Corporate governance is deemed as something necessary in today’s business world, including in Asia, where family-owned businesses predominate. Regulators are helping to amplify the voices of minority shareholders. However, there is no one-size-fits-all corporate governance standard. Companies operate in different jurisdictions, they come in varying sizes and they are involved in different industries. They also have different ownership structures.
“While some companies make their governance choices in the best interests of minority shareholders, this is not always the case,” wrote John Nowland, who is at the City University of Hong Kong, and his co-author En-Te Chen, from Queensland University of Technology. “Controlling shareholders can intentionally maintain weak governance practices for their own private benefit.”
Their paper, "Optimal Board Monitoring in Family-Owned Companies: Evidence From Asia”, was presented last year at the Singapore Management University. As the title indicates, their research focused on how family-owned companies in Asia are practicing corporate governance, as measured by the number and involvement of independent directors on their boards.
The obvious way for minority shareholders to look out for their rights and to maximise their interests is to try to implement a stronger corporate governance framework. This can be done, specifically, through close monitoring exercised by independent directors sitting on the boards that supervise the companies.
What makes family-owned businesses an interesting subject? For one, cases abound where Asian family-controlled firms -- through complicated webs of cross-holdings among their various listed affiliated companies -- exert a degree of control that far exceeds their nominal ownership level. Put simply, family owners are exploiting loopholes in getting a cheaper, better deal than the other investors.
The authors say that a certain level of monitoring is good for minority shareholders. But they also hypothesised that there is a tipping point when this truism ceases to be true, or worse, becomes counterproductive. The so-called ‘optimal level of monitoring,’ as defined by the authors, is one that is reached when the marginal benefit of additional monitoring equals the marginal cost to outside investors.
According to an earlier study by Anderson and Reeb (2004), the performance of family-owned companies is highest in America when there is a balance between independent directors and family representatives on the board of directors. In their study, Nowland and Chen set out to find this balancing point – the optimal level of monitoring among Asia’s family-owned companies.
“We propose that performance is highest when family-owned companies adopt a level of board monitoring that satisfies minority shareholders. This optimal level balances the agency conflict between the family group and minority shareholders, while ensuring that the family group is not hindered in creating wealth for all shareholders,” they wrote.
Data and methodology
For the study, the authors drew on data from Asian companies in the period after the Asian Financial Crisis of 1997-1998, when voluntary corporate governance codes were implemented. “This allows us to have sufficient changes over time and since the changes were voluntary there is still variation in practices across companies. A focus on Asia also allows us to compare the relative benefits and costs of monitoring in Asian family-owned companies to the prior results of Anderson and Reeb (2004).”
The final sample consists of seven years (between 1998 and 2004) of data from 185 companies from four locations: 47 from Hong Kong, 58 from Malaysia, 32 from Singapore and 48 from Taiwan. These locations were selected due to the widespread availability of board governance and ownership data over the entire sample period.
These are also locations with a relatively high level of family ownership. Companies are only identified as ‘family-owned’ if the largest ultimate shareholder is the family group that founded the company. The largest (but still minority) shareholders in the non-family-owned companies are either government-owned entities, other widely-held companies, or non-founders.
For the study, two board monitoring variables were used: board independence and committee monitoring (audit, nomination and remuneration committees). Based on modelling done by the authors, firm performance is highest in family-owned companies when board independence is at 38% (and not 100%), showing that “increased monitoring is only beneficial up to the optimal level for minority shareholders. Beyond this level, additional monitoring is wealth-decreasing,” the authors concluded.
To make sure that the results are reliable, a few checks were made. First, a different measure – return on assets – of company performance was used. Consistent results were found. Next, the way the model is structured means that the direction of causality runs from the governance and disclosure measures to the firm’s performance. To clear any doubts on reverse causality, further analysis was conducted relating lagged board governance and disclosure variables to firm performance, with consistent results.
Thirdly, to ensure that the results were not biased within any of the four countries in the sample, the models were also run on the subsets of each country.
More Is Not Optimal
The modelling has shown that the highest level of board monitoring might not be the most optimal in family-owned companies. What might be the reasons?
According to the authors, there are two. First, higher information asymmetry between the family group and outside parties in family-owned companies means that monitoring by outsiders is less effective in family-owned companies than in other companies.
Second, the family group’s substantial involvement in the selection and appointment of outside directors means that outside directors in family-owned companies are less likely to be truly independent monitors. The result is that the same level of board monitoring results in a lower reduction in agency costs in family-owned companies relative to other companies.
Shareholders need to take into account other factors too – including those that will impede wealth creation by the family for the firm. For example, there are three reasons why the costs of board monitoring are expected to be higher in family-owned companies.
First, where the family group has an extensive track record of successfully managing the company, increased monitoring hinders the ability of the family to create wealth. This increased monitoring draws time and resources away from the wealth-creation activities to satisfying the needs of the additional monitoring.
Second, since wealth creation done through ‘undisclosable’ channels, such as political connections, is higher in family-owned companies, too much monitoring restricts the family group from creating wealth through these channels. Quite often, these channels – widely recognised but hardly acknowledged – are successfully cultivated only after many years of painstaking and patient effort.
Third, in family-owned companies, a high level of external monitoring can be unnecessary and costly as too much monitoring will replicate the monitoring already performed by the family group and add additional costs to the business.
Taken in totality, the lower benefits and higher costs of board monitoring mean that the optimal level of board monitoring in family-owned companies is expected to be at a much lower level than other companies. Therefore, at moderate levels of board monitoring, we expect to find an optimal level of board monitoring for family-owned companies – in this case, 38% -- but this does not apply to other companies.
Longer Way To Go
So what are the implications on corporate governance in Asia? Just like companies in different industries at different stages in the cycle need different management styles and philosophies, companies with different ownership and control structures have different optimal levels of monitoring.
“Therefore it may be inappropriate for regulators to advise all companies to follow the same set of corporate governance and disclosure guidelines. In particular, corporate governance guidelines designed by widely-held companies may need to be modified for family-owned enterprises as more monitoring is not always associated with better performance. In some instances, too much monitoring can be wealth decreasing in family-owned enterprises,” the authors wrote.
Also, while the study has shown that 38% is the optimal figure for board independence, the authors pointed out that depending on the severity of the agency conflicts between owners, this ‘optimal’ level of monitoring varies within family ownership sub-types: “In family-owned companies, monitoring needs to be higher when family owners maintain control of their companies through control rights in excess of their cashflow rights.”
The authors are not advocating more relaxed corporate governance standards over these family-owned companies in the name of improving overall shareholder value. Here is the reality: the average board independence level found in these family-owned firms, at 23%, is 15 percentage points lower than the optimal level found by the study. “The optimal level of board governance in our sample of Asian family-owned companies is identified at a level higher than current practices,” Nowland and Chen noted.
“Therefore, it does seem that family-owned companies as a group are still refusing to adopt monitoring practices in the best interests of minority shareholders.”
Thus, if corporate governance is seen as the main framework whereby minority investors hope to maximise their value under the aegis of the controlling Asian families, there is clearly still some way to go in naming independent directors to the board and letting them monitor the company through the audit, nomination and remuneration committees.
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