The value of shareholder rights in family firms: Global evidence from a death in the family

• Published date: 01 July 2023
• Author: Başak Tanyeri Günsür,Ezgi Alp
• Date: 01 July 2023
• DOI: http://doi.org/10.1111/corg.12484

ORIGINAL ARTICLE

The value of shareholder rights in family firms: Global evidence

from a death in the family

Bas¸ak Tanyeri Günsür

1

| Ezgi Alp

1,2

1

Faculty of Business Administration, Bilkent

University, Ankara, Turkey

2

Faculty of Economics and Administrative

Sciences, TED University, Ankara, Turkey

Correspondence

Basak Tanyeri Günsür and Ezgi Alp, Faculty of

Business Administration, Bilkent University,

Ankara, Turkey.

Email: basak@bilkent.edu.tr and

ezgi_a@bilkent.edu.tr

Abstract

Research Question: How does the protection of shareholder rights affect the pricing

of family firms?

Research Findings: Investor reaction to a death in the family, measured using abnor-

mal stock returns, averages 0.58% and is significant.Investors perceive the death to

be a value enhancing event with the potential to dilute family control. The positive

investor reaction is amplified in countries and periods with weaker protection of

shareholder rights.

Theoretical Implications: External and internal corporate governance mechanisms

limit the extent to which majority shareholders can take actions that hurt firm value.

As such, investor perceptions of how faithfully their interests are protected depend

on the extent to which legal rules protect shareholder rights.

Policy Implications: Investors pay attention to the regulatory environment of the

country, as well as corporate governance in the firm when evaluating agency costs.

Our research has important policy implications because we show how better protec-

tion of shareholder rights affects the pricing and hence the funding costs of family

firms.

KEYWORDS

corporate governance, family firms, internal and external corporate governance, incentive

conflicts between the family and outside shareholders, law and finance nexus

1|INTRODUCTION

The corporation is an organizational form in which a nexus of legally

enforceable contracts defines the mutual rights and obligations of

shareholders, creditors, managers, employees, suppliers, and cus-

tomers to one another. Firms grow if their cost of coordinating eco-

nomic activity using legally enforceable contracts is lower than that of

the market (Coase, 1937). Firms that use outside equity financing face

a substantial coordination cost: the agency costs arising from the sep-

aration of control on how the firm is run and of ownership by outside

shareholders. Equity funding cost depends on investor perceptions

about whether managerial decisions serve the interests of outside

shareholders. The convergence of control and ownership may allow

the inside shareholder who holds a majority stake to overlook the

interests of outside shareholders who hold minority stakes (Berle &

Means, 1932; Fama, 1980; Jensen & Meckling, 1976). Internal and

external corporate governance mechanisms mutually supplement each

other and make up the governance environment that binds managerial

decisions. We investigate how one dimension of the external corpo-

rate governance environment, the legal protection of shareholder

rights, affects the incentive conflicts between majority and minority

shareholders and the pricing of family firms. We examine family firms

to minimize the variation in ownership concentration (an internal cor-

porate governance mechanism) and isolate how legal protection of

shareholder rights (an external corporate governance mechanism)

affects investors' pricing of shares.

1

Received: 29 April 2021 Revised: 24 June 2022 Accepted: 11 July 2022

DOI: 10.1111/corg.12484

Corp Govern Int Rev. 2023;31:625–646. wileyonlinelibrary.com/journal/corg © 2022 John Wiley & Sons Ltd. 625

Measuring how conflicts of interest between stakeholders affect

investors' perception of firm value is problematic. Firm value, organi-

zational form, and internal and external corporate governance mecha-

nisms are endogenous. We address the endogeneity by identifying an

exogenous shock, a death in the family, to measure how investors per-

ceive and price the change in the balance of power between the fam-

ily and outside shareholders. Death is exogenous because it allows no

conscious choice but changes the perimeters under which the family

makes decisions.

Investors' perceptions of how a death in the family will change

decision making inform their trading in stock markets. On the one

hand, investors may perceive the death as loss of valuable human cap-

ital. Stewardship theory suggests that family members develop dis-

tinct competencies and are emotionally invested in the firm

(Bubolz, 2001; Davis et al., 1997,2000). In this case, investors would

react negatively to a death in the family. On the other hand, agency

theory suggests that a decrease in entrenchment would constrain the

self-serving actions of family members. In this case, investors would

welcome the expected dilution in family control and react positively

to a death in a family if they expect the balance of power to tilt from

the family to outside shareholders.

The sample covers 132 deaths in 109 publicly traded family firms

operating in 24 countries. Investor reaction to a death in the family,

measured using abnormal stock returns, is positive and statistically

significant at 0.58%. The positive abnormal returns support agency

theory that investors expect a dilution in family control resulting from

the death.

Internal and external corporate governance mechanisms that

determine the rights and obligations of stakeholders affect the agency

costs arising from incentive conflicts between majority and minority

shareholders. We focus on one specific dimension of the external cor-

porate governance environment and investigate how the legal protec-

tion of shareholder rights affects the pricing of family firms. We

hypothesize that the legal system constrains the extent to which the

controlling family can make self-serving decisions. We find that inves-

tors react more positively to news about the possible dilution of

family control in countries and time periods where shareholder rights

are less protected. The results support our theory that the legal pro-

tection of shareholder rights, as an external corporate governance

mechanism, is vital in shaping investor perceptions about firm value.

Investors' pricing of family firms determines the cost of outside equity

financing and hence their growth opportunities. A country's regulatory

environment and the firm's corporate governance are critical to inves-

tors' perception when evaluating the agency costs that arise from

incentive conflicts between inside and outside shareholders.

Our work contributes to the literature on: agency costs, the law

and finance nexus, and executive deaths. The literature on agency

costs concentrates on how conflicts of interest between outside

shareholders and the family affect the investment and financing deci-

sions while holding the external legal environment constant (Gomez-

Mejia et al., 2001; Keil et al., 2017; Morck & Yeung, 2003; Nguyen &

Nielsen, 2014; Villalonga & Amit, 2006; Villalonga et al., 2015). The

law and finance literature investigates how the law affects decision-

making in firms with widely dispersed shareholders and the valuation

of these firms (Allen et al., 2005; la Porta et al., 1997,1998; Peng &

Jiang, 2010). These two strands of literature are related: One of the

assumptions of the law and finance literature is that protection of

shareholder rights and internal corporate governance mechanisms

mutually supplement each other and make up the governance envi-

ronment to limit agency costs (Aguilera et al., 2015; Bell et al., 2014;

Chrisman et al., 2018; Martins et al., 2017,2020; Peng et al., 2018;

Schiehll & Martins, 2016; Walsh & Seward, 1990). We contribute to

the discussion by focusing on the endogenous relationship between

internal (organizational form and ownership concentration) and exter-

nal governance mechanisms (shareholder rights) in family firms. We

use agency theory as a building block to develop and test our predic-

tions on how legal rules shape investor perceptions and affect the

pricing of family firms. Our research has policy implications for regula-

tors because we show how strengthening the rule of law that protects

the rights of all shareholders may affect the valuation and hence the

growth of family firms.

We also contribute to the discussion on how the death of execu-

tives and block-holders affects firm value (Johnson et al., 1985;

Madden et al., 2012; Nguyen & Nielsen, 2014; Salas, 2010; Slovin &

Sushka, 1993; Worrell et al., 1986). This literature focuses on how

investors evaluate the entrenchment of the deceased versus the

uniqueness of his/her human capital. We theorize that the external

environment is an important factor that motivates family members

with the executive power to develop firm-specific competencies and

to serve all shareholders faithfully. Regulatory, cultural, and competi-

tive differences in the external environment are important forces for

aligning the family's interests with outside shareholders. We show the

importance of cross-country differences in the extent to which the

law protects the rights of outside shareholders, and differences in

investor perceptions about the effect of founders versus descendants

in positions with executive power. Entrenchment and human capital

development cannot be evaluated in isolation and are endogenous to

the external environment, including the legal rules of the country in

which the firm is incorporated.

2|THEORY AND HYPOTHESIS

DEVELOPMENT

2.1 |How do incentive conflicts between the

family and outside shareholders affect firm value?

Firms whose internal funds are insufficient to finance profitable pro-

jects need to raise capital from outside investors. Listing on stock mar-

kets is an external financing choice that allows access to a broader

base of investors. Firms that decide to issue shares to outside share-

holders change the distribution of control in the firm. The inside and

outside shareholders are equity investors who finance the firm and

monitor the performance of their investment. However, the control

that inside shareholders exert over the firm relative to outside share-

holders is significantly higher.

626 TANYERI GÜNSÜR AND ALP