Bad News is Good News: Propping and Tunnelling Evidence from China

When there is competition for the control over a listed firm, the contestants have to bid for it by committing their own resources to prop up the firm, which benefits ordinary outside shareholders. The existing literature has not provided clear evidence of propping and the conditions under which propping prevails. The evidence for the benefits of having a market for corporate control is also lacking. This paper fills the aforementioned void by presenting a case study of China’s emerging corporate control market. We examine why a typical piece of bad news a listed firm gets into financial trouble and is designated a special treatment (ST) firm by the regulatory authorities could have generated overwhelmingly favorable market reactions. Our analysis shows that the firms’ 31.8 percentage points of abnormal stock market performance over the two years after being designated ST reflects the price paid by their controlling shareholder (incumbent or entrant) in resources commitment in order to gain control over and save the firms. We find that the controlling shareholders’ propping is more conspicuous in firms where the competition for the control rights is tougher and the size of control benefits is larger. We also suggest an innovative way to estimate the private benefits of control and find that they are on average 33.5% of firm value in China. JEL Classification: G34, G32