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Dividends and expropriation, Faccio, Lang, and Young (2001 AER)

 The failures in East Asian corporate governance are blamed for the East Asian financial crisis.  In East Asia, the predominant form of ownership is control by a family, termed as "crony capitalism", and the top managers are often from the family. In Faccio, Lang, and Young (2001 AER, citation 1861), they document ownership and control structures among East Asian corporations and analyze the salient agency problem, namely the expropriation of outside shareholders by controlling shareholders, by looking at dividend behavior.

To start with, they show an extraordinary concentration of control in East Asia, whereby 6 groups control more than 20% of the corporations in the 9 most advanced East Asian economies. This control is obscured behind layers of corporations, hence insulated against the forces of competition on less-then-transparent capital markets. However, family control is also predominant in West Europe, though the group sizes are smaller, with 5 groups control about 10% of the corporations. Thus West European corporations are used as benchmarks for the study.

The main contribution of the paper is to study the tradeoff between expropriation due to opaque ownership structures and investors' reaction to insider expropriation, by relating dividend rates to the discrepancy between the controlling shareholder's ownership rights and its control rights (O/C ratio).  The O/C ratio will be low if the controlling shareholder controls the corporation via a long chain of intermediate corporations, which indicates that a corporation with a low O/C ratio will pay low dividends. However, managers might also commit to refrain from expropriation by committing to a high dividend rate, thereby sustaining their corporation's stock market valuation and future access to capital.

Dividend payments could provide evidence on expropriation of the outside shareholders of corporations at the base of extensive corporate pyramids. The controlling shareholders can extract high returns from projects that yield negative returns to the corporation. The piling up of such projects, with their burden of unrepayable debt, helped precipitate the financial crisis. Dividends play a basic role in limiting insider expropriation because they remove corporate wealth from insider control.

They find that significantly higher dividends are paid by corporations that are "tightly-affiliated" to a business group, and amongst such corporations, to those having a lower O/C ratio. By contrast, for corporations "loosely affiliated" to a group, a lower O/C ratio is associated with significantly lower dividend rates. This suggest that investors are highly alert to expropriation within tight-affiliated corporations but seem slack within loosely-affiliated corporations. In their sample, loose affiliation comprise only 2.94 percent in West Europe but 15.44 percent in East Asia. This provides a breeding ground for expropriations. In addition, they find that the presence of multiple large shareholders increases dividend rates in Europe, but reduces them in Asia. Thus, the other large shareholders appear to help dampen expropriation in Europe, but exacerbate it in Asia.

A rich set of possibilities for expropriation arise when the corporation is affiliated to a group of corporations,all controlled by the same shareholder. Corporate wealth can then be expropriated by the insiders who set unfair terms for intra-group sales goods and services and transfers of assets and control stakes.  Other papers include Shleifer and  Vishny (1997), Claessens, Djankov, and Lang (2000), Bebchuk,  Kraakman, and Triantis (2000), Almeida and  Wolfenzon (2006).


Concepts in the paper
control rights (voting ownership) and ownership rights (cash ownership)
Suppose, a controlling shareholder owns a fraction x of the shares of corporation X, which owns a fraction of y of the shares in corporation Y, which owns a fraction z of the shares in Z, then his ownership rights in Z is xyz while control rights is the minimum of x y z.

controlling shareholder (ultimate owner)
Controlling shareholder, or ultimate owner, is defined by the control rights.

group affiliation
A corporation is said to be “group-affiliated” if it satisfies one of the following criteria: 
(i) it is controlled by a shareholder via pyramiding, i.e., indirectly through a chain of corporations; 
(ii) it controls another corporation in the sample; 
(iii) it has the same controlling shareholder as at least one other corporation in the sample; 
(iv) its controlling shareholder is a widely-held corporation or a widely-held financial institution.

Dividend rates
Balance sheet items above the dividend line can be manipulated in favor of the controlling shareholder. We define dividends as total cash dividends paid to common and preferred shareholders.
The rate at which dividends are paid shall be measured by four ratios: 
The dividend/cash-flows ratio (Div/cf), where cash flows are defined as total cash from operations, net of non-cash items from discontinued operations. 
The dividend/earnings ratio (Div/earn), where earnings are measured after taxes and interest but before extraordinary items. 
The dividend/sales ratio (Div/sale), where sales are net sales. 
The dividend/market-capitalization ratio (Div/mkcap), where market capitalization is the total market value of common and preferred stocks.

Claessens, Stijn, Simeon Djankov, and Larry HP Lang. "The separation of ownership and control in East Asian corporations." Journal of financial Economics 58.1-2 (2000): 81-112.
Faccio, Mara, Larry HP Lang, and Leslie Young. "Dividends and expropriation." American Economic Review 91.1 (2001): 54-78.
Bebchuk, Lucian A., Reinier Kraakman, and George Triantis. "Stock pyramids, cross-ownership, and dual class equity: the mechanisms and agency costs of separating control from cash-flow rights." Concentrated corporate ownership. University of Chicago Press, 2000. 295-318.
Almeida, Heitor V., and Daniel Wolfenzon. "A theory of pyramidal ownership and family business groups." The Journal of Finance 61.6 (2006): 2637-2680.
Shleifer, Andrei, and Robert W. Vishny. "A survey of corporate governance." The journal of finance 52.2 (1997): 737-783.


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