Excess control rights in family firms: A socioemotional wealth perspective

• Published date: 01 November 2022
• Author: Wei Shi,Brian L. Connelly,Jiangyan Li
• Date: 01 November 2022
• DOI: http://doi.org/10.1111/corg.12429

SPECIAL ISSUE ARTICLE

Excess control rights in family firms: A socioemotional wealth

perspective

Wei Shi

1

| Brian L. Connelly

2

| Jiangyan Li

3

1

Miami Herbert Business School, University of

Miami, Coral Gables, Florida, USA

2

Auburn University, Auburn, Alabama, USA

3

School of Economics and Business

Administration, Chongqing University,

Chongqing, PR China

Correspondence

Jiangyan Li, School of Economics and Business

Administration, Chongqing University,

174 Shapingba Street, Shapingba District,

Chongqing, PR China.

Email: lijiangyan@cqu.edu.cn

Funding information

Natural Science Foundation of Guangdong

Province, Grant/Award Number:

2019B1515210003; National Natural Science

Foundation of China, Grant/Award Numbers:

72072188, 71672196, 71810107002,

71902197

Abstract

Research Question/Issue: This study attempts to uncover a hidden benefit of share-

holders' excess control rights in family firms by examining whether excess control

rights can reduce the likelihood of financial misconduct in family firms, compared

with nonfamily firms.

Research Findings/Insights: We argue that excess control rights are especially useful

for family-owned firms, compared with firms with other types of ownership, in

preventing financial misconduct. They afford family owners the ability to guard

against misconduct that can damage the founder's legacy and reduce the family's

socioemotional wealth. We also investigate two boundary conditions, the presence

of a family member as the board chair and the family's public visibility, that validate

our proposed theoretical mechanism. In these scenarios, the family owner's socio-

emotional wealth is particularly high and could be impacted severely by misconduct.

Results from a sample of 2516 publicly traded firms in China support our theory.

Theoretical/Academic Implications: Our study challenges traditional agency theory

about excess control rights by exploring the potential of excess control rights to miti-

gate principal–agent problems and prevent financial misconduct in family firms.

Practitioner/Policy Implications: Regulators who make decisions to forbid or permit

excess shareholder control in publicly listed firms must be aware that excess share-

holder control could deter financial misconduct in family firms.

KEYWORDS

corporate governance, excess control rights, family firms, financial misconduct,

socioemotional wealth

1|INTRODUCTION

Excess control rights occur when a shareholder's votes exceed the

number of shares he or she holds (Bebchuk et al., 2000;

Nenova, 2003). Agency theorists criticize these arrangements in part

because principals who gain high levels of excess control are likely to

appropriate rent for themselves at the expense of other principals,

creating principal–principal conflicts (Faccio et al., 2001). Supporting

this perspective, finance and economic researchers have found evi-

dence that excess control rights are detrimental to firm value

(e.g., Claessens et al., 2002). Firms with high levels of excess

shareholder control exhibit a range of inefficiencies, such as higher

borrowing costs (Lin et al., 2011), reduced value of excess cash

(Belkhir et al., 2014), and lower market-to-book value (Claessens

et al., 2002). These studies, which focus on economic valuation and

resource allocation, offer important insights about the economic con-

sequences of excess control and are consistent in their conclusions:

Excess control rights are harmful to firms and their shareholders.

We, however, uncover a means by which excess control can ben-

efit a firm. We do this by analyzing the role of excess control rights

through a behavioral lens, examining their influence on financial

misconduct. Steier (2003) explains that traditional agency theory

Received: 10 July 2020 Revised: 20 December 2021 Accepted: 3 January 2022

DOI: 10.1111/corg.12429

806 © 2022 John Wiley & Sons Ltd Corp Govern Int Rev. 2022;30:806–828.wileyonlinelibrary.com/journal/corg

prescriptions can sometimes be inverted in the context of family firms

because contracts between family owners and their managerial agents

differ from traditional contracts between principals and agents. We

expect this inversion to hold for agency theory's prescriptions about

excess control rights. While many agency theorists denounce excess

control, we argue that the sociopsychological dimensions of family

ownership introduce behavioral considerations that reveal potential

value in excess control in family firms, as opposed to nonfamily firms.

Family owners differ from other shareholders in that they are

endowed with what G

omez-Mejía et al. (2007) call socioemotional

wealth, or the “non-financial aspects of the firm that meet the family's

affective needs”(p. 106). Family owners are greatly concerned with

protecting their socioemotional wealth (G

omez-Mejía et al., 2007).

Illegal behavior by a manager at a family firm can stigmatize the com-

pany as an irresponsible corporate citizen (Marcel & Cowen, 2014).

When this happens, Berrone et al. (2010) observe that the “negative

image of the firm …is privatized and personalized, directly implying a

loss of the family's socioemotional wealth”(p. 87). Family owners,

therefore, are especially impacted by financial misconduct: They lose

not only economic wealth when their firms' stock prices decline but

also socioemotional wealth because others associate the family with

the transgression.

We argue that excess control provides family owners with the

ability to prevent financial misconduct. Excess control rights

strengthen family owners' capacity for monitoring and influencing

managers and mitigating principal–agent problems, thus protecting

against potentially nefarious behavior. We draw upon socioemotional

wealth arguments to theorize about the role of excess control rights

in deterring financial misconduct in family firms, as opposed to

nonfamily firms, and introduce two boundary conditions to validate

our proposed theoretical mechanism. The first condition—whether the

chairman of the board is a family member—pertains to the organiza-

tion's structure. It identifies firms in which family owners could be

especially well positioned to leverage excess control rights to protect

their socioemotional wealth. The second condition—the family's public

visibility—pertains to the family. It identifies families whose socio-

emotional wealth would be greatly impacted by misconduct because

their firm's actions would be magnified by public scrutiny.

We test our theory on publicly traded firms in China between

2003 and 2014. We chose China for our empirical context for several

reasons. First and foremost, the Chinese context allows us to better

isolate the governance influence of excess control rights because

China lacks many of the internal and external governance mechanisms

found in many developed markets (Cheung et al., 2008; Jiang &

Kim, 2015). In China, the institutional and legal systems that protect

minority shareholders have not been fully developed (Peng &

Heath, 1996). Therefore, key characteristics of controlling share-

holders, such as excess control rights, exert a powerful influence on

managerial decisions and actions. It is relatively easy for large share-

holders and managers to manipulate financial resources when corpo-

rate governance mechanisms are ineffective and legal protections for

minority shareholders are weak (Aggarwal et al., 2015). Conducting

our study in such a setting ensures that the effects under

investigation will be observable. Another motivation for selecting the

Chinese context is that excess control rights for controlling share-

holders are relatively common. About 40% of firm-year observations

in our sample are from firms with excess control rights, allowing us to

conduct meaningful empirical analyses. Lastly, China is the second-

largest economy in the world, but our understanding of corporate

governance in Chinese firms remains limited at best. Studying corpo-

rate governance in China can advance our insights into governance as

a whole; however, it is also important to situate empirical research

within this massive global marketplace (Shen et al., 2016).

We consider the likelihood of financial misconduct at Chinese

publicly traded firms. We define financial misconduct in this context

as China Securities Regulatory Commission (CSRC) investigations in

which firms were found guilty of securities violations (we focus on

securities violations because they have a direct relationship to firm

value and thus to minority shareholders' interests). Chen et al. (2005)

describe CSRC convictions as critical organizational events that typi-

cally result in a 15% to 25% drop in firm value. CSRC convictions are

also relatively widespread in China, where publicly traded firms have a

history of inflating profits, creating fake transactions, and making false

disclosures (Hass et al., 2016). When such misconduct occurs, it harms

not only the organization but also the capital markets (Ball, 2009).

Thus, scholars have called for more research on corporate governance

practices in emerging economies (Dharwadkar et al., 2000; Young

et al., 2008).

Our study, which responds to this need, makes an important con-

tribution to the “Ownership and Corporate Governance across Institu-

tional Contexts”Special Issue. We add to agency theory research by

elucidating the role of excess control rights, which agency theorists

have widely denounced as value-reducing encumbrances in the US

context (Belkhir et al., 2014; Liu & Magnan, 2011). Our study also pro-

vides new insight into excess control rights by investigating an impor-

tant behavioral consequence—reduced financial misconduct—and

thereby revealing a benefit of excess control in family firms. Our find-

ings indicate that excess control rights enable family owners to miti-

gate principal–agent problems in a country with less developed

institutions, thereby reducing the likelihood of financial misconduct.

Our moderating analyses extend this insight further, confirming our

socioemotional wealth logic by investigating scenarios where socio-

emotional wealth is likely to be most readily protected and most

severely impacted by financial misconduct.

2|CONCEPTUAL DEVELOPMENT

2.1 |Excess control rights

A shareholder's ownership includes control rights and cash flow rights.

In this study, we refer to the number of votes to which a shareholder

is entitled as “control rights”and the number of shares that he or she

holds as “cash flow rights”(Bebchuk et al., 2000; Francis et al., 2005).

Some scholars also utilize “legal rights”to describe the extent of a

one's legal claim on an organization and “economic rights”to describe

SHI ET AL.807