Tunneling in China

Numerous findings in the literature suggest that paying cash dividend mitigates the agency problem between controlling 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 whereas the controlling shareholders have low propensity to subscribe rights offering. Furthermore, state dominant firms often increase cash dividend payment soon after rights offerings. Our empirical analysis indicates that giving up subscription rights and using receipts from rights offering to pay cash dividend are equivalent to selling a portion of the non-negotiable shares by the controlling shareholders to the minority shareholders. The effective selling price through the combination of rights offering and cash dividends is about three times higher than what the controlling shareholders can get from elsewhere. Our findings suggest that instead of alleviating agency problem, cash dividend might be used by the controlling shareholders in China as a vehicle for tunneling.