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Does the Relationship between the Controlling Shareholder and Other Large Shareholders Affect the Firm Value?

Minying Cheng#, Bingxuan Lin*&, Minghai Wei#

Abstract

This study analyzes the identity of non-controlling large shareholders and investigates their

effects on firm value in the Chinese market. We find that when the non-controlling large

shareholders have prior relationship with the controlling shareholders, firm values are lower. As

well, higher ownership stakes and board representation by relational non-controlling large

shareholders are associated with lower firm value. Such an effect is more pronounced when

agency conflicts between majority shareholders and minority shareholders are greater. Our

findings suggest that it is important to consider the identities of non-controlling shareholders

when studying the effects of multiple large shareholders on corporate governance or firm value.

Furthermore, we find that the non-controlling large shareholders play a detrimental role in an

emerging market.

Keywords: Non-controlling shareholder, Relational shareholder, Firm value, Corporate

governance, Agency problem.

__________________ # School of Business, Sun Yat-Sen University, Guangzhou, China * College of Business, University of Rhode Isalnd, Kingston, RI, USA 02881 & Corresponding Author. Email. blin@uri.edu, Tel. 1-401-874-4895

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1. Introduction

Extant literature (La Porta et al., 1999; Claessens et al., 2000; Faccio and Lang, 2002)

highlights the importance of the controlling shareholder in corporate governance, and the impact

of the controlling shareholder on overall firm valuation, especially when the traditional

assumption of diverse ownership does not hold. To better understand the governance

mechanisms that mitigate the agency costs driven by controlling shareholders, some researchers

direct their attention to the effect of other non-controlling large shareholders (NCLS) on firm

value. However, the empirical findings are scarce and mixed. Volpin (2002), Laeven and Levine

(2008), and Attig et al. (2009) find that in the economies of Italy, Western Europe, and East Asia,

NCLS are associated with a valuation premium, yet Konijn’s (2011) analysis of U.S. data finds

an opposite condition.

To better distinguish the effects of NCLS on firm value, it becomes important to determine

the role of these NCLS. Maury and Pajuste (2005) show that in family firms the identity of

secondary blockholders is critical in determining the relationship between firm value and NCLS.

Laeven and Levin (2008) also suggest that the characteristics of NCLS (distribution of voting,

and cash flow rights) determine whether their presence enhances firm valuation. Their studies

imply that uncovering the relationship between NCLS and the controlling shareholder will help

develop a stronger understanding of the intricate relationship between NCLS and firm value.

By using a unique dataset from the Chinese market that includes detailed information

regarding the identity of NCLS, we are able to explore how NCLS might affect firm value. We

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find that many NCLS are related to the controlling shareholder either through shared ownership,

prior work experience or kindredship. These related NCLS are actively involved in the

management of the firm by appointing directors and managers. In particular, related NCLS often

have disproportionately higher board representation—that is, excessive power relative to their

level of ownership than NCLS with no direct relationship with the controlling shareholder.

As well, our study reveals that the presence and the ownership stake of relational NCLS are

both negatively associated with firm value. Next, we consider the power that relational NCLS

wields over the board and over management, and conclude that firm value decreases with

increased representation of relational NCLS for the board and for management. Finally, we

explore whether or not relational NCLS play different roles between firms faced with different

types of agency costs (agency cost between managers and shareholders, or between controlling

shareholders and minority shareholders). Our investigation revealed that the negative effect of

relational NCLS on firm value is more pronounced in firms where there is greater conflict

between majority shareholder and minority shareholder.

The approach we take for this study allows us to contribute to the literature by providing

direct evidence about how the relation between NCLS and controlling shareholder might affect

firm value. A second way that our study extends the literature is by providing empirical evidence

on the role of NCLS in an emerging market. Significantly, our study is the first to analyze the

implication of NCLS on firm value in China. Given the uniqueness of the Chinese institutional

system, and the importance of China in the global economic structure, the literature gap filled by

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our study takes on greater value. Finally, we further enhance the field by exploring how NCLS

might play different roles in firms that are faced with various types of agency conflict.

The remainder of the paper is organized as follows. Section 2 summarizes the related

literature. Section 3 presents our hypotheses. Section 4 discusses our research design, and

Section 5 provides sample descriptions and our empirical analysis. Section 6 reports the

robustness tests, and Section 7 concludes.

2. Literature Review

Studies profiling the structures of corporate ownership reveal that a significant number of

firms have multiple blockholders. For instance, 32.2% of East Asian firms and 45.26% of

Western European firms are run by multiple blockholders (Claessens et al., 2000; Faccio and

Lang, 2002). NCLS clearly play an important role in corporate governance. In the model by

Bennedsen and Wolfenzon (2000), an initial owner chooses an ownership structure with multiple

large shareholders to prevent a single shareholder from taking unilateral actions that might hurt

other shareholders. Pagano and Röell (1998) suggest that having two or more large shareholders

monitoring the controlling shareholder results in free-riding in monitoring but a higher firm

value because it reduces excessive monitoring by a very large shareholder. Edmans and Manso

(2011) argue that competition among NCLS impounds more information into prices and makes

the threat of disciplinary exit more credible, thus inducing higher managerial effort.

The total number of NCLS and their cash-flow rights distribution also affects the firm value.

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Gome and Novaes (2001) indicate that increasing the number of shareholders has two effects for

a given ownership stake of the controlling group—rent extraction will be less likely, but the

approval of positive net present value projects will become more difficult. In Bloch and Hege’s

(2001) model, two blockholders compete for the votes of the minority by committing to reduce

their private benefits. Hence, minority expropriation will be lower in companies where control is

more contestable. Gomes and Novaes (2006) further consider how firm characteristics and

governance laws determine the number of large shareholders. They conclude that letting a large

shareholder monitor the firm is efficient if investment opportunities are difficult for insiders to

evaluate, while sharing control is efficient if investment opportunities are difficult for outsiders

to evaluate, if financing requirements are large, and if the country offers poor protection for

minority shareholders.

Only a few empirical research studies examine the role of NCLS. Volpin (2002) suggests a

higher Q for Italian-listed firms when control is shared by a set of blockholders, compared to that

of a single blockholder. Isakov and Weisskopf (2009) find a higher ROA and Tobin’s Q in Swiss

family firms where a second blockholder is present. Nagar et al. (2009) also find a higher ROA

and lower expense ratios for closely-held corporations in the U.S. These studies provide initial

evidence for the effect of multiple large shareholders on firm value, although they are mostly

based on developed markets. Other articles focus on the cash-flow distribution of NCLS and the

controlling shareholder. Maury and Pajuste (2005) show that a more equal distribution of votes

among large blockholders is associated with a positive effect on firm value for Finnish listed

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firms. Similarly, when the gap in voting rights between the first and the second largest

shareholders is small, the second largest shareholder increases firm value for Western European

(Laeven and Levine, 2008) and East Asian (Attig et al., 2009) firms. These results imply a

positive correlation between the power of NCLS and firm valuation, which is consistent with the

predictions in Bennedsen and Wolfenzon (2000), Gome and Novaes (2001), and Bloch and Hege

(2001). However, Konijin et al. (2011) provide opposite results for the U.S. firms, determining

that blockholder dispersion is negatively related to firm value. Tribo et al. (2007) also find a

negative correlation between number of NCLS and R&D investment in Spanish firms.

Two studies consider the ways in which the identity of NCLS affects firm value. Maury and

Pajuste (2005) find that in family-controlled firms, a higher voting stake by another family

member is negatively related to firm value, whereas a higher voting stake held by another

non-family owner, typically a financial institution, is positively related to firm value in

family-controlled firms. Attig et al. (2008) find a higher cost of equity capital when the two

largest shareholders are families, in contrast to the presence of the state as the second largest

shareholder in family-controlled firms.

Extant literature is relatively silent regarding the role of NCLS in firms faced with different

agency cost. Faccio et al. (2001) find that the existence of NCLS increases dividend payouts in

Europe, but lowers them in Asia where agency conflicts between controlling shareholders and

minority shareholders dominates. In contrast, Attig et al. (2008) find that the negative correlation

between cost of capital and NCLS is more pronounced in East Asia than in Western Europe.

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Although we can argue that the agency conflicts between the controlling shareholder and

minority shareholders are more striking in Asia, it is difficult to draw the conclusion about how

NCLS might function differently in firms faced with different agency conflicts, because many

country-specific factors can cloud the interpretation.

3. Hypotheses development

3.1 Relational NCLS ownership and firm valuation

NCLS might form relations with controlling shareholders in many ways. We uncover

NCLS’ identity by finding out whether an NCLS is a related or a concerted party of a controlling

shareholder. Based on the definition of related party by the Chinese Corporation Law, a related

party would include the individuals and legal parties who are connected to the controlling

shareholders by ownership, family, or work1. Concerted parties are individuals or legal parties

who are connected by agreement, cooperation or affiliation, and whose vote is consistent with

that of the controlling shareholder. In general, relational NCLS include the following four types

of relations: ownership, family, work, or concerted agreement.

Theoretically, NCLS might improve firm value because they have greater incentive to, and

more opportunities to, monitor the controlling shareholders and to prevent them from tunneling.

However, NCLS ownership might also have adverse effects on firm value, especially when their

relationship with the controlling shareholder results in control benefits that magnify the conflicts

1 Chinese Corporation Law defines related parties as controlling shareholders, ultimate owners, directors, supervisors, senior executives, subsidiaries, and other parties with relations that may induce benefit transfer.

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between large shareholders and minority shareholders. For example, relational NCLS would

prefer to collude with the controlling shareholder to gain access to critical information that they

would otherwise not be able to achieve without the relations (Chiasson and See-To,2007,

Standifird and Marshall,2000). Furthermore, empirical studies suggest that the presence of

relational NCLS offers facilities for achieving private benefits from expropriating minority

shareholders. Take the enterprise groups as an example; we know that a significant amount of

tunneling occurs in business groups. For example, Baek at al. (2006) find that equity-linked

private securities are used as a mechanism for tunneling among firms that belong to a Korean

chaebol. In the Chinese market, Jian and Wong (2010) find that firms within the same corporate

group report abnormally high levels of related party sales when they have incentives to manage

earnings, causing a discount in Tobin’s Q. It appears that relational NCLS serves as a source for

more tunneling activities within business groups. The presence of NCLS is likely to lower the

firm value if the market would expect more looting from controlling shareholders and their

coalitions (Claessens et al., 2002; Lemmon and Lins, 2003; King and Santor, 2008). Furthermore,

controlling shareholders might mask their collusion and tunneling activities by lowering

corporate information transparency (Fan and Wong,2002; Anderson et al., 2009). Under the weak

legal institutions and imperfect investor protections in China, it is even more difficult to detect

and prevent minority shareholder expropriations and information quality damages (La Porta et

al.,2002; Dyck and Zingales,2004; Haw et al.,2004).

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Given the previous discussion, we have the following hypothesis

H1: Ceteris paribus, the relationship between relational NCLS ownership and firm value

will be negative.

3.2 Relational NCLS management and firm value

For a large shareholder, the power is often carried out through active involvement in the

company board or management team (Hermalin and Weisbach, 2003). Therefore, we further

examine how relational NCLS influences the board and the management differently, based on

their relations with the controlling shareholder.

If NCLS management can mitigate the classic owner-manager conflict, we would expect a

positive effect on the value of relational management. However, this effect may be offset by the

access to private benefits obtained from excessive authority bestowed to relational NCLS. First,

relational management substantially magnifies controlling shareholders’ abilities to achieve

private benefits. Lins (2003) finds that management blockholdings are negatively related to firm

value, and the effect is significantly more pronounced in countries with low shareholder

protection. Second, NCLS and the controlling shareholder may share the same interest in

fighting off any potential takeover, and in protecting their controlling benefits. Moreover,

limiting board and executive management positions to relational NCLS suggests a restricted

labor pool from which to obtain qualified and capable talent. This is especially true for family

firms (Burkart et al., 2003). Smith and Amoako-Adu (1999) and Pérez-González (2001) find that

the stock market reacts negatively to the appointment of family heirs as managers. Taken

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together, we expect that relational management is also associated with a lower firm value.

Given the above discussions, we propose the following hypothesis.

H2: Ceteris paribus, the controlling power of relational NCLS in the board and

management is negatively correlated to the firm value.

3.3 The effect of relational NCLS on firm value under different agency conflicts

Because state-owned enterprises and private firms are exposed to different types of agency

conflicts, for each of the two categories of firms, we develop a separate investigation of the role

of relational NCLS. Prior research has shown that agency problems between managers and

shareholders (type I agency problem) are more serious in state-owned enterprises (SOEs), and

agency conflicts between the controlling shareholder and minority shareholders (type II agency

problem) are more severe in private firms. In a situation of nominal state ownership, where many

contractual and residual rights of control have been reallocated to managers, managers exercise

many effective rights of control and discretionary power (Qian, 1996; Zhou and Wang, 2000).

Therefore, in SOEs we observe high agency costs from managerial self-dealing and

empire-building. Alternatively, conflicts between the controlling shareholders and minority

shareholders are more severe in private firms. For example, the founder or descendants of the

family owner usually serve as CEO or Chairperson in private firms (Anderson and Reeb, 2003;

Villalong and Amit, 2006). They often use dual-class stock, disproportionate board

representation, and voting agreements to achieve control rights over cash flow rights (Villalong

and Amit, 2009). Meanwhile, they exploit firm opacity to accrue private benefits of control

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(Anderson et al., 2009). Unlike SOEs, private firms are more driven by wealth maximization,

and are more aggressive in looting company resources. We therefore expect a more negative

effect of relational NCLS on firm value in private firms.

In addition to the use of SOEs and private firm samples, we also compute the separation of

controlling rights and cash flow rights as a more direct measure of type II agency conflicts. Prior

studies show that greater separation of control rights and cash flow rights reveals severe type II

agency conflicts in the firms.

We propose the third hypothesis as follows:

H3: Ceteris paribus, the negative effect of NCLS on firm value is more significant in firms

dominated by the type II agency problem than firms dominated by the type I agency problem.

4. Research Design

4.1 Sample and data

To examine the relationship between relational NCSL and firm value, we use Chinese

A-share companies listed on the Shanghai Stock Exchange and the Shenzhen Stock Exchange

from 2002 to 2008. Identities of the top ten shareholders and their relations with the controlling

shareholder are available in China from 2002 to the present. We exclude banks and insurance

companies due to the difficulties in calculating Tobin’s Q for these firms, and because of the

governmental regulations that would bias the measure of firm performance. We also drop 226

observations with insufficient financial data. Our final sample includes 9323 firm-year

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observations and 83,907 observations for NCLS.

We define controlling shareholder as the shareholder who holds the largest proportion of

shares in a firm. If the two largest shareholders own the same amount of stock, we identify the

controlling shareholder according to the disclosure in the annual report.2 NCLS is defined as the

top two to top ten shareholders. An NCLS is defined as a relational NCLS if he or she has one of

the following relationships with the controlling shareholder: ownership, family, work, or

concerted agreement3.

We use the China Stock Market and Accounting Research (CSMAR) database to obtain

ownership data of the top ten shareholders. We build a shareholder database that includes: (1)

information on relations between the controlling shareholder and NCLS, which was manually

collected from annual reports; (2) the number of directors and officers appointed by the top ten

shareholders, which was manually collected from annual reports; (3) the size of the board and

management, which was found in the CSMAR database and cross-referenced with data from

both the China Economic Research Center (CCER) database and company annual reports; and (4)

identification of the ultimate controlling owners, which was obtained from CCER, with data

beginning at 2003. (For 2002, we hand-collected information on ultimate owners using annual

reports.) Finally, we obtained financial data and corporate governance data from CSMAR, and

2 58 observations (22 firms) have a situation where the two largest shareholders have the same number of shares. These firms distinguish a shareholder as a controlling shareholder, then, if one of the shareholders (1) holds more voting rights, or (2) appoints more directors, or (3) is in the chain of ultimate owner; or (4) holds a more important position in the firm. We find no influence on controlling relational shareholders for observations whose largest shareholders have the same stockholdings and power in the management. 3 In prior studies such as Porta et al. (1999) and Claessens et al. (2002), shares held by different members of a family are usually aggregated. Maury and Pajuste (2005) and Attig et al. (2008) also take family members as a group when they examine the function of secondary large shareholders. However, it is our aim to separate the role of relational shareholders from controlling shareholder in this study. Hence, when the NCLS have a family relationship with the controlling shareholder, we do not simply aggregate their shares to the controlling shares, but analyze their effects separately.

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retrieved SIC codes from CCER.

4.2 Variables

4.2.1 Relational NCLS ownership and power

We first measure the presence of a relational shareholder by the use of a dummy variable,

and measure NCLS voting rights by their respective ownership. To determine whether a director

or officer is appointed by an NCLS, we carefully reviewed the director and officer’s resumes. If

a director or officer is one of the NCLS, is working for the NCLS, or has direct control of shares

held by NCLS, he or she is identified as a director or officer appointed by the NCLS. To analyze

NCLS influence on the board and management, we calculate the percentage of board

representation and management representation by NCLS over the total number of people on the

board and management. We also use a measure called “power leverage” to determine whether

relational shareholders obtain excessive power on the board and management. The power

leverage is computed as the ratio of NCLS board/management representation to NCLS

percentage ownership. The relational NCLS is considered to have excessive power beyond that

individual’s holdings if the power leverage is greater than one.

4.2.2 Proxy for agency cost

To examine which type of agency problem might exacerbate the negative impact of

relational NCLS, we identify SOEs and private firms according to the ultimate owner of the firm.

The procedure of identifying ultimate owners is similar to that used in La Porta et al. (1999) and

Claessens et al. (2000). An ultimate owner is defined as the shareholder who has the controlling

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voting rights of the company. If the ultimate owner is the government at any level or is an

administrative institution, we identify the firm as an SOE. If the ultimate owner is a family or an

individual, we identify the firm as a private firm. Our sample comprises 6345 SOEs and 2668

private firms, representing 68.06% and 28.62% of the firm-year observations, respectively.

We also compute the separation of control (voting rights) and ownership (cash flow rights)

of the ultimate owners as an alternative proxy for the type II agency cost. Following La Porta et

al. (1999) and Claessens et al. (2000), the separation is the ratio of voting rights to cash flow

rights of the ultimate owner. The voting right is the weakest link in the chain of control rights.

The cash flow right is the product of the ownership stakes along the chain. The incentives for and

abilities of ultimate owners to derive private benefits from outside investors increase with the

level of voting rights over the associated cash flow rights.

4.2.3 Firm valuation

Following earlier studies of ownership and performance since Morck et al. (1988), we use

Tobin’s Q as the measure of firm value. We define Tobin’s Q as the ratio of the firm’s market

value to the replacement cost of its assets. The market value is the market value of common

stock plus the book value of preferred stock and debt. The market value of common equity is the

product of the share price at fiscal year-end, times the number of common shares outstanding.

4.3 The model

The basic multivariate specifications are estimated using ordinary least squares (OLS). We

winsorize all variables at the 5th and 95th percentile. Our primary tests are robust regressions

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with clusters, in which observations are clustered by firm and the covariance matrix is estimated

using the Huber (1964) or White (1980) estimator. This method allows us to exploit information

in both the cross-sectional and time-series nature of the data, while still controlling for the serial

correlation that is observed in each firm’s time series observations. We include industry and year

fixed effects in all regression models to control for the underlying economic environment that

might jointly determine ownership structure and valuation, and use alternative techniques to

control for the potential endogeneity in Section 6.

The regression equation we employ for multivariate analysis for H1 and H2 takes the

following form

k

i i controlselationRqsTobin210 ._' (1)

where Tobin’s Q represents firm value and is the ratio of the firm’s market value to the

book value of assets. Relation includes two groups of variables to test H1 and H2. The variables

for testing H1 include: (a) the presence of relational shareholder (Rel_dum), a dummy variable

that equals to one if the NCLS are related to the controlling shareholder, and zero otherwise, and

(b) the ownership of relational NCLS (Share_rela). The variables for testing H2 include: (a) the

presence of relational directors (RelDir_dum), a dummy variable equal to one if one or more

directors is appointed by the relational NCLS, and zero otherwise; (b) the ratio of the number of

directors appointed by the relational NCLS to the size of the board (RelDir_rat); (c) the presence

of relational directors and officers (RelMan_dum), a dummy variable equal to one if one or more

directors and officers is appointed by the relational NCLS, and zero otherwise; (d) the ratio of

the number of directors and officers appointed by relational NCLS to the size of the management

(RelMan_rat); (e) the power leverage of relational directors (RelDir_str), measured as ratio of

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RelDir_rat to Share_rela; and (f) the power leverage of relational directors and officers

(RelMan_str), measured as ratio of RelMan_rat to Share_rela. We expect a negative sign for β1

because the presence, ownership, and management of relational NCLS should lower firm value

based on our H1 and H2.

Following Anderson and Reeb (2003) and Villalonga and Amit (2006), we control for the

financial characteristics in the model. Financial leverage (Debt) is measured as the ratio of debt

to total asset. Firm size (Size) is measured as the natural log of total assets. Profitability (ROA) is

measured as return on assets. Growth is measured as the growth on sales. Idiosyncratic risk (Risk)

is measured as the standard deviation of daily stock returns for a year. Firm age (Age) is the

natural log of number of years since firm inception. We also control for other corporate

governance factors that might affect the relational ownership and valuation. Share_top1 is the

holdings of controlling shareholders, and Share_top12 is the square to capture potential nonlinear

correlations (McConnell and Servaes, 1990). Manage_top1 is the ratio of directors and officers

appointed by the controlling shareholder to the size of the management. Share_block is the

aggregated holdings of non-relational blockholders. Manage_block is the ratio of number of

directors and officers appointed by non-relational NCSL to the size of the management.

Managerial compensation (Compensation) is the natural log of total compensation for directors,

supervisors, and managers. We also control for the type of ultimate owner (Ultimate), which is

equal to one if it is a state-owned company, and zero otherwise. For easy reference, we list all the

variables’ definitions in Appendix 1.

To examine the interaction effects of different types of agency conflicts and the role of

relational NCLS, we run models (2) and (3).

controlsSOElationSOElationqsTobin i*ReRe_' 3210 (2)

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controlsSeparationlationSeparationlationqsTobin i*ReRe_' 3210 (3)

where SOE is a dummy variable that is equal to one if it is a state-owned company, and zero

if it is a private company.4 Separation is the ratio of voting rights to cash flow rights of the

ultimate owners. β3 captures the effect of relational shareholder on firm value for SOEs. A

positive β3 suggests that the effect of relational NCLS on firm value should be less in firms with

lower type II agency conflicts. Per H3, we predict β3 to be positive. γ3 captures the effect of

relational NCLS on firm value for firms with serious conflicts between majority shareholders

and minority shareholders. A negative γ3 implies that the effect of relational shareholder on firm

value would be higher for firms with greater type II agency conflicts. We predict γ3 to be

negative.

5. Empirical Results

5.1 Descriptive Statistics

Table 1 indicates that firms with relational NCLS are quite common in our sample,

representing 27.71% of our 9323 firm-year observations. We classify the sample by ultimate

owner in Panel A.5 68.06% of the sample firms are SOEs in which 25.85% are held by relational

NCLS. 28.62% of the sample firms are private firms in which 32.98% are held by relational

NCLS. For the rest of the sample, 0.54% are owned by foreign investors and 2.79% have

ownership classified as collective holdings. Firms with relational NCLS are spread evenly from

4 We only include SOE and private firms in model (2). 5 There are four types of ultimate owners: the Chinese government, individual or family, foreign companies, and collective companies. Collective companies are companies whose ultimate owners are village committees, village/town co-operatives operating center, asset operating centers, asset management committees, social organizations, trade unions, Employee Stock Ownership, or cooperative organizations (e.g., Chinese Economic Development Advisory Committee, Chinese Economic and Enterprise Federation).

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2002 to 2008 (Panel B), indicating that ownership structures of relational coalition are stable

over time, which is consistent with La Porta et al. (1999).

[Insert Table 1 here]

Table 2 reports the NCLS identity, ownership, and board/management representation. We

sum up the number, holdings, directors, and officers of relational NCLS in each firm to measure

their controlling power in the firm. Panel A presents the type of relational NCLS. The NCLS in

2014 firm-year observations (79.3% of firms with relational shareholders) are related to the

controlling shareholders by ownership. Family relations represent 7.5% of our sample. 104

observations have working relations, and 121 observations are found to have concerted

agreements with the controlling shareholders. Finally, 117 observations have more than one

types of connections with the controlling shareholder (e.g. family NCLS who have concerted

agreements).

Panel B shows the number of relational shareholders and their holdings. In 2583

observations with relational shareholders, 1612 have one relational shareholder (62.4%) and 971

have two or more relational shareholders (37.6%). Relational shareholders in 1558 observations

hold more than 5% of the ownership, representing 60.3% of observations with relational

shareholders, which implies that relational shareholders in most firms may have significant

influence on firm decisions.

Panel C and Panel D present the number and percentage of directors and officers appointed

by relational shareholders. One director may work for more than one shareholder, so some NCLS

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may appoint 1/2 or 1/3 directors if they jointly appoint an individual. Relational shareholders

have appointed directors (officers) in 1303 (1432) observations. They hold more than 10% of the

votes on the board in 889 observations (34.4% of those with relational shareholders), and hold

more than 10% of the votes in the management in 592 observations (22.9% of those with

relational shareholders). Panel E reports the relational NCLS power leverage on the board and in

the management. In 830 and 679 observations (32.1% and 26.3% of those with relational

shareholders), relational shareholders obtain excessive authority on the board and in the

management above their ownership. We see that relational shareholders obtain not only

significant voting rights along with their holdings, but also real power on the board and in the

management. Based on their relations with the controlling shareholders, some of them gain

power beyond what is justified by their ownership.

We also compare the differences in ownership and management between relational NCLS

and non-relational NCLS.6 There are 23,247 NCLS in firms with relational shareholders, among

which 4523 are relational shareholders (19.46%). The average ownership is 5.6% for relational

NCLS and 1.81% for non-relational NCLS. The difference is statistically significant at the 1%

level in both t-test and rank sum tests. Relational NCLS usually have substantive ownership in

the firm. On average, each relational NCLS has a 4.38% vote among board members,

significantly more than the ratio of 1.2% of non-relational NCLS. The average votes among

managers for a relational NCLS is also significantly higher than for a non-relational NCLS. We

compare, as well, the average power leverage (winsorized at the 1st and 99th percentiles). The

6 We report the main results here and do not repeat the same information in the table.

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director power leverage of each relational NCLS is 1.46, significantly greater than 0.41, the

power leverage of non-relational NCLS. Similarly, each relational NCLS holds a mean leverage

of 1.22 in the management, which is significantly greater than the mean leverage of 0.4 for

non-relational NCLS. These results suggest that relational NCLS have more influence upon

company decision- making than non-relational NCLS. Moreover, they are granted excessive

authority, beyond what is justified by their holdings.

5.2 Univariate analysis

To better illustrate the impact of relational NCLS on firm value, and to control for the

engogeneity problem, we construct a sample that includes only firms that experience a change in

the status of relational NCLS. We also require that the ultimate owners stay the same during the

change of NCLS. We compare the Tobin’s Q before and after the presence of relational NCLS. If

the addition (absence) of relational shareholders is negatively (positively) correlated to firm

value, Tobin’s Q should fall (rise) accordingly. Panel A of Table 3 reports the univariate tests for

the subsample. In the period from 2002 to 2008, 272 firms in our sample experienced the loss of

relational NCLS, and 210 firms experienced the addition of new NCLS. Relational directors

(officers) leave the board (management) in 204 (208) firms, and enter in 175 (180) firms. It

seems that Tobin’s Q does not significantly change when relational NCLS or their

directors/officers leave. However, for firms with new relational shareholders, Tobin’s Q drops

from 1.45 to 1.29. The discount is 11%, and is statistically significant at the 1% level. For firms

with new relational shareholders on the board or management, Tobin’s Q also drops significantly.

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This suggests a negative effect of relational NCLS on firm valuation.

Panel B and Panel C further divide the subsample into SOEs and private firms. Similar to

Panel A, Tobin’s Q seems to stay the same when relational NCLS leave for both SOEs and

private firms, but falls significantly when relational NCLS join the firm. Interestingly, the mean

discount and significance are much greater for private firms. The mean Tobin’s Q declines by

0.261 for private firms and 0.132 for SOEs when relational shareholders join in the ownership,

which suggests that the negative effect of relational ownership and management are more

striking in firms characterized with type II agency conflicts. Results are also consistent with

expectation when using the separation of voting rights and control rights as a proxy of type II

agency problem.

[Insert Table 3 here]

Table 4 provides the descriptive statistics of all variables. The mean Q is 1.36 (median 1.18)

and debt ratio is 50% (median 51%). The size is 26.8 million of total assets, on average, and

yields an ROA of 3%. The mean sales growth is 18% (median is 15%), with a standard deviation

of 32%, suggesting a significant difference between the growth rates of firms. The average firm

age of the sample is 10.86 years (median is 11). The controlling shareholders own 39% of the

stocks, on average (median is 37%), with votes of 23% (median is 22%) on the board and 18%

(median is 17%) in the management. The firms listed in the Chinese Stock Exchange usually

have a concentrated ownership, but the votes on the board and the management controlled by the

controlling shareholders may vary across firms. Non-relational blockholders have an average

22

ownership of 9% (median is 0), and the average who have votes in management is 7%. The

average compensation for the management of our sample firm is 1.67 million RMB.

[Insert Table 4 here]

5.3 Regression Analysis

Table 5 reports our main results from regressing firm value on relational NCLS dummy,

ownership, and management. Following the theoretical predictions for the effects of relational

NCLS on firm value that have been previously outlined, we group our main results into three

groups. Specification (1) reports the valuation effects of the presence of relational shareholders

(Rel_dum). The estimated coefficient on Rel_dum is negative and statistically significant at the

10% level, suggesting that the mere presence of relational shareholders is associated with lower

firm valuation. The results in Specification (2) show that increasing the ownership of relational

shareholders lowers corporate value significantly (at the 5% level). The findings support H1 and

extend the study of Maury and Pajuste (2005) and Attig et al. (2009).

Specifications (3) to (6) report the multiple regression results for H2. If relational

shareholders play a detrimental role in corporate governance, their participation in the corporate

operation should be more relevant to the firm valuation. Specifications (3) to (6) suggest that the

relational NCLS representations on the board and management are significantly and negatively

associated with firm value. When relational NCLS appoint insiders to the board (RelDir_dum) or

the management (RelMan_dum), the firm value decreases, and it is significant at a 1% level.

This result is consistent with the collusion effect of relational shareholders. The coefficients of

23

relational NCLS power leverage (RelDir_str and RelMan_str) are also negative, and statistically

significant at the 10% and 5% levels, respectively. The results highlight the premise that

investors expect a greater extraction of private benefits if the relational NCLS hold excessive

power.

The Coefficient for the variable Ultimate is negative, which is consistent with the evidence

of higher efficiency of the private sector (Frydman et al., 1999; Kikeri and Nellis, 2004). Size is

negatively correlated to firm value, suggesting a better prospective for small firms (Claessens et

al., 2002). Firms with higher risk and greater return are associated with higher value, and age is

positively related to firm value. The effect of controlling ownership on firm value is U-shaped,

indicating that the entrenchment effect dominates when the controlling ownership is small, and

alignment effect dominates when the controlling ownership increase. This is consistent with the

findings in Morck et al. (1988), though they focus on the effect of managerial ownership. We

observe that holdings and management by non-relational NCLS are negative to firm value.

Managerial compensation is positively correlated to firm value, which is consistent with the

incentive role of compensation contracts.

[Insert Table 5 here]

Table 6 reports how two types of agency problems influence the role of relational NCLS. In

Panel A, we focus on the interaction between SOE and Relation, and the interaction between

Separation and Relation. Specification (a) examines the interaction of SOE and Relation. The

coefficients of Specification (1) show that the presence of relational shareholders is associated

24

with a lower value; however, the effect is less prominent for SOE (statistically significant at the

10% level). Specifications (3) to (6) also suggest that the negative effect of relational board

representation on firm value is less severe for SOEs (statistically significant at the 5% level).

Furthermore, Specifications (7) and (8) show that the negative impact of excessive authority by

relational NCLS on valuation is more pronounced for private firms. The overall results suggest

that relational shareholders play a more negative role, primarily, in those firms exposed to type II

agency problems.

[Insert Table 6 here]

In Specification (a) of Panel B, we split the sample into SOEs and private firms to examine

how the major type of agency problem shapes the role of relational NCLS. The results support

the premise that the negative role of relational NCLS is more pronounced in private firms. In

particular, the coefficient estimates are statistically insignificant in the subsample of SOEs, while

the coefficient estimates of relational management are all negatively significant in the subsample

of private firms. The results suggest a more negative effect of relational NCLS on firm value in

private firms, which is consistent with H3.

In Specification (b) of Panel A and Panel B, we also use separation between ownership and

control rights of ultimate owners to investigate whether type II agency conflicts are associated

with the effect of NCLS on firm value. Results are consistent with those using SOEs and private

firms as the indicator to distinguish the difference in agency conflicts.

25

6. Robustness Tests

6.1 Controlling for endogeneity

In this section, we use 2SLS (two-stage least squares) and 3SLS (three-stage least squares),

where endogeneity in relational ownership is addressed using an instrumental variable. We use

the incorporation method as the instrument to predict the ratio of relational ownership and their

representation in the company management. Chinese law stipulates that a limited stock company

(prior to exchange listing) should be established by means of promotion or stock floatation. The

minimum capital requirement is 10 million RMB7. The promotion method requires sponsors to

subscribe to all shares issued by the company, and the stock flotation method allows sponsors to

subscribe to only part of the shares (no less than 35%) and offer the remaining shares to the

general public. To engage in stock flotation, the sponsors need to prepare detailed disclosures,

similar to an IPO prospectus that describes company history and performance projections. The

firm also needs to retain the services of a broker to conduce due diligence and underwrite the

private offering of company shares. Meanwhile, the promotion method only requires an

agreement among various sponsors and proof of the capital investment by sponsors. Simply

speaking, the promotion method requires the sponsors to provide the entire capital when starting

the company, while the stock flotation method would allow the sponsor to raise the capital from

a larger pool of investors. The promotion method also allows the sponsors to have full control of

the firm, including the election of board of directors, while the stock flotation method requires

sponsors to include all shareholders in a general meeting to vote on the board of directors and

7 In the revision of Corporate Law in 2005, the minimum capital requirement was reduced to 5 million RMB.

26

major corporate decisions. Using the promotion method, the interests of the sponsors are closely

aligned and the sponsors are more likely to establish a stronger relationship with each other. The

method of establishment, therefore, affects the ownership and board structure in subsequent

years, but it should have little effect on current firm value. We therefore construct an

instrumental variable Promotion that equals to one if a firm uses the promotion method to

establish the firm, and zero otherwise.

We first estimate the model using 2SLS. In the first stage, we regress relational holdings

(relational management) on Promotion. In the second stage, we employ the predicted values

estimated from the first-stage regression in order to replace Relation in Models (1) to (3). We

also include industry and year dummies in the 2SLS regressions, and estimate robust standard

errors adjusted for clustering within firms.

The results of 2SLS regressions are reported in Table 8. Panel A shows that Promotion in

the first stage is significant and positively correlated to relational management. In the second

stage, the coefficients on RelDir_rat, RelMan_rat, RelDir_str and RelMan_str are negative and

statistically significant, suggesting a negative effect of relational management on valuation, even

after addressing potential endogeneity problems. Panel B presents the second-stage results of

Models (2) and (3). The coefficients of the interaction term of Relation and SOE are significantly

positive. Panel C shows the second-stage results of the subsample regressions. The coefficients

of relational management are only statistically significant in firms with separation of ultimate

voting and cash flow rights.

27

[Insert Table 7 here]

While the 2SLS regression may ignore some information in the system, we also use 3SLS

regressions to estimate simultaneous equations in Tobin’s Q, relational management, and

relational ownership. We find that the results are also consistent with our hypotheses8.

6.2 Sensitivity analysis

To ensure that our results are robust, we construct three alternative proxies for firm value as

the dependent variables: (1) the firm’s annual buy-and-hold returns, following the approach of

Loughran and Ritter (1995) and based on monthly returns for each firm; and (2) the annual

cumulated abnormal returns, calculated as the monthly raw return on a stock minus the

corresponding monthly value-weighted market return. We can see from Table 9 that our results

continue to hold with the new measures.

As well, we use a robust regression to re-estimate the model regarding to the right-skewed

distribution. Also, we use a fixed effects panel data model as another approach to control for

unobserved heterogeneity and endogeneity, and a random effect panel data model as an

alternative technique to control for serial correlation. Results show that our prior results reported

in Table 5 do not change.

[Insert Table 8 here]

7. Conclusion

Recent studies have found that NCLS play significant roles in corporate governance and

8 For the sake of brevity, we do not report the tables in the paper. Results are available upon request.

28

decisions. It is also important to recognize that not all NCLS share the same vision or incentive

with the controlling shareholder. The role of NCLS, therefore, can be either beneficial or

detrimental to minority shareholders, depending on the ways in which NCLS participate in

company activities. Understanding their relationships with the controlling shareholder are critical

steps in discovering the incentives of NCLS.

Using the Chinese data, we identify the ways in which NCLS are related to the controlling

shareholder, and we explore how NCLS affect firm value. We trace the relation between NCLS

and the controlling shareholder based on prior connections in work, family, ownership, and prior

agreements, and we look at the presence, the ownership, and the board/management

representation of relational NCLS. Collectively, we find that relational NCLS are negatively

correlated to the firm value. Higher ownership or management participation by relational NCLS

is associated with lower Tobin’s Q. Our results suggest that when NCLS are related to the

controlling shareholder, they tend to have negative impact on firm value. The situation is even

worse in firms where the conflicts between controlling shareholder and minority shareholder are

more pronounced.

Our study highlights the important role of NCLS. Future studies that explore how relational

NCLS affects various corporate decisions might help us better understand the relationship

between relational NCLS and firm value and corporate governance.

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Appendix 1: Definition of variables

Variables Definitions

Tobin’s Q The ratio of the firm’s market value to the replacement cost of its assets, where

market value is the market value of common stock plus the book value of preferred

stock and debt, and the replacement cost of asset is the book value of total assets.

Rel_dum A dummy variable equal to one if the NCLS are correlated to the controlling

shareholder, and zero otherwise.

Rel_share Aggregated ownership of relational shareholders.

RelDir_dum A dummy variable equal to one if one or more directors is appointed by the

relational shareholders in the firm, and zero otherwise.

RelDir_rat The ratio of directors appointed by relational shareholders to the size of the board.

RelMan_dum A dummy variable equal to one if one or more directors and officers is appointed

by the relational shareholders in the firm and, zero otherwise.

RelMan_rat The ratio of directors and officers appointed by relational shareholders to the size of

the management.

RelDir_str The ratio of RelDir_rat to Share_rela.

RelMan_str The ratio of RelMan_rat to Share_rela.

SOE A dummy variable equal to one if it is a state-owned company, and zero otherwise.

Separation The ratio of voting rights to cash flow rights of the controlling coalitions.

Debt The ratio of debt to total assets at the end of fiscal year.

Size The natural log of total assets at the end of fiscal year.

ROA The ratio of annual net income to the average assets at the end of year t and t+1.

Growth The income of year t minus income of year t-1, divided by the income of year t-1.

Risk The standard deviation of daily stock returns for a fiscal year.

Age The natural log of number of years since firm inception.

Share_top1 The ownership of controlling shareholder.

Manage_top1 The ratio of directors and officers appointed by the controlling shareholder to the

size of the management.

Share_block The aggregated ownership of blockholders other than relational shareholders.

Manage_block The ratio of directors and officers appointed by NCSL other than relational

shareholders to the size of the management.

Compensation The natural log of total compensation for directors, supervisors, and managers.

Table 1: Sample and the prevalence of relational NCLS This table reports the number of firms where relational NCLS is present, and its percentage in the full sample and different categories of subsamples. We distinguish firms between 2 distinct categories: the type of ultimate owners and year. Relational NCLS are non-controlling large shareholders that are related to the controlling shareholders by different types of contracts, including related parties and acting in concert. The sample consists of 9323 firm-year observations listed in the Chinese stock market in the period from 2002 to 2008.

Ultimate owner The state Individuals/family Foreign investor Collective firm Total

Full sample 6,345 2,668 50 260 9,323

Firms with relational NCLS 1,640 880 13 50 2,583

(%) (25.85) (32.98) (26.00) (19.23) (27.71)

Year 2002 2003 2004 2005 2006 2007 2008 Total

Full sample 1,137 1,198 1,308 1,322 1,353 1,470 1,535 9,323

Firms with relational NCLS 284 327 367 379 385 402 439 2,583

(%) (24.98) (27.30) (28.06) (28.67) (28.46) (27.35) (28.60) (27.71)

Table 2: The type of relational NCLS and the distribution of their power. This table reports the types of relational NCLS and the distribution of their authority in 2583 observations where relational NCLS is present. Panel A reports the type of relations between relational NCLS and the controlling shareholders. Panel B reports the number of observations with different number and ownership of relational NCLS. Panel C reports the number of observations with different board representation of relational NCLS. Panel D reports the number of observations with different management representation of relational NCLS. Panel E reports the number of observations with different power leverage on the board and management of relational NCLS. Panel A: Type of relation

Acting in concert

More than one type

Type of relation Ownership Family Working Total

Observation 2,048 193 104 121 117 2583

(%) (79.3) (7.5) (4.0) (4.7) (4.5) (100)

Panel B: Number and ownership of relational NCLS

Number Observation (%) Ownership Observation (%)

1 1,612 (62.4) (0,5%] 1,025 (39.7)

2 471 (18.2) (5%,10%] 565 (21.9)

3 259 (10.0) (10%,20%] 609 (23.6)

4 132 (5.1) (20%,30%] 283 (11.0)

>5 109 (4.2) >30% 101 (3.9)

Total 2,583 (100) Total 2,583 (100)

Panel C: Board representation of relational NCLS

No. of directors Observation (%) Percentage on board Observation (%)

0 1,280 (49.6) 0 1,280 (49.6)

(0,1] 774 (30.0) (0,10%] 414 (16.0)

(1,2] 328 (12.7) (10%,20%] 577 (22.3)

(2,3] 145 (5.6) (20%,30%] 190 (7.4)

>3 56 (2.2) >30% 122 (4.7)

Total 2,583 (100) Total 2,583 (100)

Panel D: Management representation of relational NCLS

No. of directors and officers

Observation (%) Percentage in board

and management Observation (%)

0 1,151 (44.6) 0 1,151 (44.6)

(0,1] 657 (25.4) (0,10%] 840 (32.5)

(1,2] 349 (13.5) (10%,20%] 427 (16.5)

(2,3] 219 (8.5) (20%,30%] 131 (5.1)

>3 207 (8.0) >30% 34 (1.3)

Total 2,583 (100) Total 2,583 (100)

Panel E: Power leverage of relational NCLS

Leverage of directors Observation (%) Leverage of

directors and officers Observation (%)

0 1,280 (49.6) 0 1,151 (44.6)

(0,1] 473 (18.3) (0,1] 753 (29.2)

(1,2] 435 (16.8) (1,2] 348 (13.5)

(2,3] 133 (5.2) (2,3] 114 (4.4)

>3 262 (10.1) >3 217 (8.4)

Total 2,583 (100) Total 2,583 (100)

Table 3: Univariate analysis: Tobin’s Q before and after relational NCLS in and out This table reports results of univariate analysis on Tobin’s Q in the year when relational NCLS sell or buy the stocks while ultimate owners do not change. We compare Tobin’s Q in three situations: relational NCLS sell all or newly buy the stocks, directors from relational NCLS exit from or newly join the board, directors and officers from relational NCLS exit from or newly join the management. Panel A reports results from the full sample. Panel B and C report results from the SOEs and private firms, respectively. Panel D and E report results from observations with low and high separation between voting rights and cash flow rights of ultimate owners, respectively. ***, **,* denote statistical significance at the 1%, 5% or 10% level, respectively. (1) when relational NCSL exit (2) when relational NCLS come in

N

mean of Q Diff.

p value N

mean of Q Diff.

p value

before after (ttest) before after (ttest)

Panel A: Full sample

Rel_dum 272 1.430 1.454 0.024 0.550 210 1.451 1.290 -0.160*** 0.000

RelDir_dum 204 1.463 1.453 -0.010 0.805 175 1.477 1.317 -0.159*** 0.001

RelMan_dum 208 1.439 1.457 0.018 0.666 180 1.486 1.323 -0.163*** 0.000

Panel B: SOEs

Rel_dum 180 1.383 1.426 0.043 0.382 152 1.408 1.275 -0.132*** 0.002

RelDir_dum 135 1.445 1.444 0.000 0.995 126 1.388 1.306 -0.082 0.103

RelMan_dum 140 1.415 1.460 0.045 0.392 131 1.396 1.310 -0.086* 0.077

Panel C: Private firms

Rel_dum 85 1.522 1.520 -0.002 0.980 55 1.596 1.335 -0.261** 0.013

RelDir_dum 64 1.509 1.464 -0.045 0.550 46 1.720 1.346 -0.374*** 0.000

RelMan_dum 64 1.499 1.446 -0.052 0.489 46 1.743 1.358 -0.385*** 0.000

Panel D: Observations with low separation between voting rights and cash flow rights of ultimate owners

Rel_dum 104 1.434 1.388 -0.046 0.487 73 1.482 1.305 -0.177*** 0.010

RelDir_dum 67 1.468 1.531 0.063 0.465 50 1.333 1.396 0.063 0.439

RelMan_dum 73 1.435 1.552 0.116 0.163 53 1.391 1.381 -0.010 0.899

Panel E: Observations with high separation between voting rights and cash flow rights of ultimate owners

Rel_dum 40 1.505 1.400 -0.106 0.315 25 1.543 1.277 -0.265** 0.050

RelDir_dum 32 1.394 1.250 -0.144 0.140 27 1.773 1.235 -0.538*** 0.000

RelMan_dum 27 1.401 1.280 -0.121 0.281 26 1.786 1.245 -0.541*** 0.000

Table 4: Descriptive statistics This table reports the descriptive statistics of all variables in the regression analysis. Tobin’s Q is the ratio of the firm’s market value to the replacement cost of its assets, where market value is the market value of common stock plus the book value of preferred stock and debt, and the replacement cost of asset is the book value of total assets. Rel_dum is a dummy variable equal to one if the NCLS are correlated to the controlling shareholder, and zero otherwise. Rel_share is the aggregated ownership of relational shareholders. RelDir_dum is a dummy variable equal to one if one or more directors is appointed by the relational shareholders in the firm, and zero otherwise. RelDir_rat is the ratio of directors appointed by relational shareholders to the size of the board. RelMan_dum is a dummy variable equal to one if there are one or more directors and officers appointed by the relational shareholders in the firm and zero otherwise. RelMan_rat is the ratio of officers appointed by relational shareholders to the size of the management. RelDir_str is the ratio of RelDir_rat to Share_rela. RelMan_str is the ratio of RelMan_rat to Share_rela. SOE is a dummy variable equal to one if it is a state-owned company, and zero otherwise. Separation is the ratio of voting rights to cash flow rights of the controlling coalitions. Debt is the ratio of debt to total asset at the end of fiscal year. Size is the natural log of total assets at the end of fiscal year. ROA is the ratio of annual net income to the average assets at the end of year t and t+1. Growth is the income of year t minus income of year t-1, divided by the income of year t-1. Risk is the standard deviation of daily stock returns for a fiscal year. Age is the natural log of number of years since firm inception. Share_top1 is the ownership of controlling shareholder. Manage_top1 is the ratio of directors and officers appointed by the controlling shareholder to the size of the management. Share_block is the aggregated ownership of blockholders other than relational shareholders. Manage_block is the ratio of directors and officers appointed by NCSL other than relational shareholders to the size of the management. Compensation is the natural log of total compensation for directors, supervisors, and managers. All variables are winsorized at the 5% and 95% percentile. The sample consists of 9323 firm-year observations listed in the Chinese stock market in the period from 2002 to 2008. The p-values are in parentheses. ***,**,* denote statistical significance at the 1%, 5% or 10% level, respectively. Panel A: Descriptive statistics (N=9323)

variable mean sd min p25 p50 P75 max variable mean sd min p25 p50 P75 max

Rel_dum 0.28 0.45 0.00 0.00 0.00 1.00 1.00 Assets 2.68 2.84 0.36 0.85 1.56 3.20 11.31

Rel_share 0.02 0.05 0.00 0.00 0.00 0.01 0.18 ROA 0.03 0.06 -0.13 0.01 0.03 0.06 0.13

RelDir_dum 0.14 0.35 0.00 0.00 0.00 0.00 1.00 Growth 0.18 0.32 -0.39 0.00 0.15 0.34 0.94

RelDir_rat 0.02 0.05 0.00 0.00 0.00 0.00 0.17 Risk 6.53 2.50 3.05 4.42 5.96 8.52 11.43

RelMan_dum 0.15 0.36 0.00 0.00 0.00 0.00 1.00 Age 10.86 4.02 1.00 8.00 11.00 14.00 28.00

RelMan_rat 0.01 0.03 0.00 0.00 0.00 0.00 0.13 Share_top1 0.39 0.16 0.16 0.26 0.37 0.52 0.68

RelDir_str 0.17 0.46 0.00 0.00 0.00 0.00 1.72 Direct_top1 0.23 0.16 0.00 0.11 0.22 0.33 0.56

RelMan_str 0.15 0.39 0.00 0.00 0.00 0.00 1.47 Manage_top1 0.18 0.12 0.00 0.08 0.17 0.28 0.43

Tobin’s q 1.36 0.49 0.89 1.02 1.18 1.50 2.77 Share_block 0.09 0.11 0.00 0.00 0.00 0.17 0.34

SOE 0.68 0.47 0.00 0.00 1.00 1.00 1.00 Manage_block 0.07 0.09 0.00 0.00 0.00 0.13 0.27

Separation 1.42 0.71 1.00 1.00 1.00 1.60 3.54 Compensation 1.67 1.31 0.29 0.70 1.25 2.21 5.19

Debt 0.50 0.19 0.17 0.37 0.51 0.64 0.86

Table 5: Relational NCLS and firm value: Multivariate regression This table reports the effect of the presence, ownership, and authority of relational NCLS on firm value. The dependent variable is Tobin’s Q. Definitions of variables are the same as Table 4. All variables are winsorized at the 5% and 95% percentile. The sample consists of 9323 firm-year observations listed in the Chinese stock market in the period from 2002 to 2008. The p-values are in parentheses. ***,**,* denote statistical significance at the 1%, 5% or 10% level, respectively. (1) (2) (3) (4) (5) (6) (7) (8)

Rel_dum -0.022*

(0.074)

Rel_share -0.254**

(0.036)

RelDir_dum -0.043***

(0.007)

RelDir_rat -0.322***

(0.009)

RelMan_dum -0.043***

(0.005)

RelMan_rat -0.436***

(0.008)

RelDir_str -0.022*

(0.065)

RelMan_str -0.027**

(0.045)

SOE -0.026* -0.027* -0.027* -0.027* -0.027* -0.026* -0.026* -0.026*

(0.072) (0.064) (0.067) (0.067) (0.067) (0.069) (0.074) (0.076)

Debt 0.007 0.007 0.004 0.004 0.006 0.005 0.005 0.006

(0.886) (0.882) (0.923) (0.926) (0.903) (0.913) (0.916) (0.903)

Size -0.209*** -0.209*** -0.210*** -0.209*** -0.210*** -0.209*** -0.209*** -0.209***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

ROA 1.248*** 1.259*** 1.257*** 1.258*** 1.256*** 1.256*** 1.249*** 1.249***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Growth -0.008 -0.007 -0.008 -0.008 -0.007 -0.007 -0.008 -0.008

(0.577) (0.586) (0.567) (0.562) (0.590) (0.586) (0.564) (0.578)

Risk 0.023*** 0.023*** 0.023*** 0.023*** 0.023*** 0.023*** 0.023*** 0.023***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Age 0.090*** 0.086*** 0.087*** 0.087*** 0.086*** 0.087*** 0.091*** 0.091***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Share_top1 -1.326*** -1.318*** -1.326*** -1.325*** -1.325*** -1.323*** -1.324*** -1.325***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Share_top12 1.227*** 1.201*** 1.222*** 1.221*** 1.220*** 1.218*** 1.235*** 1.237***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Manage_top1 0.112** 0.107** 0.102** 0.099** 0.101** 0.100** 0.107** 0.107**

(0.018) (0.024) (0.035) (0.038) (0.037) (0.037) (0.027) (0.027)

Share_block -0.278*** -0.287*** -0.282*** -0.282*** -0.285*** -0.283*** -0.270*** -0.271***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Manage_block -0.208*** -0.224*** -0.214*** -0.219*** -0.214*** -0.220*** -0.206*** -0.205***

(0.002) (0.001) (0.001) (0.001) (0.001) (0.001) (0.002) (0.002)

Compensation 0.035*** 0.035*** 0.036*** 0.036*** 0.036*** 0.036*** 0.035*** 0.035***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Constant 5.319*** 5.343*** 5.332*** 5.333*** 5.332*** 5.332*** 5.319*** 5.318***

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Observations 9,323 9,323 9,323 9,323 9,323 9,323 9,323 9,323

Adjusted R2 0.518 0.518 0.519 0.518 0.519 0.519 0.518 0.518

Table 6: Agency problem, relational NCLS and firm value: Panel A reports the effect of (a) the interaction of ultimate property type and relational NCLS on firm value; and (b) the interaction of separation of voting rights and cash flow rights of ultimate owners and relational NCLS on firm value. Panel B reports the effect of the presence, ownership, and authority of relational NCLS on firm value in different subsamples according to: (a) the property of ultimate owners; and (b) the separation of voting rights and cash flow rights of ultimate owners. Definitions of variables are the same as Table 4. All variables are winsorized at the 5% and 95% percentile. The sample in columns (a) and (b) consists of 9013 and 7598 firm-year observations listed in the Chinese stock market in the periods from 2002 to 2008, and from 2003 to 2008, respectively. The p-values are in parentheses. ***,**,* denote statistical significance at the 1%, 5% or 10% level, respectively.

Panel A: Interaction analysis

(a) interacting SOE (b) interacting Separation Variables Tobin’s Q Variables Tobin’s Q (1) Rel_dum -0.055(0.013)** Rel_dum -0.011(0.474) SOExRelaDum 0.047(0.068)* SeparationxRelaDum -0.001(0.512)

(2) Rel_share -0.305(0.022)** Rel_share -0.242(0.138) SOExRelaShare 0.108(0.559) SeparationxRelaShare 0.000(0.998)

(3) RelDir_dum -0.081(0.001)*** RelDir_dum -0.024(0.291) SOExRelaDirDum 0.064(0.039)** SeparationxRelaDirDum -0.002(0.172)

(4) RelDir_rat -0.589(0.001)*** RelDir_rat -0.200(0.257) SOExRelaDirRat 0.477(0.046)** SeparationxRelaDirRat -0.013(0.307)

(5) RelMan_dum -0.077(0.001)*** RelMan_dum -0.025(0.249) SOExRelaManDum 0.057(0.056)* SeparationxRelaManDum -0.002(0.160)

(6) RelMan_rat -0.825 (0.001)*** RelMan_rat -0.259(0.257) SOExRelaManRat 0.658(0.040)** SeparationxRelaManRat -0.022(0.187)

(7) RelDir_str -0.045(0.018)** RelDir_str -0.006(0.692) SOExRelaDirStr 0.039(0.106) SeparationxRelaDirStr -0.002(0.178)

(8) RelMan_str -0.062(0.006)*** RelMan_str -0.014(0.479) SOExRelaManStr 0.055(0.047)** SeparationxRelaManStr -0.002(0.299) Observations 9,013 Observations 7598 Panel B: Subsample analysis (a) Property of ultimate owners (b) Separation of ultimate owners SOE Private firms Separation=0 Separation>0 (1) Rel_dum -0.011(0.422) -0.033(0.185) -0.011(0.515) -0.025(0.208)(2) Rel_share -0.157(0.288) -0.342(0.124) -0.133(0.476) -0.348(0.046)**(3) RelDir_dum -0.018(0.384) -0.057(0.043)** -0.019(0.465) -0.065(0.004)***(4) RelDir_rat -0.116(0.479) -0.454(0.029)** -0.172(0.409) -0.468(0.007)***(5) RelMan_dum -0.022(0.240) -0.056(0.046)** -0.026(0.276) -0.061(0.007)***(6) RelMan_rat -0.186(0.372) -0.670(0.024)** -0.231(0.383) -0.688(0.003)***(7) RelDir_str -0.007(0.658) -0.024(0.241) -0.008(0.682) -0.031(0.058)*(8) RelMan_str -0.010(0.565) -0.039(0.116) -0.014(0.521) -0.041(0.027)** Observations 6345 2668 4094 3504

Table 7: Relational NCLS, agency problem, and firm value: 2SLS regression This table reports the results of a 2SLS regression of relational NCLS and agency problem on firm value. Panel A reports the effect of ownership and authority of relational NCLS on firm value. Panel B reports the results of interacting: (a) SOE and relational ownership/authority; and (b) Separation and relational ownership/authority on firm value. Panel C reports the results of 2SLS regression in subsample according to: (a) the property type of ultimate owners; and (b) the separation of voting rights and cash flow rights of ultimate owners. Definitions of variables are the same as Table 4. All variables are winsorized at the 5% and 95% percentile. The sample in columns (a) and (b) consists of 9013 and 7598 firm-year observations listed in the Chinese stock market in the periods from 2002 to 2008, and from 2003 to 2008, respectively. The p-values are in parentheses. ***,**,* denote statistical significance at the 1%, 5% or 10% level, respectively.Panel A: Ownership/authorities of relational shareholder and firm value: 2SLS regression

Variables Rel_share RelDir_rat RelMan_rat RelDir_str RelMan_str

1st stage Promotion 0.009*** 0.400** 0.003** 0.045** 0.043**

(0.001) (0.015) (0.032) (0.021) (0.011)

2nd stage Tobin’s Q -0.983 -0.407** -0.512* -0.056* -0.068*

(0.531) (0.048) (0.055) (0.055) (0.065)

Observations 9,323 9,323 9,323 9,323 9,323

Panel B: Agency problem, relational NCLS and Tobin’s q: interaction analysis (2nd stage)

(a) interacting SOE (b) interacting Separation Variables Tobin’s Q Variables Tobin’s Q (1) Rel_share -1.915(0.447) Rel_share -14.348(0.385) SOExRelaShare 1.672(0.479) SeparationxRelaShare 7.671(0.392) (2) RelDir_rat -0.876(0.030)** RelDir_dum -0.041(0.379) SOExRelaDirRat 0.753(0.067)* SeparationxRelaDirDum -0.001(0.631) (3) RelMan_rat -1.100(0.037)** RelDir_rat -0.339(0.334) SOExRelaManRat 0.921(0.083)* SeparationxRelaDirRat -0.005(0.811) (4) RelDir_str -0.145(0.027)** RelMan_dum -0.032(0.446) SOExRelaDirStr 0.137(0.033)** SeparationxRelaManDum -0.002(0.466) (5) RelMan_str -0.189(0.030)** RelMan_rat -0.342(0.439) SOExRelaManStr 0.179(0.035)** SeparationxRelaManRat -0.017(0.520) Observations 9,013 Observations 7,598

Panel C: Agency problem, relational NCLS and Tobin’s q: Subsample analysis (2nd stage)

(a) Property of ultimate owners (2) Separation of ultimate owners Variables SOE Private firms Separation =0 Separation>0 (6) Rel_share 2.402 -2.619 5.166 -7.872** (0.453) (0.148) (0.297) (0.026) (7) RelDir_rat -0.234 -0.578 -0.206 -0.604* (0.351) (0.145) (0.516) (0.052) (8) RelMan_rat -0.287 -0.750 -0.256 -0.735* (0.366) (0.151) (0.521) (0.067) (9) RelDir_str -0.028 -0.088 -0.024 -0.090* (0.401) (0.146) (0.581) (0.051) (10) RelMan_str -0.032 -0.115 -0.028 -0.106* (0.432) (0.150) (0.609) (0.061) Observations 6345 2668 4,094 3504

Table 8: Relational NCLS and firm value: Robustness check This table reports the results of a robustness test of the effect of relational NCLS on firm value. Annual cumulated abnormal return, CAR, is calculated as the monthly raw return on a stock, minus the corresponding monthly value-weighted market return. Annual buy-holder return is calculated following the approach of Loughran and Ritter (1995), and is based on monthly returns for each firm. Definitions of independent variables are the same as Table 4. All variables are winsorized at the 5% and 95% percentile. The sample consists of 9323 firm-year observations listed in the Chinese stock market in the period from 2002 to 2008. The p-values are in parentheses. ***,**,* denote statistical significance at the 1%, 5% or 10% level, respectively.

Dependent Variable Rel_dum Rel_share RelDir_rat RelMan_rat RelDir_str RelMan_str N

1. CAR -0.014** -0.002*** -0.002*** -0.002*** -0.013** -0.014** 9,314

(0.013) (0.002) (0.002) (0.004) (0.020) (0.027)

2. Buy-hold return -0.019** -0.002*** -0.002*** -0.003*** -0.009* -0.018** 9,314

(0.012) (0.010) (0.005) (0.008) (0.058) (0.048)

3. Robust regression -0.012** -0.001*** -0.002*** -0.002*** -0.017*** -0.018*** 9,323

(0.020) (0.008) (0.000) (0.001) (0.001) (0.002)

4. Fixed-effect -0.120*** -1.621*** -0.871*** -1.362*** -0.051*** -0.073*** 9,323

(0.000) (0.000) (0.000) (0.000) (0.001) (0.000)

5. Random-effect -0.073*** -0.815*** -0.720*** -1.043*** -0.047*** -0.061*** 9,323

(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)