Separation of Cash Flow and Voting Rights and Firm Performance in Large Family Business Groups in Korea

• Author: Kyuho Jin,Choelsoon Park
• Date: 01 September 2015
• DOI: http://doi.org/10.1111/corg.12102
• Published date: 01 September 2015

Separation of Cash Flow and Voting Rights and

Firm Performance in Large Family Business

Groups in Korea

Kyuho Jin*and Choelsoon Park

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines howseparation 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 cashflow and voting rights has positive influence on firmperformance in the context of largefamily business

groups.

Research Findings/Insights: Using the data from the large family business groups in Korea, or Chaebols, between 2003 and

2010, we foundthat the separation is positivelyassociated with firmaccounting performance, butnot with market performance.

We alsofound that the effect of the separationis moderated by analyst coverage,R&D expenditure, and sales sharein the busi-

ness group.

Theoretical/Academic Implications: This study reveals that in the large family business groups,the context in which the sep-

aration most frequently occurs, the separation not only inducesthe controlling minority shareholders to pursue privatebenefits

of control butalso accompanies financing benefitsfrom active use of the internalcapital 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 cashflow and voting rights in the pursuit of corporategovernance reform especiallyin countries with poor share-

holder protection.

Keywords: Corporate Governance, Separation of Cash Flow and Voting Rights, Internal Capital Market, Family Business

Group

INTRODUCTION

Controlling minority shareholders are ubiquitous around

the world (Claessens, Djankov, & Lang, 2000; Faccio &

Lang, 2002;La Porta, Lopez-de-Silanes,& Shleifer, 1999).They

exercise controlover their firms with merely a meagerportion

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, & 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 theminsu-

lated from the discipline of the capital markets (Morck,

Wolfenzon, & Yeung, 2005; Young, Peng, Ahlstrom, Bruton,

& Jiang, 2008).According to this view, the controlling minority

shareholdersare able as well as motivatedto pursue their own

interestsat the expense of other minority shareholdersand en-

gage in non-value maximizing investments, expropriation,

and tunneling (Bebchuk et al., 2000; La Porta et al., 1999;

Morck et al., 2005; Shleifer & Vishny, 1997); thus, the separa-

tion impairs firm performance. And empirical evidence lends

general support to this view (e.g., Baek, Kang, & Park, 2004;

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

2003; Joh, 2003; Lemmon & Lins, 2003; Lins, 2003; Mitton,

2002).

One caveat, however, is in order: this view is derived with

loose connectionto the context in which the separationgener-

ally occurs –i.e., family business groups.

1

This is surprising,

given that a wealth of research evidence has revealed that

the separation is observed mostly in firms affiliated with

“family-controlled conglomerates”or family business groups

(Almeida & Wolfenzon, 2006b; Bebchuk et al., 2000: 296;

Khanna & Yafeh, 2007; La Porta et al., 1999; Masulis, Pham,

& Zein, 2011). The context of family business groupsis essen-

tial for precisely understanding the performance implication

*Address for correspondence: Kyuho Jin, College of Business Administration, Seoul

National University, Seoul, South Korea 151-916. Tel: +82 (10) 2239 7839; E-mail:

hypergeometric@mensakorea.org

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12102

434

Corporate Governance: An International Review, 2015, 23(5): 434–451

of the separationbecause it may undermine the validity of the

two implicit assumptions adopted by 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, & Hamilton, 1997). If firms are

stand-aloneas in the United States, it may stand toreason that

the separationarises solely from the control-enhancingmotive

of the controlling shareholders (Almeida & Wolfenzon,

2006b). 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,

Park, Subrahmanyam, & Wolfenzon, 2011; Khanna & Yafeh,

2007; Masulis et al., 2011; Villalonga & Amit, 2009). Since tap-

ping the internal capital market is argued to bring various fi-

nancing benefits by addressing information asymmetry and

moral hazard (Myers & Majluf, 1984; Williamson, 1975,

1985) and by circumventing capital market failure (Khanna

& Palepu, 2000a, 2000b; Khanna & Yafeh, 2007), it seems rea-

sonable to surmise that “the net effect [of the separation] on

value may not always be negative”(Villalonga & Amit,

2009: 3050). Evenso, this possibility has gone largely unexam-

ined in the dominant view.

On the other hand, the dominant view also implicitly as-

sumes that the controlling minority shareholders have rela-

tively short-term management horizons (Bertrand & Schoar,

2006; James, 1999) and hence pursue instant benefits even at

the cost of the firm’s long-termprospects or likelihood of sur-

vival. However, this assumption may not hold in the context

of family business groups either, given that to the family its

firms are “an asset to passto family members or their descen-

dants rather than wealth to consume during their lifetimes”

(Anderson & Reeb, 2003: 657; Bertrand & Schoar, 2006). Ac-

cording to the literature, family managers may care not just

about their present utility but about their descendants’future

utility (James, 1999); they “[manage] for the long term”

(Bertrand & Schoar, 2006: 75) or “[are] committed to

transgenerational wealth”(Habbershon & Pistrui, 2002: 224).

Thus, firms are not necessarily objects from which the family

extracts immediate private benefitsof control as the dominant

view speculates (Burkart, Panunzi, & Shleifer, 2003; Gomez-

Mejia, Cruz,Berrone, & De Castro, 2011; Gomez-Mejia,Makri,

& Kintana, 2010; Miller, Minichilli, & Corbetta, 2013). Such an

extension of management horizons is all the more likely in

publicly traded firms of family business groups, our central

focus. It is notable that the literature on the separation mostly

considers widely held firms or publicly traded firmsasthey

have minority shareholders to be directly expropriated. How-

ever, given that publicly traded firms typically serve as ker-

nels of business group governance (Chang, 2000; Jin, Park, &

Lee, 2011; Kim, 2003) and thereby determine the fate of their

business groups, it may be too costlyin the long run to extract

immediate privategain from such firms (Yim, Lee, & Hwang,

2014). Unfortunately, however, such extended management

horizons of the familyhave not received as much attention ei-

ther in this research stream.

We seek to fill these gaps by focusing attention on the large

family business groups. In keeping with the recent literature,

we connect the sepa ration of cash flow and voting rightswith

the workings of theinternal capital market and underscore its

positive ramification for performance. At the same time, we

put spotlight on the extended management horizons of the

family, which possibly curb the family’s self-serving beha-

viors. Taking these two aspects into consideration, we main-

tain that the performance implication of the separation may

be positive. To add precision to our theory, we also consider

several contingencies which help demarcate the boundaries

of our theoretical argument. In addition, we address the con-

cern about the endogeneity typicallyarising in the relation be-

tween ownership structure and performance (Almeida et al.,

2011: 449; Demsetz & Lehn, 1985) by adopting the Arellano-

Bond generalized method of moments (GMM) estimator in

the panel data setting. Using large family business groups in

Korea, or Chaebols,as our sample during the period between

2003 and 2010, we find that the separation of cash flow and

voting rights is positively associated with accounting perfor-

mance but not withmarket performance and that analystcov-

erage, R&D expenditure, and salesshare in the business group

moderate this relation.

This study contributesto the literature in severalways. First,

it brings thecontext of family business groupsdirectly into the

spotlight, recognizing the possibility that this context could

entail other theoretical processes that have been overlooked

in the dominant explanation. Second,this study takes into ac-

count the actuality that shareholders are not homogeneous

but vary in termsof their behavioral pattern accordingto their

identities (Hoskisson, Hitt, Johnson, & Grossman, 2002). By

delving into the family among others as one distinct type of

shareholder, this study sheds further light on how the share-

holder identity can shift the traditional agency argument. Fi-

nally, this study highlights the importance of addressing the

endogeneityin the analysis of the relation betweenownership

structure and performance. While it is an imperative rather

than an option to correct bias resulting from the endogeneity,

prior studies examining the performance implication of the

separation have been relatively unsuccessful in doing so,

which calls into question the statisticalconsistency of their pa-

rameter estimates (Adams & Ferreira, 2008; Baeket al., 2004).

Our study remedies this deficiency.

THEORY AND HYPOTHESES

Recent surveys reveal that in marked contrast to the conven-

tional image, modern corporations are not widely held, but

in the hands of just a small number of controlling minority

shareholders especially outside the United States and the

United Kingdom (Bebchuk et al., 2000; Claessens et al., 2000;

Faccio & Lang, 2002; La Porta et al., 1999). Equally revealing

is the fact that ownership structureof this kind is in effect con-

current with a radical separation of cash flow and voting

rights, which inevitably violates the “one share-one vote”

principle (Adams & Ferreira, 2008; Grossman & Hart, 1988;

Harris & Raviv,1988). Indeed, scholars havesuggested that vi-

olation of the one share-one vote principle is socially undesir-

able and holds negative implications for firm value and

ultimately social welfare (Grossman & Hart, 1988; Harris &

Raviv, 1988), the reason being that it distorts the incentive

structureof shareholders via an unfair redistribution of power

(Burkart & Lee, 2008).

In this spirit,prior literature typicallyattends to its dark side

mainly through the lens of agency theory. Fundamentally, it

435SEPARATION OF CASH FLOW AND VOTING RIGHTS

© 2015 JohnWiley & Sons Ltd Volume 23 Number 5 September 2015