Excess Control Rights and Debt Maturity Structure in Family‐Controlled Firms

• Author: Chun I. Lee,Yih‐Wen Shyu
• Published date: 01 September 2009
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00755.x
• Date: 01 September 2009

Excess Control Rights and Debt Maturity

Structure in Family-Controlled Firms

Yih-Wen Shyu* and Chun I. Lee

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Numerous studies have documented that the controlling shareholders in many f‌irms worldwide

possess control rights far greater than their cash f‌low rights. The excess of control rights over cash f‌low rights, hereafter

referred to as excess control rights, leads to potential conf‌licts of interest between controlling and minority shareholders.

The purpose of this study is to investigate the link between excess control rights and debt maturity structure in family-

controlled f‌irms, a topic that has yet to be addressed in the literature. We attempt to examine how controlling shareholders

exploit the excess control rights in making debt maturity decisions at the expense of minority shareholders.

Research Findings/Insights: Using panel data for 611 f‌irms listed on the Taiwan Stock Exchange from 2002 to 2006, we

found that a robust, signif‌icantly negative link exists between excess control rights and short-term debt. This is consistent

with the hypothesis that the divergence of control rights from cash f‌low rights offers an opportunity for the controlling

shareholders in family-controlled f‌irms to entrench themselves and expropriate wealth from minority shareholders. Fur-

thermore, by examining board structure, CEO duality, and ownership structure, we show how these factors work together

with excess control rights to help determine the debt maturity structure in the sample f‌irms.corg_755611..628

Theoretical/Academic Implications: The theoretical implication of this study is that corporate governance issues such as

excess control rights in family-controlled f‌irms are important in corporate decisions, and that studies on these issues enrich

our understanding of corporate decision-making. Further studies along this line of corporatedecisions – such as investment,

leverage structure, and dividend policy – will be instrumental in the development of a comprehensive theory of how

corporate governance inf‌luences a f‌irm’s valuation.

Practitioner/Policy Implications: The fact that short-term debt is negatively linked to excess control rights suggests that

short-term debt providers are an effective monitor for constraining entrenchment and expropriationactivities of controlling

shareholders. Investors who seek to invest in family-controlled f‌irms, especially in, but not limited to, emerging markets,

can benef‌it from being aware of this link and taking it into account in making investment decisions. Many corporate

governance scorecards have emerged over the years to provide market participants a measure of a f‌irm’s corporate

governance practice’s soundness. In view of this study’s f‌indings, adding a new factor in measuring the monitoring level

the providers of short-term debt can potentially increase its usefulness. Finally, policy makers, especially those in emerging

markets, pursuing continuous reform to improve the functioning of their capital markets by improving the corporate

governance landscape, should heed the f‌indings and the aforementioned practical implications. This study also elaborates

the actions they can take to help investors by effectivelyimproving the transparency of f‌inancial information, throughbetter

disclosure of the debt maturity of publicly traded f‌irms.

Keywords: Corporate Governance, Debt Maturity, Family Ownership

INTRODUCTION

Many studies, such as those of La Porta, Lopez-de-

Silanes, and Shleifer (1999), Claessens, Djankov, and

Lang (2000), and Anderson, Mansi, and Reeb (2003), have

shown that concentrated corporate ownership structure is

prevalent around the world, and that concentration fre-

quently occurs within a family. Typically, the controlling

shareholders manage to gain control rights far greater than

cash f‌low rights, and maintain control through the use of

cross-shareholdings and pyramids, in many cases without

owning a majority stake. The excess of control rights over

cash f‌low rights, hereafter excess control rights, presents an

*Address for correspondence: Department of Business Administration, Chang Gung

University, 259 Wen-Hwa 1st Road, Kwei-Shan, Tao-Yuan 333, Taiwan. Tel: 886-3-

2118800 ext. 5415; E-mail: yishyu@mail.cgu.edu.tw

611

Corporate Governance: An International Review, 2009, 17(5): 611–628

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00755.x

opportunity for the controlling shareholders to expropriate

private benef‌its from the minority shareholders, potentially

driving a wedge into the valuation of the f‌irm. Yeh, Lee, and

Woidtke (2001) examine this valuation effect in Taiwan,

where the ownership of many listed companies is concen-

trated and controlled within a family or a small group of

shareholders. They f‌ind that family-controlled f‌irms with

low cash f‌low rights have lower performance, consistent

with the hypothesis of conf‌licts of interest between control-

ling and minority shareholders. Holderness and Sheehan

(1988) report a similar result of family-controlled f‌irms

trading at a discount among large US corporations.

However, Anderson, Mansi, and Reeb (2003) f‌ind that

family-controlledf‌irms are more valuable. Mixed results like

these have also been found in other countries (Claessens,

Djankov, Fan & Lang, 2002; Cronqvist & Nilsson, 2003;

Morck & Yeung, 2003).

Addressing the possibility that these mixed results ref‌lect

the three elements used to def‌ine family-controlled f‌irms

(i.e., ownership, control, and management), Villalonga and

Amit (2006) show that family-controlled f‌irms only trade ata

premium over non-family controlled f‌irms when the

founder serves as CEO or as chairman with a hired CEO.

Family-controlled f‌irms trade at a discount in all other cases,

such as when a descendant of the founder is the CEO,

or when dual-share classes, pyramids, and voting agree-

ments exist. This recent work suggests that classic manager-

shareholder conf‌licts in non-family-controlled f‌irms are

more costly than the conf‌licts between controlling and

minority shareholders when the founder is the CEO/

Chairman, resulting in a premium for such family-

controlled f‌irms. In contrast, for family-controlled f‌irms in

all other cases and f‌irms with controlling shareholders, these

results suggest that as control rights diverge further from

cash f‌low rights, the benef‌its of expropriation by the control-

ling shareholders outweigh the costs. Realizing this risk,

investors observe the actions of managementand react ratio-

nally by undervaluing those f‌irms where expropriation of

wealth from minority shareholders by controlling share-

holders is more likely.

Among the actions that have been linked to f‌irm value are

those related to capital structure decisions. Since the seminal

work of Modigliani and Miller (1958), it has been well

accepted that capital structure is one of the important deter-

minants of f‌irm value.1Many studies have identif‌ied deter-

minants of capital structure. Among these determinants is

the agency cost resulting from the conf‌licts of interest in the

classic agency setting of managers versus shareholders.

However, this line of research is less relevant for under-

standing how f‌irm valuation is affected by conf‌licts between

majority and minority shareholders resulting from the sepa-

ration of control rights from cash f‌low rights thatis typical of

family-controlled f‌irms around the world. To shed light on

how corporate leverage decisions are affected by such con-

f‌licts, Du and Dai (2005) look at f‌irms in nine East Asian

countries, and f‌ind that f‌irms whose controlling sharehold-

ers hold a relatively small proportion of shares tend to have

higher leverage. This evidence is consistent with the hypoth-

esis that the controlling shareholders increase leverage out

of an entrenchment motive in order to prevent the dilution

of their dominant control. Given that a signif‌icant part of

leverage decisions involve choosing between short- and

long-term debts, i.e., the debt maturity decision, it is possible

that this entrenchment motive also manifests itself in debt

maturity decisions, consequently debt maturity decisions

should be linked to the entrenchment motive of controlling

shareholder. The purpose of this paperis to provide some of

the f‌irst detailed insights into how conf‌licts of interest

between controlling and minority shareholders affect debt

maturity structure.

Extending the conf‌lict-of-interest research from leverage

decisions to debt maturity structure is warranted, given that

debt maturity has been shown to be an integral part of the

overall leverage policy of a f‌irm. As important to f‌irm value

as leverage policy is, debt maturity decisions are at the dis-

cretion of managers, who have been shown to make subop-

timal decisions in the face of conf‌licts of interest with

shareholders, which is an important issue to corporate gov-

ernance. Firms with good corporate governance practice will

arguably make better debt maturity decisions. It is only

logical, then, to link debt maturity choices to corporate gov-

ernance. In their research, Datta, Iskandar-Datta, and Ramna

(2005) and Marchica (2007) do exactly that, and they show

that debt maturity is linked to corporate governance factors

such as managerial ownership. In fact, managerial owner-

ship can be viewed as a proxy for how much inf‌luence the

managers exert, and previous studies have often used it to

examine the principal-agent type of conf‌licts. However,

despite the prevalence of family-controlled f‌irms around the

world, little research has been done on the association

between debt maturity structure and the separation of

control and cash f‌low rights. Inferring from related studies,

it should not be diff‌icult to fathom the existence of such an

association.

Specif‌ically, studies (e.g., Bertrand, Mehta, & Mullain-

athan, 2002; Johnson, Boone, Breach, & Friedman, 2000)

have demonstrated how controlling shareholders engage in

various tunneling activities, such as transferring resources

out of f‌irms, siphoning off prof‌its to escape creditors,

and expropriating corporate opportunities. In the present

context of controlling shareholders versus minority share-

holders, the excess control rights create strong incentives for

the former to entrench themselves and expropriate wealth

from the minority shareholders by diverting resources to

themselves at the expense of the latter. In f‌irms where such

tunneling activities take place, the internal monitoring

mechanisms such as the board of directors usually are at the

disposal of the controlling shareholder, rendering external

mechanisms such as creditors and takeover as the only

recourse for curbing such activities. While there are active

takeover markets in the US and UK and a few OECD coun-

tries, the similar markets are typically wanting in countries

where shareholder protection is weak, leaving creditors the

only external monitoring mechanism viable in checking

the tunneling activities. However, not all creditors wield the

same inf‌luence and studies (DeAngelo, DeAngelo, & Wruck,

2002; Jensen, 1986; Rajan & Winton, 1995; Stulz, 2000)

have shown that providers of short-term debt can exercise

their monitoring power more effectively than their long-

term counterparts. Not surprisingly, managers, out of

self-interest, inherently prefer longer-term debt, and many

studies (e.g., Benmelech, 2006; Datta, Iskandar-Datta, &

612 CORPORATE GOVERNANCE

Volume 17 Number 5 September 2009 © 2009 Blackwell Publishing Ltd