institutions and organizational structure: the case of state-owned corporate pyramids
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Institutions and Organizational Structure: The Case of State-Owned Corporate Pyramids. Joseph P.H. Fan T.J. Wong Tianyu Zhang The Chinese University of Hong Kong. Emergence of Chinese State Owned Corporate Pyramids. - PowerPoint PPT PresentationTRANSCRIPT
Joseph P.H. Fan Organization and Value 1
Institutions and Organizational Structure:
The Case of State-Owned Corporate Pyramids
Joseph P.H. FanT.J. Wong
Tianyu Zhang
The Chinese University of Hong Kong
Emergence of Chinese State Owned Corporate Pyramids
Since the 1990s China witnessed a wave of enterprise restructuring in which state assets were spun off from parent state-owned enterprises (SOEs) and injected into their newly set up subsidiaries.
The organizational transformation is typically through several rounds of joint ventures established by SOEs and their subsidiaries with other government and SOE partners. A subsidiary may further spin off assets into another newly created subsidiary, and so on.
The system of state-owned companies forming China’s business groups is called “Multi-layer Legal Person System (多级法人制 )” (Wu, 2005).
Joseph P.H. Fan Organization and Value 3
Chinese Pyramids 4
SOE Under Old System
Central Govt
SOE
Chinese Pyramids 5
SOE Under New SystemCentral Govt
Local Govt / SAMB
Parent SOE / SAMC
Managers
Board of directorsListed SOE
Market competitions Product and jurisdictions
Outside Shareholders
Banks
CSRC,Judicial Courts
External auditors
Chinese Pyramids 6
Types of Control of SOEs in China
SAMB SAMB
Listed Firm Parent SOE/SAMC
Listed Firm
SAMB
Parent SOE
Intermediate Companies
Listed Firm
Joseph P.H. Fan Organization and Value 7
NINGBO VEKEN ELITE GROUP CO.,
LTD(600152)
NINGBO VEKEN
GROUP CO., LTD
NingBo Textile Holding
(Group) Co. LTD.
Ningbo Industry Investment
Co. LTD.
29.7%
17.5% 6.13%
93.19% 2.33%
Local Government
100% 100%
Pyramidal Organizational Structure in China
(Multi-layer Legal Person System)
Joseph P.H. Fan Organization and Value 10
Pyramidal Organizational Structure
X X
V=50%Y
V=20%Z
V=C=10%Z
V=C=50%Y
V = 20%, weakest link in the chain,C = 10%. Pyramid structure allows leveraging up in control
Joseph P.H. Fan Organization and Value 11
Why pyramiding? Highly popular around the world Why the owner builds pyramid is a puzzle Few theoretical and empirical works Morck, Wolfenzon, Young (2004); Khanna and
Yafeh (2005) Tax (Morck, 2005) Facilitating business group formation Relieving financial constraints while preserving
control (Almeida and Wolfenzon , 2006) Expropriation due to separating control from
ownership
Joseph P.H. Fan Organization and Value 12
Why Chinese build pyramids?
No prior research Ownership transfer restriction of SOEs precludes equity
financing and expropriation as primary motives Separation between ownership and control of SOEs is
small Cash flow over voting rights of common stocks
N Mean Median Std. Deviation Min Max
Government-controlled Firms
750 0.96 1.00 0.12 0.11 1.00
Privately-controlled Firms
62 0.54 0.52 0.23 0.14 1.00
Joseph P.H. Fan Organization and Value 13
Why pyramiding?Our new hypothesis
Credibly decentralizing decision rights within organization From a controlling owner (headquarter) to a local
(divisional) manager Intermediate layers associated with high information
cost, making the owner difficult to intervene the manager’s daily decision process
Compared with a horizontal control structure, a pyramidal structure allows local managers more autonomy in decision making
Joseph P.H. Fan Organization and Value 14
Theories of Firm Decentralization
Williamson (1985): decentralization provides manager high-power incentive
Jensen and Meckling (1992): the gain of decentralization arises from co-locating knowledge and decision rights
Credibility of decentralization depends on how costly is ex post intervention The IO literature emphasize information cost as a credible
commitment (Cremer, 1995; Aghion and Tirole, 1997; Baker, Gibbson, Murphy, 1999)
The extent of decentralization is constrained by the cost of losing control (agency problem)
Evidence is sparse: Baker (1992), Rajan and Wulf (2006)
Division of Power in SOEs
The government, lack of managerial expertise and information, will typically empower managers
Gain from the autonomy might be expropriated by managers – agency problem
However, empowering managers means lower government intervention – political cost
Optimal division of power should be the point where marginal agency cost equals marginal political cost
Joseph P.H. Fan Organization and Value 15
Joseph P.H. Fan Organization and Value 16
Ownership Transfer Restriction and Pyramiding of SOEs
The ownership restriction of SOEs prevents outright sales (such as M&As, MBOs) as a means to transfer decision rights that is common in markets of diffused ownership (Burkart, Gromb, Panuzi, 1997)
Pyramiding is a way of decentralizing business decision rights, or establishing real authority (Aghion and Tirole, 1997) as oppose to formal authority, short of actual transfer of ownership Compared with a policy order, decentralization through
pyramid is more credible to firm management Credible because of high information and bureaucratic
costs if the government intervenes ex post
Joseph P.H. Fan Organization and Value 18
This research focuses on local government controlled firms upon
their going publicYear Total
1 2 3 >=4
Before 1993 16 13 6 1 36 67.92%
1993 54 34 5 0 93 75.00%
1994 42 32 5 0 79 71.17%
1995 7 8 2 0 17 70.83%
1996 33 82 18 0 133 65.84%
1997 24 94 14 2 134 65.05%
1998 8 59 7 0 74 69.81%
1999 6 43 10 2 61 62.24%
2000 7 50 6 2 65 47.45%
2001 3 37 9 1 50 63.29%
Total 200 452 82 8 742 65.09%
Number of pyramidal Layers As a percenterage of total IPO firms
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China – One Country, Many Systems
Protection for property rights
HighMiddleLow Missing
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Predictions of the Extent of Pyramidal Layers Controlling a Publicly Listed SOE
A government owner’s (whose transfer rights is restricted) pyramiding (decentralization) decision is affected by his conflict with the firm in objective and the degrees of managerial agency problem Regional unemployment problem (-) Fiscal health (+) Government long-term incentive (R&D and education
expenditure) (+) The degree of conflicts of interest reduces when the
market and the laws provide strong disciplines Regional market development (+) Regional legal environment (+) Regional property rights protection (+) Government deregulation (+)
Joseph P.H. Fan Organization and Value 22
Empirical Design
Regression (probit) analysis to find the determinants of pyramids
Regression analysis to find whether firm performance/productivity is related to the pyramidal control structure
Joseph P.H. Fan Organization and Value 23
Determinants of pyramids (probit regressions)
Independent Variables (1) (2) (3) (4) (5) (6) (7) (8)Institutions 0.108
(2.89)***Marketization 0.094
(2.37)**Legal Environment 0.201
(3.76)***Property Rights 0.127
(3.05)***Deregulation 0.252
(2.53)**Incentive 0.095
(2.19)**Unemploy rat -0.123
(3.65)***Fiscal Surplus 0.539
(2.35)**R&D 0.109
(3.01)***Total Assets 0.187 0.142 0.177 0.173 0.183 0.184 0.199 0.142
(2.97)*** (2.50)** (3.04)*** (2.67)*** (3.17)*** (3.18)*** (3.31)*** (2.38)**Leverage 0.018 0.015 0.010 0.009 0.019 0.018 0.020 0.014
(0.52) (0.40) (0.28) (0.24) (0.55) (0.50) (0.55) (0.37)M/B 0.043 0.037 0.040 0.038 0.044 0.040 0.049 0.034
(1.34) (1.13) (1.26) (1.19) (1.33) (1.19) (1.53) (1.04)Regulated Industry 0.110 0.073 0.099 0.094 0.116 0.138 0.129 0.087
(0.71) (0.45) (0.58) (0.64) (0.68) (0.86) (0.78) (0.54)N 742 742 742 739 742 742 742 739Pseudo R-square 0.084 0.097 0.090 0.093 0.084 0.088 0.084 0.099
Joseph P.H. Fan Organization and Value 24
Independent Variable(1) (2) (3) (1) (2) (3)
Commercial Port 1.967 1.135(3.95)*** (1.81)*
Leased Territory 2.103 1.320(4.09)*** (2.01)*
Institutions 0.100 0.076 0.086(2.52)** (2.25)** (2.63)***
Incentive 0.146 0.142 0.143(3.47)*** (3.32)*** (3.39)***
Total Assets 0.160 0.164 0.160(2.93)*** (2.83)*** (2.86)***
Leverage 0.020 0.021 0.020(0.55) (0.58) (0.57)
M/B 0.038 0.038 0.037(1.14) (1.13) (1.11)
Regulated Industry 0.108 0.117 0.112(0.62) (0.69) (0.65)
Constant -1.595 -1.439 -1.678(4.79)*** (4.77)*** (5.27)***
Observations 29 29 29 742 742 742Adjusted (Pseudo) R-square 0.34 0.36 0.41 0.092 0.091 0.092
First Stage Second Stage
Two-stage model
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Control Pyramids and Managerial Professionalism
More decentralized firms, more managerial professionalism
More decentralized firms, higher productivity
We do not claim causality
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Pyramidal Structures and Management Professionalism
CEO and ChairmanProfessionalism Political Connection
(1) (2) (3) (4)
Pyramid 0.554 0.532 0.085 0.072
(2.84)*** (2.97)*** (0.49) (0.44)
Aggregate Institutions
-0.066 -0.080
(1.01) (0.95)
Aggregate Incentive 0.173 0.071
(1.13) (0.83)
N 625 622 625 622
Pseudo R square 0.097 0.100 0.062 0.063
Joseph P.H. Fan Organization and Value 27
Pyramidal Structures and Management Professionalism
Board of Directors Professionalism Political Connection
(1) (2) (3) (4)
Pyramid 0.077 0.080 0.014 0.016
(4.48)*** (4.33)*** (0.81) (0.96)
Aggregate Institutions
-0.007 -0.005
(1.33) (0.80)
Aggregate Incentive 0.002 0.004
(0.15) (0.68)
N 645 642 645 642
Adjusted R square 0.19 0.20 0.11 0.11
Joseph P.H. Fan Organization and Value 28
Pyramidal Structures and Employment Efficiency
Employee Employee
(1) (2)
Pyramid -1.409 -1.161
(2.88)*** (2.93)***
Aggregate Institutions -0.662
(4.48)***
Aggregate Incentive -0.034
(0.17)
N 617 614
Adjusted R-squared 0.19 0.20
Joseph P.H. Fan Organization and Value 29
Structures and Total Factor Productivity
Output Output
(1) (2)
Pyramids 0.088 0.075
(1.72)* (1.75)*
Aggregate Institutions 0.048
(1.40)
Aggregate Incentive 0.069
(2.13)**
Labour 0.197 0.202
(5.46)*** (6.47)***
Capital 0.513 0.516
(8.57)*** (9.34)***
Observations 1922 1913
Adjusted R-squared 0.41 0.43
Joseph P.H. Fan Organization and Value 30
Pyramidal Structures and Tobin’s Q
Tobin's Q Tobin's Q
(1) (2)
Pyramids 0.086 0.058
(1.76)* (1.09)
Aggregate Institutions 0.040
(1.80)*
Aggregate Incentive 0.025
(0.99)
Observations 562 559
Adjusted R-squared 0.34 0.34
Pyramidal Structures and Accounting Returns
Joseph P.H. Fan Organization and Value 31
ROS ROS ROA ROA
(1) (2) (3) (4)Layers 0.018 0.021 0.005 0.006
(1.73)* (2.27)** (1.47) (1.77)*Aggregate Institutions -0.006 -0.002
(2.44)** (0.67)Aggregate Incentives -0.008 -0.002
0.007 0.007 -0.030 -0.030Financial Leverage (0.85) (0.83) (11.97)*** (11.75)***
0.005 0.009 0.012 0.013Firm Size (0.68) (1.22) (6.98)*** (7.27)***
0.011 0.012 0.007 0.008Growth (4.37)*** (4.43)*** (6.49)*** (7.24)***
0.148 0.151 0.016 0.017Regulated (8.90)*** (9.01)*** (3.00)*** (3.16)***
(1.22) (1.98)**Constant -0.010 -0.090 -0.177 -0.200
(0.06) (0.57) (4.93)*** (5.13)***Observations 2224 2215 2224 2215Adjusted R-squared 0.32 0.33 0.43 0.44
Survey of Bureaucrats in State Asset Management Systemthe response from 15 government bureaucrats in state assets management system with regards to control of firms under different structure.
1 - if the government has more control of firm A’s particular decision than firm B’s.
0 - if the government has the same level of control over firm A and B’s decision.
-1 - if the government has more control of firm B’s decision than firm A’s.
Joseph P.H. Fan Organization and Value 32
Government
Firm A
Government
Parent SOE
Firm B
Survey among bureaucrats in state assets management system
Joseph P.H. Fan Organization and Value 33
Question N Mean Median Std.Dev. Min Max
Long-term strategic decisionsSet production plans 15 0.53*** 1*** 0.52 0 1Make investment decisions 15 0.93*** 1*** 0.26 0 1Appoint executives 11 0.64** 1** 0.81 -1 1Set dividend policy 15 0.67*** 1*** 0.72 -1 1Closure/sell of subsidiary 15 0.67*** 1*** 0.72 -1 1Pay equity compensation to executives 15 0.73*** 1*** 0.70 -1 1Borrow loans from banks 15 0.27 1 0.88 -1 1Raise additional capital from stock market 15 0.80*** 1*** 0.41 0 1M&A activities 15 0.67*** 1*** 0.62 -1 1
Short-term operating decisionsPurchase raw material 14 0.14 0 0.53 -1 1Purchase electricity and other energy input 14 0.29** 0** 0.47 0 1Set product prices 14 0.14 0 0.53 -1 1Choose customers 14 0.21* 0* 0.43 0 1Choose suppliers 14 0.29** 0* 0.47 0 1Set bonus level 14 0.29 0 0.61 -1 1Set salary level 14 0.14 0 0.77 -1 1Set bonus differentials 14 0.36* 0* 0.63 -1 1Recruit employees 14 0.29** 0** 0.47 0 1Dismiss employees 14 0.29** 0** 0.47 0 1
Survey of Senior managers
12 responses from SOEs and 19 from non-SOEs.
Does government set limit on a particular firm decision
1-No limit; 2-Some limit; 3-Many limits; 4-Completely limit
Joseph P.H. Fan Organization and Value 34
Survey among senior management
Joseph P.H. Fan Organization and Value 35
State-owned Enterprises
Non SOEs(N=19)
One layer (N=3)Two Layers
(N=4)More than two layers
(N=5)
Long-term strategic decisions Mean Median Mean Median Mean Median Mean MedianSet production plans 2.00 2.00 1.50 1.50 1.60 1.00 1.16 1.00Make investment decisions 3.00 3.00 2.50 3.00 2.20 2.00 1.32 1.00Appoint executives 3.67 4.00 2.75 3.00 2.80 3.00 1.05 1.00Set dividend policy 2.00 2.00 2.50 2.50 1.80 1.00 1.21 1.00Closure/sell of subsidiary 3.33 3.00 2.25 2.50 2.20 2.00 1.37 1.00Pay equity compensation to executives 3.00 3.00 2.75 3.00 2.60 3.00 1.05 1.00Borrow loans from banks 2.33 2.00 1.50 1.00 1.80 1.00 1.42 1.00Raise additional capital from stock market 3.00 4.00 2.50 2.50 2.20 2.00 2.21 2.00M&A activities 3.00 3.00 2.50 2.50 2.40 2.00 1.68 1.00Mean of long-term strategic decisions 2.81 2.89 2.31 2.39 2.18 1.78 1.39 1.33
Short-term operating decisionsPurchase raw material 1.00 1.00 1.25 1.00 1.20 1.00 1.00 1.00Purchase electricity and other energy input 1.50 1.50 1.25 1.00 1.20 1.00 1.32 1.00Set product prices 2.67 3.00 1.75 1.00 1.80 1.00 1.05 1.00Choose customers 2.00 2.00 1.00 1.00 1.20 1.00 1.00 1.00Choose suppliers 1.67 1.00 2.00 1.50 1.20 1.00 1.11 1.00Set bonus level 1.67 2.00 2.00 2.00 1.60 1.00 1.05 1.00Set salary differentials 2.00 2.00 2.25 2.50 1.80 2.00 1.58 1.00Set bonus differentials 1.67 1.00 1.75 1.50 1.40 1.00 1.06 1.00Recruit employees 1.67 2.00 1.25 1.00 1.40 1.00 1.11 1.00Dismiss employees 2.00 2.00 1.75 1.50 1.40 1.00 1.32 1.00Mean short-term decisions 1.85 2.25 1.63 1.45 1.42 1.10 1.16 1.10
Joseph P.H. Fan Organization and Value 36
Summary of Findings
The extent of a government-controlled pyramid is positively related to local government’s decentralization incentive
Positive relation between the pyramidal control structure and firm performance/efficiency
Positive relation between pyramidal control and managerial professionalism and productivity
Survey of bureaucrats and managers confirms our hypothesis
Joseph P.H. Fan Organization and Value 37
Conclusions and Future Research Implications
The pyramidal ownership structures of China’s state enterprises are fundamentally related to state ownership transfer restriction
It is the right to transfer, not cash flow or voting right, that is of first order importance in shaping owners’/managers’ incentives
We need more research on the effects of these (and other) property rights constraints on firm behaviors
How general are the results? Any state owned pyramids outside China? Can the decentralization explanation of pyramiding
behavior be generalized to private firms?