Separation of Cash Flow and Voting Rights and Firm Performance in Large Family Business Groups in Koreaby Kyuho Jin, Choelsoon Park

Corporate Governance: An International Review

Similar

LXVIII. The Abbot and Convent of Woburn to the King

Authors:
Thabbot and convent of Woburn
1843

Regulatory approaches to the control of environmental mutagens and carcinogens

Authors:
Members and Consultant of Committee
1983

Occupational safety and health standards adopted for fourteen carcinogens

Authors:
U.S. Department of Labor Occupational Safety and Health Admi
1974

Renegotiation of cash flow rights in the sale of VC-backed firms

Authors:
Brian Broughman, Jesse Fried
2010

Text

Separation of cash flow and voting rights and firm performance in large family business groups in Korea

Kyuho Jin*

College of Business Administration

Seoul National University

Seoul, South Korea 151-916

Tel: +82 (10) 2239 7839 hypergeometric@meansakorea.org

Choelsoon Park

College of Business Administration

Seoul National University

Seoul, South Korea 151-916

Tel: +82 (2) 880 8259 cpark@snu.ac.kr * corresponding author

This article has been accepted for publication and undergone full peer review but has not been through the copyediting, typesetting, pagination and proofreading process, which may lead to differences between this version and the Version of Record. Please cite this article as doi: 10.1002/corg.12102

This article is protected by copyright. All rights reserved.

Manuscript Type: Empirical

Research Question/Issue: This study examines how separation of cash flow and voting rights influences performance of firms affiliated with large family business groups.

Complementing the dominant view grounded in agency theory, we suggest that the separation of cash flow and voting rights has positive influence on firm performance in the context of the large family business groups.

Research Findings/Insights: Using the data from the large family business groups in Korea, or Chaebols, between 2003 and 2010, we found that the separation is positively associated with firm accounting performance, but not with market performance. We also found that the effect of the separation is moderated by analyst coverage, R&D expenditure, and sales share in the business group.

Theoretical/Academic Implications: This study reveals that in the large family business groups, the context in which the separation most frequently occurs, the separation not just induces the controlling minority shareholders to pursue private benefits of control but also accompanies financing benefits from active use of the internal capital market. In addition, this study notes the importance of addressing the endogeneity in the analysis of the relation between ownership structure and performance.

Practitioner/Policy Implications: This study offers insights to policy makers planning to enforce/revoke the regulation on the separation of cash flow and voting rights in the pursuit of corporate governance reform especially in countries with poor shareholder protection.

Keywords

Corporate Governance; Separation of Cash Flow and Voting Rights; Internal Capital Market;

Family Business Group

This article is protected by copyright. All rights reserved.

INTRODUCTION

The controlling minority shareholders are ubiquitous around the world (Claessens, Djankov and Lang, 2000; Faccio and Lang, 2002; La Porta, Lopez-de-Silanes and Shleifer, 1999).

They exercise control over their firms with merely a meager portion of cash flow rights of the firms or equity claims on the firms' cash flows, resulting in "a radical separation" of cash flow and voting rights (Bebchuk, Kraakman and Triantis, 2000:295). Scholars have regarded this separation as inducing a new kind of agency problem by distorting the controlling shareholders' incentive structure and by rendering them insulated from the capital market discipline (Morck, Wolfenzon and Yeung, 2005; Young, et al., 2008). According to this view, the controlling minority shareholders are able as well as motivated to pursue their own interest at the expense of other minority shareholders and engage in non-value maximizing investments, expropriation, and tunneling (Bebchuk, et al., 2000; La Porta, et al., 1999;

Morck, et al., 2005; Shleifer and Vishny, 1997); thus, the separation impairs firm performance. And empirical evidence lends general support to this view (e.g., Baek, Kang and Park, 2004; Claessens, et al., 2002; Cronqvist and Nilsson, 2003; Joh, 2003; Lemmon and Lins, 2003; Lins, 2003; Mitton, 2002).

One caveat, however, is in order: this view is derived with loose connection to the context in which the separation generally occurs—i.e., family business groups1. This is surprising, given that a wealth of research evidence has revealed that the separation is observed mostly in firms affiliated with the "family-controlled conglomerates" or family business groups (Almeida and Wolfenzon, 2006; Bebchuk, et al., 2000:296; Khanna and

Yafeh, 2007; La Porta, et al., 1999; Masulis, Pham and Zein, 2011). The context of family business groups is essential for precisely understanding the performance implication of the separation because it may undermine the validity of the two implicit assumptions adopted by

This article is protected by copyright. All rights reserved. the dominant view. On the one hand, the dominant view by and large presumes that firms are autonomous or stand-alone; so each firm is analyzed in isolation (cf. Orru, Biggart and

Hamilton, 1997). If firms are stand-alone as in the United States, it may stand to reason that the separation arises solely from the control-enhancing motive of the controlling shareholders (Almeida and Wolfenzon, 2006). Yet, a growing body of literature equally takes into consideration the fact that in the context of family business groups the separation can also come about as a by-product of the well-functioning internal capital market (Almeida, et al., 2011; Khanna and Yafeh, 2007; Masulis, et al., 2011; Villalonga and Amit, 2009). Since tapping the internal capital market is argued to bring various financing benefits by addressing information asymmetry and moral hazard (Myers and Majluf, 1984; Williamson, 1975;

Williamson, 1985) and by circumventing capital market failure (Khanna and Palepu, 2000;

Khanna and Palepu, 2000; Khanna and Yafeh, 2007), it seems reasonable to surmise that “the net effect [of the separation] on value may not always be negative” (Villalonga and Amit, 2009:3050). Even so, this possibility has gone largely unexamined in the dominant view.

On the other hand, the dominant view also implicitly assumes that the controlling minority shareholders have relatively short-term horizons of management (Bertrand and