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Dividends and tunneling: evidence from family rms in China

Feng Xunan
Shanghai Jiaotong University, Shanghai, China
Abstract
Purpose The purpose of this paper is to empirically analyze the motive of family-controlled rms to pay cash dividends in China. Design/methodology/approach Using some econometrical models, the paper designs and conducts a series of empirical research on cash dividends behavior, thus acquiring credible empirical data. Findings Using a sample of 204 family rms, the motive of family-controlled rms to pay cash dividends was investigated. Dividend ratio was found to decrease with the separation of ultimate ownership and control right; this may reect the tunneling motive of the family owners. Different from others, it was also found that high-growth rms pay more dividends and that the family doing so may want to build a high reputation for the friendly treatment of minority investors for future nancing. Practical implications The paper discusses investor protection matters in China. Originality/value The paper ndings provide policy implications for corporate governance reform and capital market development in China. Keywords Family rms, Dividends, Investors, China Paper type Research paper

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China Finance Review International Vol. 1 No. 2, 2011 pp. 152-167 q Emerald Group Publishing Limited 2044-1398 DOI 10.1108/20441391111100732

I. Introduction La Porta et al. (2000b) argued that the ultimate owners tend to use the pyramidal structure to tunnel listed rms, and that the fundamental problem of corporate governance is the containment of ultimate owners expropriation of minority investors. Studying the cash dividend behavior of 4,103 listed rms in 33 countries, La Porta et al. (2000a) concluded that in countries with weak investor protection, very few dividends are paid. Therefore, they argue that cash dividend payment is the result of the legal protection of investors, and ultimate owners will not try to build a high reputation of investor protection through cash dividends as a means of weakening their self interested behaviors. Their view has been further supported by Faccio et al. (2001) with large samples from 14 countries in western Europe and eastern Asia. But, Faccio et al. (2001) also found that, although western Europe and eastern Asia are both faced with ultimate control, ultimate owners in western Europe, compared with their counterparts in eastern Asia, tend to give more cash dividends in order to build a high reputation, especially when the separation of ultimate control and ownership is large in western Europe. Such comparative studies offer a unique perspective towards solving the dividend puzzle (Black, 1976), but cross-country analysis is limited by the difculty in controlling other factors inuencing dividend payment, such as distinct tax systems and accounting
JEL classication G35, C51, L21

standards among different countries. Besides, other factors such as greatly changing growth potentials, nancing environments, etc. which may also be explained by different stages of economic development in different countries, will signicantly inuence rms dividend policies. Unfortunately, La Porta et al. (2000a) and Faccio et al. (2001) have failed to control for these factors due to their sample design. At the same time, China is excluded from their sample. In this paper, we mainly focus on China, the largest transition country and emerging economy in the world. Chinas gross domestic product (GDP) per capita grew quickly from CNY 379 in 1978, when the reform and opening-up policy was launched, to CNY 18,934 in 2007 (Executive Summary of Chinas Progress towards the MDGs 2008 Report), with an annual GDP growth rate of 9.8 percent, fast exceeding the world average of 3.0 percent (World Bank, 2008). Allen et al. (2005) have suggested that, although investor protections in China are usually very low, the private sector has always served as the main driving force of the growth. Against the backdrop of rapid economic growth in China, listed rms become more motivated to build a high reputation for further high growth. Feng and Li (2009) has found that ultimate control is a common phenomenon for listed rms in China, and that the separation of ownership and control rights is especially pronounced for family rms. We believe that such separation without adequate investor protection makes it easier for ultimate owners to expropriate listed rms, which harms the interests of minority investors and ultimately the development of the capital market. On the one hand, a cash dividend as an effective means of reducing agency problems (Easterbrook, 1984; Jensen, 1986; Fluck, 1998; Fluck and Lynch, 1999; Zwiebel, 1996; Myers and Shyam-Sunder, 1999; Gomes, 2000) may become a substitute for lack of legal protection for minority investors, which helps with monitoring of ultimate owners and enhances corporate governance and thus fuels their motive of competition for growth. Consistent with these arguments, Easterbrook and Fischel (1991) have particularly stressed that rms with strong nancing needs make credible commitments to treat their investors kindly. On the other hand, ultimate owners may also take advantage of the precious opportunity of legal loopholes to cut cash dividend as a means of private benets control. Therefore, how family rms pay cash dividends is the main topic in this study. In other words, does the cash dividend behavior reect the ultimate owners intention to build a high reputation of reducing agency problems, or mainly reect their expropriation tendency? We believe that the cash dividends discussion has both policy and theoretical implications due to following arguments: . Glancing at the overall situation of deteriorating state-owned rms and thriving private rms, the rapid growth of family rms not only provides primary fuel to economic growth, but also creates a lot of job opportunities. But, at the same time, an increasing number of cases are exposed in the media that expropriation of minority investors often happened by capital predators such as Tang Wanxin, Zhou Zhengyi, Gu Chujun and Yan Caihong, which have become obstacles to the healthy development of the capital market. Therefore, a systematic study of family rms becomes necessary for policy making. . The coexistence of rapid economic growth as a whole versus seriously inadequate investor protection provides a good opportunity to study the role of dividends in reducing agency problems.

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Focusing on one country can greatly avoid or reduce systematical differences encountered in cross-country studies. As to policy implication, cash dividend obviously helps policy makers in emerging markets such as China to promote stock market development.

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The remainder of this paper proceeds as follows: Section II provides a review of the related studies on cash dividends; Section III focuses on the main hypothesis based on Chinese institutional background; Section IV describes the sample; Section V reports the result; and Section VI concludes. II. Literature review In China, studies on dividend policy focus on the following two areas: (1) Stock market reection of dividend behavior, mainly through case study. Research conducted by Chen et al. (2003) on the Foshan Lighting (code: 000541) case shows that the market regards distribution of cash dividends as bad news; investors suffered 5 percent losses from the date of dividend declaration to the date of ex-dividend. Researches conducted with large-scale samples by Chen et al. (1998), Wei (1998), He and Chen (2002), Lv and Wang (2002) and Xiao (2005) have come to similar results that the market either makes no reaction to cash dividend distribution or regards it as bad, especially when large shareholders hold a high proportion of shares. Using the Catering Theory of Dividends introduced by Baker and Wurgler (2004a, b), we believe that the reason might be that the dividend policies are made by listed rms only to cater to the needs of major shareholders, while the interests of minority investors are excluded from their consideration. The advantage of case study is that we can get vivid pictures, but in China, since cash dividend policies of listed rms are released publicly together with the annual report, it is not easy to control other information in the annual report, such as prot. (2) Determinants of cash dividend policy. Considering the unique background of non-transferable shares in China, Lee and Xiao (2004), Chen and Jian (2005), Yuan (2004), Wei et al. (2004) and Lee and Xiao (2004) have all pointed out that cash dividends are used as a means for major shareholders to usurp the interests of minority shareholders. The reason is that since large shareholders cannot transfer equity to a secondary market, they therefore tend to collect cash from minority shareholders through equity nancing, and thereafter legally or illegally transfer part of the cash to major shareholders through cash dividends. Therefore, cash dividends have been turned into a tool of wealth transfer unique to large shareholders in Chinas stock market. These studies have also found that there is a positive correlation between major shareholders share proportion and cash dividends. Although these arguments are very insightful, they are all based on specic periods when state and legal shares transfer were strictly prohibited in China. Besides, the domination by state-owned listed rms makes these studies difcult to reect the status of family-controlled listed rms. Fan et al.(2005) and Feng and Li (2009) have both discovered that state-owned rms and family rms face different incentives, nancing, operation and agency problems, and as a result, their cash dividend distribution policies may differ greatly. With the completion of state share reform (Guquan Fenzhi ),

the incentive mechanism of major shareholders has been fundamentally changed, and therefore cash dividend policies made by major shareholders, especially family rms, provide us with the opportunity to study the ultimate owners motive of wealth distribution. III. Institutions and hypothesis Chinas stock market, reopened in 1990s with the intention of relieving the nancial burden of state-owned enterprises, bears one signicant feature: it is dominated by state-owned listed rms. Aharony et al. (2000), Chen et al. (2003), Chen et al. (2008) have all noted that the government often tries to facilitate the listing of state-owned listed rms. In contrast to this, private-listed rms are faced with great difculties when trying to issue A-shares. As a result, the number of private-listed rms has long been obviously fewer than that of state-owned listed rms, and this phenomenon has not changed too much until recent years. Reports conducted by the Shenzhen Stock Exchange show that, due to historic and institutional reasons, a large number of private rms get listed overseas. Such a situation reveals to us the gloomy A-share nancing environment for family-controlled rms. Such discrimination is also well-reected in other nancing. Allen et al. (2007) have pointed out that Chinas commercial banking system has long been dominated by the four major state-owned banks run with poor efciency. When a country serves as an ultimate owner, bank loans will inevitably favor traditional state-owned rms (La Porta et al., 2002), and long-term non-performing loans in large sums provided by the four major banks are one important reection of this tilted policy orientation. Brandt and Li (2003), Cull and Xu (2003) have analyzed from different angles the reason for the difculty faced by private rms in getting nanced by commercial banks, and a further summary made by the World Bank (2008) clearly suggests that difculty in nancing for private rms is caused by asymmetric information, lack of collateral, low-efcient court of law, etc. Consistent with this argument, Allen et al. (2005) have made it clear that private sectors, as the pillar of economic development in China, are nanced mainly through internal nancing, informal mechanisms like reputation and interpersonal relationship, and only a small portion of bank loans ow to private sectors. Fan et al. (2005) further point out that, restricted by external nancing, families tend to control their listed rms through a pyramidal structure. Referring to Williamson (1985) and Stein (1997), they believe that the internal capital market based on the pyramidal structure can relieve a family-controlled rm from nancing difculties. Theoretical studies by Almeida and Wolfenzon (2006) suggest that when external investors are poorly protected and functions of the capital market are not complete, families facing tremendous demand for investment tend to turn to the pyramids to control their listed rms. Consistent with such analysis, Feng and Li (2009) has noted that family-controlled listed rms in China, being no exception from using the pyramidal structure, have their ultimate ownership and control rights separated to a larger extent than that in the nine east Asia economies. Under such circumstances, listed rms may tend to pay fewer cash dividends and therefore leave more at the disposal of families. We believe that the pyramidal structure, although with ease of nancing to a certain extent, results in ownership and control separation which provide a chance to expropriate minority investors. Prominent expropriation results in investors loss of condence and drop in stock price, depriving listed rms of further nancing

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opportunities, such as right offerings or seasoned equity offerings. For this reason, family-controlled rms have to pay a price to transfer funds from minority shareholders. Therefore, when making a decision, ultimate owners should trade off private benets and future nancing opportunities. Stulz (1999) and Coffee (1999, 2001) have pointed out that when the company faces a valuable investment opportunity, the ultimate owner will often restrain their self-interested behaviors and build a high reputation of protecting minority investors for the sake of future nancing. This idea is actually based on that of Coase (1960), who believes that as long as transaction costs are 0, individuals can always nd ways to attain the best result (Johnson and Shleifer, 2000). Reese and Weisbach (2002), Doidge et al. (2004) have proved that cross-listing is such an effective restraint mechanism. Ross (1979) has pointed out that other market mechanisms, such as reputed auditors and underwriters, will also build such reputations. Easterbrook (1984) has made it clear that listed rms can pay cash dividends to relieve investors concern about agency costs. By paying cash dividends, ultimate owners return prot to investors, making it impossible to misuse cash ow. For minority investors, cash dividends obtained are much more reliable than capital gains in that the latter is companied with price uctuations and are unrealized income. Using Gordon (1959)s words, this is called A bird (cash dividends) in the hand is worth two (capital gains) in the bush. Besides, payment of cash dividends reduces the source of internal nancing, while adding to the necessity of entering the capital market for external nancing. As a result, the company is put under much stricter monitoring by the capital market, which facilitates reducing agency problems. Besides, cash dividends paid by listed rms easily put serious problems faced by listed rms into the spotlight, unlike other means, such as stock dividends distribution, which can cheat minority investors through accounting games. In this sense, cash dividend acts as a credible commitment that reduces agency costs. When agency problems become signicantly serious, i.e. obvious separation of control and ownership, ultimate owners often make a commitment to agency cost reduction by paying cash dividends as a means of maintaining stock price and winning future nancing opportunities. Therefore, we believe that cash dividend policy is the result of trading off these two aspects, and which aspect dominates depends on empirical analysis. If the family favors private benets of control, the rm tends to pay fewer or no cash dividends in case of large control and ownership separation. If the family favors building a high reputation of investor protection, the rm tends to pay high-cash dividends under the same circumstances. IV. Sample A. Sample We study only family rms. Using La Porta et al. (1999) method, we identify the ultimate owner by tracking the ownership chains. As long as the family or individuals controls over 10 percent of the listed rms, we call them family rms. Using this standard, we identied 506 family rms at the scal end of 2007. We used the following procedure to nalize our sample: . Financial rms are excluded due to lack of comparability caused by signicant differences in accounting standards and regulations. . B-share listed rms are excluded, since accounting disclosure of such rms is different from only A-share listed rms.

ST, *ST, SST, S *ST and S listed rms are excluded, since their nancial status is dubious. Family rms that went public in 2007 are excluded, since newly listed rms are different from others. Listed rms whose ultimate owners are subject to judicial enforcement (such as arrest and sentence) are excluded, since their stock price may easily change too much. Listed rms without insufcient nancial data are excluded. Thus, the nal sample is 318.

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Since the main analysis of this study is to study cash dividend behaviors of rms with dividend payment capacity under normal business conditions, it is necessary that we rule out listed rms with negative cash ow or negative net prot or ones with cash dividend exceeding net income or revenue. Then, we have 204 family rms left, all of which were listed before December 31, 2006. We will study their cash dividend payment in 2008. B. Main variables 1. Separation of ownership and control rights. Similar with La Porta et al. (1999) and Claessens et al. (2000), the ownership rights (ownership) are measured by cash ow rights; control rights (control) are measured by voting rights; the separation of ownership and control (wedge) is measured by the difference between ultimate control and ownership. In other words, wedge equals control minus ownership. Suppose a family holds 50 percent of the equity of company B and company B holds 60 percent of equity of sample company C, its obvious that the family holds 30 percent (50 60 percent) of cash ow rights of company C. At the same time, we believe that the family holds 50 percent of voting rights of company C, i.e. the minimum value of the control chain. In this case, the separation of ownership and control is 20 percent (50-30 percent). In order to analyze ownership, control and wedge for a family rm, we rst need to nd the ultimate owner according to share changes and shareholders status subsection in the 2007 annual report. As for further identication of family members, we shall refer to information disclosed by controlling shareholder and actual controller subsection and director, supervisor and senior management subsection in 2007 annual reports to maximally analyze family relationships among persons. With help of Chinas newspapers database, in conjunction with supplementation and conrmation with Google, we searched all news reports about each family rm, and sorted out and conrmed relationships among them, in order to at most minimize any analysis error. Finally, to ensure the accuracy of manually collected data, we conducted conrmation and calculation for each company three times. 2. Dividends. Predatory behavior of ultimate owner is, to a certain extent, reected by whether the company pays dividends and the level of dividend payment, since cash dividends are shared by all shareholders and thus reducing the cash ow at the disposal of the families. Since earning management is common in Chinas capital market (Aharony et al., 2000; Ming and Wong, 2004), we will use the following four variables to measure dividend payment for family rms:

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(1) DIV_D: This variable is used to show whether the family rms pay cash dividends. If so, DIV_D equals 1; if not, 0. This indicator is the most objective and gives a clear indication of whether cash dividends are paid. It should be noted that when listed rms in China make public their dividend distribution plans, both pre-tax dividends and post-tax dividends of each share are announced. Since our main purpose is to study the motive of ultimate owners payment of dividends through hand-in money that can be obtained by minority investors, cash dividends in this paper refers to post-tax dividends. We have found that pre-tax cash dividends of some listed rms exceed 0 while post-tax cash dividends are 0. In such cases, DIV_D takes 0. (2) Div/Cf: This variable stands for the ratio of cash dividend to cash ow, where cash ow refers to the net amount of cash ow from operation. We use it just because cash dividends are paid in cash. Cash ow from operations is sustainable and can reect operating performance. (3) Div/Earn: This variable stands for the ratio of cash dividend to net income, where net income refers to net prot after deduction of nonrecurring gains and losses. It should be stressed that Div/Cf and Div/Earn have some aws that cannot be avoided. First, listed rms may manipulate cash ow and net income through some kinds of accounting practice. Second, plundering by ultimate owners occurs before disclosure of cash ow and net income indicators, and under such circumstances, there is the possibility that dividend payment rate is overestimated. (4) Div/Sales: This variable stands for the ratio of cash dividend to net sales. We have used it because it is not necessary for ultimate owners to manipulate or smooth revenue. Using different indicators to analyze cash dividend, we can greatly reduce errors that can be brought about by any single indicator. If conclusions, we reach using most variables are basically the same, credibility of the results can be enhanced tremendously. To reduce as much as possible the effect of industrial characteristics on dividend payment, we have also conducted industry adjusted cash dividends analysis, respectively, by IA_Div/Sales, IA_Div/Earn and IA_Div/Sales. The main reason for using industry adjustment is that different industries (such as life science, retailing, etc.) have different growth cycles and differing prospects, which impose inuence on dividend policies. Meanwhile, we have learnt from the behavioral nance that the management of listed rms often joins yardstick competition, which we believe will affect the formulation of dividend policies. We have found in data retrieval that cash dividend payments by family rms are related to industry. For example, those engaged in transportation, food, beverage and tobacco do not pay dividends. We use WIND industry classication because it has referred to GICS, with some ne adjustments and their classication standard is widely used by analysts in China. 3. Control variables. The theory of corporate nance has told us that payment of cash dividends is affected by other factors besides agency problems. Opportunity of rm growth (GSDecile): Textbooks have told us that rms with strong growth prospects tend to pay fewer cash dividends in order to reduce external nancing. Consistence with La Porta et al. (2000a) and Faccio et al. (2001), we used the average sales growth rate from 2003 to 2007 in an ascending sequence. We divide them into ten groups, respectively, ranked from one to ten.

Financing constraint (CRation). This is used to control nancing constraints. If the average sales growth rate from 2003 to 2007 is higher than the sample median, but the average ratio of the net cash ow from self-nancing to sales in the past ve years is less than the sample median, CRation equals 1 and 0 otherwise. To minimize the sample loss, we will use maximum year data available if less than ve years. Jensen (1986) has clearly pointed out that liabilities play an important role in reducing agency problems while strengthening creditors monitoring because debt interest can greatly reduce cash ow under the families control. Besides, compared with cash dividend, interest payment is mandatory in law, and therefore liabilities may become an effective substitute for cash dividends in reducing agency costs. So, we can use liability ratio (Leverage) to control the inuence of high liabilities on dividend policies. Other control variables include company size (Size), which is the natural logarithm of year-end total assets of the company. Main variables used in this paper are in Table I, with nancial data from CSMAR. Descriptive analysis is not included just for brevity. C. Test model First, we use Logit model to analyze the dividend distribution of ultimate owners, the main specication is equation (1): log probDIV _D b0 b1 wedge b2 GSDecile b3 CRation 1 2 probDIV _D b4 leverage b5 size 1 1

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In model (1), probDIV _D stands for the probability that the company pays cash dividends.
Variables DIV_D Div/Cf IA_Div/Cf Div/Earn IA_Div/Earn Div/Sales IA_Div/Sales Wedge CRation Denition and description 1 if company pays cash dividends and 0 otherwise Ratio of cash dividends to cash ow, where cash ow refers to net amount of cash ow from operation activities DIV_D after industrial adjustment Ratio of cash dividend to net income, where net income refers to net prot after deduction of nonrecurring gains and losses Div/Earn after industrial adjustment Ratio of cash dividend to net sales, where net sales refers to the amount after deduction of sales returns and sales allowances from total sales Div/Sales after industrial adjustment Difference between ultimate control and ownership, to measure the separation of control rights and ownership CRation equals 1 if the averaged annual sales growth rate of the company in recent ve years is higher than the sample median while the averaged ratio of the net amount of cash ow from self-nancing to sales in recent ve years is less than the sample median, equals 0 otherwise Natural logarithm of total assets Total liability over total assets Sequence of sales growth rate. Averaged annual sales growth rate from 2003 to 2007 in ascending sequence, falling into ten groups marked from one to ten

Size Leverage GSDecile

Table I. Variable denitions and descriptions

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As for those paying cash dividends, we use OLS regression in model (2) to study cash dividend level: IA DIV _Ratio b0 b1 wedge b2 GSDecile b3 Cration b4 leverage b5 size 1 2

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Where IA DIV _Ratio stands for the cash dividend level of family rms, respectively, represented by IA_Div/Cf, IA_Div/Earn and IA_Div/Sales. V. Results 1. Results We rst study the tendency of dividend distribution for family rms, with Logit regression results shown in models (1.1) and (1.2), Table II. It shows that coefcient of Wedges remains negative whether or not the family pays dividends, and Wedge is signicant at 10 percent only in model (1.2). So, we can conclude that the ultimate owners of family rms do not tend to pay cash dividends, especially when the separation of ultimate control and ownership enlarges. This result does not seem a surprise since cash dividends payment will reduce the amount of resources under family control. It is interesting that GSDecile is positive and signicant at 10 percent in model (1.1). Considering that family rms face much difculty in nancing either through the stock market or bank loans and that rapid-growing rms face great demand for investment, these companies, according to corporate nance theory, should pay fewer dividends due to investing needs, because rapid growth in itself is a credible signal to the market. But, our result suggests the opposite: rapid-growing family rms in China tend to pay dividends to investors. We believe that such a surprising phenomenon can be explained by the tendency of rapid-growing rms to make signals to the market through cash dividends to enhance investors condence for better nancing opportunities in future. The reason why family rms signal such hard information to the market through cash dividends might be the fact that some listed rms in China cheat investors seriously and earning management is common, and therefore, paying cash dividends to investors, family rms can to some extent distinguish themselves from other rms and relieve the concern of minority investors. If, we otherwise divide the average sales growth rate of family rms into two groups, respectively, marked by 0 and 1, the conclusion is further strengthened. Now, we analyze the dividend payment by family rms. It should be pointed out that in Table II, if the family company does not pay cash dividends, Div/Cf, Div/Earn and Div/Sales without industrial adjustment will be marked as 0. In models (2.1), (2.2), (2.5) and (2.6), coefcient of wedge is negative and passes signicance statistically when only ownership and control separation (Wedge control-ownership is not 0) is considered, another evidence that families with ownership and control separation tend to pay fewer cash dividends. In models (2.3) and (2.4), Wedge is positive but not signicant. We cannot explain it deeply and only tentatively suggest that a possible reason is that Earn here refers to net prot after deduction of nonrecurring gains and losses, i.e. net prot after dehydration. What is especially paid attention to by either the ultimate owners or minority investors is the real net prot, but it is the ultimate owner who knows the truth much more. It is the same part tunneled by ultimate owners in some sophisticated ways such as related-party transactions, with the result that smaller Earn disclosed in annual report and higher Div/Earn.

OLogit model DIV_D Ownership and control separation samples All samples Model (1.1) Model (1.2)

Ols Model IA_Div/Cf IA_Div/Earn Ownership and Ownership and control separation Samples control separation samples with samples with Samples with with DIV 0 DIV 0 DIV 0 DIV 0 Model (2.1) Model (2.2) Model (2.3) Model (2.4)

IA_Div/Sales Ownership and control separation Samples samples with with DIV 0 DIV 0 Model (2.5) Model (2.6)

Wedge

GSDecile

Cration

Leverage

Size

Intercept

Sample F-value Adjusted R 2

2 0.0516 (2 0.01) 0.1128 * (3.08) 2 0.5257 (1.18) 0.0263 * * * (6.40) 1.1066 * * * (24.0372) 1.0836 * (3.02) 204 2 2.06258 (2 1.60) 2 0.00456 (2 0.98) 2 0.50540 * (1.78) 0.00575 (0.14) 0.42828 (1.58) 0.44860 * * * (2.62) 204 14.77 * * * 0.5014 0.36286 (1.09) 0.01442 * (1.88) 2 0.44007 * * * (2.33) 2 0.00737 (2 0.42) 0.06301 * * (2.02) 0.2815 * * (6.98) 204 19.81 * * * 0.0968 0.39850 (1.45) 0.02204 * (1.70) 2 0.06505 * (2 1.76) 2 0.00221 (2 1.12) 0.09035 * * (2.59) 0.21278 * * * (10.11) 158 16.97 * * * 0.0830

2 3.5720 * (3.17) 0.1169 (2.07) 2 0.6542 (1.39) 0.0393 * * * (10.10) 1.2261 * * * (21.16) 1.5409 * * (4.41) 158

2 1.22878 * (2 1.77) 0.02902 (1.27) 2 0.40417 (2 1.58) 2 0.00636 (2 0.39) 0.50457 * (1.79) 0.45403 * * * (2.99) 158 17.8 * * * 0.0512

2 0.01830 (2 1.08) 0.05484 (0.63) 2 0.01057 * (2 1.74) 2 0.00432 * * (2 3.00) 0.00835 * * (3.22) 0.00266 * * * (4.32) 204 18.09 * * * 0.0797

2 0.03604 * * (2.56) 0.06647 (1.43) 2 0.01089 * * (1.86) 2 0.00523 * * * (2 3.02) 0.00812 * * (2.66) 0.00663 * * * (7.67) 158 17.62 * * * 0.0832

Notes: *, * * and * * *respectively, stand for signicance at: 10, 5 and 1 percent; only in Models (1.1) and (1.2), Wald values are given within parentheses and others robust t-values

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Table II. Regression results

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In OLS model, rapid-growing rms tend to pay dividends, except in (2.1), but only signicant in models (2.3) and (2.4). We can suggestively conclude that rapid-growing family rms are still motivated to pay high dividends. What is more, Cration is negative in Table II and is signicant in most specications. It is obvious that listed rms with great growth potentials, but faced with difculties in nancing tend to pay fewer cash dividends. Size is positive except in model (2.1). This suggests that big family rms also tend to pay dividends; the reason may lie in their maturity and stable development. For small rms with great growth potential, however, prot is retained for investment. In Logit models, companies with high liabilities tend to pay dividends, but in OLS models, they tend to pay fewer dividends, a phenomenon that might be accounted for by such companies willingness to pay some cash dividends just in only symbolic ways. Based on these analyses, we nd that rms with separated ownership and control are not willing to pay or only pay fewer cash dividends because it will reduce private benets of control, while rapid-growing rms are willing to use it as hard information to relieve the concerns of minority investors. 2. Robustness test Since 81 family rms in our samples do not pay cash dividends, we further analyze the remaining 123 rms, accounting for 60.29 percent of the sample. The results are given in Table III, with the main conclusions unchanged. Critics may argue that rapid-growing companies paying more cash dividends might be because they have more cash. Such an argument is reasonable, but using the ratio of Cash and Cash Equivalents over Sales in models in Tables II and III nds no relationship and p-value is always larger than 0.20. Such relationship remains not statistically signicant in regression even using cash ratio in the same calculation method as GSDecile. So, we can say that rapid-growing companies tend to pay more cash dividends to build a high reputation for better nancing opportunities in future, and that thus listed rms have strong motive to build a high reputation for growth. To enhance robustness of results, we only consider companies where families hold over 20 percent of control rights, and there are 175 such companies, with the conclusions basically unchanged. Besides, we divide family-controlled rms into three groups according to control rights: 10-30 percent, 30-50 percent and above 50 percent for separate studies, and we see no substantial changes in the main conclusions. Critics may point out that, for samples with ultimate control rights over 50 percent, such as cases where the family holds 51 or 85 percent of the voting rights, our measurement might have been biased since they all possess absolute control. Such concerns are reasonable, but not necessary. First, what we focus on is the effect of control-ownership separation on dividend policies, not merely the effect of control rights, and second, the conclusions basically remained the same even if we deleted 33 companies whose family ultimate control rights exceeds 50 percent. Critics may also argue that less cash dividend payment by family-controlled rms might be explained by their main reliance on debt nancing, not stock nancing. For example, if they are totally relying on debt nancing, they simply do not have to pay cash dividends. Therefore, we use liability ratio in an ascending sequence to separately study rms within each group using quantile, the main results still are not changed too much.

IA_Div/Cf Ownership and Only samples with control separation DIV . 0 samples with DIV . 0 Model (2.1) Model (2.2)

OLS model IA_Div/Earn Ownership and Only samples with control separation DIV . 0 samples with DIV . 0 Model (2.3) Model (2.4)

IA_Div/Sales Ownership and Only samples with control separation DIV . 0 samples with DIV . 0 Model (2.5) Model (2.6)

(2 1.75) 2 1.64624 * * (2 2.19) 0.58841 (0.62) 0.75077 (0.43) 2 0.0169586 * (1.97) 2 0.04853 * * (2.01) Wedge 2 2.33820 * (1.78) 0.00462 (1.31) 0.01421 (1.02) 0.00153 (1.15) 0.01331 * * (2.05) GSDecile 0.01986 (1.13) 0.04544 * (2 1.81) 2 0.21431 * (2 1.88) 2 0.20564 (2 1.54) 2 0.01964 * (2 1.96) 2 0.01959 * (1.83) Cration 2 0.9043 (2 1.26) 2 0.69149 * 0.00828 (0.29) 2 0.00661 (2 1.42) 2 0.00547 * * (2 2.19) 2 0.00735 * * (2 2.14) Leverage 0.00531 (0.19) 2 0.00995 * * (2 2.21) (1.70) 0.00880 (1.47) Size 0.39296 (0.77) 0.67664 (1.14) 0.07144 (1.61) 0.05854 (0.88) 0.00765 * (3.35) 0.57050 * * * (2.75) 0.04151 * * * (3.28) 0.01539 * * * (3.08) 0.00412 * * * (10.32) 0.01119 * * * (8.68) Intercept 0.50423 * * * Sample population 123 91 123 91 123 91 F-value of * * * * * * * * * * * * * * * 18.47 16.21 18.12 15.32 17.15 * * * model 15.28 Adjusted 0.0718 0.0976 0.081 0.0968 0.0872 0.0932 R 2 value

Notes: *, * * and * * *respectively, stand for signicance at: 10, 5 and 1 percent; robust t-values are given within parentheses

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Table III. Results with only family rms paying non-zero cash dividends

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VI. Conclusions Using 204 family-controlled rms, we studied their cash dividend behaviors. We nd that the more the ultimate control rights and ownership are separated, the less willing ultimate owners are to pay cash dividends and the fewer dividends are paid. This nding is inconsistent with the idea brought forward by Easterbrook (1984) and Jensen (1986) that dividend policy acts as a credible commitment to reduce agency problems. Considering the reality that minority investors lack strong legal protection in China, these results have conrmed the conclusion with LLSV (2000): cash dividend payment is the result of legal protection of investors, and ultimate owners will not voluntarily try to build a high reputation of investor protection using cash dividends as a means of weakening their tunneling behaviors. That is, as to cash dividends, family owners in China put private benets of control rst. This result thus provides policy implications for corporate governance reform and capital market development in China: limiting the tunneling behavior by ultimate owners matters. We have also found that rapid-growing family rms tend to pay more cash dividends, which is consistent with the theory of corporate nance. In two of the most inuential papers by La Porta et al. (2000a) and Faccio et al. (2001), they both found that rapid-growing companies pay fewer cash dividends. We believe such a difference can be explained by the fact that, against rapid economic growth in China, family-controlled rms have strong incentives to compete for growth, and rapid-growing rms are willing to pay cash dividends as a means of building high reputation of being friendly to investors for better nancing opportunities in the future. From this respective, it may suggest that cash dividends can be used as a commitment to reduce agency problems especially for rapid-growing rms.
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Further reading Deng, J., Zeng, Y. and He, J. (2007), To share or to monopolize prots?, Economic Research Journal, No. 4, pp. 112-23 (in Chinese). Dyck, A. and Zingales, L. (2004), Private benets of control: an international comparison, Journal of Finance, Vol. 59 No. 2, pp. 537-600. Grossman, S.J. and Hart, O.D. (1988), One share-one vote and the market for corporate control, Journal of Financial Economics, Vol. 20 Nos 1/2, pp. 175-202.

Jian, M. and Wong, T.J. (2005), Tunneling and earnings management through related party transactions: evidence from Chinese corporate groups, SSRN working paper, available at: http://ssrn.com Nenova, T. (2003), The value of corporate voting rights and control: a cross-country analysis, Journal of Financial Economic, Vol. 68 No. 3, pp. 325-51. Corresponding author Feng Xunan can be contacted at: xunanfeng@gmail.com

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