Tunneling, Propping and
Expropriation: Evidence from
Connected Party Transactions in
Hong Kong
by
Stephen Yan-leung Cheung
Department of Economics and Finance
City University of Hong Kong
“...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.
Stephen Cheung
City University of Hong Kong
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Corporate Governance in Asia
Shareholder
environment
Concentrated
ownership
“Insider
boards”
Reliance on
family and
state finance
INSTITUTIONAL
CONTEXT Underdeveloped
and illiquid
investment
market
Capital
market
liquidity
Inefficient
corporate
governance
Limited
market for
corporate
control
Independence
and performance
Incentives
aligned with
core
shareholders
Limited
disclosure
Inadequate
minority
protection
CORPORATE
CONTEXT
Transparency
and
accountability
Source: McKinsey, 2001
Stephen Cheung
City University of Hong Kong
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Introduction
Companies with concentrated ownership:
 extract case by selling assets, goods, or
services
 obtain loans on preferential terms
 assets transfer
 dilute the minority shareholders’ interests
Stephen Cheung
City University of Hong Kong
4
Rules in Hong Kong

A connected transaction is defined as any transaction
between a company (or any of its subsidiaries) and a
connected person.

Connected persons are the listed firm’s (or the
subsidiary’s) substantial shareholders, the directors
(current directors or anyone who held this position at any
time during the preceding 12 months), the chief executive
and their associates, including any company where the
above hold a substantial shareholding.

The definition also applies to any person co-habiting with
the above and relatives (such as spouses, parents, stepparents, brothers/sisters, step-brothers/sisters, and inlaws).
Stephen Cheung
City University of Hong Kong
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Rules in Hong Kong




For all transactions more than HK$10 million, in addition to
a public announcement, the listed company must also
notify the exchange by making a filing.
The minutes of the board meeting where the transaction
was approved, noting also the views of the company’s
independent non-executive directors, must be submitted to
the exchange.
Within three weeks of such notification, the listed company
must send a circular to shareholders providing full details
of the transaction, including an opinion by an independent
expert.
This is to be followed by approval of the transaction by
shareholders in a general meeting, where any connected
person interested in the transaction should abstain from
voting.
Stephen Cheung
City University of Hong Kong
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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?
What should be done?
Stephen Cheung
City University of Hong Kong
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Observations
1) There were 328 connected
transactions worth at least HK$116
billion during 1998-2000. The value of
the median transaction was HK$ 106
million, representing 17.5% of firm’s
market capitalization.
Stephen Cheung
City University of Hong Kong
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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
Stephen Cheung
City University of Hong Kong
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Observations
2) 2 times more assets acquisition than asset
sales; cash from listed companies to its
controlling owners
3) 3.5 times more in providing cash assistance to
third parties as opposed to receiving
assistance
4) Terms are unfavorable (acquiring at a premium
or selling at a discount) for most deals when
information are available
Stephen Cheung
City University of Hong Kong
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Observations
5) 15% did not disclose the value of
6)
7)
8)
9)
transaction in filing.
2.7% did not attach a report by independent
financial advisors
3.4% violated a previously granted waiver
7% had taken place in the past but had not
disclosed to the exchange
4.9% constitute an outright breach of listing
rules
Stephen Cheung
City University of Hong Kong
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Case: Dickson Concepts
International Ltd (I)


Background
It trades in luxury goods
 Bvlgari
watches
 Lighters, pens
 Jewellery, fashion products
 Warner Bros. Products

The operations of the group mainly base in
Hong Kong, Asia, UK, European countries and
in North America.
Stephen Cheung
City University of Hong Kong
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Case: Dickson Concepts
International Ltd (II)




Unusual Transaction
On 30th December, 1999, the company
entered into a consultancy agreement with a
related company which is wholly controlled by
the director himself.
It was said to be for the design, development,
construction, and technological infrastructure
of the “Cybermall”.
The fixed fee was HK$130 million.
Stephen Cheung
City University of Hong Kong
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Case: Dickson Concepts
International Ltd (III)






Market Reaction
It was clear to be a related party transaction
The director was being criticized for failure to
disclose the agreement.
No records of work done for the consultancy
No approval initially from independent
shareholders, but was later ratified by them.
The company argued that this was a service
contract not a transaction.
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City University of Hong Kong
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Results
Short-term,
 Average of -3.4% during a period of 10 days
after announcement
Sales of equity stake
Sales of assets
Acquiring of assets
Trading relationships
Selling JV
Cash payment
Stephen Cheung
City University of Hong Kong
-11.8%
-6.4%
-7.5%
-7.5%
-6.1%
-2.5%
15
Long term,
 Average of -12.6% during a period of 12
months after announcements
Sales of assets
Trading relationships
Cash payment
Takeover & JV
Selling JV
Stephen Cheung
City University of Hong Kong
-21.9%
-21.8%
-18.7%
-29.8%
-17.2%
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All connected
CARs
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-12 -9
-6
-3
0
3
Month
6
9
12
Blue: Size & MB adjusted CARs
Red: Size adjusted CARs
Stephen Cheung
City University of Hong Kong
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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
Stephen Cheung
City University of Hong Kong
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
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
Stephen Cheung
City University of Hong Kong
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
Variable of Corporate governance do not
have any impact
 audit
committee
 number of independent non-executive
directors
 CEO duality
Stephen Cheung
City University of Hong Kong
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Discussion

The quality of independent non-executive
directors

Information disclosure

Regulatory framework
Stephen Cheung
City University of Hong Kong
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The Legal Approach to Corporate
Governance


The law and its enforcement are key mechanisms of investor
protection.
When investors finance firms, they receive rights or powers in
exchange. Without an ability to enforce rights, investors might
end up with nothing.
•Company Law
•Bankruptcy Law
•Securities Law
•Takeover Law
•Courts & Regulators

•Protect Shareholders & Creditors
•Force timely disclosure of
accurate information
Implication: Strong investor protection leads to deeper
financial markets & better financing terms for firms.
Stephen Cheung
City University of Hong Kong
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Challenges Ahead

But more importantly, the evidence raised here
suggests that there are 3 essential ingredients for
the system to work in the long run:
1. Better investor rights in corporate laws, strong
regulation on disclosure and accounting
standards.
2. Regulations and laws that facilitate shareholder
actions and private enforcement.
3. A well functioning judicial system which allows
the functioning of financial markets and business
transactions in general.
Stephen Cheung
City University of Hong Kong
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~END~
Stephen Cheung
City University of Hong Kong
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