Academic journal article Indian Journal of Industrial Relations

Governance Challenges for Family Controlled Firms While Globalising

Academic journal article Indian Journal of Industrial Relations

Governance Challenges for Family Controlled Firms While Globalising

Article excerpt

Role of Business Groups

Firm affiliation to a large business group is a common institutional feature in many emerging markets including India. The unique feature of such arrangement is that while all affiliated firms have a common share holder (often one particular family), there are likely to be different sets of non-family shareholders for each affiliated firm. This unique setting can lead to often abnormal potential private benefits to the family. This has attracted substantial research interest in recent years with many researchers looking at the pros and cons of such affiliation to the non-family shareholders (Wolfenzen 1999, Morck & Yeung 2003). Studies such as Khanna and Palepu (1997, 2000), Khanna and Yafeh (2005), Gopalan et al (2007) highlight the important role of business groups in markets with institutional voids. These studies assert that business groups perform an important institution building function in less developed economies by building pseudo institutions that supply efficient materials, labour and capital for the group firms. Hence the affiliate firms of business groups are traded at higher value than standalone firms in the same market (Khanna & Palepu 1997). At the same time they are co-insured for external negative shocks, thanks to the inter linkages between group firms. This can be termed as value creation hypothesis.

A number of studies such as Johnson et. al (2000), Bertrand et. al (2002), Bae et. al (2002), Baek (2006) highlight the negative aspects of group affiliation. La Porta, Lopez-de-Silanes and Shleifer (1999:502) notes, "families often have control rights over firms significantly in excess of their cash flow rights, particularly through pyramids, and typically manage the firms they control". In separate studies, Shleifr, Andrei and Vishny (1997), Hyland and Diltz (2002), Betrand, Mehta and Mullainathan (2002) and Cheung, Rao and Stouraitis (2006), point out and also provide evidence that the controlling family/owner of the group has incentives to tunnel funds from the affiliated firms, especially from those firms in which the controlling owner has low cash flow rights to firms with high cash flows rights. In other words, while affiliated firms benefit from parenting advantages (Campell & Goold 2002), there are significant agency cost implications for the so called off springs, particularly when governance norms are not sufficiently strong to address the interests of affiliated firms. This can be termed as tunnelling hypothesis. However, Khanna and Yapeh (2007), in a review of the relevant literature, discuss several limitations of many of these studies.

The challenge is much higher when the controlling families are involved in management too, which is quite high particularly in emerging market economies. Managers who are agents tend to avoid agency costs by working as per the instructions of the controlling owner or parent (Manikutty 2000, Claessens et al 2000, Mishra & Akbar 2007), creates another set of agency costs by neglecting the interests of the non-family share holders. Ramachandran and Jha (2009) have argued that the co-existence of agency and stewardship values in the same set of individuals can ensure that the entrepreneurial initiatives of the parent to invest in new ventures (through acquisition or not) have a beneficial impact on all stakeholders.

In this paper we extend the group affiliation literature by examining whether group firms are interconnected and whether the valuation effects spill over across all the group firms. The existing literature provides evidence mainly at firm level and not at group level. We argue that understanding "group effect" that is common to all affiliated firms is very important for nonfamily shareholders, particularly when relatively small domestic groups take over larger foreign firms as part of their globalisation strategy. Understanding group level market reactions is of importance both for families who control the business groups and also for the nonfamily investors who are interested in investing in group affiliated firms. …

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