1、1Control Right & Cash Flow Right Divergence of Majority Shareholders Agency Cost and Effect of Tax EnAbstract. Based on the Enterprise Income Tax Reform in 2007， we empirically test the relationship between the control right and cash flow right divergence of majority shareholders and second type of
2、agency cost， and the governance effect of tax enforcement. We find that， higher tunneling motivation increases the agency cost between majority and minority shareholders. Furthermore， we find that as an effective external supervision mechanism， tax enforcement can alleviate the conflicts， reducing 2
3、nd type of agency cost. Key words： Control Right & Cash Flow Right Divergence of Majority Shareholders， Second Type of Agency Cost， Tax Enforcement， Tax Avoidance 1. Introduction In recent years， tunneling of majority shareholders prevails in Chinese capital market， causing great loss to minority sh
4、areholders. Prior studies indicate that expropriation or tunneling hurt long-term value of firms（Claessens et al.1）. Especially when the divergence of 2ownership and control of majority shareholders is larger， they have more motivations to tunneling， hurting firm value. The reasons causing above phe
5、nomenon may be due to the weakness of governance system， investor protection system etc. Therefore， it is of great urgency to enhance the corporate governance system. Some researchers find some proper ways to constrain tunneling of majority shareholders by empirical test， such as the enhancement of
6、legal system， investor protection system and audit market. While they may neglect the mirco-environment influence， such as tax enforcement. Theoretical analysis argues that the enhancement of tax enforcement may exert great effect on tunneling for the reason that tunneling of majority shareholders m
7、ay reduce the profit reporting to tax authority， and in order to increase tax revenue， tax authority will strengthen tax enforcement， and it may constrain the tunneling behavior of majority shareholders （Desai et al.2）. Therefore， this paper will thoroughly the effect of divergence of ownership and
8、control of majority shareholders on second type of agency cost， and the corporate governance effect of tax enforcement. 2. Literature Review and Hypothesis 3Prior studies argue that in regions where legal and investor protection system are weaker， the equity is always to be concentrated， making majo
9、rity shareholders have motivations to expropriate higher profit（Grossman and Hart3）. In detail， the influence of control right of majority shareholders on minority has two aspect， one is entrenchment effect and the other is incentive effect （Claessens et al. 1）. La Porta et al.4 find that control ri
10、ght of majority shareholders is the source of entrenchment effect， the higher control right， the more motivation to tunneling， causing great loss to firm value.However when the cash right of majority sharehloders is higher， the incentive effect prevails more， and with higher cash right， the motivati
11、on of tunneling will be constrained more. Claessens et al. 1find that performance is positively correlated with cash right， and negatively with control right. Rego and Wilson5 find that with larger divergence of control and cash right， majority shareholders will gain more profit with less cost， and
12、tax avoidance activities provide them a great tool to do so. Tunneling will cause great bad consequences， hurting firm value in the long run. Therefore some studies begin to find out the proper mechanism to constrain such expropriation behavior. 4La Porta et al.4 find that legal system may constrain
13、 majority tunneling behavior to some extent. Luo and Huang6 find that audit is a great mechanism to enhance the efficiency of capital market to protect investors. With the development of corporate governance， microeconomy factors begin to be the attention recently， for example Desai et al.2 when gov
14、ernment begins to strenghten tax enforcement， tunneling behavior of majority shareholders may be constrained to some degree. As above stated， we may hypothesize that with larger divergence of control and cash right， the agency cost between majority and minority shareholders will increase， and with t
15、he enhancement of tax enforcement， the tunneling behavior will be constrained and the agency cost will be reduced. 3. Research Design 3.1 Definition of Tax Aggressiveness Activities This paper will employ BTDi，t=1*Tai，t+i+i，t to calculate residual to capture the tax aggressiveness activities. Where
16、BTD=（income tax-deferred tax）/nominal tax rate. TAi，t is the total accruals. i+i，t is the fixed attributes of tax avoidance. TAi，t=（CAi，t-Cashi，t）-（CLi，t-STDi，t）- Depi，t， CAi，t is the incremental variable of current liability. Cashi，t is the incremental variable of 5cash. STDi，t is the incremental v
17、ariable of long-term liability which is due within one year. Depi，t is the depreciation. 3.2 Measurement of Divergence of Control Right and Cash Flow Right of Majority Shareholders We define Seper as Control Right minus Cash Right of Majority Shareholders to measure the divergence， obtaining data fr
18、om CSMAR database. 3.3 Measurement of 2nd type of Agency Cost We define second type of agency cost as occupation of fund of first shareholders/total assets， where occupation of fund of first shareholders=（receivables + prepayments +other receivables）-（payables+ receive in advance+ other payables）. 4
19、. Empirical Results 4.1 Sample Selection Our data is from CSMAR /CCER/WIMD database， and the data is based on Chinese listed companies from 2008-2011. Moreover， we first delete the samples of financial firms and firms which are ST. Then we delete missing observations. Next， we winsorize the sample b
20、y 1% and 99%. Overall， we obtain 2907 observations. 4.2 Description Statistics From Panel A， we may find 6that the main value of Seper is -0.0608， indicating that control right is higher than that of cash right. The main value of TE and AC are1.0019 and -0.0631 respectively. Meanwhile， from Panel B，
21、 we can see that Seper is positively correlated with AC， TE is negatively correlated with AC by Spearman and Pearson， initially supporting our assumption. 4.3 Basic Empirical Test： the Effect of Divergence of Control Right and Cash Flow Right of Majority Shareholders on Agency Cost We find in Table
22、2 that Seper is positively correlated with AC， indicating that majority shareholders with more motivation of tunneling may increase the agency cost， and further we find that in state-owned and non state-owned firms it shows the positive relation between the two. Chow s Test confirms the empirical re
23、sults. 4.4 Extensive Test： ： Tax Enforcement and Second Type of Agency Cost We find in Table 3 that TE is negatively correlated with AC， and further we classify the overall sample into two groups，one group is Seper is higher than the median value and the other is lower than the median value. After t
24、hat， we find in the group which Seper is higher than the median value， TE 7has not relation with AC. While in the other group， we find the negetive relation.Chow s Test confirms the empirical results. 4.5 Robustness Check In robustness check： （1） we find that CashR/VoteR is positively correlated wit
25、h AC and otherreceivable.（2） TE is negatively correlated with otherreceivable. No substantial change is made in robustness check. 5. Summary Based on the Enterprise Income Tax Reform in 2007， this paper empirically tests the relationship between the control right and cash flow right divergence of ma
26、jority shareholders and second type of agency cost， and the governance effect of tax enforcement. We find that， higher tunneling motivation increases the agency cost between majority and minority shareholders. Furthermore， we find that as an effective external supervision mechanism， tax enforcement
27、can alleviate the conflicts， reducing 2nd type of agency cost. From above empirical result， we suggest that government should exert great effort to carry out tax policies and to constrain the tax avoidance activities， so as to protect investors and enhance firm value to the greatest extent. 86. Ackn
28、owledgement This research was financially supported by Fundamental Research Funds for the Central Universities（No. B13JB00100）. References 1 Claessens， S.， S. Djankov， J.P.H. Fan and L.H.P. Lang，Disentangling the Incentive and Entrenchment Effects of Large Shareholdings， The Journal of Finance， vol.
29、57，pp.2741-2771， 2002. 2 Desai， M.， A. Dyck， and L. Zingales，Theft and taxes，Journal of Financial Economics， vol.84，pp. 591-623，2007. 3 Grossman， S.and D.Hart，The Costs and Benefits of Ownership： A Theory of Vertical and Lateral Integration，The Journal of Political Economy， vol.3， pp.691-719，1986. 4
30、 La Porta， R.， F. Lopez-de-Silanes， and A，Shleifer.Corporate Ownership Around the World，The Journal of Finance， vol.54， pp.471-516，1999. 5 Rego， S.O. and R. Wilson，Equity Risk Incentives and Corporate Tax Aggressiveness，Journal of Accounting Research， vol.50，pp.775-810，2012. 6 Luo，T.L，J.H ，Auditors
31、and Tunneling of Majority Shareholders：Evidenc from Chinese Listed Companies， 9Comteporary Economy Mangement， vol.2，pp.122-127，2007. 7 Hanlon， M. and S. Heitzman，A review of tax research，Journal of Accounting and Economics， vol.50，pp. 127-178，2010. 8 Jiang， G.， C.M.C. Lee， and H. Yue，Tunneling through Intercorporate Loan： The China Experience，Journal of Financial Economics， vol.98，pp. 1-20，2010.
