Controlling Shareholder, Expropriations and Firm’s Leverage Decision : Evidence from Chinese Non-Tradable Share Reform

In this paper we examine the effect of excess control rights on the leverage decisions of Chinese non-SOEs before and after the reforms of non-tradable shares. We identify that both inter-corporate loans and related party transactions are channels through which controlling shareholders expropriate minority shareholders by adopting a policy of excess leverage. We found that firms with more excess control rights also have more excess leverage and the controlling shareholders of these firms used the resources they obtained to facilitate tunneling activities rather than invest in positive NPV projects. We also found that the excess leverage in firms with excess control rights decreased after the non-tradable shares were reformed. We further found a positive market reaction to firms' announcement of related party transactions and better performance in firms with more excess control rights after the reform, confirming a reduction in the controlling shareholder's tunneling behavior. We argue that in emerging markets when legal protection for both creditors and shareholders is weak, controlling shareholders borrow excess debt to tunnel