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Unpublished Paper
Puzzles in Controlling Shareholder Regimes and China: Shareholder Primacy and (Quasi) Monopoly
ExpressO (2015)
  • Sang Yop Kang, Peking University

Professor Mark Roe explained that the shareholder wealth maximization norm (“the norm”) is not fit for a country with a (quasi) monopoly, because the norm encourages managers to maximize monopoly rents, to the detriment of the national economy. This Article provides new findings and counter-intuitive arguments as to the tension created by the norm and (quasi) monopoly by exploring three key corporate governance concepts that Roe did not examine—(1) “controlling minority structure” (CMS), where dominant shareholders hold a fractional ownership in their controlled-corporations, (2) “tunneling” (i.e., illicit transfer of corporate wealth to controlling shareholders), and (3) Chinese state-owned enterprises (SOEs).

First, given (quasi) monopoly, this Article considers the impact of CMS. CMS controllers, due to their fractional economic interests (e.g., 5% ownership), do not have a strong incentive to vigorously follow the norm. Their incentive is further weakened, as CMS controllers’ percentage of shareholding is lowered and/or there are other compensating sources for CMS controllers to attain pecuniary/non-pecuniary benefits. When the norm is not actively sought, public shareholders lose the opportunity to gain the maximum level of monopoly profits. A positive byproduct, however, is that the welfare of a nation is improved, since non-maximized monopoly profits do not hurt society and consumers to the fullest extent.

Second, given CMS and (quasi) monopoly, this Article analyzes the impact of tunneling. Since tunneling provides more cash flows—including illicit cash flows—to CMS controllers, it strengthens their incentive to maximize shareholder wealth. The direct effect of tunneling to public shareholders is, by definition, negative. Counter-intuitively, however, tunneling is indirectly beneficial—to some extent—to public shareholders, due to CMS controllers’ reinforced incentive to increase profits. Thus, the net effect of tunneling on public shareholders is mixed. In regard to the welfare of society in (quasi) monopoly CMS, tunneling is affected in a negative way, since it encourages CMS controllers to pursue monopoly rents in a more aggressive manner.

Third, this Article calls into question the effectiveness of the norm in a context of Chinese SOEs that do their business in domestic markets. Formally, the controlling shareholder of Chinese SOEs is the party-state. The party-state is, however, an agent of Chinese citizens, who are the ultimate shareholders (and consumers). Given (quasi) monopoly of SOEs, if the norm is imported to China, the norm will encourage SOE managers to set a monopoly-profit maximizing price in domestic markets. Such a pricing is beneficial to Chinese citizens as the ultimate shareholders. The pricing, however, damages Chinese citizens as consumers. The combined effect of the norm on ultimate shareholders—i.e., Chinese citizens—is a net loss, since a significant amount of welfare in society will disappear in the form of a dead-weight loss (DWL) in the national economy. Due to the negative effect of the norm in China, stock options—an arrangement designed to encourage the norm—might bring undesirable consequences.

  • Shareholder Wealth Maximization,
  • Shareholder Primacy,
  • Controlling Shareholder,
  • (Quasi) Monopoly,
  • Controlling Minority Structure (CMS),
  • Tunneling,
  • China,
  • State-owned Enterprise (SOE),
  • Welfare of a Nation,
  • Investor Protection,
  • Monopoly Profits (Rents),
  • Deadweight Loss,
  • Stock Options
Publication Date
August 10, 2015
Citation Information
Sang Yop Kang. "Puzzles in Controlling Shareholder Regimes and China: Shareholder Primacy and (Quasi) Monopoly" ExpressO (2015)
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