[Flashback] Tunneling Dividends

Click to access LeeXiao.pdf

Posted by John SOH Yong Ye, Year 4 undergrad at the School of Economics, Singapore Management University

Chi-Wen Jevons Lee, Xing Xiao (November 2004)

Numerous findings in the literature suggest that paying cash dividend mitigates agency problem
between majority shareholders and minority shareholders. Many common law countries require
mandatory cash dividend policy to protect minority shareholder’s interest. This paper provides
opposite evidence. We find that state dominant firms in China have high propensity to pay cash
dividend but low propensity to subscribe rights offering. Furthermore, state dominant firms often
increase cash dividend payment soon after rights offerings.

As state-held shares in China are
non-tradable, giving up subscription rights and using receipts from rights offering to pay cash
dividend are equivalent to selling a portion of the non-tradable shares by the majority
shareholders to the minority shareholders. The computed selling price is about three times higher
than that of officially approved private placement. Market reacts negatively to the cash dividend
announcement of state dominant firms, but positively to others. Our findings suggest that instead
of alleviating agency problem, cash dividend might be used as a vehicle for tunneling in state
dominant firms.


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