Investigaciones Internacionales

This study also conducts a cross-sectional regression analysis by employing ordinary least squares (OLS) regressions to explain the stock response to bank loan announcements. The OLS regression model uses t-statistics calculated from heteroscedastic corrected standard error (White, 1980) and was estimated as follows:

it LOAN BORROWER BANK t t CAR(1, 2)=α+β1( )+β2( )+β3( )+ε (9)

The dependent variable CAR(t₁,t₂) is the cumulative abnormal return which starts at time t1 to

time t2. The independent variables are the proxies for bank, borrower and loan characteristics. 3.4.2.1 Measurement of Bank Characteristics

This study divides banks into two categories: Big Four state-owned banks (BIG4_BANK), equals one, and zero otherwise (Bailey et al., 2010). According to bank ownership, this study divided banks into two categories: state-owned/controlled banks and private banks. Except for China Minsheng Bank and foreign banks, the other commercial banks fall into the state- owned/controlled bank category. This study employed a dummy variable with a value of one if the lender is one of the state owned or controlled banks (BANK_OWNERSHIP), and zero otherwise (Bailey et al., 2010). In terms of bank ranking, this study assumes that the ranking of local branches is lower than that of headquarters or provincial branches. The study employs a dummy variable with a value of one if a loan is issued by a bank’s local branches below the provincial level (BANK_RANKING), and zero otherwise (Bailey et al., 2010). In addition,

the marketization index in credit allocation for China’s provinces23 from Fan and Wang (2001) and Fan et al. (2002, 2004, 2007 & 2009) is used to divide banks according to their location (BANK_LOCATION). The study employs a dummy variable with a value of one if the bank in the province with the lower marketization level in credit allocation.

3.4.2.2 Measurement of Borrower Characteristics

To identify borrower characteristics, this study measures the information opaqueness, the possibility of expropriation or tunnelling, the expropriation-reduction mechanisms and the financial situation.

3.4.2.2.1 Measurement of Information Opaqueness

Following Slovin et al. (1992), firm size (BORROWER_SIZE) (the natural logarithm of total assets) is employed as a proxy measure of the level of information opaqueness. It is expected that information opaqueness will be more pronounced in smaller firms. This study classifies sample firms as small if the natural logarithm of total assets is less than the median natural logarithm of total assets of all the listed firms in the relevant year and large if greater than median value.

3.4.2.2.2 The Possibility of Expropriation/Tunnelling

In order to measure the possibility of expropriation or tunnelling, this study first identifies the ultimate controlling shareholders. This study uses the ownership structure chain to identify the controlling shareholder. Since the regulation for the disclosure of the ownership structure chain in China was not in effect until 2001, we follow Fan et al. (2005, 2007) to trace the ownership information to the IPO year based on the ownership information disclosed in 2001. If there is no change in the ownership structure, we may conclude that the ultimate controlling shareholder remains the same since the IPO. If there is any change in the ownership structure, we identify the ultimate controlling shareholder in the IPO year from the IPO prospectus, media reports and the websites of the company and its affiliated companies.

The controlling shareholder can expropriate outsiders through diverting valuable resources out of the firms. Previous studies attempt to measure the expropriation problem or tunnelling using different proxies for the degree of expropriation. For example, Claessens, Djankov, Fan and Lang (2002), Faccio and Lang (2002), and La Porta et al. (1999) propose that the divergence between cash-flow rights and control rights is the root of the expropriation problem. Thus, the deviation of cash flow from control rights can be a proxy for the

23

According to Fan, Wang and Zhang (2000), while having achieved great progress in its market-oriented institutional transformation and economic development, China has been suffering significantly and with growing problem of regional disparity. The purpose of employing the marketization index in credit allocation for China’s provinces is to examine the magnitude of local government intervention in banks located in different provinces.

likelihood of expropriation. The greater divergence in voting and cash-flow rights of controlling shareholders, the more likely they are to expropriate minority shareholders.

A second strand of literature uses the value/performance of a firm (market-to-book ratios or Tobin’s Q) as a proxy for the likelihood of expropriation (Claessens et al., 2002; Joh, 2003; La Porta, Lopez-de-Silanes, Shleifer & Vishny, 2002; Lemmon & Lins, 2003; Lins, 2003; Mitton, 2002). For example, using a Southeast Asian sample, Claessens et al. (2002) find that market-to-book ratios are negatively related to the divergence between cash-flow and control rights. This implies that ex ante firms are more likely to expropriate traded at a lower valuation.

A third vein of literature uses the specific action of expropriation as a proxy for the likelihood of expropriation. For example, studies examine expropriation problems from a related-party transaction perspective (Cheung et al., 2006; Jian & Wong, 2003), from a dividend perspective (Chen et al., 2008; Gugler & Yurtoglu, 2003), and from earning management (Ding et al., 2007; Jian & Wong, 2003; Leuz, Nanda & Wysocki, 2003; Liu & Lu, 2003). Atanasov, Black and Ciccotello (2008) divide actions of expropriation into three broad groups: cash flow, asset, and equity tunnelling and present a model how each type of tunnelling affects share prices and financial metrics. The authors conclude that the different ways taken by insiders to expropriate outsiders on share price and financial metrics can be measured by gross margin, operating margin, return on asset (ROA), Tobin’s Q and P/E ratio.

This study uses three alternative measures as proxies for the possibility of expropriation or tunnelling. These various measures involve different proof of the existence of expropriation for the purpose of furnishing a robust and comprehensive investigation into the level of expropriation for outside investors in Chinese listed firms. The three measures are divided into two categories. The first category concerns the roots of the expropriation problem (the degree of divergence between cash-flow rights and control rights); the second category focuses on the effect of expropriation on share price and financial metrics.

I. The Divergence between Cash-flow Rights and Control Rights (DCC)

Previous studies (Claessens et al., 2002; Faccio & Lang, 2002; La Porta et al., 1999) show that the greater the divergence in voting and cash-flow rights of the ultimate controlling shareholders, the more likely they are to expropriate minority shareholders and creditors. The size of cash-flow rights and voting rights of the ultimate controlling shareholder is identified by La Porta et al. (1999), and explored further by Claessens et al. (2000), Claessens et al. (2002), Faccio and Lang (2002) and Faccio, Lang and Young (2001). These authors propose

that the definition of control takes only voting rights into account whereas the definition of ownership is based on cash-flow rights. They define the difference between voting and cash- flow rights of the ultimate controlling shareholder as the percentage of votes controlled by the firm’s ultimate controlling shareholder minus the percentage of cash-flow rights owned by the firm’s ultimate controlling shareholder. According to Claessens et al.’s (2002) and Faccio et al.’s (2001) studies, the fraction of cash flow rights owned by the ultimate controlling shareholder is defined as the fraction of cash flow rights held by the ultimate controlling shareholder multiplied by the fraction of shares owned in each firm in the ownership chain. For example, if an investor owns 30% of the shares of Company A, which in turn owns 20% of the shares of Company B, which in turn owns 10% of the shares of Company C, the investor would end up with 0.6% (30%×20%×10%) of the ownership (cash-flow) rights of Company C but 10% of its control rights. In this case, the difference between voting rights and cash-flow rights for the investor is 9.4% (10%－0.6%). If there are several chains of ownership between a shareholder and the firm, this study adopts the sum of control rights across these chains following Claessens et al.’s (2002), Faccio and Lang’s (2002) and La Porta et al.’s (1999) methods.

II. The Effect of the Expropriation Problem

According to Atanasov et al. (2008), the expropriation of creditors is categorised as cash flow tunnelling, and affects the firm’s operating margin, ROA and Tobin’s Q. In addition, Claessens et al. (2002), La Porta et al. (2002), Lemmon and Lins (2003) and Mitton (2002) suggest that a measure of firm performance (Market-to-book ratio or Tobin’s Q) can be a proxy for the level of the expropriation problem since expropriation by the majority shareholder is detrimental to the firm’s value.

This study used the firm’s ROA and Tobin’s Q to proxy for the level of the expropriation problem. ROA is defined as after tax profits divided by the book value of total assets. Tobin’s Q is measured as the market value of equity and debts over the replacement value of net fixed assets and inventory. Tobin’s Q can be calculated as:

RVAI BVCA BVCL BVINV BVLTD BVPS MVCS Q Tobins’ = + + + + − (10)

Where: MVCS is the market value of the firm’s common stock shares, BVPS is the book value of the firm’s preferred stocks, BVLTD is the book value of the firm’s long-term debt,

current liabilities, BVCA is the book value of the firm’s current assets, and RVAI is the replacement value of net fixed assets and inventory.

Because the replacement value of net fixed assets and inventory is unavailable for Chinese firms, this study uses the book value of total assets as a proxy following Bai et al.’s (2004), Chung and Pruitt’s (1994), Gunasekarage, Hess and Hu’s (2007) and Wei et al.’s (2005) methods. In addition, since no preferred stock exists in China, the above formula reduces to:

BVTA BVCA BVCL BVINV BVLTD MVCS Q Tobins’ = + + + − (11)

Where: BVTA is the book value of the firm’s total assets.

Tobin’s Q is a market-based measurement for firm performance. However, a large proportion of shares of Chinese listed firms cannot be traded and do not have market value. There is no consensus about how to calculate the total market value of firms with a substantial percentage of non-tradable shares. Bai et al. (2004) suggest using the price of the tradable shares as a proxy for the price of the non-tradable shares which results in overstatement of the market valuation of the firm since non-tradable shares should have a lower price than the tradable ones. Chen and Xiong (2002) find that the non-tradable state-owned shares and legal-person shares in China have an average illiquidity discount of between 70 and 80% when they are traded in the informal markets. Therefore, Bai et al. (2004) adjust the measurement of Tobin’s Q to take into account of illiquidity discounts of 70 to 80% in the Chinese market. The authors suggest these discounted measures may better reflect the market valuation of China’s listed firms. This study follows Bai et al.’s (2004) modification to define two valuation measures: using a 70% and an 80% discount for non-tradable shares. We multiply the number of tradable shares by the market price, and then add the number of non-tradable shares discounted by 30 and 20% of the market share price respectively to obtain the value of equity in the Tobin’s Q formula denoted by Tq_70 and Tq_80, respectively. For example, Tq_70 was calculated as:

BVTA BVCA BVCL BVINV BVLTD MP NTRA MP TRA Tq_70= * + * *30%+ + + − (12)

Where: TRA is the number of tradable shares; MP is the market share price; and NTRA is the number of non-tradable shares.