive Officer Chief Finance Officer Gro Domeic Produc Hong Kong Exchange Korea Exchange London Sock Exchange NASDAQ Sock Exchange Naional Sock Exchange of India New York Sock Exchange Organizaion for Economic Cooperaion and Developmen Ordinary Lea Square Reurn of Equiy Shanghai Broadband Technology Co. Ld Sock Exchange of Thailand Singapore Exchange Shanghai Sock Exchange Shenzhen Sock Exchange Tokyo Sock Exchange Taiwan Sock Exchange Corporaion Torono Sock Exchange Weighed Average Capial Co VIII

10 Li of Symbol CR CR= ROE of he firm / ROE of he indury e (q, k, ) Co-of-hef funcion burdened by conrolling hareholder f Percen of he equiy held by he conrolling hareholder g (p, k, h) Co-of-grabbing funcion burdened by ae ruler G Payoff o he ae ruler from a firm a he end of period G Payoff o he ae ruler from all he firm a he end of period h Fracion of he profi expropriaed by ae ruler, 0 h h * i Opimal value of h, which i decided by ae ruler Capial co of he firm i Marke rae of reurn of he porfolio I All he capial inveed in he firm a period 0 I D Capial demanded o e up he firm a period 0 I E Capial inveed by he enrepreneur o e up he firm a period 0 I M Capial colleced from he marke o e up he firm a period 0 I S k p q R R * U Capial upply on he marke Qualiy of baic legal environmen, called legal ene Qualiy of proecion of all he inveor, conrain on ae ruler Qualiy of proecion of ouide hareholder Rae of reurn of he projec Rae of reurn of he projec a period Fracion of he profi expropriaed by conrolling hareholder, 0 Opimal value of, which i decided by conrolling hareholder Wealh held by he enrepreneur in he firm a he end of period W 0 Iniial wealh owned by he enrepreneur a period 0 W ΔW Toal wealh held by he enrepreneur a he end of period Ne value of aring a firm a he end of period IX

11 Inroducion. The ae of financial globalizaion Since he end of World War II, he explici barrier o inernaional invemen aciviy have been harply knocked down and he financial marke of mo counrie are no cloed o croborder rade in financial ae. Over he pa decade, financial marke have increaingly exended beyond naional border. The reducion of formal barrier o rade in financial ae i ofen called financial globalizaion (ee Sulz 2005b). Friedman (2005) make he cae ha globalizaion lead o a fla world. By ha, he mean ha i remove obacle ha, in he pa, would have prevened firm and individual from compeing wih each oher acro he world. Such compeiion improve welfare no only by inuring ha good are produced a he lowe co bu alo by making ure ha conumer ge acce o new and beer good. he meaphor i helpful o underand he force ha hape our world. I i even more ap o decribe he financial world han he world of rade in good (Sulz, 2005a, page ). In neoclaical model, financial globalizaion generae major economic benefi. In paricular, i enable inveor worldwide o hare rik beer, i allow capial o flow where i produciviy i he highe, and i provide counrie wih an opporuniy o reap he benefi of heir repecive comparaive advanage (ee Sulz (999a), for a review) (Sulz, 2005b, pp.595). I generae welfare gain by reducing he volailiy of aggregae conumpion and alo by delinking naional conumpion and income (Koe e al, 2006). Welfare i maximized wih complee financial globalizaion and perfec marke wihin counrie. Kaminki and Schmuckler (2006) conruced a comprehenive chronology of financial liberalizaion in 28 maure and emerging marke economie ince 973 o examine he hor- and long-run effec of financial liberalizaion on capial marke. Their reul revealed ha financial liberalizaion i followed by more pronounced boom-bu cycle in he hor run. However, financial liberalizaion lead o more able marke in he long run. Acually, inernaional financial marke are an inheren feaure of oday economie: he ranmiion of aving acro counrie ha been faciliaed; he agen in differen counrie have been enabled o hedge macroeconomic and financial rik; and he agen have been allowed o diverify and opimize heir inernaional ae and liabiliy porfolio. (ee Sark 2006). See Sorenen e al. (2007), Ari and Hoffman (2006a, 2006b), Giannone and Reichlin (2006) and Koe e al. (2007) for a review.

12 The phenomenon of financial globalizaion canno be capured wih a ingle cachword, meaure or index. I ha variou dimenion. I i viible in he increaing cale and volume of financial ranacion, he growing amoun of inernaional financial ranacion, he increaing peed wih which ranacion are decided, implemened and eled, and he widening geographical cope of financial marke o counrie and region ha unil ome year ago were cu off from worldwide financial marke (ee Sark 2006)..2 Three puzzle in financial globalizaion Alhough he explici barrier o inernaional invemen aciviy have been dramaically reduced over he la 60 year and he cro-border rade in financial ae ha dramaically increaed, he poiive impac of financial globalizaion ha been urpriingly limied. Recen udie reveal ome evidence differen from he predicion of he radiional heory: a) Direcion of capial flow Inernaional capial flow have increaed dramaically ince he 980. During he 990 gro capial flow beween indurial counrie roe by 300 percen, much of which i due o rade in equiy and deb marke (Evan and Hnakovka, 2006). According o he andard neoclaical heory, if producion funcion are he ame acro counrie, he capial produciviy mu be very high in he developing counrie, becaue he co of labor i very low in hee counrie. Large capial flow from rich o poor counrie migh be expeced unil he reurn o invemen i equal in all counrie. Therefore, he aving of rich counrie could finance much-needed invemen in poor counrie, which increae he rae of reurn on aving of indurial counrie and enhance he economic growh in developing counrie (ee Smaghi 2006). However, uch flow do no ake place. Luca (990) made a comparion beween he U.S. and India in 988 and he reul howed ha a maive capial flow from he U.S. o India hould have been generaed by a large reurn differenial becaue he marginal produc of capial in India i abou 58 ime higher han ha of he U.S. However, he expeced maive capial flow did no occur. Obfeld and Taylor (2003, p.75) hold ha inernaional invemen in poor counrie i a an all ime low oday. In 2000, developed counrie invemen per capial wa US$6,000, much greaer han ha of developing counrie (only US$400) (Wolf, 2004, pp. 4-5). Schularick (2005) ook a comparaive look a capial flow o le-developed counrie in wo era of financial globalizaion. He found ha invemen in developing counrie wa a cenral elemen of 9 h cenral financial globalizaion, bu play only a minor role oday. In he year of 94, 7 ou of 2 mo imporan recipien of foreign capial were le-developed economie: Ruia, Brazil, Mexico, India, Souh Africa, 2

13 China and Spain. In he year 200, only one le-developed economy can be found among 2 mo imporan deinaion for inernaional invemen flow China come ou lighly ahead of mall Swizerland. The mo obviou difference beween now and hen i ha he weern European economie do no appear a all on he hiorical li, bu belong o he mo imporan recipien of foreign invemen oday (Schularick, 2005, pp. 0). b) Home bia In pie of he rend oward inernaional porfolio diverificaion, inernaional inveor coninue o have rong preference for domeic financial ae (Lewi 999; Karolyi and Sulz, 2003). According o daa from 997, he U.S. inveor have roughly 9% of heir ock invemen in he U.S. ock, bu he U.S. ock repreen only 49% of he world marke porfolio (Dahlqui e al, 2002). Home bia ha been - eadily bu lowly - declining over recen year, epecially in Euro area economie a hee end o be relaively highly inegraed wih each oher. However, mo economie in he world inve only around 0 percen of heir porfolio wealh in foreign ecuriie alhough imple benchmark would ugge a much higher hare of foreign invemen o be opimal (Sark, 2006, pp. 4). c) Concenraion of corporae ownerhip In heir book The Modern Corporaion and Privae Propery, aenion wa called by Berle and Mean (932) o he prevalence of widely held corporaion in he Unied Sae, where ownerhip of he corporaion wa dipered among mall hareholder, bu he conrol righ wa concenraed in he hand of manager. Thi image ha been queioned. On he bai of daa on ownerhip rucure of large corporaion in 27 wealhy economie, i i found ou by La Pora, Lopez-de-Silane and Shleifer (999) ha excep in counrie wih very good proecion of hareholder, few of hee firm are widely held. Thee firm are ypically conrolled by rich familie or he ae. Equiy conrol by financial iniuion i found o be uncommon..3 Twin Agency Problem propoed by Sulz o explain he puzzle Why i he financial world ill full of obacle in pie of he collape of explici barrier and capial doe no flow o he counry wih he highe capial produciviy? Why are he inveor hindered from buying foreign financial ae, and he corporae ownerhip i no dipered o mall hareholder? To explain hee problem, Sulz (2005b) oulined an alernaive o he neoclaical model, which i called he Twin Agency Problem. Referring o Sulz (2005b) for he review of Sulz heory and model inroduced in ecion.3. 3

14 Firly, he corporae inider who conrol he firm can ue heir power for heir own benefi and diver from he firm a he expene of ouide inveor, which creae he agency problem of corporae inider dicreion. Bu heir expropriaion i coly and he co depend on he fracion hey ake away from he company and he qualiy of he proecion of minoriy hareholder. Secondly, he ae ruler who conrol he reource of he ae can ue heir power o expropriae he company and improve heir welfare a he expene of all hareholder, which creae he agency problem of ae ruler dicreion. Thi expropriaion i alo coly and he co depend on he fracion he ae ruler diver from he company and he qualiy of proecion of all inveor, or conrain on he ae ruler. Thee wo problem are win problem raher han wo eparae one and hey can feed on each oher. Expropriaion by he ae ruler lead o greaer conumpion of privae benefi by corporae inider, becaue any money he inider leave in he firm will be parially aken away by he ae ruler. The corporae inider can be reduce he rik of ae expropriaion by aking acion ha boh increae heir dicreion and alo make i harder for he ae ruler o monior heir acion (Sulz, 2005b, pp 597~598). They can alo be conneced wih ae ruler and ue he ae o expropriae oher inveor. Thee rik are counry-pecific becaue, ubjec o conrain and rade-off ha depend on counry characeriic, uch a hiory, law, locaion, and economic developmen, hoe who conrol a counry ae can eablih, enforce, and break rule ha affec inveor payoff wihin ha counry (Sulz 2005b, page597). Nenova (2000) meaured corporae conrol benefi he value ha dominan voe-holder deprived from he company conrolled by hem o he derimen of minoriy hareholder, uing daa of 66 firm in 8 counrie. He found ha he benefi ha conrolling hareholder exrac ou of corporae conrol are ignifican in magniude and vary widely acro counrie. Mexican conrolling hareholder expropriae one half of he value of he company, haring he remaining half wih minoriy hareholder in proporion o hare holding. The privae benefi in Scandinavian and Englihpeaking counrie are dwarfed in comparion. They are below 4% for Canada, Denmark, Hong Kong, Sweden, and he US, and below 0% for Finland, Norway, Souh Africa, and UK. Germanic counrie uch a Swizerland and Germany exhibi voe value of around 0-5%. Sulz (2005b) exploied a imple one-period model o explain he impac of he Twin Agency Problem on financial globalizaion. In hi model he firm exi only one period, which i e up a he beginning of he period wih he fixed amoun of capial, I. The conrolling hareholder cah flow ownerhip in he company i f. A he end of he period, he The ymbol ued here are differen o he original in Sulz model bu he eenial meaning of he equaion i he ame. The ymbol in Sulz model are changed o make he ame ymbol ued in differen chaper of hi paper have he ame meaning. 4

15 following equence of even ake place: he invemen opporuniy yield a cah flow of IR, inider expropriaor appropriae privae benefi equal o a fracion of IR, he ae ruler engage in expropriaion equal o a fracion h of (-) IR, and finally he firm liquidae and pay ou a liquidaing dividend, (-h) (-) IR. He aume ha corporae inider can conume privae benefi wihou co up o a fracion, c of he firm cah flow. Any expropriaion of cah flow in exce of he hrehold level c i ubjec o a co of 0.5q (Max[-c, 0]) 2 IR, where q>0. Inveor proecion i an increaing funcion of q, which i a counry-pecific conan. Wih hee aumpion, he payoff o he inider a he end of he period i 2 ( )( h) f IR 0.5q( Max[ c,0] ) IR U = IR (.3-) The inider chooe o maximize equaion.3-. I i alway opimal for inider o expropriae a lea a fracion c of he cah flow, ince hey incur no penaly for doing o and canno credibly commi no o ha. So he oluion i ( h) * f = c (.3-2) q The co burndened on he ae ruler becaue of heir expropriaion i 0.5ph 2 (-) IR. Here p i an exogenou index of conrain on he ae. So he payoff o he ae ruler a he end of he period i 2 ( ) h 0.5 ph IR( ) G = IR The ae ruler chooe h o maximize equaion.3-3 and he opimal h i given by (.3-3) h * = (.3-4) p Minoriy hareholder value he firm by dicouning he firm cah flow ne of expropriaion by inider and he ae a heir required expeced reurn, i. From heir perpecive, firm value i ( h) f c ( h) IR b V = 0 (.3-5) i Wih hee model Sulz examined he relaionhip beween ownerhip concenraion and he exen of expropriaion and he analyze he influence of hee problem on financial globalizaion. A he co of appropriaing privae benefi i low and hee agency problem woren, diffue ownerhip i inefficien and dominaed by concenraed ownerhip, ince coinvemen by corporae inider align heir incenive beer wih minoriy hareholder and, herefore, reduce he expropriaion of hee hareholder. 5

16 Becaue of he ownerhip concenraion he rik haring benefi of financial globalizaion i inverely relaed o how much he conrolling hareholder co-inve in he equilibrium becaue when corporae inider co-inve, heir porfolio are over weighed in he equiy of heir firm (Sulz, 2005b, pp. 598), which i one of he reaon of he home bia puzzle. I i hown by Dahlqui e al. (2003) ha he phenomenon of home bia i inricaely linked o corporae governance. When companie are conrolled by large inveor, porfolio inveor are limied in he fracion of a firm hey can hold. Porfolio inveor canno hold world marke porfolio in a world wih conrolling hareholder. So he removal of barrier o inernaional invemen canno make he home bia diappear. For he home bia o diappear, i i neceary ha inveor righ improve acro counrie where firm are moly conrolled by large hareholder o ha i become opimal for firm o have aomiic hareholder in hee counrie. Alhough developing counrie are expeced o aborb capial inflow becaue of heir high phyical produciviy of capial, he expropriaion by corporae inider and ae ruler decreae he cah flow, inveor can expec o receive from he firm hey inve ino and hence he value of heir claim on he firm. When hee problem are ufficienly eriou, he firm canno promie a high enough reurn o inveor o raie capial and canno exploi heir invemen opporuniie in hoe counrie o capial will inverely ouflow from developing o developed counrie. Ownerhip concenraion caued by hee Twin Agency Problem limi a counry abiliy o benefi from financial globalizaion. I lead o lower financial developmen, more conumpion volailiy, ronger correlaion beween aving and invemen, le foreign invemen, lower firm valuaion, maller firm, and lower economic growh (Sulz 2005a, page 2). On he bai of hee Twin Agency Problem, Sulz alo made predicion abou apec of corporae finance. In paricular, counrie in which he Twin Agency Problem are evere hould be expeced o have higher leverage and a higher proporion of hor-erm deb han counrie in which hee problem are more benign. Furher, invemen in corporae governance i le profiable in counrie in which he agency problem of ae ruler dicreion i ignifican becaue many aciviie ha enrench corporae inider help reduce he rik of expropriaion by he ae (Sulz, 2005b, pp. 634). Bu Sulz model have ome limiaion: hi model are one-period and focue moly on new firm bu in realiy firm may exi for more han one period; he conidered only allequiy public firm wihou deb; he co-of-hef funcion i given a quadraic, which i oo concree and he reaonablene may be doubed. 6

17 .4 Objecive of he Sudy.4. Developing he model of Sulz heory and looking for heoreical oluion On he bai of Sulz heory, remaining he cenral role of he Twin Agency Problem in foering ownerhip concenraion, hi paper make ome change on Sulz model: Firly, one-period model i developed ino muli-period. Sulz aume ha he firm exi only in one period and focue moly on new firm. Bu in he realiy he firm may urvive more han one period o ha hi muli-period model make hi reearch more pracical. Secondly, corporae value model i buil under he muli-period aumpion. Wih he muli-period aumpion he paricipan do no only care abou heir cah gain a he momen, which i conidered by Sulz model, bu alo care abou he value of heir ock in he firm which depend on he cah flow creaed in he fuure, which i ignored by Sulz. So a corporae value model wih he conideraion of Twin Agency Problem i buil o analyze he impac of hee problem on corporae value. Thirdly, he qualiy of baic legal environmen, under which he law will be well enforced, defined a facor k in hi udy, i added in he model. In Sulz model, he co of expropriaion paid by corporae inider depend only on he qualiy of proecion of ouide hareholder, which mean ha when he ouide hareholder are beer proeced he inider will mo probably be everely punihed for heir hef. Here, he co i aumed o alo depend on k, becaue in ome developing counrie legal ene i o weak among he people ha many rule and law are ignored a if hey did no exi. The facor k influence boh corporae inider and ae ruler. Fourhly, deb i conidered in he model. Sulz conider only all-equiy firm and analye only porfolio equiy flow. In hi udy i i defined a he average capial co of he firm, which can be een a WACC (Weighed Average Capial Co) in he corporae value model, o he impac of deb on he expropriaion can be conidered in hi model. Fifhly, he co-of-hef funcion i more common. Sulz ha given a quadraic funcion o define he co of expropriaion burdened by he expropriaor. Thi udy doe no give a concree co funcion, bu aume ha he funcion aifie a erie of condiion. The reul deduced from hi funcion migh be more common and convincing. On he bai of hi improved model, heoreical oluion are uppoed o be found o olve hee Twin Agency Problem, concerning educaion, economic poliic, law and regulaion, which hould be conidered by he governmen. 7

18 .4.2 Reearching he Chinee financial marke and looking for empirical oluion Since 990, he Chinee financial marke ha experienced a fa expanion. Bu compared o oher global financial marke, i developmen i lagged and diproporional o he economic properiy of China. Recognizing he problem in he developmen of Chinee financial marke and finding a good way o make i go furher i an urgen ak of he economi and poliician. According o Sulz heory, he Twin Agency Problem caue ownerhip concenraion and lead o a lower financial developmen. So anoher objecive of hi udy i o inveigae he iuaion of ownerhip concenraion caued by Twin Agency Problem in China, examine he impac of hee problem on Chinee financial marke and find ome oluion indicaed by he empirical daa. An overview of he developmen of Chinee financial marke in la decade and i acual iuaion will be diplayed. Then, on he bai of more han houand lied companie financial daa from annual repor 2007, he acual iuaion of ownerhip concenraion in China will be dicloed. The relaionhip beween ownerhip concenraion and oher characer, uch a capial cale, profiabiliy, ownerhip rucure and o on, will alo be examined in he pracical par. Furhermore, on he bai of empirical evidence, pracical uggeion will be propoed o olve he Twin Agency Problem in China..5 The rucure of he udy The re of hi udy i organized a follow. In Chaper 2 an improved model on he bai of Sulz heory i buil, and according o hi developed model, he behavior of he expropriaor afer eablihing he firm i inveigaed. Firly, he aumpion and decripion of he model i inroduced, uch a he paricipan, he environmen of he firm, and he definiion of he facor. Then a corporae value model wih he conideraion of Twin Agency Problem i buil. Wih hi corporae value model he opimal fracion of expropriaion and he deerminan facor of hi fracion are reearched for boh inider expropriaor and ae ruler. Afer ha he imporan facor influencing corporae value are examined. Then he implicaion of inveor proecion on expropriaor benefi i udied. Laly, he impac of fuure profiabiliy and capial co on corporae inider benefi are examined. Chaper 3 concern he deciion of expropriaor and ouide inveor before he company i eablihed. A fir he corporae inider financing and invemen deciion i inveigaed, including how he firm will be financed, he impac of inveor proecion, capial co and expeced rae of reurn on he enrepreneur willingne o e up a firm. Then, he ouide inveor invemen deciion i reearched, concenraing on he facor which affec he um 8

19 ha can be colleced from ouide inveor. Laly, he ae ruler behavior before he eablihmen of he firm i udied. Sae ruler can decide o improve or no o improve he inveor proecion. Thi depend on wheher hi meaure increae heir own benefi. In Chaper 4 he reul in Chaper 2 and Chaper 3 are combined o find meaure propoed by he heoreical model o olve he Twin Agency Problem. Firly, wha hould be done o weaken he Twin Agency Problem i inveigaed, uch a improving inveor proecion, increaing expeced rae of reurn, reducing capial co and adoping ownerhip-concenraed capial rucure. Bu no all hee mean could be uccefully performed becaue ome may come up again embarramen. So wha could be done i examined o find ou beer way, which can avoid rong reiance. On he bai of he analyi above, raegie for he governmen are uggeed. Chaper 5 i a pracical inveigaion in China. A fir i give a review of he developmen of Chinee financial marke in he la decade and a comparion of Chinee ock marke o oher main ock marke. Then, on he bai of daa of more han houand publicly raded Chinee firm, he iuaion of ownerhip concenraion in China i dicloed. Afer ha, a careful comparion of ownerhip concenraion beween companie lied abroad and hoe lied in he mainland i performed o ee wheher liing abroad i a good way o make companie more ownerhip dipered. Nex, he relaionhip beween profiabiliy and ownerhip concenraion i examined o eify ownerhip concenraed companie are really more profiable han oher. For here exi a few companie which are ownerhip-dipered and alo more profiable han oher firm in he ame indury, o nex, hi udy focue on he ownerhip-dipered companie o reearch he meaure aken by hee firm o olve he Twin Agency Problem. Laly, on he bai of he empirical evidence above, uggeion indicaed by he empirical daa are propoed o olve he Twin Agency Problem in China. Chaper 6 i a ummary of he whole udy. 9

20 2 Expropriaor Deciion on Expropriaing he Exiing Company 2. Aumpion and decripion of he model On he bai of Sulz heory, remaining he cenral role of he Twin Agency Problem, hi udy relaxe ome limiaion of Sulz model and preen a more pracical one o analyze he implicaion of hee problem on corporae finance. In hi implified model, firm alo produce one good and pay a liquid dividend a he end of each period. The gain of he company i hared by hree kind of paricipan: ae ruler, conrolling hareholder (alo called inide expropriaor) and ouide inveor. Sae ruler are he official in he governmen, who conrol he reource of he counry, iue licene, or have oher righ o make companie obey heir command. They ue heir power o expropriae he company and heir behavior affec he benefi of all inveor conrolling hareholder and ouide inveor. Conrolling hareholder are alo called corporae inider, ince hey are omeime manager and a oher ime conrolling hareholder or ulimae owner of he companie. Inide expropriaor have many chance and righ o eal from he company when corporae governance i no o good and heir hef affec he ouide inveor. Afer he gain i expropriaed by inide expropriaor and ae ruler, he ouide inveor hare he remaining gain of he company wih he inide hareholder, proporional o heir hare in he company. Differen o Sulz one-period model, he firm in hi model are aumed o urvive for n period. A period 0, enrepreneur decide wheher o e up a firm. If he enrepreneur ha decided o ar a firm, he ha wo ource o finance he company. Fir, from hi own iniial wealh (W 0 ), he can inve I E in he firm, wih a fracion (f) of he equiy in he firm, and become conrolling hareholder, on he condiion ha I E W 0. The re of he iniial wealh he can inve in he marke, a a porfolio inveor. Secondly, he can raie I M from he capial marke by elling a fracion (-f) of he firm cah flow righ. I i aumed ha enrepreneur reain conrol of hi firm regardle of he fracion of he cah flow righ he ell. The enrepreneur can alo chooe o inve all hi iniial wealh W 0 in he capial marke if he hink aring a firm i unprofiable. Porfolio inveor can inve in any ecuriie iued by all he firm bu have no conrol over he firm. The capial co of he firm, i, and he marke rae of reurn of he porfolio, i, are boh deermined by he upply and demand for fund. The demand for fund i generaed by he The aumpion in hi paragraph i he ame wih Sulz heory, referring o Sulz (2005b). 0

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