Seeing nearby companies getting punished for bad behavior may inspire the rest to behave better, research suggests. And that could have positive effects for shareholders, write Boston College’s Francesco D’Acunto, Chicago Booth’s Michael Weber, and Jin Xie of the Chinese University of Hong Kong.
To study this issue, the researchers looked to China, specifically at state-owned enterprises. Although China is transitioning to a more market-based economy, for many large corporations in strategic industries, the Chinese government is still their largest shareholder. This ownership structure makes SOEs less subject to the internal and external governance mechanisms that reign in wrongdoing. For example, senior executives or other shareholders might transfer company assets for personal gain, knowing that the government, as the main shareholder, can influence regulators to look the other way.
But public discipline could help, the study indicates. The researchers analyzed the effects of 254 instances, between 1997 and 2014, of companies being punished for excessively guaranteeing the loans of related parties. Loan guarantees are legal, but it’s illegal for a company or an SOE to issue loans to borrowers who are likely or even certain to default on them.
SOEs in the same province as a listed company punished by authorities cut their loan guarantees to private parties, reducing the amount of their guaranteed loans over total assets by 2.4 percent, the researchers find. These companies were also 43 percent more likely to move to more-independent corporate board structures, the study finds. “These results suggest SOEs react to the punishment of local peers by aligning their actions with the interests of minority shareholders,” write the researchers.
Moreover, the change in governance led to an increase in shareholder value. Stock market returns increased 1.5 percent in the 15 days after news of a peer being disciplined. While the returns for non-SOEs remained insignificantly negative during this time frame, returns for SOEs “increase significantly after the peer’s punishment and keep increasing,” write the researchers.
The crackdown also affected those private parties that were getting loans from SOEs; the research indicates that they cut their investments and reduced their bank borrowing by 5 percent of total assets.
The economic effects downstream suggest that SOEs aren’t likely to move to more-opaque forms of corporate malfeasance either—such as constructing a pyramidal scheme to transfer resources to a private, affiliated company—to get around regulators, the study indicates.
And the sobering effect of seeing a peer being punished may be a cost-effective way to contain fraud. “Regulators would only need to monitor and punish a small set of listed firms to obtain broad compliance, which reduces dramatically the costs of monitoring listed firms on the part of regulators and activist shareholders,” write the researchers.