Ultimate Ownership, Multiple Control Chains and Performance of Malaysian Firms

Transcription

1 Ultimate Ownership, Multiple Control Chains and Performance of Malaysian Firms Hooy Guat Khim, Chee Hong Kok and Hooy Chee Wooi This study analyzes the effects of ultimate ownership on firm performance of Malaysian listed firms over We addressed the issues of non-linear relationship, ownership identity and control mechanism. Using piecewise regression, we found evidence of non-linear relationship following N-shape, which could be explain by the tradeoff between alignment and entrenchment effects as in some managerial literature. We also found evidence that ownership identity do affect firm performance where foreign firms significantly outperformed government and family firms. With regards to control mechanism, the results reveal that the use of multiple control chains by the ultimate owners has negative impact on firm performance. In addition, we also find that there is an interaction effect between ownership identity and control mechanism. It appears that the adverse effect of multiple control chains is more pronounce for foreign firms as compared to family and government firms. Field of Research: Accounting 1. Introduction The literature on corporate ownership and firm performance focuses much on managerial ownership. The examination on the relationship based on ultimate ownership is still limited, especially in a development country like Malaysia (Song, 2007). Under concentrated ownership environment, majority of the publicly listed firms in Malaysia are under the control of dominant shareholders or particularly the ultimate owners (Claessens et al., 2000). The ultimate owner is expected to be the person that has vital influence on the decision making process or operation of the business which could directly affects firm performance. According to Wiwattanakantang (2001), the ownership data used in most of the studies came from the databases which include only the direct shareholdings of the major shareholders. The used of direct shareholdings might not reflect the actual situation in Malaysia as a number of the firms in this country are control indirectly by a chain of firms that are privately held (Song, 2007). Following La Porta et al. (1999), Wiwattanakantang (2001) and Song (2007), this study trace the ultimate owner in order to provide a clearer picture that closely reflects the impact of ultimate ownership on firm performance in Malaysia. Our measure for ultimate ownership is based on control rights which consist of direct and indirect shareholdings, instead of cash flow rights which only cover direct shareholdings. Hooy Guat Khim, Accounting Section, School of Management, Universiti Sains Malaysia, Penang. gtkhm@yahoo.com Dr. Chee Hong Kok, Accounting Section, School of Management, Universiti Sains Malaysia, Penang. hkchee@usm.my Dr. Hooy Chee Wooi, Finance Section, School of Management, Universiti Sains Malaysia, Penang. cwhooy@usm.my

2 Besides the degree of ultimate ownership, identity of the ultimate owner could also have an impact on firm s governance structure and performance (Wiwattanakantang, 2001; Anderson & Reeb, 2003; Andres, 2008). Different identity of owner might have different objectives and interest towards the firm. The families might be more interested to involve in managerial and control activities while institutional shareholder might only concern about profitability. The differences in interests give raise to the question of whether the equity owners are playing their monitoring role (Loh & Mat Zin, 2007). This study will address this issue by examining the effects of types of ultimate owners on firm performance. Another issue regarding ultimate ownership is the use of control mechanisms such as pyramidal structure, cross-shareholdings and multiple control chains which separate the cash flow and control rights. Empirical evidence consistently show that the used of control mechanisms have negative impact on firm performance. However, we did not find any study that empirically examining the effects based on multiple control chains. The main objective of this study is to fill up the gap by examining the said relationship using this mechanism. As different identity of owner could have different impact on firm performance, it is believe that the use of multiple control chains by different types of owner might have different effects on firm performance. Thus, the interaction effects will also be tested. The remainder of this paper is structured in sequence as follows: section 2 reviews of theoretical background of the study; the next section focuses on data sources and variables; section 4 reports the results and analysis, and finally section 5 presents summary of the study and concluding remarks. 2. Literature Review The relationship between ownership and firm performance has been of long-standing interest by researchers since Jensen and Meckling (1976) hypothesize that shareholding by managers or manager-owner helps to align the interest of managers and shareholders. Theoretically, the connection between ownership and firm performance depends on the tradeoffs between alignment and entrenchment effects (King & Santor, 2008). According to Florackis et al. (2009), the relationship between managerial ownership and firm performance is likely to be non-linear. They state that incentive alignment effect occurs when ownership helps to align the interests of managers and other shareholders by constraining the consumption of perks and the engagement in sub-optimal investment policies. On the other hand, the entrenchment effect occurs as managers tend to exert insufficient effort and expropriate corporate assets, leading to the negative impact on firm performance. Consistent with the existence of these two effects, empirical studies do provide evidence for non-linear relationship between ownership and firm performance (Morck et al., 1988; Short & Keasey, 1999; Wiwattanakantang, 2001; Cui & Mak, 2002; Davies et al., 2005; Song et al., 2007). These studies indicate that both the alignment and the entrenchment effect are the cause of the non-linear relationship, even though the actual nature of this non-linearity differs across studies. Based on the previous arguments and evidences, ultimate ownership is expected to be non-linearly related to firm performance in this study. An important factor that might have an impact on firm performance is its ownership composition. It is crucial to identify who controls the firm as different types of controlling persons may have different impact on the firm s governance structure and performance (Wiwattanakantang, 2001). There are at least three major types of blockholders in Malaysia,

3 namely individual or family-based ownership, government-controlled institutions and foreign investors (Mat Nor & Sulong, 2007). However, there is no consensus among previous studies regarding the effects of owner s identity and firm performance. According to Mallin (2007), the problems of information asymmetry and opportunistic behavior should also be lessened in family firm as the owners are usually involved in the management of the firm. Wiwattanakantang (2001) argued that the implicit contract among family members such as responsibility toward the family is an important factor that helps to reduce agency problems in family firms. This is supported by Anderson and Reeb (2003) and Andres (2008) where they found that family firms outperform other types of firms. Meanwhile, government firms might perform better as under the watchful eye of the government, the management team is more conscious towards maximizing shareholders wealth rather than to obtain private benefits (Lau & Tong, 2008). Moreover, government firms are usually operating in a monopoly or regulated duopoly markets (Wiwattanakantang, 2001). Sulong and Mat Nor (2008) provide two explanations on the behavior of foreign investor that contribute to favorable firm performance. Firstly, they choose to invest in well established companies which are able to provide better information or have less information asymmetry problems. Secondly, the management style and governance policy applied by foreign controlling shareholders in their subsidiaries are generally standardized with the holding company in overseas. Thus, foreign subsidiaries will generally have access to managerial talent and skill and superior technological know-how from the holding company. Foreign firms in this country are owned by large multinational corporations which have great experience and expertise in monitoring their subsidiaries, it is expected that foreign firms will perform better than government and family firms. Government firms might perform poorer as they are always guided by social altruism (Razak et al., 2008) while family firms might use the control mechanisms as the tools for them to extract private benefits (Morck & Yeung, 2003; King & Santor, 2008). The used of control mechanisms such as pyramidal structure and cross-shareholdings permit the ultimate owners to reduce their cash flow rights while still maintaining a high control rights in a firm (Bany-Ariffin et al., 2010). The gap between cash flow and control rights might create problems if it attracts the ultimate owners to extract private benefits as they only bare part of the expropriation costs based on their cash flow rights while enjoying the full part of private benefits (Wiwattanakantang, 2001). The ultimate owner might transfer funds, assets or investments that they expect to be profitable to the firm that they fully own or to the firms that they have largest proportion of cash flow rights. The transferring of the costs and benefits among the firms are done through numerous internal transactions (Singam, 2003). Consistent with the theoretical arguments, numerous previous studies found that the used of control mechanisms have negative impact on firm performance (Claessens et al., 2002; Lemmon & Lins, 2003; Cronqvist & Nilsson, 2003; Bany-Ariffin et al., 2010). However, to our knowledge, there is another type of control mechanism, namely the multiple control chains, have not been tested separately in the literature of control mechanism besides the discussion paper by Faccio and Lang (2002). This study will fill up the gap by analyzing the said relationship. It is expected that the use of multiple control chains will have adverse impact on firm performance as it also produce a gap between cash flow and control rights. The use of multiple control chains by different types of ultimate owners might have different impacts on firm performance. Thus, we hypothesizes that there is interaction effects between these two firm s characteristics.

4 3. Data and Methodology 3.1 Data and sample The sample for this study is Malaysian listed firms in Bursa Malaysia from 2001 to Financial firms were dropped in order to make our sample comparable with other studies. These firms are normally excluded in many empirical studies in finance due to the different income measuring rules governing these firms as compared to firms from other sectors (Short & Keasey, 1999). Firms where the financial or ownership data is incomplete were excluded in this study. This procedure results in a final sample of 2655 firm-year observations from 295 firms. The accounting data was obtained from Datastream database, while the data for ownership information was manually extracted from firm s annual reports. Market performance is proxied by the broad acceptance Tobin s q ratio, a forward-looking measure that shows the market s valuation of the company s assets relative to the replacement cost of the firm's assets (Tobin 1969). However, due to the difficulty to obtain an estimate of the replacement cost of assets, the Tobin s q ratio used in this study follows the ratio recommended by Chung and Pruitt (1994). The simpler approximation of Tobin s q which is widely used in finance literatures is defined as the sum of market value of equity, book value of long-term debt and net current assets to total assets. The control variables employed in this study include firm size (logarithm of total assets), financial leverage (ratio of total debt to book value of total assets), sales growth (percentage change in sales, average over 2 years), ROA (ratio of net profit before interests and taxes to total assets) and year (year dummies). There are 8 year dummies that derived from 9 years (2001 to 2009) with 2001 as the reference group. These control variables have been widely used in corporate governance research as previous studies demonstrate that they are having influence on firm performance. Following King and Santor (2008), random effects panel models were employed to tests the hypotheses as some of the variables in this study are time-invariant (for instance industry dummies) or show few changes over time (for instance ultimate owner type). Following La Porta et al. (1999), Claessens et al. (2000), Wiwattanakantang (2001) and Song (2007), the ultimate ownership in this study is referring to the ownership percentage of the largest shareholder of a firm based on his control rights which consist of the direct and indirect shareholdings. 3.2 The baseline model Previous studies commonly used a cut-off point to define firm with dispersed ownership and firms with blockholders. That means firms where blockholder s ownership is less than the cutoff point will be classified as dispersed firms, instead of be classified based on owner s identity. This study is different from previous studies as it did not employ a cut-off point in the analysis. All firms under studied are classified based on identity of the ultimate owner in order to study the whole effect of the identity of the ultimate owners. It is believe that even if the ultimate owners are having lower ownership, the differences in identity could still have different influence on firm performance as different characteristics of owner might have different objective and interest towards the firm.

5 The impact of ultimate ownership might not be in a linear form. Considering this point, we tested the relationship between ultimate ownership and firm performance using model (1) and model (2). In model (1), UO and UOSQ represent ultimate ownership and the square of ultimate ownership, respectively. The nonlinear relationship is further tested using piecewise regression as shown in model (2). The piecewise regression model is able to capture the changes of slopes for two or more linear pieces of segments. In this study, ultimate ownership is divided into four segments. up to 2, 2 to 0, 0 to and over are the four variables used to represent the four different segments of ultimate ownership of the firms. The descriptions for other items which will consistently appear in all models in this study are: Y represents Tobin s q. α represents intercept of the equation. SIZE, LEV, GRW, ROA and are control variables which represent firm size, debt-asset ratio, 2 years average sales growth, return on assets and year dummies, respectively. Ɛ is the mean-zero residual adjusted for firm-specific heterogeneity. (1) 3.3 Model with ownership identity The entire sample firms are classified into three groups based on the identity of the ultimate owners, namely family, government and foreign firms which are the three major types of firms in this country (Mat Nor & Sulong, 2007). Model (3) is used to test whether foreign firms have the best performance. DFAM and DGOV are dummy variables, indicating if a firm has an ultimate owner who is an individual or a family and the government, respectively. The reference group is firms where the ultimate owner is a foreigner. 3.4 Model with multiple control chains Following Faccio and Lang (2002), a firm is classified as control through multiple control chains when the ultimate owner controls the firm through more than one channels and each of the chain is having at least 5% of control rights. Model (4) is derived to test whether firms control through multiple control chains perform poorer. DMULTI is a dummy variable, indicating if a firm is control through multiple control chains by its ultimate owner. Lastly, model (5) is generated to test whether there is an interaction effect between multiple control chains and types of firms. (DFAM DMULTI) and (DGOV DMULTI) represents the interaction terms between multiple control chains by types of ultimate owner s firm, namely, family and government firms. (2) (3) (4) (5)

6 4. Results The estimated results are presented in Table 1. Model (1) shows that ultimate ownership is non-linearly related to Tobin s q at the significance level of 10%. The negative coefficient indicates that the relationship is in inverse u shape which is consistent with Song et al. (2007). The piecewise regression s results in model (2) further confirm that the said relationship is non-linear. At lower level of ownership (up to 25%), the coefficient is positive but not significant. However, at intermediate level of ownership (UO 25% to 50%), the coefficient is positive and strongly significant at the 1% level. The result at this level of ownership is similar to the study of Morck et al. (1988) and Davies et al. (2005). This might be due to the ultimate owner does not have complete control over the firm and their actions are still governed by external discipline such as external large shareholders which could serve as an effective monitoring device in mitigating agency problems or information asymmetry problem between the ultimate owner and other shareholders. The findings are in contrast with the study of Wiwattanakantang (2001) and Cui and Mak (2002). At higher level of ownership (50% to 75%), the coefficient is negative and marginally significant at the 10% level. This result is close to the study of Davies et al. (2005). At this level, the ultimate owners might prefer to sacrifice firm s profitability for two reasons: (1) they are not entitled to the entire profit of the firm when the firm performs well and (2) they already have high enough power to extract private benefits. Even if they are not involved in the management, with such a high degree of control, they are still able to persuade the management to act towards their private interests. At extremely higher level of ownership (over 75%), the coefficient is positive and marginally significant at the 10% level. At this level, the ultimate owner will most probably act align with the interest of other shareholders as they might see themselves as the sole owner of the firm. They will put more efforts to ensure the firm performs well as they are the ones who have to bare the largest fraction of loss if the firm performs poorly. This is supported by Wiwattanakantang (2000) and Davies et al. (2005). The result in model (3) reflects that foreign firms perform significantly better than family and government firms. It is in contrast to the findings of Andres (2008) and Anderson and Reeb (2003) where they found that family firms outperformed other types of firms. This might be due to the following reasons. Firstly, the foreign ultimate owners in this country who usually hold a high fraction of ownership are perceived to have intention to maintain their investment in the firms for long term. Hence, they are more concern about firm s profitability which in turn ensuring firm s survival in long term. Secondly, a large number of these ultimate owners are Multi-national Corporations that have great experiences and achievements in their area of business for long time. They are capable of transferring their superior technology and managerial expertise into their subsidiary companies in this country. Thirdly, these firms are enjoying various incentives from the Malaysian government for their investments in the country. The outcome in model (4) indicates that firms control through multiple control chains perform poorer than firms that did not control through multiple control chains. The result is marginally significant at the 10% level. The reason for the negative effects is consistent to those of pyramidal structure as both mechanisms could create a gap between the cash flow and control rights. The intention to expropriate corporate assets is rise when control rights are higher than cash flows rights. One might prefer to transfer assets or investments which are

7 expected to be profitable to firms that he has full ownership than retain the benefits in the firm that not fully owned by him and share with other shareholders. The findings in model (5) provide evidence that there are interaction effects between multiple control chains and identity of ultimate owner. The coefficient of the interaction term for family firms is strongly significant and positive at the 1% level. The performance gap between family firms and foreign firms is narrower for firms control through multiple control chains than firms with no multiple control chains or ( ) rather than Alternatively, the coefficient also indicates that there is significant difference in the effect of being using multiple control chains for family firms relative to foreign firms. The performance difference is for foreign firms and ( ) for family firms. The results of government firms have same indication as to those of family firms. Table 1: Panel regressions Variables Model 1 Model 2 Model 3 Model 4 Model 5 Constant *** *** *** *** *** SIZE *** *** *** *** *** LEV * * * * GRW *** *** *** *** *** ROA *** *** *** *** *** UO ** UOSQ * UO (up to 25%) UO (25%-50%) *** UO (50%-75%) * UO (over 75%) * DFAM *** *** DGOV *** *** DMULTI * *** DFAM*DMULTI *** DGOV*DMULTI *** Year dummies Yes Yes Yes Yes Yes Observations Each model includes a set of 8 year dummies but the results are suppressed. The unreported Wald tests results for all the models are significant at the 1% level. p-values are in parentheses. *, ** and *** indicate statistical significance at the levels of 10%, 5% and 1%, respectively. To verify the robustness of the results, we re-run the entire tests by adding a set of industry dummies into all the models. The sample firms were grouped into 9 industries according to the classification of Bursa Malaysia. The results are consistent with those reported in Table Conclusion This study examines the impacts of ultimate ownership on firm performance for 295 Malaysian listed firms from 2001 to The findings provide evidence that ultimate ownership is non-linearly related to firm performance. Using piecewise regression method, we found that the relationship between ultimate ownership and Tobin s q are in N-shape. The relationship might be cause by the tradeoff between alignment and entrenchment effects

8 which is similar to the effects for managerial ownership. Our next findings present that identity of the ultimate owner could have different impact on firm performance. The results show that foreign firms significantly outperformed government and family firms. With regards to control mechanism, the findings illustrate that the used of multiple control chains are having negative impact on firm performance. This to some extend signify that so long as there is a gap between cash flow and control rights, there will be possibilities for the ultimate owner to expropriate corporate assets, regardless of the types of control mechanism used. The final results in this study show that there is an interaction effect between types of firms and the used of multiple control chains by ultimate owner. It appears that the adverse effect of multiple control chains is more pronounce for foreign firms as compared to family and government firms. Although foreign ultimate owners are view as having more capability such as wider experience and managerial expertise that contribute to higher firm performance, these positive characteristics might in turn become weaknesses when firms are control through multiple control chains. In other words, the vast experiences and expertise could become the tools that enhance the intention as well as the ability of the foreign ultimate owner in extracting private benefits. Acknowledgements This research is supported by Short Term Grant from Universiti Sains Malaysia [Grant no: 304/PMGT/ ]. References Anderson, R.C. & Reeb, D.M Founding-family ownership and firm performance: Evidence from the S&P 00, The Journal of Finance, vol. 58, no. 3, pp Andres, C Large shareholders and firm performance: An empirical examination of founding-family ownership, Journal of Corporate Finance, vol. 14, pp Bany-Ariffin, A.N., Mat Nor, F. & McGowan Jr, C.B Pyramidal structure, firm capital structure exploitation and ultimate owners' dominance, International Review of Financial Analysis, vol. 19, pp Chung, K.H. & Pruitt, S.W A simple approximation of Tobin's Q, Financial Management, vol. 23, no. 3, pp Claessens, S., Djankov, S., Fan, J.P.H. & Lang, L.H.P Disentangling the incentive and entrenchment effects of large shareholdings, The Journal of Finance, vol. 57, no. 6, pp Claessens, S., Djankov, S. & Lang, L.H.P The separation of ownership and control in East Asian corporations, Journal of Financial Economics, vol. 58, pp Cronqvist, H. & Nilsson, M Agency costs of controlling minority shareholders, Journal of Financial and Quantitative Analysis, vol. 38, no. 4, pp Cui, H. & Mak, Y.T The relationship between managerial ownership and firm performance in high R&D firms, Journal of Corporate Finance, vol. 8, pp Davies, J.R., Hillier, D. & McColgan, P Ownership structure, managerial behavior and corporate value, Journal of Corporate Finance, vol. 11, pp Faccio, M. & Lang, L.H.P The ultimate ownership of Western European corporations, Journal of Financial Economics, vol. 65, pp Florackis, C., Kostakis, A. & Ozkan, A Managerial ownership and performance, Journal of Business Research, vol. 62, no. 12, pp

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