Rights Issues in China as Evidence for the Existence of Two Types of Agency Problems

Abstract

This paper identifies the existence of two kinds of agency problem by focusing on rights issues by Chinese firms. It begins by examining the context in which state-designated managers are strongly encouraged by the government to provide funds for its use, often at the expense of their companies` interests. The statistics presented in this paper further show how Chinese managers transfer these cash funds, raised from their public shareholders, via rights issues, to the state as cash dividends. An empirical examination of 459 rights issues by Chinese firms from 1999 to 2004 shows how Chinese managers have inflated their earnings prior to rights issues in order to gain regulatory permission and thus process the cash transfers more smoothly. This is evidence of the first type of agency problem: managers behaving in a way that is against the interests of their shareholders. In addition, during rights issues. existing shareholders can purchase new shares at lower prices and as a result there is a substantial drop in both the firm`s share price and its returns. Wealth reallocation from the nation to subscribed shareholders occurs during this period, which implies that state-designated managers disregard this obligation to safeguard national assets. This practice is a sign of the second type of agency problem: Chinese state-designated managers violating the national interest for the sake of their own self-interest.