Dividends for tunneling in a regulated economy: The case of China

Some Chinese listed companies pay out high dividends, despite the weak legal and institutional pressure on them to mitigate agency problems by paying dividends. We conjecture that such a phenomenon is caused by the differential pricing for tradable and non-tradable shares during the IPO of these listed companies. Such companies might use high-dividend payments to divert proceeds from an IPO or rights issue to controlling shareholders' pockets. The empirical results support our hypotheses, showing that companies with more differential pricing in the IPO, a recent IPO or rights issue, or more concentrated ownership tend to pay more dividends. Similarly, companies that are ultimately owned by the government tend to pay more dividends. Furthermore, a dividend increase accompanied by large IPO price discounts, a recent-year rights issue, an ROE qualified for rights issue, or great dividend variation is associated with more negative stock returns than other types of dividend increases. These findings indicate that dividends are not used purely for signaling or distributing free cash flows in China. Instead, dividends might be used by the controlling shareholders to engage in tunneling.