Tunneling in China: The Remarkable Case of Inter-Corporate Loans

Abstract

Recent events in China provide a historical opportunity to study the expropriation of minority shareholders. In this paper, we document the use of inter-corporate loans by controlling shareholders to extract funds from Chinese listed firms. Using accounting information from public sources, we show how tens of billions of RMB were siphoned from hundreds of companies during the 1996 to 2006 period. Specifically, we show the nature and extent of these abuses, evaluate their economic consequences, explore their cross-sectional determinants, and report on the extensive efforts by auditors and regulators that eventually contained this practice. Collectively, our findings shed light on the nature and severity of the tunneling problem in China, and the on-going challenges associated with regulatory reform in the country.

Keywords: Tunneling, minority shareholder rights, investor protection, regulatory reform, corporate governance, emerging markets, Chinese stock market

JEL Classification: G15, G18, N25, P21, P31, P34