Working Paper. Wealth Effects of Family Succession: A Case of Indian Family Business Groups

Transcription

1 Working Paper Wealth Effects of Family Succession: A Case of Indian Family Business Groups By Professor Vijay Marisetty Professor K Ramachandran & Rachna Jha Indian School of Business Hyderabad March 2008 Thomas Schmidheiny Chair of Family Business & Wealth Management

2 Wealth Effects of Family Succession: A Case of Indian Family Business Groups Vijaya B Marisetty#, Kavil Ramachandran*, and Rachna Jha* * Indian School of Business: # Monash University and National Institute of Securities Markets, India. ABSTRACT Interest in research on family business is rapidly growing and there have been several studies on leadership succession too. However, most of them are anecdotal or at best case study based, covering the process and implications of succession on family relationships. This study attempts to fill a void in this area by exploring the wealth effects of management succession announcement on Indian family business groups during Using a sample of 124 firms, we found that: 1. Family succession is generally perceived as positive news by the market participants. It generates, on average, a cumulative abnormal return of 6.58% during the announcement period. ; 2. Firm profitability also improves significantly after succession; 3. Families that have succession without fight or split show higher rates of profitability. JEL: G14 Key words: family succession; event study; business groups.

3 Wealth Effects of Family Succession: A Case of Indian Family Business Groups Management Succession is a significant moment in a family business life and an issue that requires analysis from the perspectives of different stakeholders. - Robert H. Brockhaus (2004) Family Business Review Introduction Family businesses constitute majority of the businesses across the world (Ward, 1987; Chittoor and Das, 2007). For instance, 35% of the market capitalization of the top 500 firms in the US is owned by founder family members (Bertrand and Schoar, 2006). Given the significance of family control, leadership succession in business has a significant influence on the wealth of the family firms as well as those of outside shareholders. Although succession planning has always been an important challenge confronting family businesses, it assumes greater significance in present times from a corporate governance angle, particularly in publicly-held firms. Research suggests that only about 30% of the family businesses are able to make a successful transition to the second generation (Birley, 1986) and only about 10% to the third generation (Ward, 1987). This indicates that chalking out a succession plan well-in advance so as to choose competent leaders, who can successfully carry out management responsibilities, is one of the most challenging tasks confronting family business owners and managers. This naturally makes succession one of the most widely researched topics in family business literature. Succession affects all stakeholders, particularly the shareholders. Stock market valuation of a business firm is an indicator of its size and growth. This valuation is dependent on a number of internal and external variables, leadership succession being one such important

4 variable. Unfortunately, no study has been undertaken to study the reaction of the stock market to management succession announcement by family-controlled firms (FCBs). Impact of succession (planned or unplanned) on a family firm s financial performance is a critical issue that merits investigation. In this paper, we have made an attempt to examine the wealth effects of management succession announcement on family business firms in India. Understanding the wealth effects of succession will enable founders, owners and managers of family firms to plan appropriately and well-in-advance for succession. India has a very high concentration of family controlled business groups. The country has a rich history and tradition of strong family ties and family businesses have long been a part of the Indian culture. Our observation shows that about 50% of the Nifty50 firms (top 50 in the National Stock Exchange) are family-controlled and managed, the rest being public sector undertakings or multinational companies. As a matter of fact, the Hindu Undivided Family (HUF) is a separate form of business under the Indian tax code. The head of the family, also called the karta is analogous to the chairman of the board of directors. He influences all the important decisions of the business. These businesses were traditionally passed down only to male members of the family, though recent laws allow succession to female members as well. Indian family businesses, thus, provide an interesting setting to understand the impact of management succession on firm value. After analyzing 124 family succession announcements of Indian family business groups, we have reached the following conclusions: One, succession improves firm s profitability, irrespective of whether the split is through a fight or not. Second, succession announcement leads to a positive abnormal return. Third, performance of firms without fight or split around the time of succession is far better than those with. This paper is divided into four sections. The first section above is the introductory section which is followed by a literature review in section two. Section three presents the data,

5 methodology and results. Section four provides concluding remarks and future directions for research. Literature review Family business research has been of interest to scholars from many sub-disciplines of social sciences. However, it is only in recent years that efforts have been made to undertake serious empirical research in this emerging young discipline. The relationship between family succession and firm value is not straight forward and has not been investigated much. Though some papers have focused on financial economics and business strategy literature, rigorous research on family business in these areas has been quite sparse. This is mainly due to non-availability of data. Family business succession is the passing of the leadership baton from the founder-owner to a family or non-family successor. There is a difference between management succession (transferring business leadership) and ownership (transferring business ownership) succession, though at times both may happen simultaneously. In this paper, we have restricted ourselves to a discussion of management succession in family firms, which means handing over of the management responsibilities to a family or non-family member. The important question here is what determines a successful or effective succession. Researchers have argued that determinants of a successful succession can range from the subsequent financial performance of the firm after succession, the satisfaction of various stakeholders with the succession performance, to the ultimate viability or the survival of the firm (Miller, Steier and Miller, 2003). Our paper makes an attempt to analyze the success or failure of succession by studying the impact it has on a firm s share market performance. Intersection of ownership, management and family found in family businesses makes them unique in their needs and creates challenges for a successful succession (Lansberg, 1997). Firms, in which both ownership and management are vested with the family, have to constantly balance the needs of the family with that of the business and this further

6 complicates the issue of succession (Veliyath, 2004). Trust and harmony amongst the family members are also important factors affecting the succession process (Ward, 1987; Venter and Maas, 2005). As incumbent leaders of family businesses can exert a great deal of control over the process of succession (Sharma, Chrisman and Chua, 2003), much of the research has focused on their unwillingness to cede control (Ward, 1987; Sharma, Chrisman and Chua 2001; Pontet, Worsch and Gagne, 2007). There are a number of studies (Sharma, Chrisman and Chua 2001; Handler, 1990) that have focused on successor-related factors as well, but not much has been said about the successor s experience of succession. Despite the widespread attention given to succession by family business scholars, the discussion around the issue remains lopsided with the focus being too much on succession as a process (Chua, Chrisman and Sharma, 2005; Zahra and Sharma, 2004). Researchers have repeatedly discussed the interpersonal dynamics between the incumbent and the successor, and the incumbents inability or apprehensions about letting go of the business leadership. In family-owned businesses, the important actors involved or getting affected by the succession process are the incumbent, the successor and the shareholders. The family and business are the immediate contexts in which these actors operate and have been covered adequately in the literature. However, the wider contexts like the industry and the social context in which the business is embedded are often neglected. Authors like Handler (1990), Fox, Nilakant and Hamilton (1996), Miller, Steier and Miller (2004) and Vera and Dean (2005) have discussed in detail the importance and implications of any succession on the firm and its performance. For instance, Handler (1990) conceptualized succession as a mutual role adjustment between the predecessor (founder-owner) and next-generation family member(s) and put forward a stages-ofsuccession model. Typically the entrepreneur seems to progress through various stages of

7 lessening involvement in business over time and this role adjustment influences the parallel role adjustment process of next generation family members in business. Emphasizing the long-term, dynamic and iterative nature of succession, Miller, Steier and Miller (2003) put forward an integrative model of succession. Their integrative model consists of three contexts non-family context which includes the industry and the organization s competitive environment, the business context that includes the primary actors (incumbents and successors) within it, and the family context which, in turn, is embedded in the social context. At the heart of the model, are the four critical stages of the succession process itself, each unfolding in sequence and influenced by both family and business contexts. The four stages are: establishing ground rules for succession planning, nurturing/development of successors, selection of the successor, and final hand-off to the chosen successor. They argue that all the three components of the model (processes, actors and context) and their interaction collectively determine the success of a succession. In essence, a successful succession in family firms has two dimensions: satisfaction with the process and performance of the firm after succession. An alignment of the perceptions of incumbents and successors increases the probability of a satisfactory succession process (Sharma, Chrisman and Chua, 2003). Incumbents and successors preparedness to give up control and take charge respectively, the extent to which family unanimously takes business decisions and a clear succession plan are other factors that enhance the shareholders satisfaction with the succession process. Brockhaus (2004) did not find any empirical study examining the implications of interactions among these variables on firm performance, though, as noted by Venter and Mass (2005) and Sharma and Irving (2005), the perceived success of the succession process is determined by the extent of satisfaction with the process and continued profitability of the business. Willingness and preparation level of the successor to take over and relationship between incumbent and successor are the successor-related factors

8 that influence the success of the succession process. As noted by Chittoor and Das (2007) family business literature on succession to has repeatedly focused on a few issues only. King (2003) undertook a quantitative study to establish that business performance, following succession, is in part attributable to the extent of differences between predecessors and successors in terms of potential capability and found that successor potential capability is significantly related to business performance in the third year following succession. Miller, Steier and Miller (2003), in their study, found that at the core of failing successions was lack of a smooth transition from the legacies of the past into the perceived future potential. Succession of CEOs by family heirs may have a positive impact on family businesses because these CEOs benefit from non-monetary rewards linked to the firm s long term success (Bertrand and Schoar, 2006; Bennedsen et al, 2006; and Perez-Gonzalez, 2006). These family successors are often brought up learning the business and hence have a more fundamental understanding of its operations, resulting in them being able to secure the trust of majority of the stakeholders. A smooth transition of control from one generation to next is crucial to the survival of these businesses. Quality and clarity of relationship within the family naturally impacts the succession process (Aronoff and Ward, 1992; Ramachandran and Jha, 2008). This is particularly so when the future roles of family members are likely to impact their individual access to wealth, personal growth ambitions, social recognition and trust in the capabilities of the successor (Ramachandran, 2008). Family firms are also characterized by nepotism, inheritance norms, and family politics. Relationships between family members often have an effect on business decisions which may lead to destruction of value. The situation gets often murkier when the ownership structure of the business(s) is neither clear nor accepted by all the key family members.

9 The above discussion clearly suggests that succession is more than an event in family businesses. It, in fact, is a process which if planned well in advance and executed properly without causing any damage to family relationships, can not only increase the firm value in the short run, but can also contribute positively towards the long-term viability of business. In short, succession can be considered to have either positive or negative impact on firm value, depending on how it is planned. Our results clearly suggest that family succession is generally perceived as positive news by market participants as succession announcement leads to an improvement in firm s profitability. Data and Methodology The data on succession announcement was pulled out from Lexis-Nexus news database using the keywords succession and India. The database search provided a list of firms that witnessed succession events between 1990 and It also provided data on the date of succession, number of heirs to the business, the current generation involved in business, whether the succession was planned or not, whether or not there was a fight for control of the firm between the heirs around the issue of succession, whether or not a split took place in the operations of the firm as a result of succession, as well as some additional information for some of the firms. Financial and accounting information was sourced from Prowess, a dataset maintained by the Centre for Monitoring of the Indian Economy. Prowess provides all the financial statements for public and some private firms in India ranging from 1990 until 2005, as well as profitability measures such as return on capital employed, age of incorporation and details about the promoters of the company. The daily stock price data was also obtained from Prowess. However, some of the business firms are not listed on Prowess. The dataset also does not provide some of the firm variables for certain periods of time.

10 Methodology For examining the wealth effects of succession plans, we used the standard event study methodology proposed by Brown and Warner (1981). An event study uses transactions data from the stock market to examine the financial gains and losses associated with newly disseminated information. For our study, we used family business succession as the newly disseminated information. We first calculated the market-adjusted abnormal return as follows: ARit = Rit Rmt; where ARit represents abnormal return of stock i for time t. Rit represents daily return of stock i for time t, and Rmt daily return of the market index (BSE 100) for time t. Abnormal return allows for general market movements, but assumes that each firm has the same average return and risk characteristics as the market as a whole. We then calculated the cumulative abnormal return around an event-window period of 30 days before and 30 days after the succession announcement. The cumulative average abnormal return for all 124 announcements was calculated as follows: N 1 CAR = CAR it N The test statistic for the significance of the cumulative abnormal return is as follows: i= 1 t = CAR σ CAR N t is distributed Student-t with N-1 degrees of freedom. σ represents the standard deviation of CAR and N represents the number of observations.

11 Results The tables 1, 2 and 3 report the change of profitability measured by Return on Assets for family firms around succession. The pre and post succession windows are made up of three years before and after succession. As indicated in the table, succession leads to increase in profitability of firms. Given that these are univariate results, they are not conclusive but only indicative. The sample has been further divided based on whether or not succession was followed by a fight in the family. The results indicate that fight has no significant influence on the firm profitability. When the sample was divided based on whether succession was followed by family spilt, we found interesting results. As shown in the table, spilt seems to have reduced firm profitability compared to non-spilt. This indicates that family spilt during succession decreases firm value. Event study results are displayed in Figure 1. The graph of the cumulative average abnormal returns (CAAR) during the event window period indicates that on the succession announcement day (day 16 in the graph) there is a positive abnormal return and this continued for few more days. This clearly indicated that investors perceived change of generation as a positive signal for the future value of the firm. Is this optimism reflected in terms of actual performance of firms? As shown in Table 1, average firm profitability reflected in terms of Return on Assets, on average, has gone up from percent before succession to percent after succession. Tables 2 and Table 3 show the possible effects of family fights and splits on firm profitability. We used printed media reports on fights and splits for our analysis. It appears that in cases where fights occur before succession, firm's profitability tends to rise after succession, may be indicating the cooling down effects and use of organizational and family energies more productively. Table 3 reflects the effect of split around succession on firm performance. Firm performance seems to improve if a family split precedes leadership succession. Again,

12 supporting the conclusion from the earlier paragraph, average firm performance is significantly higher in the case of firms that do not experience family splits around the time of succession. Conclusion This research brings out two interesting insights. One, stock market seems to be optimistic with the announcement of succession, whether there is a split or not. This could be partly because of the positive effects of media and also optimism about the capabilities of the successor. Also, in a turbulent world undergoing changes rapidly, succession to a younger generation is normally perceived to be positive. The second conclusion is about the argument for perpetuating family businesses. The significantly higher performance of firms that do not have fights or splits underline the need for high quality governance mechanisms in businesses families. We can not rule out the possibility of poorer performance as a trigger for fights and splits, or at least an influential factor that has a vicious and interactive effect on both the firms and the families. Future directions for research Most of the succession literature in the context of family businesses discusses either the succession process or the success of succession in terms of its implications for family relationships and unity. This paper makes an attempt to empirically measure the postsuccession share market performance of the firm, which is one of the important determinants of any successful succession and has not caught the attention of family business scholars. The paper discusses the effect of succession announcement on the stock market valuation of a family firm. The results suggest that contrary to the popular belief, leadership succession announcement leads to an overall positive impact on the financial

13 performance of the firm, irrespective of whether or not succession is followed by a fight in the family. However, a split in the family as a result of handing over the leadership baton to the next generation seems to have a negative impact on firm profitability, when compared to succession without a split. This discussion is to show that succession is complex and market can react either way - negatively or positively. Moreover, the performance of the firm post succession announcement can get influenced by several other factors that have not been taken into consideration in this paper. The optimism of the market regarding the image and capabilities of the new incumbent and the extent to which market is aware of the internal dynamics of succession are important factors influencing the share market s reaction to succession announcement. The shareholders of a firm that has been at a plateau for quite some time anticipate a major change in business management subsequent to the successor s entry into business. Their expectations for change with succession can also be a major determinant of the market s reaction. Exploration of the above mentioned areas is imperative to have a holistic perspective on the wealth effects of management succession on family business groups.

14 Table 1 Change in Profitability (ROA) Around Succession Before Succession After Succession Return on Assets (Avg) 17.98% 18.96% Std Error 6.71% 4.57% T-statistic Table 2 Change in Profitability (ROA) Around Succession: The Effect of Fights Before Succession After Succession Fight 7.06% 8.43% Std Error 3.31% 6.27% T-statistic No Fight 22.34% 23.18% Std error 9.21% 5.74% T-statistic Difference 15.28% 14.74% Std error 14.84% 9.95% T-statistic

15 Table 3 Change in Profitability (ROA) Around Succession: The Effect of Splits Before Succession After Succession Split 6.52% 7.48% Std Error 2.53% 4.23% T-statistic No Split 24.74% 25.75% Std Error 8.37% 5.52% T-statistic Difference 18.22% 18.27% Std Error 1.37% 9.06% T-statistic

16 Figure 1 Wealth effects of family succession % return S1 Days (announcement day is day16)

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