Expropriation-Related Variables & Firm Performance

Expropriation-Related Variables & Firm Performance: Evidence From Malaysian Family Firms Chee Yoong, Liew* M. Fazilah Samadb# Sa’adiah Haji Munirc Ervina Alfand a

Department of Finance & Banking, Faculty of Business & Accountancy, University Malaya 50603 Kuala

Lumpur, Malaysia b

Department of Finance & Banking, Faculty of Business & Accountancy, University Malaya 50603 Kuala

Lumpur, Malaysia c

Department Accounting & Finance, School of Business, Monash University Malaysia 46150 Selangor,

Malaysia d

Department of Financial Accounting & Audit, Faculty of Business & Accountancy, University Malaya 50603 Kuala Lumpur, Malaysia

Abstract This research investigates the principal-principal conflict by analysing variables which can be related or linked to expropriation by controlling shareholders of listed family firms and their impact upon firm value, within a unique government and institutional setting in this country. 2-Stage Least Square (2SLS) Pooled Ordinary Least Square (OLS) Model and 2Stage Least Square (2SLS) Random Effects Model are used as analytical tools. We found that related party transactions that are likely to result in expropriation reduce firm value. In addition, we found that the number of local principal bankers engaged by non-technology listed family firms reduce firm value as well. We conclude that these 2 variables are used as expropriation tools by controlling shareholders of listed family firms in this country and this also proved that Agency Problem Type II (Principal-Principal Problem) exist among these firms. We also found that average independent directors’ tenure is not linked to expropriation by controlling shareholders of these firms and there is also no conclusive & significant evidence that ownership concentration by family firms’ controlling shareholders increases or reduce agency problems. There is also no significant evidence of non-monotonicity in the relationship between ownership concentration and firm performance. In addition, we found that there is significant evidence that corporate risk moderates the relationship between related party transactions that are likely to result in expropriation and firm value by reducing the negativity of this relationship. Keywords : Corporate governance, Expropriation, Family firms, Agency problems *Corresponding Author, Department of Finance & Banking, Faculty of Business & Accountancy, University Malaya 50603 Kuala Lumpur. Tel : 03-26173044; Fax : 03-26173050. Email address : [email protected]. #Deceased. JEL Classifications : G34

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Electronic copy available at: http://ssrn.com/abstract=1874592

1.0 Background Most corporate governance discussions centred around the traditional shareholdermanager problems or Agency Problem Type I. These discussions typically assume that greater insider ownership leads to better corporate governance (Morck & Yeung, 2003) because managers who own huge equity blocks in their firms are less likely to take actions that reduce the value of their shares (Jensen & Meckling, 1976). This mitigation framework is certainly relevant in developed economies whereby ownership structures are very much diffused (Morck & Yeung, 2003). However, this framework may not work in emerging markets where ownership structure is highly concentrated and most firms are family-controlled (Morck & Yeung, 2003). Such ownership structure in emerging markets coupled with absence of effective external governance mechanisms; result in frequent conflicts between controlling shareholders and public shareholders (Morck et.al, 2005). This conflict between controlling shareholders and public shareholders is also known as Agency Problem Type II (Villalonga & Amit, 2006). One important manifestation of this Agency Problem Type II is controlling shareholders’ expropriation of firms’ resources for their own private benefits (Le Breton-Miller & Miller, 2009). Expropriation by controlling shareholders occur due to conflict of interest between controlling shareholders and public shareholders as the interests of both these shareholders are diverged and the former do not act in the best interest of the latter. When expropriation by controlling shareholders occur, there is a transfer of value from public shareholders to controlling shareholders (Shleifer & Vishny, 1997). This value transfer emphasise the point that expropriation is indeed a key characteristic of Agency 2

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Problem Type II, because it is used to fulfill controlling shareholders’ interests which are in direct conflict with, as well as, at the expense of public shareholders’ interests (Claessens et al., 2000; Faccio et al., 2001a; Johnson et al., 2000b; Mitton, 2002; Young et.al, 2008). As illustrated by Morck & Yeung (2003), families and business groups control a high percentage of corporations in emerging countries. In fact, in most cases, there is a majority family shareholder who exercises control over the strategic decisions of the firm and bear the consequences (Silva & Majluf, 2008). The power to control a corporation might provide the majority family shareholder (family controlling shareholder) the opportunity and incentives to expropriate the firm’s resources for his or her own interests while other shareholders as well as other stakeholders of the firm bear the costs (Shleifer & Vishny, 1997). Family controlling shareholders’ expropriation can come in many forms such as perks consumption, setting excessive salaries, stealing investment opportunities and making inefficient investment (Wiwattanakantang, 2001). This expropriation problem by family controlling shareholders is likely to be more severe in firms where the family controlling shareholders are also in management teams, when family controlling shareholders own more voting rights than cash flow rights, and in countries where legal protection and enforcement of laws are poor (La Porta et.al., 1997, 1999; Bebchuk et.al.,1999). The reason for this is that family controlling shareholders have the incentives to expropriate resources from the firm due to their power in controlling the corporation (Shleifer & Vishny, 1997). Such expropriation generally reduce the observed market value of the firm (Dahya et.al, 2008). Empirically, this is proven from studies such as 3

Electronic copy available at: http://ssrn.com/abstract=1874592

Claessens et.al (1999a), Claessens et.al (2002), Grossman & Hart (1988), Harris & Raviv (1988), Bebchuk et.al (1999), Bebchuk (1999), Lins (2003), Lemmon & Lins (2003), Morck et.al (1988), Barclay & Holderness (1989), McConnell & Servaes (1990), Zingales (1994), Claessens et.al (1999a), among others. From these empirical studies, the reason for the negative relationship between family controlling shareholder’s expropriation and firm value is that family firms which are expropriated by family controlling shareholders do not perform as well as other firms where their controlling shareholders do not expropriate (Shleifer & Vishny, 1997; Morck et.al, 1998; Porta et.al, 1999; Lins, 2003; Dahya et.al, 2008; Qian, et.al, 2010). The economic rationale underlying this reasoning is that expropriation activities undertaken by family controlling shareholders to maximize their personal utility lead to suboptimal firm policies resulting in poor firm performance (Anderson & Reeb, 2003). This poor performance may manifest in weak growth, inferior returns and poor stock market valuations (Bennedsen et.al, 2007; Cronqvist & Nilsson, 2003; Maury, 2006; PerezGonzalez, 2006). 1.1 The Problem Of Expropriation The problem of controlling shareholders’ expropriation as illustrated in the background section, is highly relevant to East Asian emerging market firms due to the high percentage of East Asian emerging market firms (60%) which are not widely held and is related to the family controlling shareholder (Claessens et.al, 2000). Among East Asian family firms, this problem is particularly profound among Malaysian family firms. This argument is supported by the following statistics. Approximately 40.4% of listed firms in Malaysia are closely held by a single large shareholder (Claessens et.al, 2000) with 4

family shareholding forming the predominant controlling shareholders and 67.2% of the total firms in stock exchange are family owned. This figure is the highest among East Asian countries i.e. Hong Kong, Indonesia, Japan, Korea, Philippines, Singapore, Taiwan and Thailand for 1996 (Claessens et.al, 2000). The percentage of concentration of control among listed family firms in this country amounts to 76.2% of its Gross Domestic Product (GDP) which is the second highest after Hong Kong for the year 1996 among all the East Asian countries studied by Claessens et.al (2000). For the year 2004, the average shareholding of the family controlling shareholders is 27.3% in Bursa Malaysia (Munir & Salleh, 2010). Aside from the above statistics, another important statistic that need to be considered is the separation of ownership and control rights which is measured by the ratio of cashflow rights over control rights. The ratio of cash-flow rights over control rights for Malaysia is 0.785. This ratio is the 4th highest in East Asia after Indonesia, Singapore and Taiwan, from 9 East Asian countries analysed by Claessens et.al (2000). This ratio emphasise the relevance of the expropriation problem among Malaysian family firms because according to Claessens et.al (1999a), when control rights exceed ownership rights, expropriation incentives of the controlling shareholder will be huge. Therefore, the lower the ratio, the higher the likelihood of expropriation by the family controlling shareholder. As Malaysia is ranked 4th highest in East Asia (Claessens et.al, 2000), it can be inferred that there is a high likelihood of expropriation by the family controlling shareholder in this country. In essence, the above statistics reveal that family firms are basically the dominant type of firms in the Malaysian Stock Exchange (Bursa Malaysia) and they are exposed to 5

controlling shareholders’ expropriation due to their high ownership concentration and high separation of ownership rights and control rights. Based upon this statistical revelation, the issue of expropriation by controlling shareholders is a significant issue that needs to be dealt with in Malaysia particularly with respect to family firms. Besides statistics as an important information to support the significance of the expropriation problem among Malaysian family firms, other factors are also important; particularly, the contextual government and institutional setting that Malaysian family firms are located in. Malaysian family firms are also situated in a unique government and institutional setting. They embrace the culture of rent-seeking which is encouraged by the Government’s affirmative action policy for a particular majority ethnic group who are the natives of the land (Bumiputras or Son of the Soil). This policy is called the New Economic Policy (NEP) (Gomez & Jomo, 1997; Searle, 1999). Malaysia is one of the only two countries in the world aside from South Africa, which implement affirmative action policies for the majority (Adam, 1997). The NEP policy favour certain government-linked companies (GLCs) or state agencies in awarding and approving business projects as well as granting business licenses in order to fulfill the political objective of more Bumiputra involvement in the commercial sector so that the Bumiputra can achieve economic parity with other races (Gomez & Jomo, 1997; Searle, 1999). As a result, other non-connected firms such as large family firms (examples Genting Group, Berjaya Group, Lion Group, etc) have to build closer ties with the Government and the GLCs in order to obtain business favours or approvals as part of business

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survival (Gomez & Jomo, 1997; Searle, 1999). The rents or favours obtained from the government and GLCs encourage expropriation by family controlling shareholders because the latter could expropriate these rents for their own private benefits. This may happen due to the following reasons. Firstly, these rents or favours are usually on a long-term basis due to the close relationship built upon between the family firms and the government as well as GLCs (Gomez & Jomo, 1997; Searle, 1999). Due to the longterm nature of these rents or favours, they can easily be used in an inefficient manner to serve the private benefits of the family controlling shareholder such as excessive unrelated industry diversification for empire building purposes. Secondly, due to the close relationship built with the government, they can get easy access to soft loans from government-backed local banks (bank-directed lending) or state development bodies and pension funds (Searle, 1999; Zhuang et.al, 2001); hence, encouraging debt expropriation by family controlling shareholders. As a conclusion for the above explanations; the unique government and institutional setting that Malaysian family firms are located in, encourages expropriation by family controlling shareholders. Hence, this also support the significance of the expropriation problem among Malaysian family firms as the contextual setting (government and institutional setting) that they are located in supported it so. Even if the significance of the expropriation problem is supported, studies upon expropriation particularly by Malaysian family controlling shareholders are still not sufficiently broad-based.

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One of the reasons for this insufficiency is that most expropriation studies examine expropriation in family firms by analyzing its separation of control and ownership rights (Claessens et.al, 1999a, 1999b, 2000; Porta et.al, 1999) and its relationship with firm value (Barontini & Caprio, 2006). However, the real act of expropriation is not investigated. Aside from separation of control and ownership rights; a lot of emphasis also had been put on variables such as board composition, CEO duality, leverage, firm size, ownership concentration/structure, capital structure, etc. These variables also do not measure the real act of expropriation. Variables which can be used to measure the real act of expropriation such as related party transactions; as well as variables which support the real act of expropriation such as independent directors’ tenure and type of principal banker that the firm engaged; have not been researched extensively particularly within the context of emerging markets such as Malaysia. The following are further illustrations of this research deficit. In terms of related party transactions; as mentioned, an investigation of it will enhance our understanding of expropriation in terms of its real act. Basically, past research on this country have not examine extensively, the effects of specifc related party transactions that are likely to result in expropriation of public shareholders and their effects towards firm value1. Past studies on this country have so far only investigated the effects of the total value of related party transactions upon firm value as well as the moderating effects of corporate governance variables towards this relationship. Past research on this country have not investigated the effects of specific related party 1

There are basically 3 types of these transactions; transactions that are likely to result in expropriaton of public shareholders, transactions that are unlikely to result in expropriation of public shareholders as well as transactions that could have strategic rationales and perhaps do not result in expropriation of public shareholders (Cheung et.al, 2006).

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transactions and its effects towards firm value. Aside from detailed related party transactions analysis; the different contextual setting which prevail in this country as compared with other countries, also provides a good opportunity for researchers to look into the effects of related party transactions among Malaysian family firms and how these transactions affect firm value. Aside from related party transactions; independent director’s tenure, and its effect upon firm value, is a new area which has yet to be thoroughly investigated systematically among Malaysian family firms. Most prior studies were conducted in developed markets have yield inconclusive results. Vafeas (2003) found that long tenure of independent directors of 1994 Forbes list companies (which majority are located in developed markets) are detrimental to the interests of shareholders. However, Liu & Sun (2010) found that longer tenure of independent directors of US listed companies increase the effectiveness of the oversight of financial reporting whereas Abdelsalam & El-Masry (2008) found that longer tenure of independent directors in Irish-listed companies is positively associated with timeliness of corporate internet reporting (TCIR). Since, past results are mixed and were conducted in developed markets, there is a need to examine this variable among family firms and its firm value effects; especially within an emerging market context such as Malaysia. The reason is that less stringent regulatory environment and investor protection in emerging markets such as Malaysia encourage more expropriation by controlling shareholders. Hence, longer serving independent directors may be influenced more by controlling shareholders and thus, they are more likely to lose their independence. This is detrimental to public shareholders; thus

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contradicting the positive effects of tenure as found by Liu & Sun (2010) and Abdelsalam & El-Masry (2008). Aside from related party transactions and board tenure; another possible expropriation variable that can be analysed is the type of principal bankers engaged by family firms. The economic justification behind this possibility is that, there is a prevalence of bankdirected lending in this country (Oh, 1998). This bank-directed lending increase the incentives for the utilization of debt (bank loans) as an expropriation tool by family controlling shareholders, as family firms can obtain more loans without proper scrutiny (Thillainathan, 1999). As a result, the number of local banks engaged by Malaysian family firms may have an impact upon their firm value and this provides a research opportunity to look into this effect. Finally, ownership concentration is also worth analyzing. So far, the theory of ownership concentration is based upon the findings of corporate insider ownership research conducted in developed countries with strong investor protection regulations, such as United States, etc. Corporate insiders are defined as a company’s officers and directors (McConnell & Servaes, 1990). Morck et.al (1988) found that the relationship between insider ownership and firm valuation is concave among US firms. When insider ownership initially rises, firm value rises. This is because the traditional shareholdermanager problem (Agency Problem Type I) is resolved when insider ownership initially rises. Initially, firm value increases as the corporate insider has fewer incentives to extract private benefits from the firm for his personal welfare if his ownership increases (Jensen & Meckling, 1976). As ownership concentration increases after a certain point, corporate insiders become entrenched and pursue private benefits at the expense of 10

shareholders. This is because, beyond a certain point of insider ownership, increased insider ownership reduces the efficacy of corporate governance mechanisms that constrain inept or faithless corporate insiders (Shleifer & Vishny, 1997). However, in emerging markets such as those in East Asia, the separation of ownership and control as measured by the mean ratio of cash-flow to control rights; is high (Claessens et.al, 2000). As argued by Claessens et.al (1999a), when control rights exceed ownership rights, expropriation incentives of the controlling shareholder will be huge. The reason is this separation of ownership and control is a result of the usage of corporate pyramidal structures by firms which provide the controlling shareholder the incentives to expropriate value from the public shareholders of the firm at the lower levels of the corporate pyramidal structure (Claessens et.al, 1999a). This creates Agency Problem Type II which is the conflict between the controlling shareholder and public shareholders whereby controlling shareholders are not acting in the best interest of the public shareholders (Villalonga & Amit, 2006). Therefore, in East Asian firms; it is expected that controlling shareholders possess incentives to expropriate resources and value from the firm which are detrimental to the public shareholders. Thus, when the controlling shareholder’s ownership concentration increased; he possess more voting power which he could use it to extract private benefits or expropriate resources from the firm at the expense of the public shareholders (Shleifer & Vishny, 1997). As a result, the cost of expropriation should increase directly with ownership concentration among East Asian firms (Chandrasekhar et.al, 2005). In addition, managers of East Asian corporations are usually related to the family of the controlling shareholder which creates managerial entrenchment which are detrimental to the public shareholders.

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Hence,

the

traditional

shareholder-manager

conflict

is

generally limited

and

overshadowed by Agency Problem Type II (Claessens et.al, 2002). Thus, Agency Problem Type II is the dominant problem among East Asian corporations rather than Agency Problem Type I. As a result, the relationship between the controlling shareholder’s ownership concentration and firm value may not be the same as what is proposed by Morck et.al (1988) which is a concave relationship; due to the dominance of Agency Problem Type II over Agency Problem Type I and also due to the increase in the cost of expropriation when ownership increased, as argued by Chandrasekhar et.al (2005). Therefore, it would be desirable to verify the effects of ownership concentration upon firm value among East Asian emerging market firms such as those in Malaysia particularly family firms, due to its dominance in the stock market, high separation of ownership and control; as well as the unique contextual setting (government and institutional setting) that prevails in this country. In addition to all the above variables which had been discussed; researchers have also not examine the moderating effects of firm risk towards the relationship between related party transactions and firm value. There is a possibility that firm risk as a corporate governance variable, moderates related party transactions in its effects towards firm value as other studies such as Effiezal et.al (2011) had found that corporate governance variables i.e. executive remuneration, board independence and the presence of the big 4 auditors, does matter in this respect. Hence, this provides a good opportunity for research. Theoretically, firm risk does matter in moderating the effects of related party transactions towards firm value as the risk that a firm undertakes will also be reflected in its performance in accordance with finance theory; hence, serving as a 12

moderator. This study attempts to seek empirical evidence to support this moderating effect. In brief, the lack of extensive research upon certain expropriation-related variables as well as the interaction between some of these variables, towards firm value; the lack of conclusive results; the unique ownership structure that prevail in this country as well as the different contextual setting (government and institutional setting) that Malaysian family firms are located in; all these provides a good opportunity to conduct expropriation research on Malaysian family firms. This research will examine the effects of certain expropriation-related variables as well as the interaction of some of these variables, in Malaysian family firms and their impact upon firm value. 1.2 Research Questions This study seeks to address the following questions: 1) Do related party transactions that are likely to result in expropriation, significantly affect firm value among family firms and if yes, in what level and direction? 2) Do average independent directors’ tenure, significantly affect firm value among family firms and if yes, in what level and direction? 3) Do the quantity of local principal bankers engaged by the firm, significantly affect firm value among family firms, and if yes, in what level and direction? 4) Do the controlling shareholder’s ownership concentration significantly affect firm value among family firms, and if yes, in what level and direction? 5) Does firm risk significantly moderate the relationship between the family firm’s related party transactions that are likely to result in expropriation and firm value, and if yes, in what level and direction? 13

1.3 Objectives of Study The objectives of this study are to analyse the following: 1) The effects of the family firm’s related party transactions that are likely to result in expropriation; towards its firm value, in the Main Market, BURSA Malaysia. 2) The effects of the quantity of local principal bankers engaged by the family firm towards its firm value, in the Main Market, BURSA Malaysia. 3) The effects of the family firm’s average independent directors’ tenure towards its firm value, in the Main Market, BURSA Malaysia. 4) The effects of the family firm’s controlling shareholders’ ownership concentration

towards its firm value, in the Main Market, BURSA Malaysia. 5) The moderating effects of firm risk towards the relationship between the family

firm’s related party transactions that are likely to result in expropriation and firm value; in the Main Market, BURSA Malaysia. 1.4 Significance of Study 1) The study provides more recent analysis of the state of corporate governance from the finance perspective, of family firms in the Main Market, BURSA Malaysia. This updated analysis could assist in the improvement of corporate governance among these firms particularly within the context of public investor (minority shareholder) protection. 2) The results of this study provide useful financial information to the public shareholders of Malaysian public-listed family firms with regards to the state of their rights within the firm. For example, if from the study, the hypotheses

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variables reduce firm value; this provides useful information to public shareholders that their rights had been expropriated. 3) This study provide some insights to regulators for developing appropriate regulations on corporate governance mechanisms, especially those related to related party transactions and board tenure restrictions, so that public shareholders protection in this country could be enhanced. 4) This study is also relevant to other countries with similar ownership characteristics such as high family ownership concentration among listed firms, etc. 5) This study analyse the effects of corporate governance variables such as amount of transactions that are likely to result in expropriation, average independent directors’ tenure and quantity of local banks; towards firm value; all which have not been investigated thoroughly by academic researchers. 6) This study examines the potential significance of firm risk in mitigating the negative effects of related party transactions towards firm value so that firms can exercise proper risk management for this purpose.

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2.0 Literature Review 2.1 Related Party Transactions And Expropriation By Family-Controlled Firms In Malaysia 2.1.1 Definition And Classification Of Related Party Transactions Related party transactions can be classified under 3 categories (Cheung et.al, 2006): Type of connected transaction

Description

Panel A: Transactions that are a priori likely to result in expropriation of the listed firm’s public shareholders Asset acquisitions

Transactions that involve the acquisition of tangible or intangible assets by the listed company from a connected person or from a private company majority-controlled by this person.

Asset sales

Transactions that involve the sale of tangible or intangible assets by the listed company to a connected person or to a private company majority-controlled by this person.

Equity sales

Transactions that involve the sale of equity stake in the listed company to a connected person or a private company majoritycontrolled by this person.

Trading relationships

Transactions that involve the trade of goods and services between the listed company and a private company majoritycontrolled by a connected person. They can be purchases by

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the listed company or sales or both. Cash payments

Transactions that involve direct cash payments by the listed company to a connected person or to a company controlled by this person or to a subsidiary (including loans and cash assistance) and the provision of cash guarantees by the listed company for debts owed by the connected person or by the companies controlled by this person.

Panel B: Transactions likely to benefit the listed firm’s public shareholders Cash receipts

Transactions that involve direct cash assistance or loans provided by the connected person to the listed company.

Subsidiary

Transactions between a listed company and one of its

relationships

subsidiaries. They could involve acquisitions or sales of equity stakes or assets and trading relationships.

Panel C: Transactions that could have strategic rationales and perhaps are not expropriation Takeover offers and Cases in which the listed company receives a takeover offer by joint ventures

another publicly listed company that holds a toehold, and cases in which the listed company forms a joint venture or strategic alliance with another company that already holds a stake in the listed company.

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Joint venture stake Transactions that involve acquisitions by the listed company acquisitions

from a third party of a stake in a joint venture in which the company participates as a joint venture partner. The connected person is the third party in his or her capacity as subsidiary shareholder.

Joint venture stake Transactions that involve the sale by the listed company to a sales

third party of a stake in a joint venture in which the company participates as a joint venture partner. The connected person is the third party in his or her capacity as subsidiary shareholder.

Panel A list the transactions that are related party transactions that are likely to result in expropriation whereas Panel B and C’s transactions are potentially non-abusive. Our research will examine only related party transactions that are likely to result in expropriation in the analysis of its effects towards family firm value because our study concerns firm expropriation and only related party transactions that are likely to result in expropriation are likely to facilitate expropriation as explained in the above table (Cheung et.al, 2006).

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2.1.2 Related Party Transactions Hypotheses Gordon et.al (2004) developed 2 contrasting hypotheses about related party transactions. a) Conflict of Interest view (Gordon et.al, 2004) b) Efficient transactions hypotheses (Gordon et.al, 2004) Under the conflict of interest hypothesis, related party transactions compromise the agent’s responsibility to shareholders or a board of director’s monitoring function. In this instance, related party transactions would be more prevalent when a firm’s corporate governance mechanisms are weak, and such firms would possess lower adjusted stock returns (Gordon et.al, 2004). Alternatively, efficient transactions hypothesis states that related party transactions are efficient transactions and there would be no need to increase monitoring. Consequently, there will be no relationship between related party transactions and the strength of corporate governance mechanisms, and no adverse impact on shareholders. However, even if related party transactions are efficient transactions, a company can choose to increase monitoring to prevent the appearance of conflict of interests. In this situation, a positive relationship between stronger governance structures and related party transactions is expected (Gordon et.al, 2004). As explained in the introduction, related party transactions in this country are unique and the government and institutional setting in this country differ from many nations. Therefore, research results produced from related party transactions study conducted in other countries may not be the same as the research results produced from analysis 19

done locally. The sign and strength of the coefficients and the significance of the variable may differ due to the uniqueness of the related party transactions and the different government and institutional setting here. Our research which analyses the effects of related party transactions that are likely to result in expropriation towards family firm value in Malaysia will hopefully provide further evidence to support the related party transactions hypothesis that is relevant. This form part of our contribution in this paper. 2.2 Board Independence & Expropriation By Family Firms In Malaysia 2.2.1 Theories & Hypotheses With Respect To Board Tenure There are conflicting views with respect to the effect of director tenure on director behavior. The expertise hypothesis suggests that long-term director’s engagement is associated with higher experience, commitment and competence; because it provides a director with important knowledge about the firm and its business environment (Vafeas, 2003). Vance (1983) argues that forcing directors to retire leads to a waste of talent and experience. In addition, Buchanan (1974) finds that extended tenure enhances organizational commitment and willingness to expend effort toward company goals. Salancik (1977) suggests organizational commitment increased with tenure because employees make certain “side bets” within the firm (e.g. buying company stock) and because seasoned employees are more likely to have developed confidence and competence in doing their job. Consequently, an efficient market for directors would lead to the long-term survival of directors who are best-suited to protect shareholders. On the contrary, Katz (1982) finds that extended tenure reduces intra-group communication, and isolates groups from key information sources. He also finds that 20

the performance of groups is non-linearly related to tenure, increasing because of a learning effect initially, and declining thereafter. Lipton & Lorsch (1992) recognize that lead directors may attempt to usurp some of the CEO’s functions through time, and therefore, advocate term limits for directors. Vafeas (2003) proposed a management friendliness hypothesis, suggesting that seasoned directors are more likely to befriend, and less likely to monitor managers. Over time, directors may be co-opted by management as directors become less mobile and less employable. This phenomenon is more likely to occur in firms with more powerful CEOs. In essence, Vafeas (2003) suggest that the length of board tenure serves as an observable proxy for the extent to which non-executive directors are affiliated with management. However, Vafeas’s empirical findings show vice versa. He found that the affiliation of the board directors predict their tenure. Vafeas’s definition of affiliated independent directors are independent directors in “grey” occupations such as bankers, lawyers and retired “grey” directors or involved in interlocking relationship with any of the inside directors or possessing special consulting agreements with their CEOs. He found that these directors serve longer on the board. As argued in the introduction section, this may not be so in the case of independent directors working for family firms in emerging markets with poorer investor protection. Furthermore, as explained in the introduction section, increase in independent directors’ tenure increase the effectiveness of the oversight of financial reporting as proven by Liu & Sun (2010) which may increase firm value. Hence, research results produced from studies conducted in other countries (i.e. Liu & Sun (2010)) may not be the same as the research results produced from analysis done locally. The sign and strength of the 21

coefficients and the significance of the variable may differ due to the poorer investor protection, different government, institutional and different legal setting here which encourage expropriation by family controlling shareholders. Based upon these reasons, an empirical analysis of the effects of the independent director’s tenure towards family firm value in emerging markets like Malaysia is useful for the purpose of verifying this relationship as well as provides evidence for supporting the relevant hypotheses as explained previously, within the emerging markets context. This forms part of our contribution in this paper. In addition, Thillainathan (1999), representing the World Bank, in his comprehensive study of Malaysian corporate governance states that independent directors are liable to be influenced by the controlling shareholder, therefore, their state of independence needs to be constantly or regularly evaluated.. 2.3 Banking Structure, Regulatory Framework, Moral Hazard & Family Firms Although, locally-owned Malaysian banks are relatively free from non-financial interests, some banks are still owned by large family conglomerates such as Hong Leong Bank and Multi-Purpose Bank. However, unlike other ASEAN countries, Malaysian banks are not allowed to issue loans to related parties as according to the Banking And Financial Institutions Act (BAFIA) (1989). This helps reduce expropriation through reduction in related lending. On the other hand, local banks in this country possess the implicit assumption that the government will bail them out in the case that they fail (too big to fail) as witnessed by the creation of Danamodal and Danaharta to save the banking industry during the Asian financial crisis in 1997. Lending decisions of local banks in this country are basically, based upon the borrower’s collaterals and implied government support (government guarantees) and 22

not just on project cash flows. Both these factors led to more bank loans being issued without proper prudence which will result in higher non-performing loans (Thillainathan, 1999). This moral hazard banking increase the incentives for the utilization of debt (bank loans) as an expropriation tool by family controlling shareholders, as family firms can obtain more loans without proper scrutiny. Due to the issue of moral hazard that affect the local banks as well as the prevalence of bank-directed lending as explained in the introduction section, it is postulated that family firms that possess more local banks as their principal bankers, engage in more debt expropriation in the form of bank loans; which reduces firm value as compared with those with less local banks as their principal bankers. There is also no study conducted with respect to this locally or overseas. Due to both these factors, our empirical analysis with respect to this relationship forms part of our contribution in this paper. 2.4 Family Controlling Shareholder’s Ownership Concentration Corporate governance studies have primarily focused on the Anglo-Saxon countries’ firms in which ownership is widely held (Song et.al, 2007). However, in non-Anglo Saxon countries such as East Asia, etc, corporate ownership was found to be highly concentrated and controlled by family groups (Claessens et.al, 1999a). This type of ownership structure is generally found in poorly developed factor markets and in countries with poor investor protection (Almeida & Wolfenzon, 2003; Khanna & Palepu, 2000; Porta et.al, 1999). The percentage of concentration of control among listed family firms in this country amounts to 76.2% of its Gross Domestic Product (GDP) which is the second highest after Hong Kong for the year 1996 among all the East Asian countries studied as mentioned previously (Claessens et.al, 2000). For the year 2004, 23

the average shareholding of the family controlling shareholders is 27.3% in Bursa Malaysia (Munir & Salleh, 2010). When product, labour and capital markets were underdeveloped and inefficient, it would be more costly for firms to purchase a stake in it (Williamson, 1985). Concentrated ownership enables transaction costs in contractual engagements to be reduced (Morck et.al, 1988). Jensen & Meckling (1976) also argued that ownership concentration increases firm value as the owner has fewer incentives to extract private benefits from the firm for his personal welfare. However, Barclay & Holderness (1989) found that larger ownership reduced the probability of acquisition, therefore, reducing firm value. Some studies have also found that the relationship between ownership concentration and firm value is non-monotonic (Morck et.al, 1988; McConnell & Servaes, 1990; Wiwattanakantang, 2001, Song et.al, 2007). As explained above, past studies have shown inconclusive findings with respect to ownership concentration. In addition, the ownership structure, capital markets, and government and institutional setting in Malaysia are unique which differ from other nations, as explained in the introduction section. Furthermore, the effects of ownership concentration towards firm value have not been investigated in detail specifically for family firms in this country. Therefore, it is useful to conduct research to verify this relationship in this country particularly for family firms. An analysis will produce a new spectrum of knowledge for family firms. For example, in emerging markets like Malaysia, in which investor protection is poorer; there is a strong likelihood that

24

ownership concentration will reduce family firm value due to the extraction of private benefits by the family controlling shareholder. 2.5 The Moderating Effects Of Firm Risk Towards The Relationship Between Amount Of Transactions That Are Likely To Result In Expropriation Ratio And Firm Value There is a possibility that firm risk as a corporate governance variable, moderates related party transactions in the effects towards firm value as other studies such as Effiezal et.al (2011) had found that corporate governance variables i.e. executive remuneration, board independence and the presence of the big 4 auditors, does matter in moderating the effects of related party transactions towards firm value. Hence, this provides a good opportunity for research. Theoretically, firm risk does matter in moderating the effects of related party transactions towards firm value as the risk that a firm undertakes will also be reflected in its performance in accordance with finance theory; hence, serving as a moderator. This study attempts to seek empirical evidence to support this moderating effect. 3.0 Research Methodology Corporate governance variables play a significant role towards family firm performance (Ibrahim, 2009). In fact, previous studies found that there is a lack of literature and empirical evidence pertaining the relationship between corporate governance variables and family firm performance (Ibrahim, 2009). Hence, this has been considered for this research by analyzing expropriation-related variables against family firm value. As a result, this study suggests 4 main hypotheses that will be discussed in this section. 25

3.1 Hypotheses Development The main hypotheses proposed in this study are with respect to family-controlled firms in the Main Market, Bursa Malaysia. The hypotheses are developed to answer the research questions which have been discussed earlier in the introduction section. 3.1.1 Related PartyTransactions That Are LikelyTo Result In Expropriation & Firm Value As classified by Cheung et.al (2006), related party transactions that are likely to result in expropriation consist of asset acquisitions, asset sales, equity sales, trading relationships and cash payments to a related party. As highlighted earlier in the introduction, ownership concentration is particularly high among Malaysian family firms (average shareholding 27.3% for 2004) as well as a huge difference between control rights and ownership rights (0.785 for 1996). Therefore, the incentives for expropriation are high for the family controlling shareholders (Claessens et.al, 2000). In addition, Djankov et.al (2008) postulate that related party transactions may provide direct opportunities for related parties such as controlling shareholders to extract cash from listed companies through tunneling activities; hence, related party transactions is being used a tool for expropriation. This further enhances the incentives to expropriate. Generally, on balance, majority of research on related party transactions suggest that these transactions could directly transfer firms’ assets and profits to the related parties and negatively affect firm performance (Bertrand et.al, 2002; Cheung et.al, 2006; Kohlbeck & Mayhew, 2004). Related party transactions are also likely to have negative effects on firm performance in this country due to the weak investor protection laws and the lack of shareholder activism. Since, both law and enforcement are needed to protect investors from the opportunistic behavior of insiders (La Porta et.al, 2000); there is 26

evidence to suggest that while this country is a common law country, it suffers poor legal enforcement (Ball et.al, 2003; Leuz et.al, 2003). As a result, we expect that related party transactions that are likely to result in expropriation reduce firm value as it is a tool for expropriation. H1: There is a negative relationship between related party transactions that are likely to result in expropriation and firm performance among Malaysian family firms listed in Bursa Malaysia. 3.1.2 Average Independent Directors’ Tenure & Firm Value There is a large literature concerning the benefits and costs of directors’ tenure. Previous studies by Salancik (1977) and O’Reilly & Caldwell (1981) suggest that directors’ organizational commitment increases in tenure. O’Reilly and Caldwell (1981) provide evidence that behavioural commitment is significantly associated with job turnover. Long tenure directors have may have high job satisfaction. These directors are less likely to reverse their job acceptance. Thus, extended directors’ tenure can enhance the commitment of directors to fulfill their duties. To summarise, long-tenure directors possess greater experience, expertise and reputation. Also, they have high commitment and willingness to work better. On the other hand, long board tenure may lead to entrenchment which reduces the effectiveness of independent directors. Long tenure directors are more likely to possess a friendly relationship gradually with the management (Vafeas, 2003). Coupled by the incentives to expropriate by the controlling shareholder as elaborated earlier in the introduction and literature; this provides a golden opportunity for controlling 27

shareholders to influence the independent directors as their tenure becomes longer. Studies by Bebchuk et.al (2002) and Bebchuk & Fried (2003) suggest that management may use their power to influence the nomination process of directors as well. Independent directors with strong personal ties with the management are more likely to be re-appointed and survive long term. These directors will not operate independently because it is easier for a long-tenured director to act as an insider (Canavan et.al, 2004). In addition, long tenure directors are less mobile and less employable (Vafeas, 2003). As business operations become more sophisticated and changing more often, it is increasingly difficult for long tenure directors to keep track of the changes in technology, financial dealings, and business strategies. New directors can inject fresh ideas and critical thinking to the board or committee. However, long tenure directors may lack talent to deal with new issues (Liu & Sun, 2010). Considering the benefits and costs of long tenure directors, it is more likely that long tenure directors are less effective. Whether the effectiveness of long tenure dominates its ineffectiveness is an empirical issue. Thus, the following hypothesis is developed : H2 : There is a negative relationship between average independent directors’ tenure and firm performance among Malaysian family firms listed in Bursa Malaysia. 3.1.3 Quantity Of Local Banks Engaged By The Firm And Firm Value In Malaysia, government-owned or controlled banks account for 30% of the market share. Most of the leading locally-owned banks are public-limited corporations but each with a dominant shareholder, either government institution or a private family interest

28

(Thillainathan, 1999). Foreign-owned banks possessed only 20% market share (Thillainathan, 1999). The banking sector in this country has played a leading role in indirect financing, while experiencing problems similar to other emerging markets. The fundamental reasons for these problems are bank-directed loan policies, lack of competition and lack of prudential regulations (Oh, 1998). Through bank-directed lending via local banks which are government-owned or familyowned; a negative impression had been created which led to lower confidence towards these banks by the financial community (Oh, 1998). Family firms which built close relationship with the government could easily access soft loans from governmentbacked local banks (Zhuang et.al, 2001). They obtained easy access as a result of close ties with the government and the GLCs to obtain business favours or approvals as part of business survival (Gomez & Jomo, 1997). Bank-directed lending is also partially encouraged by the lack of development of more arms-length financing mechanism such as bond financing; due to lack of development of its infrastructure, governance mechanism and the market itself (Thillainathan, 1999; Sharma, 2001). To aggravate the situation, the ownership structure and the differences between cash flow and ownership rights among family firms (as highlighted earlier in the introduction) had

already

created

high

expropriation

incentives

among

family

controlling

shareholders. As a result, bank-directed lending creates a culture of rent-seeking which encourages expropriation via debt (bank loans) by the controlling shareholders of family firms. In addition, local and international market analysts claimed that risk assessment

29

and even routine and important processes such as cash flow analysis are not satisfactorily carried out in many local financial institutions; thus, further encouraging imprudent lending and ultimately expropriation (Oh, 1998). As illustrated earlier in the introduction, expropriation reduces firm value and hence, the following hypothesis is developed : H3 : There is a negative relationship between the number of local banks engaged by the firm and its firm performance among Malaysian family firms listed in Bursa Malaysia. 3.1.4 Ownership Concentration And Firm Value The theory of ownership concentration is based upon the findings of corporate insider ownership research conducted in developed countries with strong investor protection regulations, such as United States, etc. Morck et.al (1988) found that the relationship between insider ownership and firm valuation is concave among US firms. When insider ownership initially rises, firm value rises. This is because the traditional shareholdermanager problem (Agency Problem Type I) is resolved when insider ownership initially rises. Initially, firm value increases as the corporate insider has fewer incentives to extract private benefits from the firm for his personal welfare if his ownership increases (Jensen & Meckling, 1976). As ownership concentration increases after a certain point, corporate insiders become entrenched and pursue private benefits at the expense of shareholders. This is because, beyond a certain point of insider ownership, increased insider ownership reduces the efficacy of corporate governance mechanisms that constrain inept or faithless corporate insiders (Shleifer & Vishny, 1997). However, in emerging markets, the situation is different. The prevalence of large shareholders and concentrated ownership are believed to be relevant in the context of emerging markets 30

(Wiwattanakantang, 2001). As a result, its implications should be assessed stringently due to the country’s unique institutional specificities (Sulong & Nor, 2008). Some of these specifities are : a) A less developed and illiquid capital markets b) Relatively weak legal and regulatory framework c) Weak enforcement of the legal and regulatory framework that exist d) Less active takeover market e) A highly concentrated family-based ownership f) A higher dependence on external sources of financing (Claessens et.al, 2000; Edwards & Capulong, 2000). Based on these factors, it can be argued that institutional and economic arrangements in this country are relatively specific in comparison to developed markets. If this is true, adopting corporate governance systems from developed countries without considering these factors may lead to ineffective corporate governance (Sulong & Nor, 2008). As highlighted earlier in the introduction, the ownership structure and the differences between cash flow and control rights among family firms are high in this country. Large concentrated shareholders may use their voting power to influence management decisions, which leads to expropriation of public shareholder rights (Morck et.al, 1988). The high deviation between cash flow and control rights further exacerbate the potential for expropriation through pyramidal corporate structures on affiliated firm capital structure and investment policies, which is shown to have a negative effect on firm valuation (Bany Ariffin, 2006). Consistent with the arguments that larger controlling 31

shareholder can lead to entrenchment of huge owners and public shareholder expropriation, this research expects that higher ownership concentration and very high ownership concentration among family firms are expected to increase agency costs and subsequently lower firm value. Based upon this, the following hypotheses are formulated : H4 : There is a negative relationship between ownership concentration and firm performance among Malaysian family firms listed in Bursa Malaysia. H5 : There is a negative relationship between very high ownership concentration and firm performance among Malaysian family firms listed in Bursa Malaysia. 3.2.5 The Moderating Effects Of Firm Risk Towards The Relationship Between Amount Of Transactions That Are Likely To Result In Expropriation Ratio And Firm Value There is a possibility that firm risk as a corporate governance variable, moderates related party transactions in its effects towards firm value as other studies such as Effiezal et.al (2011) had found that corporate governance variables i.e. executive remuneration, board independence and the presence of the big 4 auditors, does matter in moderating these effects. Hence, this provides a good opportunity for research. Theoretically, firm risk does matter in moderating the effects of related party transactions towards firm value as the risk that a firm undertakes will also be reflected in its performance in accordance with finance theory; hence, serving as a moderator. This study attempts to seek empirical evidence to support this moderating effect.

32

H6 : There is a moderating effect of firm risk towards the relationship between the amount of related party transactions that are likely to result in expropriation ratio and firm value, among Malaysian family firms listed in Bursa Malaysia. 3.3 Research Design In this part, the research will explain in-depth the ways data is constructed to obtain accurate and adequate data. Furthermore, the methodology and models used to analyse the data will also be discussed and each of the variables will be defined in detail with respect to the objectives of the study. 3.3.1 Sample Data This research employs secondary data with regards to the types of ultimate owner, financial information and board statistics for the period 2007-2009. All the data are obtained from companies’ annual reports as well as from Bloomberg or DataStream database. Data of firm value and foreign bank/local bank ratio is extracted from the balance sheet, amount of related party transactions from the related party transactions disclosure section and the data to calculate average independent director tenure from directors’ profile section. Data for the controlling shareholder’s ownership concentration in terms of shareholding percentage is extracted from the section of substantial shareholding of the firm. 3.3.2 Sample Period The sample period was selected with the objective of examining the impact of expropriation towards firm value during periods of financial crisis. This is because the risk of expropriation is higher during times of financial crisis (Mitton, 2002; Lemmon & Lins, 2003) as well as the significance of corporate governance increases during these 33

periods (Johnson et.al, 2000a). Hence, periods of financial crisis are better periods to be utilized to analyse the effects of expropriation towards firm performance, since the risk of expropriation is higher as compared with non-financial crisis periods. With this objective in mind, a 3-year period of 2007 to 2009 was examined. Due to the nature of the regression technique used i.e. 2-Stage Least Square (2SLS) Method, which utilized a lagged 1-period Outside Directors Ratio (ODR) independent variable in its instruments list; ultimately, only a 2-year period of 2008 to 2009 was analysed. The periods 20082009 are periods of global financial crisis and this fits the objective of the sample period selection. 3.3.3 Sample Selection All family firms listed on the Main Market of Bursa Malaysia are selected as a sample as at 18th January, 2011. A firm is classified as a family firm if a person is the controlling shareholder; that is a person (rather than a state, corporation, management trust or mutual fund) can obtain enough shares to assure at least 20% of the voting rights and the highest percentage of voting rights in comparison to other shareholders (Kets de Vries, 1993; Porta et.al, 1999; Chakrabarty, 2009). The study did not select the firms listed on the ACE markets due to differences in the type of listed firms and listing requirements. As a time series study, it is significant to ensure that all firms were active for the entire period of study. Therefore, this study implements non-probability sampling by using self-judgment to select sample elements to fit some criterion (Cooper & Schindler, 2001).

34

To be selected as a sample, the company must be active or survive the entire period of analysis i.e. from 2007 to 2009. Companies that were newly listed after 31 st December, 2007 or delisted from the Main Market were excluded from the sample. However, the study includes firms which changed their companies’ names as well during the study period. In addition, the firm must have completed a full accounting period or 12 months business operations for each year and should be consistent with the same year-end throughout the 3-year period. Additionally, the study excludes all 32 financial related family firms from the sample since the accounting standards for income and profits for these firms are very different from other industries (Campbell & Keys, 2002; Lemmons & Lins, 2003; Claessens et.al, 1999). 3.3.3.1. Description Of Data Set Selected From The Main Market Companies Data Description

Number of Companies

Total Main Market family firms listed on

407

Bursa Malaysia and could be utilized in the research, as at 31st December, 2007 Minus : Financial related companies

32

Number of Family Firms available for

375

observation The final sample of observations for family firms across 3 years from 2007 to 2009 is used in this analysis. Details appear in the above table.

35

3.3.4 Methodology The methodology utilised will be discussed in this section. Univariate statistics (descriptive statistics) and pooled ordinary least square (OLS) regression model are used for this research as well as the Fixed Effect Least Square Dummy Variable (LSDV) Model or the Random Effects Model (REM) (Justification based upon the statistical results of the Hausman Test (Gujarati & Porter, 2009; Hausman, 1978). 3.3.5 Variables Definition & Measurement From the econometricians’ point of view, sample selectivity, measurement error and missing variables are important research methodology problems which may cause mixed research results (Borsch-Supan & Koke, 2002). In addition, Demsetz and Villalonga (2001) claimed that from a methodological perspective, this problem may be caused by the measurements used in the study. Consequently, the researcher must define the measurement of each variable used, in a clear manner with respect to the objectives of the research in order to derive significant findings. a) Dependent Variable : Firm Value This study will utilise Tobin’s Q to measure firm value. Tobin’s Q is measured by the ratio of (Market Capitalization + Total Debt)/ (Total Assets). This performance measure is used by Anderson & Reeb (2003) and Yermack (1996). For robustness check, 2 accounting-based performance measures, Return on Asset (ROA) and Return on Equity (ROE) shall be regressed against the independent variables to test the robustness of the research results. ROA is measured by Net Income / Total Assets. This performance measure is used by Anderson & Reeb (2003) and Holderness & Sheehan (1988). ROE is measured by Net Income / 36

Total Common Equity. This performance measure is used by Holderness & Sheehan (1988) and Rechner & Dalton (1991). b) Independent Variables 1) Amount of Transactions That Are Likely To Result In Expropriation Ratio (ARPTTLERatio) The amount of related party transactions that are likely to result in expropriation will be measured as per disclosed in the section of related party transactions in the annual report and as according to the definition of Cheung et.al (2006). This value will be divided by the Total Related Party Transactions value to obtain the ratio. Ratio is obtained to reduce the number of outliers in the distribution. 2) Average Tenure of Independent Directors The average tenure of independent directors is measured by adding up the tenure of each independent director of the firm (each tenure is measured from the year he or she was appointed as an independent director until the year of the annual report being analysed) and divide it by the no. of independent directors in order to obtain the average value. This measurement reflects the likelihood of the independent directors being influenced by the controlling shareholders and no longer “truly” independent. This measurement is used in board independence studies by Abdelsalam & El-Masry (2008) and Vafeas (2003). 3) Quantity Of Local Principal Bankers Engaged By The Firm This value will be calculated based upon data as disclosed in the organizational profile of the annual report.

37

4) Controlling Shareholder’s Ownership Concentration This is extracted from the data of the substantial shareholding in the annual report. It is measured in terms of percentage of total equity held by each controlling shareholder. This measurement is consistent with the measurement used by Demsetz and Lehn (1985), Wruck (1989), Maury (2006) and Gul et.al (2010). 5)Square of Controlling Shareholder’s Ownership Concentration This is the squared value of the controlling shareholders’ ownership concentration. The purpose of this variable is to test for the effects towards firm value when ownership by the controlling shareholders is very high. This is an alternative method to piecewise linear regression for testing firm value effects and it is used by McConnell & Servaes (1990) and Song et.al (2007). 6) Interaction Between ARPTTLERatio and Firm Risk The purpose of this interaction variable is to test for the moderating effects of firm risk towards the relationship between ARPTTLERatio and firm value. This interaction variable is measured by multiplying ARPTTLERatio and firm risk. 7) Control Variable : Firm Size Demsetz and Lehn (1985) argued that firm size is one of the general forces that could affect firm value. The firm’s resources are related to the size of the firm. The larger the size of the company, the larger the company’s resources of capital, and the bigger is the market value of the fraction of the ownership of the shareholder. In addition, the ability of the public shareholder to intervene in the 38

operations of the company is reduced when firm size increased. Therefore, firm size is an important control variable to be included in this research. Firm size in this research is measured by taking the natural logarithm of the total asset value of the firm as a proxy. This measurement is in accordance with the measurement used by Anderson and Reeb (2003). The reason to follow their measurement is because their study of founding-family ownership and firm performance in the United States is one of the key corporate governance papers in the study of ownership structure of firms. The natural logarithm helps to reduce the number of outliers in the distribution. 8) Control Variable : Firm Risk Firm risk affects firm value based upon the risk-return principle in finance theory. The higher the risk taken by the firm, the higher the returns obtained. In this study, firm risk is measured by the standard deviation (σ) of monthly stock returns between 2007-2009 (Anderson & Reeb, 2003). The natural logarithm is taken to reduce the number of outliers in the distribution. 9) Control Variable : Leverage Past study by Singh & Davidson III (2003) has proven that leverage affect firm value. Furthermore, Helfert (2003) states that the use of debt to asset ratio is important to lenders and creditors who are concerned about the degree of financial leverage employed, and the availability of specific residual asset values, which determine the margin of protection against risk. Therefore, high debt to asset ratio indicates a greater risk for the lender. Higher debt means higher interest expense; therefore, net income will be lower and hence, affecting

39

accounting-based firm value likes ROA and ROE. Higher debt also means higher risk of insolvency; hence, investors will discount the share price of the firm by selling off its shares (assuming they are risk-averse). This affect market-based performance measures such as stock returns. This discount due to investor selloff (as a result of higher risk of insolvency); will reduce market-based performance measures such as Tobin’s Q. In addition, debt-to-asset ratio or firm leverage may be related to agency costs in large firms, thereby, reducing firm value. On the other hand, leverage can also be a tool to control the firm’s financial resources from being used for unprofitable investment in accordance with Free Cash Flow Hypothesis (Jensen, 1986). Thus, leverage may also help increase firm value. Leverage is measured as the ratio of Long-term Debt / Total Assets (Anderson & Reeb, 2003). The natural logarithm is taken for this variable in order to reduce the number of outliers in the distribution. 10) Control Variable : Outside Directors This variable helps control the overall effects of the independent directors. The higher, the number of independent directors; the better the monitoring of the firm; hence, firm value is expected to increase with the number of independent directors. However, increase in outside directors may also signal management inefficiency as the company fail to achieve economies of scale in terms of staff utilization. Therefore, an increase in the number of independent directors in the firm may reduce firm value. Outside directors is measured by the fraction of the independent directors serving on the board divided by board size (Anderson & Reeb, 2003). The reason to follow their measurement is because their study of

40

founding-family ownership and firm performance in the United States is one of the key corporate governance papers in the study of ownership structure of firms. 3.3.6 Economic Model This research is based upon panel data analysis using the pooled ordinary least square (OLS) regression model and the Least Square Dummy Variable (LSDV) Model or Random Effects Model (REM) to empirically test the hypotheses as summarized in Table 3.2.5. The model is as follows: Q = β0 + β1 (ARPTTLERatio) + β2(AIDT) + β3(Banks) + β4(OC) + β5(OC2) + β6(FSIZE) + β7(lnFRISK) + β8(lnLEV) + β9(ODR) + β10(lnFRISK)(ARPTTLERatio) + µt Q: Tobin’s Q β0 : Constant ARPTTLERatio : Amount of Related Party Transactions That Are Likely To Result in Expropriation at year t divided by Total Related Party Transactions Value at year t. AIDT : Average tenure of independent directors in the firm at year t Banks: Quantity of local principal bankers engaged by the firm at year t OC : Controlling shareholders’ ownership concentration in the firm at year t (%) OC2: Square of Controlling shareholders’ ownership concentration in the firm at year t (%) (lnFRISK)(ARPTTLERatio) : Logarithm of Firm Risk multiplied by the amount of related party transactions That Are Likely To Result in Expropriation. 41

Control Variables FSIZE : Firm Size (Ln(Total Assets)) lnFRISK : ln(Firm Risk (Standard Deviation of monthly stock returns between 20072009)) lnLEV: ln(Leverage (Long-term Debt/Total Assets)) ODR : Outside Directors Ratio (No. of independent directors/Board Size) µt : Stochastic error term 4.0 Descriptive Statistics The following is the table which presents the descriptive statistics for the sample used in this research : Table 1 Descriptive Statistics For Full Sample Mean

Median

Standard

Maximum Minimum

Deviation Tobin’s Q ROE ROA Amount of Related Party Transactions That Are Likely to result in Expropriation Ratio (ARPTTLERatio) Ownership Concentration Square of Ownership Concentration

0.8732 0.0311 0.0293 0.3240

0.7880 0.0656 0.0362 0.1700

0.4911 0.3095 0.0890 0.3513

41.1408 40.0400 13.2904 1,869.045 1,603.202 1,195.804

42

6.4918 3.0037 0.5843 1.0000

0.0631 -5.3488 -0.8778 0.0000

82.8700 6,867.437

20.1800 407.2324

Average Independent Directors’ Tenure Ln(Firm Risk) Leverage Ln(Leverage) Firm Size Outside Directors Ratio (lnFRISK)(ARPTTLERatio)

5.7575

5.0000

3.6001

20.8000

0.0000

-2.2486

-2.3126

1.0048

1.0098

-5.1160

0.1480 -2.6670 19.6432 0.4295 0.672437

0.0948 -2.3556 19.4896 0.4000 0.239429

0.5368 1.4275 1.2442 0.1181 0.883525

17.2655 2.8487 24.5391 0.8330 0.497822

0.00004 -10.1019 15.2206 0.1820 4.629402

4.1 Endogeneity Issues Empirical studies relating performance measurement to ownership concentration potentially suffer from the problem of endogeneity (Andres, 2008). For family firms, the observed relation between family ownership and firm performance could be the result of reversed causality. Strong performance could prompt families to keep their shares whereas poor performance might be an incentive to give up family control. Therefore, there could be a possibility that ownership concentration in family firms by the family controlling shareholder could be determined by firm performance (Andres, 2008). However, the argument for stronger performance causing family ownership is questionable for several reasons. Although families possess information advantages about the firms’ future prospects, it seems unreasonable to assume that they are able to predict the performance over the decades (Andres, 2008). Thus, endogeneity test is performed to test whether this reverse causality exists or not.

Empirical studies relating performance measurement to outside directors’ ratio also potentially suffer from the problem of endogeneity (Hermalin & Weisbach, 1988). The observed relation between outside directors’ ratio and firm performance could be the 43

result of reversed causality. Using agency theory, poor firm performance is an indication of poor management and hence, of the need for greater monitoring of management. Therefore, in response to poor performance, the shareholders put more outside directors on the board to monitor management. To accommodate these new outside directors, some inside directors must leave. Thus, poor performance will cause insiders to leave the board and outsiders to join the board (Jensen & Meckling, 1976; Fama & Jensen, 1983b). As a result, there could be a possibility that outside directors’ ratio in family firms could be determined by firm performance (Hermalin & Weisbach, 1988). Thus, endogeneity test is performed to test whether this reverse causality exists or not. The possibility of reverse causality between ownership concentration and outside directors’ ratio with firm performance creates the following possible simultaneous equations : 1) Q = β0 + β1ARPTTLERatio + β2OC + β3OC2 + β4AIDT + β5BANKS + β6LNRISK + β7LNLEV + β8FSIZE + β9ODR + β10(lnFRISK)(ARPTTLERatio) + µ 2) OC = α0 + α1Q + ν 3) OC2 = θ0 + θ1Q + η 4) ODR = γ0 + γ1Q + ψ Q , OC, OC2 & ODR : Instrumental Variables The rest of variables : Exogenous Variables Q : Tobin’s Q ARPTTLERatio : Amount of related party transactions that are likely to result in expropriation ratio OC : Ownership concentration by the family controlling shareholder.

44

AIDT : Average independent directors’ tenure BANKS : No. of local banks engaged by the family firm as principal bankers. LNRISK : Natural logarithm of Firm Risk LNLEV : Natural logarithm of Firm Leverage. FSIZE : Firm Size ODR : Outside Directors’ Ratio (ARPTTLERatio)(LNRISK) : Logarithm of Firm Risk multiplied by the amount of related party transactions That Are Likely To Result in Expropriation ratio. µ : Stochastic error term ν : Stochastic error term η : Stochastic error term ψ : Stochastic error term The above is repeated for Return on Assets (ROA) and Return on Equity (ROE), substituting Tobin’s Q. The Hausman Specification Test is performed to test for these endogeneity issues (Hausman, 1978) and the results are as the following table : Table 2 Possible Endogeneity Between Variables Independent Variable Ownership Concentration Square of Ownership Concentration Outside Directors Ratio Outside Directors Ratio Outside Directors Ratio

Dependent Variable ROA ROA Tobin’s Q ROA ROE

45

The above table shows that ROA could possibly determine the level of ownership concentration by the firm’s controlling shareholder and Tobin’s Q, ROA and ROE could possibly determine the firm’s outside directors’ ratio. With endogeneity issues involved in the economic model, the best regression technique to be utilized to obtain unbiased estimators is the 2-Stage Least Square (2SLS) Model which will be shown in the following regression results. 4.2 Multicollinearity Issues There are no significant multicollinearity problems between the independent variables in the proposed economic model as all the Variance Inflation Factor (VIF) values are less than 5; except for ownership concentration and its squared value, whereby their VIF values are more than 5. This is understandable because ownership concentration and its squared value are highly correlated with each other since the latter is the squared value of the former. Also, for the interaction variable and transactions that are likely to result in expropriation (ARPTTLERatio), the VIF values are slightly above 5 and therefore, negligible. This is understandable because

ARPTTLERatio and the

interaction variable is correlated as ARPTTLERatio is also part of the interaction variable.

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4.3 Research Results The following are the research results for the 2SLS Pooled Model and 2SLS Random Effects Model for the sample used which include technology firms : Table 3 2-Stage Least Square Model (2SLS) Pooled Model (With Technology Firms) Independent Variable & Intercept

Dependent Variable ROE

Tobin’s Q

ROA

1.720466*** -0.164385*

0.372573 -0.073589

-0.027741 -0.007057

-0.004445

0.003616

0.000605

Square of Ownership Concentration

0.0000423

-0.0000282

-0.00000273

Average Independent Directors Tenure

-0.001214

0.010789***

0.004194***

No. of Local Banks Engaged by the Firm

-0.005625

-0.010376

-0.000918

Ln (Firm Risk) Ln (Firm Leverage) Firm Size Outside Directors Ratio

0.120022*** 0.011133 -0.017785 -0.258389

0.060654*** 0.021179** -0.003733 -0.457376***

0.011223** -0.001103 0.005218 -0.144655***

Ln (Firm Risk) x ARPTTLERatio Adjusted R-Squared

-0.071599**

-0.017744

0.005392

4.9075%

4.7931%

8.3917%

Intercept Amount of Related Party Transactions That Are Likely to result in Expropriation Ratio (ARPTTLERatio) Ownership Concentration

* 10% sig.level ** 5% sig.level ***1% sig.level

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Table 4 2-Stage Least Square Model (2SLS) Random Effects Model (With Technology Firms) Independent Variable & Intercept Intercept Amount of Related Party Transactions That Are Likely to result in Expropriation Ratio (ARPTTLERatio) Ownership Concentration Square Of Ownership Concentration Average Independent Directors Tenure No.of Local Banks Engaged by the Firm

Tobin’s Q

Dependent Variable ROE

ROA

1.771615***

0.386319

-0.042674

-0.155770* -0.005119

-0.096467 0.004410

-0.009270 0.0000406

0.0000532

-0.0000403

0.00000305

0.000348

0.010998***

0.004042***

-0.004293 0.113295*** 0.013233 -0.021531 -0.259453

-0.011465 0.069144*** 0.022232** -0.004364 -0.427222***

-0.001039 0.008195* 0.0000877 0.006614* -0.149650***

-0.023293 5.2256%

0.005568 5.5796%

Ln (Firm Risk) Ln (Firm Leverage) Firm Size Outside Directors Ratio Ln (Firm Risk) x ARPTTLERatio -0.070135** 4.3074% Adjusted R-Squared * 10% sig.level ** 5% sig.level ***1% sig.level

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4.4 Robustness Test Robustness test is performed using the sample excluding technology firms based upon the same regression techniques. The results are shown in the following tables : Table 5 2-Stage Least Square Model (2SLS) Pooled Model (Without Technology Firms) Independent Variable & Intercept

Dependent Variable ROE

Tobin’s Q

ROA

Intercept Amount of Related Party Transactions That Are Likely to result in Expropriation Ratio (ARPTTLERatio) Ownership Concentration Square of Ownership Concentration Average Independent Directors Tenure No. of Local Banks Engaged by the Firm

1.768261***

0.392545

-0.024071

-0.176964** -0.003951

-0.092417 0.004001

-0.011750 0.000605

0.0000375

-0.0000328

-0.00000326

-0.001314

0.010361***

0.004039***

-0.005597

-0.012471

-0.001612

Ln (Firm Risk)

0.125915***

0.066569***

0.012412**

0.010801

0.022264**

-0.000721

-0.003538 -0.465927***

0.005553 -0.147332***

-0.024029 5.0491%

0.004424 8.6287%

Ln (Firm Leverage)

-0.020384 Firm Size Outside Directors Ratio -0.247639 Ln (Firm Risk) x ARPTTLERatio -0.077885** 5.2137% Adjusted R-Squared * 10% sig.level ** 5% sig.level ***1% sig.level

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Table 6 2-Stage Least Square Model (2SLS) Random Effects Model (Without Technology Firms) Independent Variable & Intercept Intercept Amount of Related Party Transactions That Are Likely to result in Expropriation Ratio (ARPTTLERatio) Ownership Concentration Square of Ownership Concentration Average Independent Directors Tenure No. of Local Banks Engaged by the Firm Ln (Firm Risk) Ln (Firm Leverage) Firm Size Outside Directors Ratio Ln (Firm Risk) x ARPTTLERatio Adjusted R-Squared

Tobin’s Q

Dependent Variable ROE

ROA

1.822712***

0.399982

-0.047376

-0.168419*

-0.115486

-0.012446

-0.004691

0.004914

0.0000395

0.0000489

-0.0000462

0.00000261

0.000191

0.010537***

0.003874***

-0.004374 0.119106*** 0.013058 -0.024043

-0.013708* 0.075010*** 0.023150** -0.003916

-0.001675 0.008572* 0.000379 0.007261**

-0.254672

-0.438451***

-0.152223***

-0.076482** 4.6011%

-0.029709 5.5396%

0.005305 5.5866%

* 10% sig.level ** 5% sig.level ***1% sig.level

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5.0 Summary & Conclusion In this research, we found that there is a negative significant relationship between the amount of related party transactions that are likely to result in expropriation and accounting-based firm performance measure, return on assets (ROA). There is also a positive significant relationship between average independent directors’ tenure and accounting-based firm performance measures, return on equity (ROE) and return on assets (ROA), respectively. In addition, for non-technology firms; there appears to be a negative significant relationship between the number of local banks engaged by the firm and accounting-based firm performance measure, return on equity (ROE). As for ownership concentration, there are no significant relationships with both market-based and accounting-based firm performance measures. Furthermore, when ownership concentration is high (square of ownership concentration), there are also no significant relationships with both market-based and accounting-based firm performance measures. In addition, there is also a significant moderating effect of firm risk towards the relationship between the amount of related party transactions that are like to result in expropriation and Tobin’s Q. Firm risk reduces the negative effect of this relationship. From these relationships that we found, we can conclude that the amount of related party transactions that are likely to result in expropriation and bank loans from local banks are basically tools for expropriation by family firms’ controlling shareholders. Bank loans are specifically more of an expropriation tool for non-technology firms as most technology firms are able to obtain seed funding from government agencies; hence, less reliance upon bank loans. In addition, independent directors add value to family firms. As their tenure increase, they become more experienced and possess

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more insights into the firm; therefore, they can perform their jobs better and increase firm value. Basically, from the tenure perspective, independent directors of family firms do not serve the expropriation objectives of controlling shareholders. Furthermore, based upon the research results, we can conclude that there is no significant as well as conclusive evidence that ownership concentration by family firms’ controlling shareholders are able to reduce agency problems type I or II, nor does it increase agency problems. Additionally, taking into account, both relationships between ownership concentration and its squared value with firm performance respectively; we conclude that there is no significant evidence that there is non-monotonicity in the relationship between ownership concentration by family firms’ controlling shareholders and firm value. Finally, we can deduce that Agency Problem Type II does exist among family firms in this country due to the reduction of firm value found in this research. In addition, the results also show that firm risk does play an important role in mitigating the negative effects of the amount of related party transactions that are likely to result in expropriation towards firm value and this opens up a whole new spectrum of corporate finance research in terms of the role of firm risk (i.e. risk management) in mitigating the negative effects of poor governance (i.e. the usage of related party transactions for expropriation purposes). The research results and conclusion contributes to the literature in several ways. The negative relationship between the amount of related party transactions that are likely to result in expropriation and firm value is consistent with the results of Cheung et.al (2009)(China) and Cheung et.al (2006)(Hong Kong). However, the result in this paper is

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produced in a different government and institutional setting as well as the unique feature of the variable itself distinguishing it from other results from other countries or regions; hence contributing to the literature. The negative relationship between the number of local banks engaged by the firm and firm performance for non-technology listed family firms prove that bank-directed lending indeed is detrimental towards firm value; hence, supporting the claim by Oh (1998) that bank-directed lending had created a negative impression which leads to lower confidence towards banks by the financial community particularly investors. The positive relationship between average independent directors’ tenure and firm value prove that in this country, as an emerging market; longer directors’ tenure is beneficial to the firm whereby longer tenure directors possess greater insights of the firm and more experience, hence, can contribute more effectively to the firm. This corroborates Liu & Sun (2010)’s findings that longer directors’ tenure is good for the firm. However, it contradicts Vafeas (2003)’s findings that longer board tenure is detrimental to shareholders’ interests. Both these research were conducted in developed markets (Canada and USA respectively) which provides further support that research results from emerging markets such as Malaysia and other developing countries, does matter; due to differences in the level of investor protection, government and institutional setting. The non-statistical significance of the effects of ownership concentration towards firm value prove that ownership concentration by controlling shareholders of family firms in this country is not a viable tool to reduce agency problems nor does it increase agency

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problems. This finding is consistent with other Malaysian studies on ownership concentration and firm value i.e. Chang (2004) and Sulong & Nor (2008). In addition, the findings also does not provide support to the findings by Morck et.al (1988), McConnell & Servaes (1990), Wiwattanakantang (2001) and Song et.al (2007) that there is a non-monotonic relationship between ownership concentration and firm value. This further prove the previous point that in this country, ownership concentration by controlling shareholders of family firms is not a viable tool to reduce agency problems, nor does it increase agency problems; even when controlling shareholders hold a high ownership stake in their firms. In terms of moderating effects of corporate governance, the findings of the moderating role of firm risk towards the relationship between the amount of related party transactions that are likely to result in expropriation towards firm value adds to the literature of the importance of corporate governance in mitigating the negative effects of related party transactions towards firm value. In this case, firm risk (i.e. risk management) is an additional corporate governance variable that matters aside from executive remuneration, level of board independence and the presence of Big 4 auditors as found by Effiezal et.al (2011) which also matters. From this research, there are policy considerations that can be derived. By improving public shareholder protection among family firms, especially pertaining related party transactions and banking activities (i.e. long-term and short-term loans to the corporate sector); firm value could at least be preserved or if better still, increased; instead of being reduced.

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There are also practical implications of this research. Internal and external auditors could increase their scrutiny upon family firms’ related party transactions and banking activities in order to prevent or reduce expropriation by the firm’s controlling shareholder. In additional, if firms can exercise proper risk management, it can help mitigate the negative effects of the amount of related party transactions that are likely to result in expropriation towards firm value. In implementing this research, there are limitations and restrictions that limit the scope and process of conducting this research. The data sources are limited to secondary data from annual reports, Bloomberg and Datastream. The economic model is limited to variables to the power of one and two. Higher powers are not considered. This study is also limited to non-financial family firms because financial firms have their own set of rules to be adhered i.e. the Banking & Financial Institutions Act (BAFIA)(1989). In addition, there are missing data of 39 non-financial listed family firms, rendering the observation of the entire quantity of non-financial listed family firms not possible. Finally, future research could investigate how the relative costs of Agency Problem Type I and II can be possibly affected by different sets of political economy1, firm’s lifecycle, state of the economy, listing markets (e.g. between the Main Market and ACE Market in Bursa Malaysia) as well as between politically connected and non-politically connected firms.

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