1 current research status and issues of corporate governance -focusing on issues of korean corporate...

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Current research status and Issues of Corporate Governance-Focusing on issues of Korean Corporate Governance

Chang Min, Lee

August 2010

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Table of Contents

1. Introduction

2.Forms of corporate governance

a. Existence, Forms, and Management participation of Controlling

Shareholders

b. One share-One vote Principle deviation

3.Family firm control structure and Succession of control

a. Family firm control structure

b. Succession of Control

4.Business group structure

a. Business Group structure in Emerging market

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1. Introduction

Increasing Trend of theoretical and empirical study

Family firm Business Group

• A family firm is the firm which the founder and his or her family hold shares or are the members of the management or board of directors of the company in a broad sense. In a narrow sense, it refers the firm which the founder and his or her family are the controlling shareholders<1>

• A business group indicates the form of the firm where several independent companies are connected because of shares or family relations

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1. Introduction

Rafael La Porta et al (1999)

• Analyzed corporate governance of large companies in 27 developed countries.

• Many of large companies have controlling shareholders<2>.

• Many of large companies are controlled by the family and the state.

• Many firms are out of One share-One vote principle through Pyramid or

management participation.

• Cross-shareholding is rare, except in Sweden and Germany.

• Controlling family participates in management in 75% of family firms in countries with

good shareholder protection<3>, while the family does so in 64% of family firms in

countries with poor shareholder protection.

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1. Introduction

Anderson and Reeb (2003)

• Motivation: Empirical research about recognition that Founding-Family Ownership is

less efficient than separation of ownership and control.

• Analyzed US S&P 500 companies in 1992(except bank and utility industry) and

Classified firms where the founder and related family own shares or are the

members of the board of directors as family firms<4>.

• One-third of S&P 500 companies are classified as family firms

• The family owns 18% of shares on average.

• The family control and influence is much more powerful than shareholding

Ex) Control power over election of directors is 2.5 times more powerful than their

holding shares

• Performance of family firms is superior to that of non-family firms.

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1. Introduction

Two studies above trigger follow-up studies through arousing following issues

Rafael La Porta et al (1999) Anderson and Reeb (2003)

• Existence and forms of controlling shareholders of firms in each country. (family,

financial institutions, etc.)

• Fact that whether controlling shareholders participate in management or not.

• Advantages and disadvantages, and effects on corporate value of difference in

ownership and control structure.

• The proportion of family firms, corporate structure, and performance in each country.

• Succession of control in family firms.

• Characteristics of a family business group.

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1. Introduction

▣ The follow-up study has significant importance in terms of its intimate

connection with corporate governance issues of conglomerates in Korean

society

• Most Korean conglomerates can be defined as family business groups, and

show properties of both a family firm and a business group.

▣ Major issues on corporate governance structure in Korean conglomerate

• Existence of a controlling shareholder (ownership concentration) and control by the founder and family

• Ownership-Control deviation by controlling shareholder: Problems of pyramid, circular equity investment, etc.

• Controlling shareholder’s management participation and management stabilization

• Control of financial capitals over industrial capital

• Succession of control in family firms

Issue 1

Issue 2

Issue 3

Issue 4

Issue 5

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1. Introduction

▣ Issue 1: Existence of a controlling shareholder (ownership concentration)

and control by the founder and family

• Cons

−Dispersed governance structures are more efficient.

−Control of companies by family members is the phenomenon appearing in

developing countries.

• Pros

−A controlling shareholder has positive influence on corporate value since

he or she has plenty of incentives for monitoring management.

−It is not proved that family business is inefficient.

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1. Introduction

▣ Issue 2: Ownership-Control deviation by controlling shareholder: Problems

of pyramid, circular equity investment, etc.

• Cons

−A controlling shareholder exercises more powerful control through pyramid

or circular equity investment compared to shares he or she owns.

※ Possible conflict of interest between a controlling shareholder and minority shareholders

Ex) When the controlling shareholder has considerable amount of shares of company A and

controls company B through company A there is possibility to redirect company B’s assets

in favor of company A, thus causing conflict with shareholders in company B.

−Mutual assurance through circular equity investment or mutual investment

brings the problem of concentration of financial power<5>.

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1. Introduction

▣ Issue 2: Ownership-Control deviation by controlling shareholder: Problems

of pyramid, circular equity investment, etc.

• Pros

−It is correlation among companies in a business group through mutual

investment or pyramid that performs a role of risk sharing.

−Deviation of ownership and control is needed to stabilize management

−Possibility of resource redirection substantially low due to the development

in the market and the monitoring functions.

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1. Introduction

▣ Issue 3: Controlling shareholder’s management participation and

management stabilization

• Cons

−Direct management by a controlling shareholder leads absence of

monitoring body; there arises a problem that who check management

board when the controlling shareholder and the one who is in charge of

management are the same, because advantage of existence of the

controlling shareholder is effective monitoring on management board.

−Since a controlling shareholder executes powerful control and manages the

company directly with few shares, it builds trenches around the

management power and no one can check management

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1. Introduction

▣ Issue 3: Controlling shareholder’s management participation and

management stabilization

• Pros

−Direct management by the controlling shareholder reduces possible moral

hazard induced by CEOs.

−Management stabilization not only facilitates long-term investment but also

is the only protection mechanism from hostile merger and acquisition

activities of foreign capital.

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1. Introduction

▣ Issue 4: Control of financial capitals over industrial capital

• Cons

−One of the main functions of financial capital is monitoring management of

industrial capital.

※Financial capital loses its independent monitoring ability if financial capital and industrial capital

are included under conglomerates and correlated by mutual investment or other methods.

• Pros

−Financial capital has competence in rich information and management

monitor.

−Holding industrial capital of financial capital in a certain degree helps

resolve potential conflict of interest.

※If a bank makes relationship with a company only through a loan, there exists the possibility of

conflict of interest between the bank (lenders) and shareholders in that company when

monitoring management of the company.

※One of the solutions is increasing shares holding

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1. Introduction

▣ Issue 5: Succession of control in family firms

• Cons

−Election of management board in family members brings decline in

competency of management board, thus has negative impact on corporate

value and performance.

• Pros

−Management by family members directs companies with long-term view

and reduces agency cost because the executive from family is also the

controlling shareholder.

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1. Introduction

▣ This paper classifies follow-up studies in following three categories,

summarizes results, and offers implications on Korean conglomerates: (1)

Diverse forms of corporate control, (2) corporate governance structures and

business succession of family firms, and (3) business groups

• (1) Diverse forms of corporate control

• (2) corporate governance structures and business succession of family firms

• (3) business groups

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1. Introduction


•Governance structures have various forms in each country, depending on the law, the system, the degree of market development, or management-union relations.

•Firms in which a controlling shareholder exists are common globally.

•Most controlling shareholders are families and financial institutions (banks, insurance companies, etc.)

•The ratios of participation in management of a controlling shareholder (family) in US and Asia are equal.

•Deviation of ownership and control is largest in Asia and US has larger deviation than Europe.

• (2) • (3)

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1. Introduction

• (2) Corporate governance structures and business succession of family firms

• (1) • (3)

•Most family firms(US, Europe, and Asia) show deviation of ownership and control

•Studies result in different research results on the influence of pyramid or others upon corporate value.

•Ratio of firms that is controlled and managed by the family is highest in Europe, and about the same in US and Asia.

•The impact of succession of control on corporate value and performance depends on various conditions, showing different results.

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1. Introduction

• (3) Business groups

•Business groups, especially family business groups, generally appear in developing countries.

•Internal market in a business group performs as capital market and labor market, which are underdeveloped: complicated governance structure, such as pyramid or mutual investment, has been made under that historical circumstance.

•Risk sharing exists in conglomerate groups in Japan, Korea, and Thailand.

• (2)• (1)

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1. Introduction


• (2) corporate governance structures and business succession of family firms

• (3) business groups

▣ In conclusion, implications on Korean conglomerates are summarized as

following: "(1)Corporate governance structure of the conglomerates,

represented by pyramid or circular equity investment, is the product of

circumstances and has both advantages and disadvantages. (2)It is not an

exceptional phenomena in Korea that, the controlling shareholders exists,

participates in management, and shows deviation of ownership and control.

(3)It is hard to draw definite conclusion on the influence of Korean corporate

governance upon corporate value and performance.

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Table of Contents

1. Introduction



Shareholders







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2. Forms of corporate governance – a.

▣ Analysis on controlling shareholders of US firms

<Chart 1: Analysis of controlling shareholders in US, Europe, and Asia>

• Gadhoum et all. (2005) analyzed controlling shareholders of listed

companies(Family and Non-family firms) in US

a. Existence, forms, and management participation of controlling shareholders

US Asia Europe

Distributive structure 40.26% 20.28% 13.72%

Firms with controlling shareholder 59.74% 79.72% 86.28%

Firms controlled by the family 30.60% 45.05% 55.87%

Firms controlled and managed by the family 24.57% 24.57% 37.32%

Firms controlled by financial institutions 16.33% 17.80% 18.34%

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−Data: Controlling shareholder analysis of 3,607 US firms in 1996

−Firms with controlling shareholder: 59.74%(Asia 79.72%, Europe 86.28%)

※ Though the rate is lower than Asia and Europe, considerable number of US firms have

controlling shareholders

※ Define controlling shareholder as a shareholder with voting rights more than 10%

−Firms controlled by the family: 36.6%(Asia 45.05%, Europe 55.87%)

※ As size of firms gets bigger, the rate of family firms gets lower. However, family firms consist

20.36% of top 20% firms based on size

Gadhoum et all. (2005)

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−Firms controlled and managed by the family<6>: 24.57% (Asia 24.57%,

Europe 37.32%)

※ Practically, US and Asia has same rate of firms that the family has strong management power

−Firms controlled by Widely-Held Financial Institutions: 16.33% (Asia

17.80%, Europe 18.34%)

※ In case of US, Pension Fund, Mutual Fund, and Insurance companies, not banks, controls

12.38% of firms

• In conclusion, though there is powerful protection for minority shareholders by

law<7>, many firms are controlled by the family or by financial institutions


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<Chart 2: Comparison of Corporate governance in 5 developed countries>

US Japan Germany France UK

Distributive structure 44.26% 42% 3.6% 6.2% 22.59%

Family controlled

firms36.6% 13.1% 37.26% 34.3% 25.27%

Financial Institution controlled

firms

16.33% 38.5% 22.35% 20.73% 37.04%

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• Corporate governance figures of 5 developed countries(US, Japan, Germany,

France, UK) are..

• Family firm rate of US is relatively high compared to developed countries

Germany(37.26%)

US(36.6%)

France(34.3%)

UK(25.27%)

Japan(13.1%)

Japan<8>

(38.5%)UK(37.04%)

Germany(22.35%)

France(20.73%)

US(16.33%)

France(23.68%)

Us(20.36%)

Germany(16.66%)

Japan(6.66%)

UK(4.05%)

Germany(40.9%)

Japan(28.26%)

US(16.48%)

UK(16.21%)

France(14.47%)

Family controlled firms

Financial Institution controlled firms

Family firms within top 20% based on distribution

Financial Institution controlled firms within top 20% based on distribution

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• How to explain figures shown in <Chart 2> theoretically is a problem

−Assume that Corporate governance which maximize shareholder value(either

family control or financial institution control) is chosen: Compare Resource

Tunneling Costs by family control and Agency Costs by financial institution

control and choose the option with lower cost.

−In countries where protection for shareholder rights is weak, control by

financial institution is more general<9>.

※Possibility that control by financial institution, rather than family, can reduce conflict between major

and minor shareholders: family control may leads to Resource Tunneling

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−In countries with advanced system of protection for shareholder rights, control

of family, rather than financial institution, is more general<10> .

※In case where minor shareholder rights are well protected, since the possibility of Resource

Tunneling is scarce(Lower cost of ‘Private Benefit of control’), Agency Costs by financial control is

inferior<11>.

※ Control of firms by financial institution is rare in US, not only because of Glass-Steagall act which

restricts banks from owning stocks, but also because optimal structure under given legal

environment has been chosen.

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▣ Analysis on controlling shareholders of European firms

• Faccio and Lang (2002) analyzed Corporate governance in Europe

−Data: 5,232 firms of Austria, Belgium, Finland, France, Germany, Ireland,

Italy, Norway, Portugal, Spain, Sweden, Switzerland, and UK

−Including large, medium, small-sized companies, financial and Non-financial

institutions

−Distributive structure: 36.93%, Family contorlled fims: 44.29% (Define

controlling shareholder as a shareholder with voting rights more than 20%)

※Countries with distributive structure: UK(63.08%), Ireland(62.32%)

※Countries with family firms: Continental Europe(France:64.82%, Germany:64.62%, etc)

Faccio and Lang (2002)

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▣ Analysis on controlling shareholders of European firms

−Distributive structure by financial institutions: 39.92%, Control by the family:

26.54%

※Countries mainly with distributive structure: UK(60.11%), Ireland(63.64%)

※Countries mainly with family control structure: Continental Europe(France:33.16%,

Germany:37.58%, etc)

−In case of Major-corporations(top 20 companies), ratio of distributive structure

rises overall


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▣ Analysis on controlling shareholders of Asian firms

• Claessens et al. (2000) analyzed Corporate governance of East-Asian firms

−Data: Ownership data of 2,980 firms from Hong Kong, Indonesia, Japan,

Korea, Malaysia, Philippines, Singapore, Thailand, and Taiwan in 1998

−Tendency not to use stocks with Superior Voting Right

−38.7% of the firms with Ultimate Owners have pyramid structure (Indonesia

66.9%, Korea 42.6%, Thailand 12.7%)

−10.1% are Cross-Holdings

Claessens et al. (2000)

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▣ Analysis on controlling shareholders of Asian firms

−Firms with only one controlling shareholder (have no second-largest

shareholder with shares more than 10%) accounts for 67.8% (Japan 87.2%,

Korea 76.7%, Philippines 35.8%)

−Case where controlling family is directly participating in management(CEO,

Board Chairman, or Vice-Chairman) accounts for 57.1% (Malaysia 85%,

Korea 80.7%, Japan 37.2%)


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▣ Analysis on determinants of family control

• Mueller and Philippon (2008) suggested theory and empirical analysis on

determinants of family control

−Family firms are (1)efficient in dealing with difficult(hostile) labor relations

(2)appear much in countries where labor relations are difficult(labor-

management relations is hostile)

※Family firms are more likely to have more paternalistic labor-management culture because, (1)the

controlling family of the firm is more likely to have long-term perspective and, (2)since the

controlling family is interested in stability of the firm, interest of both sides is likely to be matched

−In France, family firms offer better employment insurance compared to firms

with distributive structure

Mueller and Philippon (2008)

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▣ Analysis on determinants of family control

−Analyzed correlation of labor-management relation and family control in 30

countries around the world

※The more hostile labor-management relations a country had, the more it has family firms

※The argument that family firms appear much in countries with weak protection for minor

shareholders only explain part of the phenomenon

Mueller and Philippon (2008)

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▣ Control of firms by financial institutions

• Analysis on control of firms by Bank Holding Company of US and Universal

banking of Germany

• Santos and Rumble (2006) analyzed control situation of US S&P 500 firms by US

banks

−Data: Analyzed 71 Bank Holding Company among top 100(based on asset

size) in 2000

Santos and Rumble (2006)

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−71 Bank Holding Company invested in stocks of 5,513 corporations through

Trust, and 4,641 were Non-financial firm → 403 firms among 4,614 Non-

financial firms were S&P 500<12>.

※Bank Holding Company invests 86% of Trust asset in stock

※Bank Holding Company holds more than 5% of ownership for 44 firms in S&P 500 through Trust

and holds more than 10% of ownership for 12 firms: Trust is the key factor in Financial-Industrial

connection in US

※Bank Holding Company holds 12% of stocks and 10% of voting rights from S&P 500 corporation

through Trust

※Bank Holding Company holds 12% of stocks and 10% of voting rights from Major corporation(185

firms, over $10billion) through Trust

※Bank Holding Company holds 5% of stocks and 4% of voting rights from total Non-financial firms

through Trust


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−This study analyzed possession of stocks and voting rights from Non-financial

firms by Bank Holding Company through Trust. If we consider direct

possession and possession through other channels additionally, ratio will get

even higher.

−The higher the ratio of voting rights Bank Holding Company has, the higher

the probability that management of Bank Holding Company acts as outside

director of the firm

−Overall, despite America’s strict separation policy<13>, banks exercise

dominance over Non-financial firms by holding considerable amount of voting

rights and putting their management as outside director of the firm


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• Gorton and Schmid (2000) analyzed an influence that the control of firms by

Universal Banking in Germany does to a performance of the firm

−Data: 283 firms in 1975 and 280 firms in 1986

−Existance and form of Ultimate Owner: One who has more than 25% of

voting rights based on stock holding is defined as Ultimate Owner

Gorton and Schmid (2000)

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<Chart 3: Corporate governance of German corporation>

−Analyzed how banks exercise dominance over firms

In 1975 In 1986

With Ultimate Owner 84% 81%

Form of Ultimate Owner

Bank(domestic or foreign) 29% 22%

Insurance institution 6% 6%

Family and family Trust 20% 28%

Non-financial firm 57% 53%


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<Chart 4: The way Universal banking of Germany exercise dominance>

※Bank’s control through stock is far less than 25%

※As we can see in <chart3>, the rate of Non-financial firms as Ultimate Owner is quite high and the rate

that these Non-financial firms are the only Ultimate Owner is also high

※However, most of the firms have voting restriction: 5% or 10%%<14>

※Proxy voting by banks representing minor shareholders is exception of the restriction and this makes

bank’s control power stronger

In 1975 In 1986Voting rights through stock

holding 8% 13%

Proxy voting 21% 23%


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−Various theories on how bank’s control over firms influence their performance

exist

※Possibility that performance is positively influenced because interest of banks and shareholders of

the firm is likely to be matched

※Possibility that banks gain monopoly profits by abusing their position as a controlling shareholder in

situation where capital market is not competitive: Negative influence on performance

※Possibility that two effects described above are mixed and, as a result, negative influence arises

when bank’s control power is weak and positive influence arises when bank’s control power is

strong


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−Effect that proxy voting by banks will do to a performance

※Proxy voting makes ownership and control different Hypothesis that the effect of proxy voting ※

would be similar to the effect of difference between ownership and control does to performance

−Result of empirical study: (1)Bank’s control over firms through stock holding

gives performance a positive influence and the positive influence is larger

than what Non-financial controlling shareholder can give, (2)Proxy voting

does not affect performance


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Table of Contents

1. Introduction



Shareholders







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2. Forms of corporate governance – b.

b. Existence, forms, and management participation of controlling shareholders

▣ The core of One Share-One Vote Principle is..

• Since shareholder is the most interested in maximizing corporate value, Voting right or Control right should be given based on number of shares: Based on logic that shareholder is the only Residual Claimants

• Voting right based on number of shares is reasonable in economic incentive sense

• Argument above is now under debate: Some say other stakeholders should also have Control right(Shareholder is not the only Residual Claimants), and others say giving Control right only to shareholders may not maximize corporate value (Allen and Gale (2002), Allen (2005), Allen et al. (2006))

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▣ Pros and cons of One Share-One Vote Principle Deviation

• Adams and Ferreira (2007) analyzed benefits and costs of One Share-One Vote

Principle Deviation

<Chart 5: Pros and cons of One Share-One Vote Principle Deviation>

Adams and Ferreira (2007)

Pros Cons

ㆍ Business Group replaces underdeveloped marketㆍ Large Shareholders’ Controlㆍ Management protection benefits stakeholders other than shareholder

ㆍ Distorted investment decisionsㆍ Resource Tunnelingㆍ Inefficiency in Corporate dominance market( 기업지배권 시장의 비효율 )ㆍ Inefficient Perk Consumption

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2. Forms of corporate governance



−Problem of One Share-One Vote Principle Deviation: Most family firms show

deviations through ways like pyramid structure and this is thought to be the

problem

※ Distorted investment decisions: Exercising more Control right than shares they are holding may

lead to investment decisions that is against shareholder value Ex) Empire Building

※Resource Tunneling Ex) Unfair support among affiliates

※ Inefficiency in Corporate dominance market: Powerful ownership and management power with

only a few share distorts outside M&A market

※Monopoly: Through relations with affiliates, secure the monopoly position in the market

※Inefficient Perk Consumption Ex) Excessive management compensation

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2. Forms of corporate governance



−Benefits of One Share-One Vote Principle Deviation

※Business Group replaces underdeveloped system(underdeveloped capital market and etc):

Formation of Internal capital market/Risk sharing within Business Group/Replacement of labor

market<15>(Khanna and Yafeh (2006))

※Large Shareholders’ Control has many benefits: Large shareholders have enough incentive to

monitor management and have better ability than minor shareholder to monitor management

※Management protection benefits other stakeholders<16>

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▣ Effect the One Share-One Vote Principle Deviation does to corporate value

• Claessens et al. (2002) analyzed correlation between One Share-One Vote

Principle Deviation and corporate value<17>

−Data: Ownership data of 1,301 firms from Hong Kong, Indonesia, Korea<18>,

Malaysia, Philippines, Singapore, Thailand, and Taiwan in 1996 (Except

financial and regulated industry)

−Results of research

※The higher the raio of Large shareholders' Share of Cash-Flow Rights, the higher the corporate

value become(Incentive effect)

※ 소유와 지배의 차이 (Control minus Ownership) 는 기업가치에 부정적 영향 ( 특히 가족기업 )


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▣ Choice between Pyramid VS Horizontal structure within Business Group

• Prior explanation for Pyramid structure was deviation of ownership and control: To

exercise powerful control with small Cash Flow Rights

• However, Almeida and Wolfenzon (2006) said,

−it is not general that deviation of ownership and control to appear in Pyramid

structure and,

−even in case where deviation can be reached through other ways, Pyramid

structure appears widely. Ex) Allowance of Dual-Class Share<19>

Almeida and Wolfenzon (2006)

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−Analyzed determinants of Family Business Group control structure under two

hypothesis

※Investor protection by law is not perfect

※Firms expend to new business with time difference

−If investor protection by law is weak, Pyramid structure becomes attractive:

Private Benefit of Control increases


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−In case where internal financing for new business through Pyramid structure

is Optimal

※Outside investors’ discount on Resource Tunneling: Financing cost from External Capital Market

increases

※Lack of External Capital Market

※When it needs large funds and is long-term investment that has long payback period, internal

financing through Pyramid structure is optimal


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Table of Contents

1. Introduction



Shareholders







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3. Family firm control structure and Succession of control – a.

▣ Family firm control structure of US

• Gadhoum et all. (2005) analyzed control structure of listed companies(family and

non-family firms) in US: Focusing on deviation of ownership and control

−Though it analyzed 3,607 US family and non-family firms, since most of the

family firms show deviation of ownership and control, it can be interpreted as

a analysis for family firms



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−Research result for deviation of ownership and control is..

<Chart 6: Analysis on Deviation of Ownership and Control in US, Asia, Europe>

※Pyramid (8.46%)<20> (Asia 45.68%, Europe 22.43%)

※Multiple control chain 1.15%(Asia 11.02%, Europe 6.69%)

※Multiple class shares 8.19%(Europe 19.91%)

−13.55% of US firms are controlled through Family Trust

※Since many family entrepreneur manage their asset through various Trust with different names, the

number of family firms may increase


US Asia EuropePyramid 8.46% 45.68% 22.43%

Multiple control chain 1.15% 11.02% 6.69%Multiple Class share 8.19% 19.91%

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• Villalonga and Amit (2006a) analyzed control structure of US family firms

−Data: 3,006 Firm-Year Observations of 515 firms from Fortune 500 in

1994~2000

−40% of samples are Founder or Family-Controlled Firm(Family firm):

Classified as Family firm when founder or his/her family is in the position of

management, director, or controlling shareholder

Villalonga and Amit (2006a)

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−Research result I: In US firms, measures that create deviation of ownership

and control or strengthen control can be classified into 4 categories: Dual-

Class Share, Voting Agreements, Pyramid, Disproportional Board

Representation


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Dual-Class Share

In case of Camcas, Ralph Robert, the founder, and Brian Robert, his son, have 3.14% of all shares and hold 85.64% of voting right.(Viacom, Tyson foods, Ford mortors)

Voting agreements

Katharine Graham of Washington Post and her 4 children have 44.9% of voting right → Berkshire Hathaway had 18.3% of voting right → Berkshire Hathaway delegated their voting rights to Donald Graham, the son of Katharine Graham. As a result, they holds 63.2% of voting right.

Pyramid

Tisch brothers hold 32% of Loews → Loews holds 100% of LT holding → LT holding holds 17.63% of CBSAs a result, Tisch brothers hold 5.64%(32%*17.63%) of CBS, but hold 17.63%(=min(32%, 17.63%) of voting right → CBS is controlled by Tisch brother through Pyramid.

Disproportion Board

Representation

In case of New york Times, they have two kinds of Common stock(A and B), and A accounts for 99.56% and B accounts for 0.44% → Shareholder of Class-A stock can elect 5 directors out of 15 and Shareholder of Class-B stock can elect 10 directors → Ochs Sulzberger family hold 17.9% of shares → However, since they hold 88.7% of Class-B stock, they have election right for 66.7% of directors


<Chart 7: Cases and measures of control strengthening in US family firms>

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−Research result II: 40% of all samples are family firm: Among them, 46%

are founder-controlled firm, and 54% are founder's family-controlled firm

−Research result III: Comparative analysis between family firms and non-

family firms<21>

※Tobin's Q of Family firms is higher than Non-family firms, but gains statistical significance in 10%

level. ( 가족기업의 Tobin's Q 가 비가족기업보다 높으나 10% 수준에서 통계적 유의성 획득 )

※Size difference between family and non-family firms is not statistically significant

※Non-family firms are older than family firm

※Family firms grow faster and have higher Market Return

※Family firms have higer Capital Expenditure and smaller Leverage


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−Research result IV: Deviation of ownership and control in family firms

※Founder or family holds 15.3% of shares and 18.8% of voting right

※Non-Family Blockholder holds 16.2% of shares and 13.2% of voting right

−Research result V: Measures to create deviation of ownership and control

※Disproportional Board Representation: 66%

※Dual-Class Shares: 21% (Europe 17.61%, UK 18.84%)

※Voting Agreements(7%) and Pyramid(6%) is relatively small

−Research result VI: Degree of ownership-control deviation

※Control Right is 1.28 times larger than Cash-Flow Right<22>(East-Asia 1.34, Western-Europe 1.15)

※Deviation of ownership and control is the largest when Dual-Class Share is used(2.55 times): Firms

controlled by founder often uses Dual-Class Share(May be to enable effective Succession)


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−Research result VII : Other mechanisms for control strengthening

※Family members consist 17.3% of directors

※Family member is a CEO of the firm: 51%, Family member is a CEO or a Chairman of the board:

59%

※ 가족에 의해 지배되는 이사의 비율이 보유주식 비율보다 2% 높음


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−Research result VIII : Correlation of control strengthening mechanism and

corporate value

※There has been prior empirical studies that showed deviation of ownership and control in family

firm negatively affect corporate value<23>: Discount exists in stock market

※Analyzed each mechanism's effect specifically: Pyramid and Voting Agreement positively affect

corporate value, but Dual-Class Share affect it negatively<24> Poses hypothesis that Pyramid is ☞

not just for Resource Tunneling, but has other purposes.

※Voting Agreement is a Coalition: 의결권을 위임하거나 의결권 행사 시 약정을 맺는 등 주요 의사

결정에서 전략적 도구로 사용될 수 있음


61


▣ Family firm control structure of Europe

• Faccio and Lang (2002) analyzed control structure of family firms in Europe

−Data: 2,332 firms controlled by family (44.5% of all firm samples)

−Research result

※Among family firms, Dual-Class Share 17.61%, Pyramid 13.81%, Multiple Control Chain 3.22%

※With only one controlling shareholder: 54.74%

※Top 15 family firms' assets of each country account 33.8% of all French firms, 25.01% of German

firms, and 25.01% of UK firms


62

Table of Contents

1. Introduction



Shareholders







62

63

3. Family firm control structure and Succession of control – b.

▣ Pros and Cons that Succession of control within family has

<Chart 8: Pros and Cons that Succession of control within family has>


Pros Cons

-Family has long-term perspective

-Control by family who is major shareholder

can reduce agency cost

-Collaboration and knowledge transfer within

organization is easy

-Management selected from family which often

is a small group can be inferior to professional

management from the market

64


▣ Determinant of family firm's succession of control

• Burkart, Panunzi, and Shleifer (2003) suggested theory about family firm's control

structure and succession of control

−Analyzed what founders care when deciding control structure and succeeding

control

※Current founder is controlling shareholder and a manager

※Assume professional management is better skilled than family members

−If investor protection by law is powerful, founders prefer distributive

ownership/control structure and professional management

Burkart, Panunzi, and Shleifer (2003)

65


▣ Determinant of family firm's succession of control

−If investor protection by law is moderate, founders prefer professional

management, but have incentive to remain as major shareholder and monitor

management.

−If investor protection by law is weak, founders succeed control to the family

Burkart, Panunzi, and Shleifer (2003)

66


▣ Influence of owned, managed, and controlled by family to corporate value in

US

• Villalonga and Amit (2006b) analyzed an influence of owned, managed, and

controlled by family to corporate value

−Data: 2,808 Firm-Year Observation of 508 firms from Fortune 500 in

1994~2000

−家族소유 ( 지분율 ) 은 창업자가 CEO 또는 Chairman 으로 고용된 CEO 와

함께 현직 활동을 하는 경우 기업가치에 긍정적 영향※ 창업자가 가장 큰 가치를 창출하는 경우는 지배강화의 기제 ( 피라미드 , 상호출자 , 복수의결권

주식 등 ) 가 없는 경우

Villalonga and Amit (2006b)

67


▣ Influence of owned, managed, and controlled by family to corporate value in

US

−When family firm is managed by Successor CEO, not by the founder,

corporate value is negatively influenced (Influence is negative even in case

where the Founder exists as a chairman)

※Negative influence done by Successor CEO is due to a second generation

※A third generation CEO does no influence and a forth generation CEO does positive influence on

corporate value

Villalonga and Amit (2006b)

68


▣ Influence of control succession in US family firm to its performance

• FRANCISCO PEREZ-GONZALEZ (2006) analyzed an influence of control

succession to performance

−Data: Analysis of 335 control succession cases in US firms: 122 were within

family members, and 213 were non-family succession

−Succession to family member who is well-educated in good college does not

influence corporate performance

−Succession to family member who is not well-educated in good college does

corporate performance a negative influence

FRANCISCO PEREZ-GONZALEZ (2006)

69

Table of Contents

1. Introduction



Shareholders







69

70

4. Business group structure –a.

▣ Business Group is group of legally independent firms connected through

stocks or family

▣ Hard to determine whether Business Group influences the economy positively

or negatively

• Positive: Replace external capital and labor market

• Negative: Monopoly power

▣ Khanna and Yafeh (2006) analyzed Business Group in Emerging Market

• In emerging market, Business Group exists a lot: Poses a hypothesis that

Business Group is general in country where market system is underdeveloped

−Business Group replaces underdeveloped Capital and Labor market by itself

Ex) Form an Internal Capital Market


71


▣ Diversification

• Pros: Sharing management ability and technology, Reducing risk through

industrial diversification

• Cons: Empire Building by management, Risk evasion, Inefficient resource

allocation because of Division Manager's pursuit for the rent

72


▣ Diversification

• Two different studies co-exist. One suggests Diversification Discount and the

other suggests Diversification Premium.: Analysis result of US firms<25> shows

discount mostly.

−Negative influence exists only in developed countries with advanced system

and capital market. In underdeveloped countries, negative influence does not

exists, but rather positive influence exists (Fauver et al.(2003))

−In case of Korean Cheabol(Conglomerate), they had positive influence till the

early 1999's but, after 1994, they showed negative influence (Lee, Peng, and

Lee (2001))

−In case of Korea, Taiwan, and Thailand, Risk Sharing among corporations

exists (Khanna and Yafeh (2005))

73


▣ Operation of financial business

• Having financial business and Related Lending within Business Group<26> are quite

general and have studies about both positive and negative effect

<Chart 9: Case and effect of financial business and Related Lending within

Business Group>

Financial business within Business Group

is general

-Multinational Business Groups of UK operated financial business extensively in the early 20th century(Jone2000)-Business Groups of Chile operated financial business in 1980's when financial business is not developed-Almost every bank in Turkey is Group-affiliated

Positive and negative effect

of Related Lending within

Business Group

-Large Business Groups of Indonesia uses financial affiliate when capital demand increases to start a new business.-Mourer and Haber (2006) showed positive effect of Related Lending using data from Mexican Business Groups in 1888~1993: No negative effect of Related Lending(Tunneling and inefficient allocation of resources) exists but rather firms which received Related Lending shows better performance compared to competitors.-La Porta et el (2003) showed that the default rate of Related Lending is 33% higher than non-related lending using data of Mexico in 1990's.

74


▣ Ownership and Control structure of Business Group

• Possibility that Pyramid and Circular equity investment within Business Group can

be more seen in countries where shareholder protection law and system is not

strong

• Pyramid and Circular equity investment appear widely in East-Asia countries

• Possibility that positive(Risk Sharing and Mutual Assurance) and

negative(Tunneling of resouces) effect of Pyramid and Circular equity investment

can coexist.

• Korean Business Group have two different studies about positive case of Risk

Sharing and negative case of issuing CB(Convertible Bond) and BW(Bond with

Warrant)<27>

75


▣ Ownership and Control structure of Business Group

<Chart 10: Pros and Cons of Pyramid, Circular equity investment>

Pros Cons

-Risk Sharing and Mutual Assurance: Firms

within group can share risks and enjoy mutual

assurance effect through investment relation

and mutual lending

-Tunneling of resources

(1) Controlling shareholder tunnels resources

from firm that he has less share to firm that he

has more share.

(2) Controlling shareholder sacrifices some

firms shareholder value in order to maximize

his profit.

-Buysschaert, Deloof, and Jegers(2004)

-Kahnna and Yafeh(2005)

-Chang and Shin (2005)

-Bae, Jang and Kim (2002): 대기업 집단 내

인수합병

- Bae, Jang and Lee (2006): 신주인수권부사채

발행

76

Foot notes

* <1>" 지배주주란 어느 회사의 전체적인 주주 구성과 주식의 분산도를 감안할 때 그 회사의 주요 의사결정과 일상적 의사결정에

결정적인 영향을 미칠 수 있는 주주를 뜻하는 사회학적 개념이다 . 회사의 의사결정 과정은 주주총회와 이사회에서 이루어지므로

완전한 지배권을 장악하자면 주주총회의 특별 결의 요건을 충족시킬 수 있는 주식 수 , 즉 , 발행주식수의 3 분의 2 이상을

가져야 할 것이다 . 하지만 발행주식 수의 과반수만 갖더라도 보통결의는 자신의 의사대로 지배할 수 있고 이사를 자신이 추천하는

자로 구성함으로써 일상적인 경영의사결정을 지배할 수 있다 . 그러나 상장회사에는 주식이 일반 주주에게 널리 분산되므로

주주총회의 출석률이 낮아 과반수보다 훨씬 적은 수의 주식을 가지고도 주주총회의 의사결정을 지배할 수 있다 .” 이태준 이철송

공저 , 사회법 의 7 판 전영사

* <2>A controlling shareholder is the one who is given more than 10% of voting right in this study.

* <3>The law and systematic protection on shareholders cover vastly; corporate law or commercial law, for

example, determines one share-one vote rule, shareholding ratio for opening general meeting of shareholders, or

possibility of class action. Countries can be regarded as those which with good shareholder protection if

guaranteeing one share-one vote, lowering shareholding ratio required to summon for extraordinary general

meeting, and enabling class action.

* <4>Choi, from National Assembly Budget Office, argued at Hankyoreh in Oct. 10, 2010 that (1) the range of family

firms are too wide to regard results as comparison of performance between family firms and non-family firms, (2)

families in family firms in US often exercise control without participation in management and 소유와 지배의 차이가

거의 없기 때문에 , thus it is hard to compare them directly with conglomerate group in Korea.

* <5>Strictly saying, it is the problem of fair trade rather than that of 소유와 지배의 차이에서 오는 corporate

governance structure. According to Economic Reform Reports 2008-5 from Solidarity for Economic Reform, among

Korean 200 companies (by asset size) 127 companies are subsidiaries of 40 conglomerates and occupy 62.7% of

asset and 69.5% of total sum of revenue.

* <6>Firms managed by the family means that the family members are in position of CEO, Honorary Chairman,

Chairman or Vice-Chairman

77

Foot notes

* <7>Prior researchers thought of shareholder protection law as critical factor of corporate governance. They

thought that, if there is powerful protection for minority shareholders by law, Private Benefit of governance will

decrease. Therefore, distributive structure will become universal

* <8>Figure shows that Japan has typical Bank-Dominated economy

* <9><chart2>It is hard to interpret why financial instition control shows such a high rate. Normaly, minor

shareholder protection in UK is considered as powerful as that of US’s. Since class lawsuit is prohibited and the

fact that loser have to pay for winner’s costs prevents minor shareholders from filing a lawsuit, Auther suggests

that UK’s protection is not as efficient as US’s.

* <10>Whether this theory can explain high family firm ratio in Germany and France is doubtful. Generally speaking,

Germany and France are consider to have weaker protection for minor shareholders compared to US.

* <11>When financial institution controls a firm, managers of financial institution have to monitor management of

the firm -> This is a system that agent monitoring agent and the system might cause additional agency cost.

Example) Cartel

* <12>In 2000, 407 Non-financial firms were in S&P500

* <13>The Bank Holding Company Act of US restricts Bank Holding Company from holding voting share of non-bank

firm more than 5%

* <14>Even though one holds lots of shares, he can only exercise voting right up to 5% or 10%.

* <15>Business Groups show One Share-One Vote Principle Deviation through pyramid, mutual investment, and etc

78

Foot notes

* <16>Bertrand and Mullainathan (2003) analyzed how the law which provides protection regarding M&A affects

management action or preference using data from US. In other words, they verified the theory which suggests

that, when management position is secure, management try to enjoy Private Benefit of Control rather than think

of shareholder value first. The results was (1)increase in employee's wages, (2)decrease in constructing new

factories and closing down existing factories, and (3) decrease in overall productivity and profitability.

Pagano and Volpin (2005) theoretically showed that, when management has high Private Benefit of Control and few

shares, management and employee have the same interest in dealing with M&A threats. Employees have

incentive to resist against hostile M&A because they want to maintain their high wage. This infers that wages will

likely to drop after M&A, and this inference is consistent with empirical study of Bertrand and Mullainathan (2003)

* <17>There are research results about how ownership and control structure affects corporate value other than this,

but most of them targets family firms.

* <18>There are few studies that analyzed Korean firms only, and they show different analysis before IMF and after

IMF. Before IMF, deviation of ownership and control affected performance negatively and, after IMF, it effects were

neutral.

* <19>In Europe and Asia, though many countries allow Dual-Class Share, Pyramid structure appears widely.

* <20>One of the reason that Pyramid structure is not popular in US is the tax inposed on intercorporate dividends.

* <21>Family firms appear to be superior than non-family firms, but this comes from the superiority of firms

controlled by founders.

* <22>In US, main mechanism that makes deviation of ownership and control(control strengthening) is their

influence on director selection. Since this mechanism is not considered in ratio above, we can say that deviation

in US family firms is much larger. This also means potential conflicts between controlling and minor shareholder is

not less than European or Asian firms.

79

Foot notes

* <23>Classen et al. (2002) analyzed East-Asia family firms, Villalonga and Amit (2006b) analyzed US family firms,

and Barontini and Caprio (2006) analyzed Continental-Europe family firms. They analyzed relation between

ownership/control deviation and corporate value.

* <24>A similar result can be found in study of Bennedsen and Nielson (2005). After they researched European firms

empirically, they found out that Dual-Class Share affect corporate value far more negatively compared to Pyramid

and Mutual investment. Also, deviation mechanisms like Dual-Class Share, Pyramid, and Mutual investment does

not affect earnings.

* <25>In case of US, diversification was seen till 1980's, but after 1990's, concentration of capacity to core business

is seen.

* <26> 연관대출의 긍정적 측면으로는 정보의 비대칭성 극복 , 사금고화 , 자원의 전용 , 자원의 비효율적 배분 등이 있다 .

* <27>Convertible Bond is bond that is issued as bond but can be converted to common stock after a certain period

at holder's request. Bond with Warrant is bond with right to purchase stocks of the company. When converting to

stocks, market price of conversion time is applied to CB, but agreed issuing price is used in BW so one can

convert one's share when market price of stock is higher than issuing price.

1 current research status and issues of corporate governance -focusing on issues of korean corporate...

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