When Too Much Monitoring is Costly: Evidence from Asian Family Firms

1. When Too Much Monitoring is Costly: Evidence from Asian Family Firms En-Te Chen & John Nowland Queensland University of Technology, Australia Visiting - National Cheng Kung University, Taiwan

2. Introduction • Agency theory and corporate governance research generally state that more monitoring is better. • For example, increased monitoring reduces the agency conflict between insiders and outsiders and is therefore in the best interests of minority shareholders. • Even if governance practices are endogeneously determined by firms, the choices are usually made by insiders, so more monitoring is still in minority shareholders best interests.

3. Introduction • Is it possible to have too much monitoring? • Yes - all companies will reach an optimal point where the marginal cost of monitoring equals the marginal benefit. However, this is generally assumed to be at extreme levels of monitoring. • In this study we focus on family-owned companies as we expect the relative costs and benefits of monitoring to be different in this type of company. • We expect to find an optimal point at much lower levels of monitoring for family-owned companies.

4. Introduction Family companies Other companies Firm Performance Monitoring

5. Why? • Why should family-owned companies have a lower optimal level of monitoring? • The benefits of monitoring are lower: • Information asymmetry – less likely to share information with monitors (Adams & Ferreira, 2007; Raheja, 2005; Cai et al., 2007). • Lack of independence of monitors (Chen and Jaggi, 2000).

6. Why? • The costs of monitoring are higher: • Unnecessary monitoring as family is monitoring within the company (Demsetz and Lehn, 1985; Anderson and Reeb, 2003; Anderson et al., 2003). • Family has a strong track record of successfully managing the company so too much interference actually hinders their performance (Morck et al., 1988; Villalonga and Amit, 2006). • Family creates more value through channels such as political connections, where too much monitoring limits this type of wealth creation (Faccio and Parsley, 2006).

7. Variables • Family-owned companies are defined as companies whose largest ultimate shareholder is the family group that founded the company. • Monitoring is operationalized by the following variables: • Board governance – board independence (BIND) and committee monitoring (COMM = AC + NC + RC). • Disclosure – analyst forecast error (ERROR) and forecast dispersion (DISPERSION). • Firm performance is measured by Tobin’s Q (TQ) and Return on Assets (ROA).

8. Sample • Use hand-collected data on the biggest Asian companies over the period 1998 to 2004. • This includes 185 companies (100 family and 85 other) from Hong Kong, Malaysia, Singapore and Taiwan. • To be included in main sample, companies needed to have board governance and ownership data available in annual reports and have financial data from Compustat for each year in sample period. • Disclosure sample has 94 companies (48 family and 46 other) where forecasts available from IBES.

9. Method • Models relate ln(Tobin’s Q) to external monitoring variables, squared terms and control variables – size, growth, ROA, leverage, cashflow rights, ratio of control to cashflow rights. • Use fixed firm effect regressions to control for any omitted variable bias. Also include fixed period effects. • Table 3 shows cross-sectional and time-series variation. • Regressions are run separately for family and other companies to avoid potential collinearity between fixed effects and a family dummy.

10. Results – Table 4 Other companies • No relationships between board independence, committee monitoring and performance. • Optimal board governance: • CCSPLIT • RC Family companies • Concave relationships between board independence and performance and committee monitoring and performance. • Optimal board governance: • BIND = 0.38 • COMM = 2.2 • CCSPLIT • AC + RC

11. Results – Table 5 Aligned versus entrenched family owners • Aligned (higher than median cashflow rights ownership): • Significantly lower optimal board independence (29%) and other board monitoring (1.8) than non-aligned. • Entrenched (control rights > cashflow rights): • Significantly higher optimal board independence (44%) than non-entrenched.

12. Results – Table 6 Substitute monitoring by other parties • Family monitoring • More involved (Chair + CEO) equates to lower board independence (30%). • Less involved equates to higher board independence (44%). • Blockholders (>10%): • No significant differences. • Debtholders (higher/lower than median): • Less debt equates to higher board independence (41%).

13. Results – Table 7 Disclosure • Family companies: • ERROR negative • DISPER not significant • Other companies: • ERROR negative (and bigger) • DISPER negative (and bigger) • Suggests that improvements in disclosure are associated with a greater increase in performance (steeper gradient) in other companies than family companies.

14. Robustness Checks • Using ROA instead of TQ provides consistent results. • Reverse causality – use lagged board governance and disclosure variables with consistent results. • Including board governance and disclosure variables together produces consistent results. • Removing one country at a time produces consistent results. • Using raw TQ and ROA produce consistent results.

15. Conclusions • At moderate levels of monitoring, we find an optimal level of board governance in family-owned companies but not other companies. • Optimal level is higher when family owners are entrenched, lower when family owners are aligned. • Optimal level also depends on substitute monitoring undertaken by other parties. • Implication - more monitoring is not always wealth-maximizing for all companies.

16. Conclusions • Practical implication - improvements still needed: • Optimal level of board independence is found to be 38% for the average family-owned company. • But, average board independence is currently only 23%. • Similarly on 72% have CCSPLIT and 63% have AC.