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

2 Background In Asia, family-owned companies continue to maintain weaker governance practices than other companies.

3 Background Are family owners refusing to adopt good governance practices? (Private benefits) OR Is the level of monitoring required in family-owned companies different from other companies? (Agency costs) OR Could too much monitoring actually be harmful to wealth creation in family-owned companies? (Costs vs benefits)

4 Background From a practical perspective, we want to be sure that legislation and/or corporate governance guidelines are proposing governance practices that are wealth-creating for all companies. For example, we shouldn’t be forcing/encouraging all companies to maintain majority independent boards when this may not be in minority shareholders best interests!

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

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

7 Introduction Monitoring Firm Performance Other companiesFamily companies

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

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

10 What does it mean? At low levels of monitoring, increased monitoring is preferred as this reduces the conflict of interest between the family group and minority shareholders. However, this is only up to the optimal level of monitoring. At higher levels of monitoring, the marginal benefit from reducing the agency conflict between the family group and minority shareholders is outweighed by the cost of reduced wealth creation for all shareholders. This optimal level of monitoring is consistent with the implications of some other recent studies - Lane et al. (2006), Anderson and Reeb (2004), Klein et al. (2005).

11 Other companies? What about widely-held companies?  Conflict between management and shareholders is generally minimized through higher monitoring (Jensen and Meckling, 1976). What about other controlled companies?  Could have optimal level of monitoring. May be higher or lower than family-owned companies. As a group no optimal level of monitoring is expected in non-family-owned companies (within a normal range).

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

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

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

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

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

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

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

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

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

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