Pay-or-Explain Regulation and Minority Shareholder Expropriation

We investigate a 2012 pay-or-explain regulation implemented by China's Shanghai Stock Exchange. The regulation mandates that eligible firms must either pay 30% of their current-year profits as cash dividends or explain the reasons for their nonpayment through a public conference call. Using firms listed on the Shenzhen Stock Exchange as a control group, our difference-in-differences estimates suggest that firms subject to the regulation decreased their tunneling, irrespective of whether they comply by paying or disclosing. Further analyses indicate that disclosures in the conference calls are not cheap talk and that the decrease in tunneling is, in part, attributed to improved capital market monitoring of firms that choose the disclosure option. Collectively, these findings provide novel policy evidence on how a flexible pay-or-explain form of regulation can reduce agency costs between controlling and minority shareholders in a weak-institution environment