Controlling Shareholder Entrenchment, Investor Protection, and Firm Cash Holding: Chinese Experience

Abstract

This paper shows that agency problems result from controlling-minority shareholder conflicts have a nonlinear causal relation with firm cash holding, and this relation hinges critically on the strength of investor protection. Using a direct measure of controlling shareholder’s entrenchment behavior, our theoretical work in a two-period static model and empirical analysis using Chinese financial data during 2000-2013 shows that the relation between controlling shareholder tunneling and cash holding is significantly U-shaped, and this relation is more significant with stronger investor protection. Also, The inflation point of the U-shape is inversely propotional to the strength of investor protection, which is smaller with stronger investor protection. In general, our findings reinforce the importance of informal investor protection mechanisms in mitigating agency problems and affecting firms’ cash policies in an emerging markets with undeveloped legal systems.

Keywords: tunneling, cash holding, investor protection, corporate governance

JEL Classification: G32, G34, G38