RPTs in SOEs: Tunneling, Propping, and Policy Channeling

Luca Enriques and Tobias Tröger, eds., The Law and Finance of Related Party Transactions (Cambridge University Press, Forthcoming)

Stanford Law and Economics Olin Working Paper No. 517

Stanford Public Law Working Paper

European Corporate Governance Institute (ECGI) - Law Working Paper No. 386/2018

19 Pages Posted: 19 Feb 2018 Last revised: 9 Mar 2018

Curtis J. Milhaupt

Stanford Law School

Mariana Pargendler

Fundação Getulio Vargas Law School at São Paulo; New York University School of Law; European Corporate Governance Institute

Date Written: March 1, 2018

Abstract

This essay, prepared for a volume on related-party transactions (RPTs), explores the economic, legal and policy challenges associated with RPTs in state-owned enterprises (SOEs). We show that RPTs in SOEs differ from RPTs in privately owned enterprises (POEs) in at least two ways. First, RPTs in SOEs may decrease social welfare not only when they cause harm to a given SOE by extracting wealth from minority (non-state) investors (the usual “tunneling” problem) but also when the state provides the SOE with benefits not available to POEs (“propping”). Second and more importantly, unlike the typical case with a POE, the state as controlling shareholder does not need to cause an SOE to engage in a “transaction” for it to extract private benefits from the firm to the detriment of minority investors. The state can also extract political private benefits by engaging in what we call “policy channeling” – using partial ownership of an SOE to achieve social or industrial policy objectives. As a means of carrying out these objectives, policy channeling may be preferred over regulation and taxation for a number of reasons: it may be a lower cost substitute for regulation in weak institutional environments, minority investors implicitly bear at least some of the cost of the policy’s implementation, and the SOE shields the policy from public participation and accountability. After mapping the nature of these problems in SOEs, we examine the potential of different legal strategies to address them, including those proposed by the OECD, World Bank, and stock exchange initiatives.

Keywords: state-owned enterprises, related-party transactions, industrial policy

JEL Classification: K20, L21, L32, L50, P50

Suggested Citation

Milhaupt, Curtis J. and Pargendler, Mariana, RPTs in SOEs: Tunneling, Propping, and Policy Channeling (March 1, 2018). Luca Enriques and Tobias Tröger, eds., The Law and Finance of Related Party Transactions (Cambridge University Press, Forthcoming); Stanford Law and Economics Olin Working Paper No. 517; Stanford Public Law Working Paper; European Corporate Governance Institute (ECGI) - Law Working Paper No. 386/2018. Available at SSRN: https://ssrn.com/abstract=3119164

Curtis J. Milhaupt

Stanford Law School ( email )

559 Nathan Abbott Way
Stanford, CA 94305-8610
United States

Mariana Pargendler (Contact Author)

Fundação Getulio Vargas Law School at São Paulo ( email )

R. Rocha, 233, Bela Vista
São Paulo, 01330-000
Brazil

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States

European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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