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Pyramids: Empirical Evidence on the Costs and Benefits of Family Business Groups Ronald W. Masulis, Peter K. Pham & Jason Zein. Introduction. Ownership & control of publicly listed firms by wealthy families and individuals is common in emerging markets
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Pyramids: Empirical Evidence on the Costs and Benefits of Family Business Groups Ronald W. Masulis, Peter K. Pham & Jason Zein
Introduction • Ownership & control of publicly listed firms by wealthy families and individuals is common in emerging markets • Wealthy families often control multiple independent firms through business group structures • Holding companies • Pyramids • Cross-shareholdings • Dual class shares • Several studies point to important costs and benefits of family business groups (Khanna and Yafeh, 2007 Survey)
Introduction Ultimate Investor Direct Control Firm B Firm C Middle layer Firm E Firm D Firm F Bottom layer Firm G
Costs and Benefits of Groups • Costs • Extraction of Private Benefits of Control (tunneling) • Bertrand, Mehta and Mullainathan (2002), Bae, Kang and Kim (2002), La Porta et al (2002), Claessens et al (2002), Joh (2003), Baek, Kang and Lee (2006) • Political influence and lobbying against legal and capital market reforms • Fogel (2006), Morck, Strangeland and Yeung (2000), Morck Wolfenzon and Yeung (2005), Stulz (2005). • Social welfare costs of inefficient internal capital allocations • Almeida and Wolfenzon (2006a)
Costs and Benefits of Groups • Benefits • Group reputation can substitute for weak legal and regulatory mechanisms • Fisman and Khanna (2004), Khanna and Rivkin (2001), Khanna and Palepu (1997, 2000) • Source of valuable equity capital – internal capital market. • Investment by minority shareholders • Almeida and Wolfenzon (2006a, 2006b) • Risk sharing mechanism, credit guarantees • Gopalan, Nanda and Seru (2007), Khanna and Yafeh (2005)
Motivation & Contribution • Family business groups a dominant fixture in emerging markets as well as developed markets. • Implication: Minority shareholders continue to co-invest with families within group structures, despite the risks. Why? • Are family-group firms good investment opportunities? • Examine relative costs and benefits of family business groups at: • Firm level: • Distinguish between family group firms and non-group firms • Examine business group structures and within-group positioning of firms. • Country Level: • Large number of sample countries and more extensive firm coverage compared with La Porta (1999), Claessens, Djankov, Fan and Lang (2002), Khanna and Yafeh (2005)
Ownership Data and Group Construction • Ownership data obtained for 27,987 firms from 45 countries as of 2002 • Ownership databases: Osiris, Worldscope (others from LexisNexis). Annual Reports: MergentOnline, stock exchanges and company websites • 1st Step: Distinguish between widely held, directly controlled and pyramid controlled firms: • Closely held firm threshold is 20%, but it is dropped to 10% if the largest shareholder is a founder, CEO or has board control • 2nd Step: Establish the identity of the controlling shareholders through media articles, stock exchanges, company websites, and annual reports
Ownership Data and Group Construction • 3rd Step: Distinguish family group firms from independent family firms • Two or more firms in the same national market controlled by a common family are defined as belonging to a family business group • 4th Step: Construct and verify the structure of each family group • Identify cross holdings within group • Identify the number of pyramidal layers and the position of each member firm • Calculate the cash-flow and control rights of each firm in the business group and adjusted for dual class shares • Procedure yields 845 family-controlled groups comprising 2526 firms.
Descriptive Statistics: Highlights % Listed firms belonging to a family business group % Listed firms belonging to a family group & held through pyramid % Market cap. due to family controlled groups % Market cap. due to family group firms held in pyramid
Firm-Level Analysis Widely Held / Controlled alone (Industry Peers) Ultimate Investor Top Layer Firm B Firm C Firm H Middle layer Firm E Firm D Firm F Bottom layer Firm G
Multivariate Results – Group Vs Non-Group • Multivariate OLS regressions for Tobin’s Q on group affiliation. • Controlling for Size, Beta, Leverage, Asset Growth, CAPEX, Dividend Yield, Asset Tangibility, Age, Analyst Coverage, Country Effects and Industry Effects • We address endogeneity of group affiliation choice using • Two stage IV regression and treatment effects model • Idiosyncratic risk as instruments for group affiliation, following Villalonga and Amit (2006). • Control for the benefits/costs of family and other control types • Repeat above regression using controlled firms only • Repeat above regression using family-controlled firms only
Multivariate Results – Group Vs Non-Group (Endogeneity Correction)
Family A 40% 30% Firm C Firm B 20% 60% 50% 40% Firm E Firm D Firm F Multivariate Results – Within-Group Analysis • Estimate Q regression on various group ownership and control measures. • Ultimate cash flow rights, control rights, group layer position and group direct ownership • Include (a) group-fixed effects to control for reputation and differences in entrepreneurial skill, and (b) industry fixed effects. • With respect to Firm D: • Direct Ownership: 20%+40% = 60% • Cash Flow Rights of A: 0.4*0.2 + 0.3*0.4 = 20% • Weakest Control Link: 20%+30% = 50% • Layer position: 1 (for D, E and F), 0 (for B and C)
Multivariate Results – Within-Group Analysis • Avoid systematic differences b/w group vs. non-group firms using Heckman correction for selection bias • Endogeneity of Q of ownership and control measures • IV regressions using idiosyncratic risk and same-industry indicator to instrument for individual ownership measures.
Country-Level Analysis We measure several quantifiable country-level characteristics that could explain cross-country variation in family groups. Private Benefits of Control / Corporate Governance Corporate Governance Index, Block Premium, Competition, Tax Transparency, Newspaper Circulation (Newspaper) Access to Capital Savings to GDP, Institutional Funds, Log GDP per Capita Taxation & Regulatory Factors Consolidated Accounting of Group Tax Transparency Partial Acquisition Rules (Takeover Constraint Index) Political Stability
Country-Level Robustness Checks Controlling for unobserved determinants of the scope for private benefits of control: Repeat the country level regressions using Group Firms / Controlled firms & Group Firms / Family Controlled Firms as the dependent variable Block premium as an additional explanatory variable Addressing reversal causality interpretations using instrumental variable (IV) regressions: Legal Origin Corporate Governance Standards Savings per GDP Institutional Funds Combining country- and firm-level variables Other potential determinants: alternative investor protection indices, professional manager availability, inheritance law, ownership disclosure rule Results are qualitatively unchanged.
Conclusion • Country-Level • Access to capital, as well as regulation and taxation appear to be important in explaining business groups • Firm-Level • Lower Q for group firms may simply reflect endogenous selection, consistent with internal capital markets benefits of groups. • Correcting for endogeneity biases, group affiliation leads to an increase in value. • Placing firms at the bottom of pyramids increases their value due to access to internal and external capital and reputation benefits. • The direct ownership of the group appears to be the mechanism through which groups signal commitment and increase value rather than through their ultimate cash flow rights at the Apex.