Tunneling Dividends

Abstract

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.

Keywords: agency problem, cash dividends, corporate governance, rights offering, state dominant firms

JEL Classification: G34, G35, G38, M41