Family Control and Investment‐Cash Flow Sensitivity: Moderating Effects of Excess Control Rights and Board Independence

• DOI: http://doi.org/10.1111/j.1467-8683.2011.00899.x
• Published date: 01 May 2012
• Date: 01 May 2012
• Author: Jung‐Hua Hung,Yi‐Ping Kuo

Family Control and Investment-Cash Flow

Sensitivity: Moderating Effects of Excess

Control Rights and Board Independence

Yi-Ping Kuo and Jung-Hua Hung*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: We explore the effect of family control on investment-cash f‌low sensitivity and disentangle the

effects of agency problems of free cash f‌low and asymmetric information. Excess control rights and board independence

may moderate the relationship between family control and investment-cash f‌low sensitivity by changing agency costs.

Research Findings/Insights: Family control lessens investment-cash f‌low sensitivity by mitigating the problem of asym-

metric information. Investment-cash f‌low sensitivity will be higher in family-controlled f‌irms with excess control rights

because Type II agency problems predominate. Family control may affect investment-cash f‌low sensitivity when f‌irms lack

independent directors. Having another blockholder in addition to the controlling family reduces the agency problem and

improves the independent monitoring function of the board for family-controlled f‌irms.

Theoretical/Academic Implications: This study provides a better understanding of the relationship between family control

and investment-cash f‌low sensitivity.It delineates the separate effects of agency problems stemming fromfree cash f‌low and

asymmetric information and demonstrates that excess control rights and board independence can moderate the effect of

family control on investment-cash f‌low sensitivity. We show the signif‌icant role another blockholder plays in internal

governance mechanisms.

Practitioner/Policy Implications: Investors can better gauge f‌irm value by examining the type of company control and

linkages between investment distortion and f‌irm value. Policy makers can better understand how excess control and board

independence act as mechanisms to worsen or mitigate the effects of family control. Managers can understand the effects

of control type and board independence on the f‌irm’s f‌inancial constraints.

Keywords: Corporate Governance, Agency Theory, Family Control, Board Independence, Taiwan

INTRODUCTION

The Asian f‌inancial crisis in the late 1990s highlighted

problems related to corporate governance in Southeast

Asian corporations, especially concentration of ownership,

dominance of controlling shareholders, separation of voting

and cash f‌low rights, and limited protection of minority

shareholder rights (Claessens, Djankov, Fan, & Lang, 2002;

Driff‌ield, Mahambare, & Pal, 2007). Controlling family

shareholders tend to pursue not only maximum company

value but also family benef‌its (Burkart, Panunzi, & Shleifer,

2003) and may expropriate the rights of minority

shareholders by diverting resources for personal use. The

controlling family may also allocate funds to unprof‌itable

projects that provide personal benef‌its (La Porta, Lopez-De-

Silanes, & Shleifer, 1999; Shleifer & Vishny, 1997). Several

studies have investigated entrenchment, tunneling, prop-

ping, and expropriation in family f‌irms (Cheung, Rau, &

Stouraitis, 2006; Claessens et al., 2002), but relatively few

have discussed the possibility of investment distortion in

family-controlled f‌irms.

Investment distortion includes both overinvestment and

underinvestment. The overinvestment hypothesis proposed

by Jensen (1986) suggests that agency problems between

shareholders and managers can lead to overutilization of

managerial discretion, resulting in overinvestment. The

underinvestment hypothesis is based on asymmetric infor-

mation between f‌irms and capital market investors when

*Address for Correspondence: Department of Business Administration, National

Central University, no. 300, Jhongda Road., Jungli City, 320, Taiwan. Tel: 886-3-422-

7151 Ext. 66107; E-mail: jhung@cc.ncu.edu.tw

253

Corporate Governance: An International Review, 2012, 20(3): 253–266

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2011.00899.x