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Market-Based Solutions to Vital Economic Issues
Research
May 1, 2017

When Enron Met Alibaba: The Rise of VIEs in China

Abstract

We conduct what is, to our knowledge, the first systematic examination of Chinese-based firms that utilize a variable interest entity (VIE) structure to evade Chinese regulation on foreign ownership to list equity in the U.S. The use of the VIE structure is not only questionable under Chinese laws but also exacerbates the agency costs within the firm. We find that Chinese VIE firms have a Tobin’s Q as much as 35% lower than Chinese non-VIE firms, and this discount is concentrated in firms with higher risks of government intervention and managerial expropriation. To remediate these risks, VIE firms are more likely to have a politically connected director on the board, hire a Big N auditor and have higher levels of institutional ownership. All of these characteristics help to remediate the VIE valuation discount. Overall our results suggest that valuation discounts associated with the VIE structure are substantial, vary systematically across settings based on differences in regulatory and agency risk, and can be mitigated by improved monitoring.


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