Connected Party
Transaction
Stephen Yan-leung Cheung
School of Business
Hong Kong Baptist University
Hong Kong
Contents



Corporate governance Research in Hong Kong
Corporate governance Research in China
Policy work
Corporate Governance in Hong Kong- Introduction
“...China Logistics Group (00217) to confess that millions of dollars has
gone missing from its coffers.... The bulk of the cash is suspected to
have vanished across the border.... A HK$ 200 million deposit paid
out for the acquisition of Shanghai Pudong CNCC Logistics
Development was missing... while the money left China logistics, it
was allegedly never received by the vendor.”
South China Morning Post, 18 September 2002.
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in
Hong Kong. Journal of Financial Economics, 82, 363-386
Corporate Governance - Introduction
Companies with concentrated ownership:
 Extract cash by selling assets, goods, or services
 Obtain loans on preferential terms
 Assets transfer
 Dilute the minority shareholders’ interests
A connected transaction is
a) Any transaction between a listed issuer or any of its subsidiaries and a
connected person; and
b) An acquisition or realisation by a listed issuer or any of its subsidiaries of an
interest in a company, a substantial shareholder of the listed acquiring or
realising issuer or any of its subsidiaries of the listed issuer or any of its
subsidiaries
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in
Hong Kong. Journal of Financial Economics, 82, 363-386
Types of Connected Transactions
1)
2)
3)
4)
5)
6)
7)
8)
9)
10)
Asset acquisition
Asset sales
Equity sales
Trading relationships
Cash payments
Cash receipts
Subsidiary relationships
Takeover & joint-ventures
J V stake acquisition
J V stake sales
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in Hong
Kong. Journal of Financial Economics, 82, 363-386
Corporate Governance - Objectives
1)
2)
3)
What are the valuation effects of different types of connected
transactions?
What are the characteristics of firms more likely to expropriate?
Does the market anticipate the expropriation by firms?
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in Hong
Kong. Journal of Financial Economics, 82, 363-386
Observations
1)
2)
3)
2 times more assets acquisition than asset sales; cash from listed
companies to its controlling owners
3.5 times more in providing cash assistance to third parties as
opposed to receiving assistance
Terms are unfavorable (acquiring at a premium or selling at a
discount) for most deals when information are available
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in Hong
Kong. Journal of Financial Economics, 82, 363-386
Results

Short term – Average of -3.4% during
a period of 10 days after
announcement
Sales of equity stake
-11.8%

Long term – Average of -12.6% during
a period of 12 months after
announcement
Sales of assets
-21.9%
Sales of assets
-6.4%
Trading relationships
-21.8%
Acquiring of assets
-7.5%
Cash payment
-18.7%
Trading relationships
-7.5%
Takeover & JV
-29.8%
Selling JV
-6.1%
Selling JV
-17.2%
Cash payment
-2.5%
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in Hong
Kong. Journal of Financial Economics, 82, 363-386
All Connected
All connected
CARs
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-12
-9
-6
-3
0
3
Month
6
9
12
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in Hong
Kong. Journal of Financial Economics, 82, 363-386
Returns Are





Negatively related to percentage ownerships by the main shareholders
Negatively related to proxies for information disclosure
 Value of transaction
 Independent financial advisor
 Big 5 as auditing firm
Likelihood of undertaking connected transactions is higher
 Ultimate owners can be traced to mainland China
Likelihood of not disclosing the value of the deal and likelihood of violating
the listing rules are higher for
 Mainland China ownership
 Concentrated ownership
Variables of Corporate governance do not have any impact
 Audit committee
 Number of independent non-executive directors
 CEO duality
Cheung, Y. L., P. R. Rau, and A. Stouraitis. 2006.
Tunneling, Propping and Expropriation Evidence from Connected Party Transactions in Hong Kong.
Journal of Financial Economics, 82, 363-386
Corporate Governance- Hong Kong

The Evidence
 Market reacted very negatively by the listed firms when they
announced different types of related party transactions

The Question
 What is the process through which controlling shareholders
extract resources from publicly listed firms they control?
Cheung, Y. L., Y. Qi, P. R. Rau, and A. Stouraitis. 2008
Buy High, Sell Low: How Listed Firms Price Asset Transfers in Related Party
TransactionsJournal of Banking and Finance, forthcoming
Fair Value


Asset acquisitions
Asset sales
between


Related parties
Arms’ length (non related parties)
Fair Value Estimation
 Problems
 Not publicly listed firms
 No observable market value
 “Fair” value is a function of accounting book value and past operating
earnings of these assets

Controlling shareholders appear to benefit directly at the expense of publicly
listed firms by selling (acquiring) assets to (from) them at high (low) market
price
Cheung, Y. L., Y. Qi, P. R. Rau, and A. Stouraitis. 2008
Buy High, Sell Low: How Listed Firms Price Asset Transfers in Related Party Transactions
Journal of Banking and Finance, forthcoming
Do Corporate Governance Practices Matter?

Corporate governance variables have limited impact on the
pricing of the deal. Only firm with an audit committee on the
board and firms with large number of analysts following conclude
related party transaction at a more favorable price
Cheung, Y. L., Y. Qi, P. R. Rau, and A. Stouraitis. 2008
Buy High, Sell Low: How Listed Firms Price Asset Transfers in Related Party Transactions
Journal of Banking and Finance, forthcoming
Corporate Governance -China
This paper examines a sample of 292 related party transactions between
Chinese publicly listed firms and their controlling shareholders obtained
from filings submitted to stock exchange authorities during 2001–2002.
 characteristics of firms that conduct different types of related party
transactions. On balance, there seems to be more tunneling than propping
up in our sample.
 significant differences in the information disclosure between tunneling and
propping up related party transactions.
 majority of firms in our sample experience a reduction in firm value at the
announcement of related party transactions.
 Our robustness tests show that this reduction in value is not present in
similar arms' length transactions.
Yan-Leung Cheung, Lihua Jing, Tong Lu, Raghavendra Rau,, Aris Stouraitis (2009) ”Tunneling and
propping up: An analysis of related party transactions by Chinese listed companies”, Pacific
Basin Finance Journal
Valuation effects of different types of related party
transactions in China 2001-2002
CAR [-1,+1]%
CAR [-2,+2]%
CAR [-2,+5]%
Type of ownership
All types of state
ownership (N=196)
Mean
Median
−0.3 (0.204)
−0.5 (0.020)**
−0.6(0.018)**
−0.5 (0.004)***
−0.6 (0.028)**
−0.7 (0.011)**
Central Govt state
ownership (N=39)
Mean
Median
−0.1 (0.799)
−0.2 (0.582)
-0.3(0.569)
-0.2(0.490)
-0.2(0.772)
0.1(0.917)
Local Govet state
ownership (N=161)
Mean
Median
−0.3 (0.181)
−0.5 (0.050)**
-0.3(0.257)
-0.3(0.053)*
-0.5(0.263)
-0.7(0.026)**
Private ownership
(N=79)
Mean
Median
0.5 (0.089)*
0.2 (0.068)*
2.4(0.219)
0.1(0.098)*
1.7(0.394)
0.1(0.786)
Foreign shareholder
Hshare ADR (N=15)
Mean
Median
0.8 (0.304)
0.1 (0.443)
2.8(0.059)*
2.0(0.029)**
3.4(0.300)
1.9(0.132)
Implications:
Two regulatory implications for emerging markets.
 We highlight the importance of foreign investors and cross-listing in
mitigating the expropriation of minority shareholders. These have
important implications for allowing foreign investors to participate in
emerging markets and in strengthening accounting standards in
these markets.
 Our results suggest that higher standards of disclosure with respect
to the transaction itself also help mitigate the expropriation of
minority shareholders through related party transactions.
Yan-Leung Cheung, Lihua Jing, Tong Lu, Raghavendra Rau,, Aris Stouraitis (2009) ”Tunneling
and propping up: An analysis of related party transactions by Chinese listed companies”,
Pacific Basin Finance Journal
Corporate Governance- China
Do minority shareholders in state-owned publicly listed firms benefit from the
presence of government shareholders and politically connected directors?
The helping hand hypothesis. Prior research has shown that shareholders in
firms with close ties to governments gain from political connections- borrow
on preferential terms from state-owned banks
The grabbing hand hypothesis. Corrupt government bureaucrats enrich
themselves by misappropriating funds from these firms or by demanding
lavish perks. The expropriation may be facilitated by the presence of
politically connected directors on company boards.
YAN-LEUNG CHEUNG , RAGHAVENDRA RAU and ARIS STOURAITIS
Helping Hand or Grabbing Hand? Central vs. Local Government Shareholders in Chinese
Listed Firms Review of Finance (2010) 14: 669–694
Corporate Governance- China
It is difficult to compute the “fair” value of assets changing hands in China,
we measure the transfer of value to (from) the listed firm by the abnormal
stock returns at the announcement times the firm’s market capitalization
over the announced size of the deal. We find
•Helping hand hypothesis, related party transactions by firms with central
government connections appear to benefit the minority shareholders of
the listed firms.
•Grabbing hand hypothesis, for firms connected to local governmentstransfer of wealth from the minority shareholders to their state-owned
controlling shareholders.
•What is significant is the type of government shareholder (local or
central) and the political affiliation of the firm’s directors.
YAN-LEUNG CHEUNG , RAGHAVENDRA RAU and ARIS STOURAITIS
Helping Hand or Grabbing Hand? Central vs. Local Government Shareholders in Chinese Listed Firms Review of
Finance (2010) 14: 669–694
Corporate Governance- China
Who benefits from the expropriation?
•are not related to SOE or provincial economic performance (most of
the expropriation is concentrated in China’s richest provinces) and
therefore cannot be attributed to a social role motive
•are concentrated in provinces where local government bureaucrats are
less likely to be prosecuted for misappropriation of state funds,
suggesting that they are likely related to corruption.
YAN-LEUNG CHEUNG , RAGHAVENDRA RAU and ARIS STOURAITIS
Helping Hand or Grabbing Hand? Central vs. Local Government Shareholders in Chinese Listed Firms
Review of Finance (2010) 14: 669–694
Do Corporate Governance Practices Matter?
An article in the Wall Street Journal titled “Even good insider deals raise
doubts”
“… Such related-party transactions raise questions about
whether corporate insiders are fully focused on the
interests of shareholders, experts say. The deals, no
matter how small, can create the impression that insider is
using company assets for personal benefit, and that the
company is getting the short end of the stick. …”
Discussion

The quality of independent non-executive directors

Information disclosure

Regulatory framework
Thank you