appears that business groups are not beneficial to shareholders. ... be described as a corporate organization where a number of firms are linked through cross-.
The Role and Functioning of Business Groups in East Asia and Chile Stijn Claessens, Simeon Djankov and Leora Klapper1
Abstract
We compare group affiliation in seven East Asian countries and Chile, using data for more than 1,000 publicly traded firms. We document that 75% of listed firms are associated with groups in East Asia, but only 40% in Chile. We find evidence that group structures are used to diversify risks internally as firms’ market risk is influenced not only by own characteristicssuch as size, price/book ratiobut also by group characteristics, especially in Chile. There are costs to groups, however. For East Asian countries, we find that group structures are used by controlling owners to expropriate other shareholders. On balance, it appears that business groups are not beneficial to shareholders.
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World Bank. The opinions expressed do not necessarily reflect those of the World Bank. We thank Tatiana Nenova, Gordon Phillips, Andrei Shleifer, and Rene Stulz for helpful suggestions, our discussant Salvador Valdes for useful comments, and Ying Lin for excellent research assistance.
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The Role and Functioning of Business Groups in East Asia and Chile
1.
Introduction Group structures have long been associated with early stages of countries’
development as they can substitute for underdeveloped markets and institutions. A group can be described as a corporate organization where a number of firms are linked through crossownership or where a single individual, family or coalition of families owns a number of different firms. Relative to independent firms, group structures are associated with greater use of internal financial markets and a diminished role of external financial markets in monitoring firm behavior. Capital-constrained firms may establish internal capital markets that allocate scarce capital among firms within a group, which leads to economic benefits. Internal financial markets can also allow greater diversification of firm specific risk, diversification which may not be achievable otherwise if external financial markets are imperfect. These economic benefits of forming groups in emerging marketsmore costeffective resource allocation and diversificationhave been investigated by Khanna and Palepu (1999a,b). They find that group-affiliated firms in Chile and India are associated with better performance and more diversification. At the same time, the more complex structure of groups may prove conducive to inefficient investment and greater expropriation.
The high agency costs of groups, and
associated worse allocation of resources and inefficient investment have been highlighted in a number of papers (Stulz, 1990; Shleifer and Vishny, 1997; Scharfstein and Stein, 1997; Scharfstein, 1998; Rajan et al, 1999). A recent focus has been that groups are a means for the ultimate owners to expropriate wealth from minority shareholders (Bebchuk et al., 1998; Bebchuk, 1999).
Wolfenzon (1999) in particular predicts that group structures in less-
developed countries with poor investor protection can be used by controlling owners to gain
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private benefits by expropriating minority shareholders through the use of pyramidal structures. The objective of this study is to examine the relative importance of groups in a sample of East Asian countries and Chile and study the benefits and costs of groups. We create a database regarding group affiliation for over 1,000 firms in seven East Asian economies and Chile. Using these data, we document the degree of group affiliation. We find that about 75 percent of firms are group-affiliated in East Asia, and about 40 percent in Chile. This sample of firms provides an excellent opportunity to study the reasons for group affiliation and the effects of groups on corporate policies and performance. To examine the effect of group-affiliation on relative risk, we conduct a crosssectional test on the relative market risk of each firm, its beta (the ratio of the covariance of an asset's return with the local market return to the variance of the local market return). Crosssectional tests of betas have a long tradition in finance, especially for the US. Numerous empirical tests have found, on a cross-sectional basis, relationships between firms’ beta and a number of firm-specific risk factors. Market capitalization (or size), earnings/price ratios, and book-to-market value of equity ratios have, for example, been found to be significant explanatory factors of firm’s riskiness. International empirical work, including developed marketsin particular the U.K. and Japan, with some evidence from other European marketsand developing countries (Rouwenhorst, 1999) has confirmed that firm factors can be important in explaining riskiness. We use the same methodology to examining the cross-sectional pattern of firms’ riskiness in our sample of East Asian countries and Chile to study the role of group-affiliation. For our test on the role of groups, we expand the traditional cross-sectional data to include not only firm-specific information, but also data on the group the firm is affiliated with. Our hypothesis is that firms that belong to groups should have lower betas as they can use internal
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financial markets to share risk, a mechanism which may be more efficient than the imperfect external financial markets. Group members with excess cash-flows may, for example, be willing to finance new investment opportunities of firms within the group, especially firms which would not be able to access external financial markets. During times of distress, group-affiliated firms may be more willing to extend trade credit and extend the terms of trade receivables to other group members. If the group also includes financial institutions, access to financing and renegotiations of repayment in times of distress may be further facilitated (Claessens, Djankov, and Klapper, 1999). More generally, group-affiliation allows for internal financial markets to spread risks, which can be valuable when external markets are imperfect. The regressions results show that three factors, log market value, ratio of market-tobook value of equity, and leverage (the ratio of debt to sales revenues) have significant explanatory power in most of these markets, confirming previous results for other countries. Importantly, for some of the countries studied here, and in particular Chile, we find that the betas of group-affiliated firms are lower than those of independent firms, and that this difference is statistically significant. This suggests that group-affiliation is an effective means for lowering firm risk. For some markets, firm’s riskiness is affected by group characteristics as well firm characteristics. This is particularly the case for Chile. These findings suggest that firms are not operating as independent entities and use internal markets extensively. These results also introduce new empirical evidence into the asset-pricing debate, suggesting that future research will have to incorporate the role of groups in asset pricing in emerging markets. To
examine the costs of groups, we focus on the risk of expropriation which arises
from the large separation of ultimate cash-flow and voting rights in group-affiliated firms. We find for East Asian corporations that the possibility of expropriation, proxied by the larger divergence between voting and cash-flow rights, is associated with a large discount for
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group membership (on average, a 5 percent discount). Our evidence of a group discount contrasts with Khanna and Palepu (1999a) who find a positive effect of business groups in India and, to a lesser extent, Chile. In contrast, as we show that the group discount is mostly due to expropriation, our findings rather provide strong empirical support for the models of Bebchuk et al. (1998), Bebchuk (1999) and Wolfenzon (1999) that the possibility of expropriation motivates the continued existence of groups. The paper proceeds as follows.
Section 2 describes the sample and empirical
measures. Section 3 provides an analysis of the degree of group affiliation by country and type of firms. Section 4 tests the effects of diversification on firm risk. Section 4 analyzes the relationship between group affiliation and market valuation. Section 5 concludes.
2.
Data and measurement
This study uses data for over 984 publicly traded corporations from seven Asian economiesHong Kong, Indonesia, South Korea, Malaysia, the Philippines, Singapore, and Thailand and 55 publicly traded companies from Chile for the years 1991-1996. The data come primarily from Worldscope which has financial, segment, and block ownership information on companies from 49 countries. For East Asian corporations, we supplement the ownership and segment data with information from the Asian Company Handbook 1999, the 1997 Annual Reports of the Hong Kong, Jakarta, Seoul, Kuala Lumpur, and Manila Stock Exchanges, as well as with data from the Korean Fair Trade Commission, the Securities Exchange of Thailand Companies Handbook (1998), and the Singapore Investment Guide (1998).
Our supplemental source for Chile is the Superintendencia de Valores y Seguros,
which provided us with data on group affiliation for the 1988-1998 period. 5
Group affiliation data for the East Asian countries is collected from individual country’s sources. The definition of group membership is country-specific, i.e., there is no unified approach to recording group affiliation. In Korea, for example, we use data provided by the Korean Fair Trade Commission, which defines group-affiliated firms as those which are owned at least 30% by other firms in the same group. In contrast, the definition of Indonesian and Thai business groups is based on whether the controlling family is the largest shareholder in the firm, irrespective of the actual level of holding. For Chile, we define business groups based on the lists provided by the Superintendencia. The data requirements make it impossible to track all business groups in each countrythere are over 150 family-controlled groups documented in the Thai Business Groups guide. We hence only focus on the business groups where we find affiliated firms in the Worldscope dataset. Since our data are restricted to listed companies, some privatelycontrolled firms affiliated with groups do not appear in our sample.
The full sample
comprises 1,039 firms, of which 489 group-affiliated firms and 550 independent firms. To measure firm riskiness we use the firms’ beta with respect to the local currency stock market indexes. To estimate beta, we use the CAPM market model defined as: Rjt = αj + βj Markett + AR, where Rjt is the weekly stock price return of firm j for day t, obtained from Worldscope and Markett is the weekly return of the IFC country stock price index for day t. Both rates of return are in local currency. The parameters αj and βj are the market model parameters estimated from the regression using weekly trading data for the period January 1995 to July 1997.2 Beta, βj, is defined as the sensitivity of firm j’s return to the “systematic” or market risk.
2
We end the estimation period in July 1997 to avoid the East Asian crisis period.
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We next use these betas in a cross-sectional regression. The multivariate regression uses weighted least squares with βj as the dependent variable, with standard errors of the estimation period residuals used as the weighting factors. To explain the relative magnitude of β, we use a dummy to identify a family relationship, the log of market value, the marketto-book ratio, and the total debt-to-sales ratio. In addition, we include the aggregate group characteristics for all firms within a family.3 These proxy for the total size, expected growth, and debt exposure of the family, respectively. For example, the number of firms within a business group indicates whether the firm belongs to a relatively large (more powerful) or small group. For firm performance, we employ the excess value approach of Berger and Ofek (1995). This approach defines the excess value as the natural logarithm of the ratio of the firm’s actual value to its imputed value. Market capitalization, the market value of common equity plus the book value of debt, is used as the measure of actual firm value. The imputed value is calculated as follows. We first compute median market-to-sales ratio for each twodigit SIC industry in each country using only single-segment firms. The market-to-sales ratio is the market capitalization divided by firm sales. We then multiply the level of sales in each segment of a firm by its corresponding industry median market-to-sales ratio. The imputed value of the firm is obtained by summing the multiples across all segments. As argued in Stulz (1988) in the context of tender offers, and Shleifer and Vishny (1997) in the context of expropriation, the distribution of cash-flow and voting rights can affect corporate policies and firm value.
Unlike most U.S. corporations, many public
corporations in developing countries that belong to business groups are characterized by deviations of voting from cash flow rightscaused by cross shareholdings, stock pyramids, and multiple class stockswhich allow owners to gain effective control of their firms with
3
This only includes the sum of firms that are publicly traded.
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low cash-flow rights. Large, controlling owners have incentives to expropriate minority shareholders by making investments that benefit themselves at the expense of minority shareholders. When voting rights are high and cash-flow rights low, expropriation is more likely since the controlling owner gains in private benefits but bears little of the consequences of the reduction in the firm’s value. Examples of expropriation are channeling corporate resources to projects that generate utility for the large owners but provide little benefits to the minority owners. We identify for each firm who the ultimate owners are, and what their share of cashflow and control rights is. For these ownership structures we use data assembled in Claessens et al. (1999a). The procedure of identifying ultimate owners is similar to the one used in La Porta et al. (1999). An ultimate owner is defined as the shareholder who has at least 5 percent of the control rights of the company and who is not controlled by anybody else. If a company does not have an ultimate owner, we classify it as widely-held.
Although a
company can have more than one ultimate owner, our present analysis focuses on the largest ultimate owner, i.e., the ultimate owner who has the most control rights. We further identify the cash-flow rights which support the control by ultimate owners, using firm-specific information on pyramiding structures, cross-holdings, and deviations from one-share-onevote rules.4 In all cases, we collect the ownership structure as of the end of the 1996 fiscal year. We end up with over 1,039 companies for which we have complete ownership information and where we can trace the ultimate owners.
3.
The degree of group affiliation
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This distinction can make an enormous difference in the analysis. Suppose, for example, that a family owns 10% of the stock of publicly-traded Firm A, which in turn has 20% of the stock of Firm B. We would say that the family controls 10% of Firm B, the weakest link in the chain of voting rights. In contrast, we would say that the family owns 2% of the cash flow rights of Firm B, the product of the two ownership stakes along the chain.
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To document the significance of business groups in East Asia and Chile, we first report the fraction of firms affiliated with business groups in each country (Table 1). In Hong Kong, Indonesia, the Philippines and Singapore more than 60% of companies in the sample are group affiliates. In Chile 40% of the firms in our sample are associated with groups. Business groups are especially important in the Philippines, where 83% and 74% of firms are group-affiliated, respectively. Thailand is the only country in East Asia where less than half of the sample firms (42%) are affiliated with business groups. Table 2 provides for the sample of East Asian corporations a comparison of the structure of ultimate ownership between group-affiliated and independent firms, where we construct three variables: the ultimate owner’s cash flow and voting rights percentages, and the ratio of the two (C/V), which ranges from zero to one.5 Deviations between cash-flow rights and voting rights are closely associated with group-affiliation among East Asian corporations. This is because dual-class shares are rare in East Asia (see also Nenova, 1999) and the separation of ownership and control comes through the use of pyramid structures and cross-holdings within business groups. For both types of firms, the mean cash flow rights level is lower than the voting rights level.6 Group-affiliated firms have significantly lower ratios of cash to voting rights than independent firms, 0.77 versus 0.99, suggesting that the risk of expropriation is larger for group-affiliated firms. Group-affiliated firms are also larger than independent firms in terms of total assets, but this difference is not statistically significant.
5
For a small number of firms, the cash-over-voting rights ratio is above one, as owners hold some stocks which have no voting rights. 6 These findings apply both to the whole sample as well as to most countries. Exceptions are Korea, Malaysia, the Philippines and Thailand for cash-flow rights and Indonesia, and the Philippines for voting rights where the differences are not significantly different. Only in Singapore are voting rights
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4.
Group affiliation and firm risk We first examine whether groups provide important diversification benefits. We start
with a simple comparison of betas between group-affiliated firms and independent firms (Table 3). We find that in most East Asian countries, betas of group-affiliated firms are higher than betas of independent firms, although never statistically significant. For Chile, Indonesia, the Philippines and Singapore, we find that betas are lower for group-affiliated firms than for independent firms, but again none of the differences are statistically significant. We next study the relationship between beta and firm characteristics by including the estimated betas in a cross-sectional regression with other factors. We first present results without taking into account group-affiliation (Table 4, Panel A). The results confirm previous findings in the literature: three factors, log market value, ratio of market-to-book value of equity, and leverage (ratio of debt to sales revenues) have significant explanatory power in most of these markets, confirming results for other countries. We next include a dummy for group-affiliation (Table 4, Panel B). We find that in Chile betas of group-affiliated firms are lower than those of independent firms, and that this difference is statistically significant. We do not find this for the other markets. This suggests that group-affiliation is an effective means for lowering firm risk. We next include the characteristics of the group the firm is affiliated with, where we use the weighted average of firms (Table 4, Panel C).
For some markets, firm’s riskiness is affected by group
characteristics as well firm characteristics.
This is the case for high-income East Asian
countries and particularly so in the case of Chile. These findings suggest that firms in some markets use internal markets extensively, consistent with Khanna and Palepu (1999a,b) and Lins and Servaes (1998).
significantly lower for group-affiliated firms than for independent firms. The ratio is lower for group-
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5.
Firm valuation and group-affiliation. In this section, we investigate the relative valuation of group-affiliated and
independent firms in East Asian countries. Table 5 provides the main result. The mean excess value of group-affiliated firms is about 5 percentage points lower for the whole sample than that of independent firms, and the difference is statistically significant at the 10% level. A similar result obtains for the median EXV, where group-affiliated firms have a 1 percentage points lower median EXV than independent firms, but the difference is not significant.
For most countries, group-affiliated firms have lower mean EXV and the
differences are statistically significant in Korea and Malaysia (not reported). The differences in median values are also mostly negative, but statistically significant only for Korea (not reported). Since the divergence between cash-flow and voting rights can influence valuationthrough the risks of expropriationwe study separately the excess values of group-affiliated firms by different degrees of divergence (since independent firms have very little divergenceonly for 32 firm-year observations is there a divergence, we do not study these). Figure 1 provides the mean EXV for group-affiliated firms for different degrees to which cash-flow rights are less than voting rights (C/V
