The Impact of Minority Shareholder Rights on Corporate Decisions: A China Experiment

KE, Bin | CHEN, Zhihong | YANG, Zhifeng

Corporate ownership tends to be highly concentrated in countries with weak protection for investors and this has two results. On the one hand, the agency conflict between firm executives and controlling shareholders is minimal, but on the other hand, there is potentially more conflict between minority and controlling shareholders. Since the latter and their appointed managers have strong incentives to divert firm resources to themselves if there is not a proper check in place, a hot topic of debate is whether and how this can be curbed by strengthening minority shareholders’ rights.

Zhihong Chen, Bin Ke and Zhifeng Yang examine the issue with the benefit of a “natural experiment” – an actual event in China that enabled them to see the before and after effects of strengthening minority shareholders’ rights. The findings offer encouraging support that his measure can be effective.

In December 2004 the China Securities Regulatory Commission implemented the segmented voting regulation, which required publicly-traded firms to get separate approval from minority shareholders for several types of major corporate decisions, in particular equity-offering proposals. This measure followed incidents in which controlling shareholders in A share firms had tried to divert resources to their own benefit and was intended to act as a roadblock to such behaviour.

The authors compared before and after data, from January 2004 to June 2005, to see what impact the new regulation had on corporate decisions. They looked at value-decreasing and value-increasing decisions, which were proxied by equity-offering proposals that had either a negative or positive cumulative stock return, respectively. The results were encouraging: the regulation had indeed deterred value-decreasing proposals, but not value-increasing ones. The effect was found to be stronger among firms with a higher mutual fund ownership, suggesting this type of ownership in particular contributed to corporate governance.

Interestingly, the regulation had a much weaker effect on vetoes of value-decreasing equity offering proposals by minority shareholders. The authors speculated this may have been because the greater rights conferred to these shareholders had a deterrent effect on firms submitting such proposals.

“Overall,” the authors said, “the results suggest that giving minority shareholders increased control over corporate decisions can help increase the quality of corporate decisions in a weak investor protection country like China, but only in firms with higher mutual fund ownership.

“The seemingly counterintuitive evidence that there is no negative association between proposal quality and minority shareholders’ veto for the full sample is consistent with an equilibrium where insiders are deterred from submitting value-decreasing proposals and therefore minority shareholders rarely face the need to veto submitted proposals.”

The results were relevant not only to China but also to other places with weak investor protection, they said.

“Given China’s poor record of investor protection and weak law enforcement, it is important to determine whether the segmented voting regulation worked as intended in certain firms. To our knowledge, this is the first study to show how strengthening minority shareholders’ direct control over corporate decisions affects the quality of those decisions for firms domiciled in weak investor protection countries,” they added.

CHEN, Zhihong

Associate Professor