CEO duality, board independence, corporategovernance and firm performance in family firms:Evidence from the manufacturing industry inMalaysiaReceived 6 July 2013; revised 27 January 2014; accepted 28 January 2014
Abstract In this study, we use the contestability exercised by non-dominant largeshareholders to measure how internal governance mechanisms influence firm monitoringin a structure with multiple large shareholders. This extends knowledge of principal-principal conflicts and family business by introducing the moderating effects of ChiefExecutive Officer (CEO) duality and board independence. Using a sample of Malaysianmanufacturing family firms, we find that non-dominant large shareholders rely on boardindependence to strengthen firm monitoring. However, family owners do not utilise CEOduality to weaken the monitoring of non-dominant large shareholders, even though theyprioritise firm control to safeguard family interests.Asian Business & Management advance online publication, 9 April 2014;doi:10.1057/abm.2014.4
Keywords: principal-principal conflicts; control contestability; board independence;CEO duality; family firms
Introduction
Previous literature on principal-principal conflicts demonstrates that the expropria-tion of minority shareholders by controlling shareholders is prevalent in emergingeconomies, due to high ownership concentrations. Extensive empirical studies alsoconfirm that controlling shareholders can expropriate minority shareholders through‘tunnelling resources’, such as non-arms-length transactions, transfer pricings,paying high dividends or structuring a profit-sharing scheme to serve personalinterests (Claessens and Fan, 2002; La Porta et al, 2002; Chen et al, 2009; Wahabet al, 2011).
The general unease about the expropriation of minority shareholders in emergingeconomies has led to calls for studies to examine corporate-governance mechanisms toaddress expropriation by controlling shareholders. In line with these calls, several studieshave identified that multiple large shareholders in the ownership structure can inducemutual monitoring and mitigate such expropriation (Maury and Pajuste, 2005; Attiget al, 2008, 2009; Gutierrez and Pombo, 2009; Kowalewski et al, 2010; Luo et al, 2013).Specifically, these prior studies have shown that control contestability exercised by non-dominant large shareholders on a dominant controlling shareholder is of paramountimportance in firm monitoring in emerging economies. However, researchers in the areaof corporate governance consistently note that knowledge remains inadequate forunderstanding corporate-governance mechanisms vis-a-vis the expropriation of minorityshareholders, particularly with regard to how multiple large shareholders can mitigateexpropriation by controlling shareholders (Young et al, 2008; Chen et al, 2011b).
In emerging Asian economies, the overlap between ownership and management infamily firms has brought additional challenges to corporate-governance mechanisms(Tam and Tan, 2007; Jiang and Peng, 2011). Family-business literature suggests thatfamily owners may adopt different corporate-governance practices, such as ChiefExecutive Officer (CEO) duality, to protect their family’s interests (Gomez-Mejiaet al, 2011; Berrone et al, 2012). In addition, the board of directors in family firms islikely to be less effective in a monitoring role when family principals have stronginvolvement in management (Daily and Johnson, 1997; Kowalewski et al, 2010).Yet researchers have found that the empirical evidence is fragmented, owing to a lackof comprehensive studies using family and management theory to investigatecorporate governance practices (that is CEO duality and board independence) infamily firms (Gomez-Mejia et al, 2011; Siebels and zu Knyphausen-Aufseß, 2012).
Therefore, we seek to fill the voids in the literature by examining corporate-governance structure in family firms. We answer the call from Siebels and zuKnyphausen-Aufseß (2012) to use family and management theory, that is principal-principal conflicts and family businesses, to address the following question: What arethe roles of CEO duality and board independence in corporate governance and firmperformance in family firms? This article will look beyond the causal effect ofcorporate-governance mechanisms on firm performance. We also emphasise thesignificance of the moderating effect of corporate-governance mechanisms onmonitoring family owners in family firms. Our research approach owes much to theview that corporate-governance mechanisms may be affected by other variables, dueto the complexities of such systems (Adams et al, 2010).
We argue that Malaysia is an appealing empirical setting for two reasons. First,prior studies have identified that principal-principal conflicts in family firms are asevere corporate-governance problem in East Asia (Claessens and Fan, 2002; Younget al, 2008; Claessens and Yurtoglu, 2013). Second, regulators, business analysts andentrepreneurs have acknowledged the prevalence in Malaysia of expropriation ofminority shareholders by controlling shareholders (Liew, 2007). As such, we believe
that an analysis of Malaysia’s corporate-governance mechanisms is also relevant toother Asian emerging markets. Thus, we develop our hypotheses by taking intoconsideration the institutional settings regarded as important determinants oforganisation structures and business strategies (Berrone et al, 2008; Young et al,2008; Wielemaker and Gedajlovic, 2011).
We chose family firms in the manufacturing sector of Malaysia because of theirunique business setting. First, management capacity is generally viewed as the maindriver of firm performance in technology-based firms (Prahalad and Hamel, 1990).We therefore extend the analysis to the advantages of a CEO duality structure infamily firms, because technology-based companies may rely heavily on relationaltransactions to support business operations in emerging economies (Zhou and Peng,2010). Second, we adopt the view that corporate-governance structures differ acrossindustries because of different business settings (Cui and Mak, 2002; Le et al, 2006;Grosfeld, 2009). For example, Cui and Mak and Grosfeld show that using a broadsample of firms across industries will mask different relationships between corporate-governance variables and firm performance. These results can be partly explained bymanagerial discretion and information asymmetry in technology-based industries.
This article contributes to the literature in several ways. First, we show thatmodelling the interaction effect of corporate-governance mechanisms can shed somelight on the ongoing debate over causality questions between board independence andfirm performance. Specifically, we demonstrate that board independence is not aneffective monitoring mechanism, but that it strengthens the monitoring of non-dominant large shareholders on dominant family owners. Second, our research helpsbridge the gap in the literature on CEO duality with regard to firm performance byasserting that family-controlled manufacturing firms derive benefits from utilisingrelational transactions in relationship-based economies and that lower agency costsstem from altruistic behaviours. These benefits, however, are neutralised by thenegative effects of a CEO duality leadership structure, which gives excessive firmcontrol to family owners. Third, our research represents the first attempt to provide adirect examination of CEO duality in weakening the monitoring effect of non-dominantlarge shareholders on dominant controlling shareholders in emerging economies.
This article is organised as follows. The next section reviews relevant literatureand develops the hypotheses. After that the methodology to test the hypotheses isdiscussed. The subsequent section presents the empirical findings, followed byrelevant discussions. The last section concludes.
Literature Review and Hypotheses Development
The role of non-dominant large shareholders in family firms
Recent studies on corporate governance show that there are high ownershipconcentrations with large shareholders in emerging Asian economies
(Claessens and Fan, 2002; Carney and Child, 2013). Interestingly, agency theorydepicts large shareholders as favourable in ownership structures, because they havethe incentive to engage in firm monitoring and management. However, the dominantcontrol position of large shareholders in emerging Asian economies has broughtabout conflicts of interest between dominant controlling shareholders and othershareholders, also known as principal-principal conflicts. The root cause of suchconflicts can be attributed to the divergent economic interests of dominant controllingshareholders and other shareholders.
Nevertheless, principal-principal conflicts may not necessarily lead to dominantcontrolling shareholders expropriating minority shareholders. The rationale is thatthe dominant controlling shareholders must have a comparative advantage in exer-cising control to extract private rents from a firm’s resources (Shleifer and Vishny,1997; Young et al, 2008). In line with such arguments, a study in China demon-strated that high voting power is a necessity for the largest shareholders to controlboards of directors, so that they can circumvent internal governance mechanisms toextract private rent (Su et al, 2008).
Extrapolating from related empirical studies, control contestability stems frommultiple large shareholders in an ownership structure inducing mutual monitoringbetween the largest and other large shareholders in emerging economies (Attig et al,2008, 2009; Gutierrez and Pombo, 2009). The conceptual definition of controlcontestability in this study means the control contests exercised by other shareholderson the largest shareholders, which can be reflected by the voting rights held by thelargest shareholders vis-à-vis other shareholders (Attig et al, 2008, 2009).
A common argument for why multiple large shareholders in an ownershipstructure can mitigate the expropriation of minority shareholders is that competitionin firm control can divert the attention of large shareholders towards gaining supportfrom minority shareholders (Attig et al, 2009). Thus, large shareholders are willing tosacrifice private benefits and resort to maximising firm value in corporate-controlcontests. The competition for control between multiple large shareholders in anownership structure is also manifested in corporate-control contests in Malaysia. Forexample, Business Times (2013) reported that the dominant controlling shareholdersof Bright Packing Berhad, who owned 30.58 per cent of voting rights, were removedfrom the board by four large shareholders with the support of minority shareholders.In short, control contestability in the ownership structure will limit the opportunisticbehaviour of large shareholder(s) in extracting private rents from a firm’s resources.
The role of board independence in family firms
The board of directors is commonly regarded as an important internal corporate-governance mechanism for regulators around the globe. Shareholders appointrepresentatives on the board as overseers to protect their interests in the firm. In turn,
the board is entrusted with the legal responsibility to monitor and discipline firmmanagement (FCCG, 2000; OECD, 2004; Demise, 2006). The Malaysian SecuritiesCommission suggests that hiring (or replacing) managers, pay systems and planningtop-management succession are under the board’s purview (FCCG, 2000). Thus, theeffectiveness of a board in corporate governance will impact on a firm’s competi-tiveness and operating efficiency.
A well-functioning board of directors is an important corporate-governancemechanism for maximising firm value. However, the effectiveness of corporate-governance mechanisms is largely contingent upon the configuration of nationalinstitutions (Aguilera and Jackson, 2003; Van Essen et al, 2012), which mightexplain why generally accepted ‘good practices’ of corporate governance yieldvarying degrees of effectiveness in corporate governance.
With regard to emerging economies, the monitoring role of the board is impairedby weak institutional support. To tackle this issue, regulators in many emergingeconomies have reformed corporate governance by adopting legal frameworks fromdeveloped countries. In the case of Malaysia, new regulation was implemented in2002 to impose strict definitions for independent directors of publicly listed firms onBursa Malaysia (Pascoe and Rachagan, 2005; Liew, 2007). The new regulationrequires directors claiming to be independent to fulfil the requirements of a ‘generaltest’. Specifically, the status of ‘independence’ implies that a director is independentof management and free from conflicts of interest. Thus, independent directors areexpected to exercise independent judgement in the interests of shareholders.Although some new regulations may lead to truly independent directors, corporate-governance reform in many emerging countries may be ineffective because of weakenforcement of the rule of law (Pascoe, 2008; Young et al, 2008). In addition,Peng (2004) suggests that the adoption of good corporate-governance practices inemerging economies – for example, incorporating independent directors into theboard – is mainly driven by international pressure rather than a genuine spirit of goodcorporate governance. A more indulgent explanation is that newly adopted corporate-governance regulations may be ineffective because of their unsuitability to nationalinstitutional settings (Daniel et al, 2011).
With regard to family firms, several explanations have been suggested for why theboard of directors is an inefficient internal monitoring mechanism. First, familyowners generally view outside directors as a source of expertise, not monitoring(Gomez-Mejia et al, 2011). Second, the appointment of outside directors normallyrequires voting support from family owners, who are also the dominant controllingshareholders in family firms. Moreover, outside directors may have been nominatedas candidates by the family CEO; hence, outside directors may feel gratefuland obliged to the family CEO (Fahlenbrach, 2009; Schepker and Oh, 2013).Third, family managers are well positioned to have strong control over materialinformation in owner-managed firms (Gomez-Mejia et al, 2011; Jiang and Peng,2011). As a result, the monitoring role of outside directors may be abridged if they
are unable to obtain timely and sufficient material information to make independentjudgements.
In line with these arguments, prior empirical studies on emerging Asian economiesshow that an independent board does not have a significant impact on firmperformance (Haniffa and Hudaib, 2006; Ramdani and Witteloostuijn, 2010;Wahab et al, 2011; Van Essen et al, 2012). For example, Van Essen et al show thatthe boards of directors in Asian family firms function as a derivative of familyowners. Haniffa and Hudaib offer an alternative explanation whereby independentdirectors on the board in emerging economies are used to legitimise businessactivities rather than perform independent monitoring of management, which leadsto the following hypothesis:
Hypothesis 1: Board independence is not related to firm performance.
The empirical evidence to date is equivocal about the role of board independencein corporate governance (Adams et al, 2010). One possible reason is that prior studiesoften discover inconsistent and conflicting links between board independence andfirm performance. Nevertheless, the role of board independence in corporate-governance systems may be reflected indirectly through a moderating mechanism(Adams et al, 2010).
We now examine the potential outcomes of having an independent board toidentify whether board independence can be conceptualised as a moderator incorporate-governance systems.
First, we identified that corporate-governance structure has an impact on thedisclosure of information in financial statements (Forker, 1992; Jaggi et al, 2009).Specifically, independent professional monitoring services are required to enhancethe quality of the firm’s corporate disclosure. One potential explanation is thataffiliated non-executive directors, who lack independence, are unlikely to performclose monitoring. By contrast, independent directors are more likely to exhibitindependent monitoring and enhance corporate disclosure. In line with thesearguments, prior studies show that an independent board is positively related to thedepth and quality of corporate-information disclosures to outside investors in Asia(Chen and Jaggi, 2000; Eng and Mak, 2003; Chau and Gray, 2010; Chen et al,2011a; Beaulieu et al, 2012). For example, Chau and Gray show that independentdirectors are positively related to voluntary corporate disclosures for family firms inHong Kong. In addition, Chen et al show that an independent board is an importantcorporate-governance mechanism for reducing the incidence of earnings restatementsin Taiwan. In other words, an independent board can enhance the quality ofinformation disclosure to outsiders.
Second, the outcome of having an independent board can be understood byexploring how shareholders rely on boards of directors as a proxy to control andmonitor management. In general, a higher proportion of representatives of outsideshareholders on the board will affect the de facto powers of owner-managers
(Combs et al, 2007; Van Essen et al, 2012). The rationale is that independentdirectors are more likely to make independent judgements because of their legalresponsibilities and lower affiliation with management. In addition, independentdirectors are subject to the influence of all large shareholders and are not limited todominant family owners, which is evidenced, at least in part, by the fact that theperformance of independent directors is an important criterion for re-election. Thus,an independent board is likely to reduce the dominant position of family owners infamily firms.
On the basis of these explanations, we propose that an independent board can beconceptualised as a moderator, because it enhances corporate disclosure and preventsmanagement from having de facto powers on the board. This argument centres onthe fundamental view of principal-principal conflicts that the interests of dominantcontrolling shareholders do not dovetail perfectly with those of other non-controllingshareholders. In a similar vein, family-business literature posits that an importantreason for a family owner to control the board would be the family’s desire tosafeguard family interests and agendas (Gomez-Mejia et al, 2011; Berrone et al,2012). Needless to say, a similar argument can explain why non-dominant largeshareholders rely on the board of directors to strengthen their monitoring over familyowners.
The moderating effect of board independence can be explained by the followingpoints. First, large shareholders, who are ‘information-intensive’ and long-terminvestors (Lee and O’Neill, 2003; Le et al, 2006), are able to extract moreinformation when the board is more independent. In turn, agent opportunism iscurbed, as outside parties have sufficient information to assess the behaviour ofagents (Fama and Jensen, 1983; Eisenhardt, 1989; Le et al, 2006). Second, the boardof directors is more responsive to large shareholders compared to minority share-holders (Ertimur et al, 2010). An implication of this reasoning is that independentdirectors are also responsive to multiple large shareholders because they are lessaffiliated with management (or insiders).
To reiterate, we propose that large shareholders utilise board independence tostrengthen the monitoring of dominant family owners. Similar commentaries can alsobe detected in the empirical study of Choi et al (2012a), who show that the interactionof an independent board and foreign board membership are positively related to afirm’s market performance. Choi et al conclude that an independent boardhas become an instrument for foreign investors to strengthen firm monitoring inKorea. Because control contestability in ownership structures can induce mutualmonitoring between the firm’s multiple large shareholders, we propose the followinghypothesis:
Hypothesis 2: Board independence positively moderates the relationship betweencontrol contestability in the ownership structure and firmperformance.
There are two lines of literature that are relevant to CEO duality with regard to firmperformance. The first begins with the premise that CEO duality compromises theeffectiveness of corporate-governance mechanisms in firms. Specifically, the mon-itoring role of the board is reduced, because CEO duality confers structural power tothe CEO to fully control management and the board of directors (Combs et al, 2007;Van Essen et al, 2012). The CEO also holds the firm’s material information andcontrols the board agenda (Gomez-Mejia et al, 2011; Jiang and Peng, 2011). Inaddition, when the CEO is also board chairperson, it is difficult for outsideshareholders and the board of directors to challenge the CEO’s decisions. Thus,CEO domination on the board will likely lead to ineffective oversight by the board ofdirectors.
Interestingly, a CEO dual leadership structure is commonly found in family firmsin emerging Asian economies (Chen et al, 2005; Tam and Tan, 2007). Family-business scholars argue that family owners may control a firm to safeguard thefamily’s affective needs and welfare (Gomez-Mejia et al, 2011; Berrone et al, 2012),an argument centring on the family as an economic entity that emphasises the overallwelfare of family members, according to anthropological studies (Schulze andGedajlovic, 2010). Every family member has different obligations to safeguard andcontribute to family welfare, such as by providing food, protection or shelter.Anthropologists tell us that even though kinship in a family can be characterised byfunctions such as politics, religion and law, emotional support is the only role that haspersisted in a significant way over the long history of human development (Stewart,2003). In addition, family firms may adopt generational investment strategies, withthe objective of creating a firm dynasty for future generations (Sirmon and Hitt, 2003;Schulze and Gedajlovic, 2010). There is also an inclination for family owners tomake strategic decisions with the aim of sustaining family wealth (Carney, 2005). Inshort, when the ultimate objective of a family firm is to safeguard the family’sinterests, a CEO dual leadership structure will make the business enterprise deviatefrom the objective of maximising firm value.
The second line of literature focuses on the advantages derived from CEO dualityin creating value for firms. CEO duality in a corporate structure enables the CEO togain full structural power and the authority to mobilise the firm’s resources to attainexcellent corporate performance (Donaldson and Davis, 1991; Hernandez, 2012).Stated differently, CEO duality renders a unity of command to management and theboard of directors. In turn, the controlling position of the CEO allows him (or her) tostructure tasks in the firm with clear authority and responsibility. In this regard,stewardship theory suggests that CEO duality is positively related to firm perfor-mance, provided that the CEO is a good steward and a self-actualising and collective-serving individual (Davis et al, 1997; Hernandez, 2012). Thus, the CEO’s utilityfunction is maximised along with the maximisation of shareholder wealth.
Nevertheless, we suggest that stewardship theory may be limited in explaining theCEO dual leadership structure in family firms, because family owners tend toprioritise family interests (Tam and Tan, 2007; Gomez-Mejia et al, 2011; Berroneet al, 2012).
Several empirical studies on emerging Asian economies have provided insightsinto the relationship between CEO duality and firm performance; however, theempirical evidence is mixed (Haniffa and Hudaib, 2006; Bayrakdaroglu et al, 2012;Van Essen et al, 2012). For instance, Haniffa and Hudaib found that CEO duality isnot related to firm market performance for publicly listed firms in Malaysia. Theresults support the traditional notion in corporate governance of separating the CEOand chairperson of the board to instil strong monitoring of dominant controllingshareholders in emerging economies. In contrast, the meta-analysis conducted byVan Essen et al shows that the effect of CEO duality differs across Asian countries.Thus, we can infer that the effect of CEO duality on firm performance may largelydepend on the institutional settings of the country.
Therefore, although the evidence is far from conclusive, we expect CEO duality tobe beneficial to family firms in Malaysia’s manufacturing sector in three ways. First,the Malaysian economic system is a relation-based system, which is essentially anon-arm’s length system (Rajan and Zingales, 1998; Gul, 2006). Economic agentsrely on ‘reputation’ in the business network to enforce business transactions, becausethere is weak legal enforcement using explicit contracts. In a similar vein, priorstudies provide evidence of weak enforcement of legal regulations in Malaysia eventhough creditor and shareholder rights are on par with, if not better than, developedcountries such as Australia, Ireland and New Zealand (Porta et al, 1998; Claessensand Yurtoglu, 2013). In an investigation of corporate law reform in Malaysia, Pascoe(2008) concluded that political interference and corruption have become thegovernment’s main obstacles in carrying out genuine corporate-law reform. Thus,we expect CEO duality to allow family owners to fully control their firms and tooperate under poor legal environments. Specifically, CEO duality enhances theCEO’s discretion and capacity to employ relationship-based strategies in relationaltransactions to reduce transaction costs, access more resources and achieve flexiblecoordination (Zhou and Peng, 2010).
Second, technology-based companies in emerging economies are likely to reapsignificant comparative advantages through relational transactions compared tomature industries in market competition (Zhou and Peng, 2010). Specifically,technology-based companies can utilise relational transactions to sustain processinnovation through resource-sharing and flexible coordination with business partners(Zhou and Peng, 2010). One explanation is that the business models of technology-based companies are associated with greater uncertainty because of the high volatilityand low visibility of product demands (Wu et al, 2005). Thus, flexible coordinationwith business partners, such as suppliers in production and quality control,are important for enhancing the performance of technology-based companies.
In contrast, companies in mature industries often produce standardised products andmay not rely on relational transactions in production (Zhou and Peng, 2010).
Third, a CEO dual leadership structure in family firms enables family owners toexercise strong control over the firm. A CEO dual leadership structure is adeterminant of managerial entrenchment; however, this relation may not be pertinentto family firms, as agency costs in family firms can be ameliorated owing to thealtruism of family owners through involvement in management (Schulze et al, 2003;Chrisman et al, 2004; Karra et al, 2006; Kowalewski et al, 2010). In essence,altruism emphasises welfare-based economic utility for a group of connectedindividuals, which dominates individual self-serving behaviour (Schulze et al,2003; Karra et al, 2006). Altruism creates a parenthood of unselfish caring, strongloyalty and commitment towards family members. In family businesses, familyprincipals tend to show altruistic behaviour towards family agents and receive similartreatment reciprocally (Karra et al, 2006). The embedded altruism in familybusinesses allows family principals and agents to share common interests and bestrategically aligned in building the business’s core competencies (Chrisman et al,2004; Eddleston et al, 2008). For example, Sharma and Irving (2005) argue thatfamily agents generally have a strong commitment to the family business regardlessof whether their motivations are intrinsically or extrinsically oriented. Passionatefamily managers do not view job satisfaction as their main motivation in terms of jobperformance, but are driven by their belief that they are working for their business,not other people’s businesses. Unlike hired professional managers, family managersstill maintain a strong commitment to the family business even when they lackintrinsic motivation. Two explanations have been suggested as to why familymanagers have this strong commitment: (i) they view running the family businessas a means to fulfilling their obligations to the family, and (ii) they want to sustain thestatus quo of the family business to prevent any changes in family conditions(Sharma and Irving, 2005). A similar argument can be found in Schulze et al (2003),who show that a flat wage is sufficient for family agents in corporate-governancestructures in family-controlled firms. They conclude that, owing to altruism,incentive-based compensation packages are not an instrument to align interestsamong family agents.
Combining these ideas, we propose that the benefits of CEO duality are likely tooutweigh the compromised corporate-governance structure for family firms in theMalaysian manufacturing sector. This background leads to the following testablehypothesis:
Hypothesis 3: CEO duality is positively related to firm performance.
Thus far, we have argued that CEO duality exhibits a positive effect on firmperformance in family firms. Although traditional corporate-governance notionssuggest that CEO duality structure is detrimental to firm performance, CEO dualitymay not have a negative impact on firm performance (see the discussion for
Hypothesis 3). Specifically, family-business scholars suggest that family owners maycontrol a firm to safeguard family interests (Gomez-Mejia et al, 2011; Berrone et al,2012). In this regard, the unification of ownership and firm control via CEO dualityoffers high levels of managerial discretion over family owners in business operationsand management. In addition, family CEOs have full control of the firm’s materialinformation and board agendas. As a result, a CEO duality structure weakens themonitoring effects of non-dominant large shareholders, stemming from controlcontestability in the ownership structure. Hence, we propose the following:
Hypothesis 4: CEO duality negatively moderates the relationship between controlcontestability in the ownership structure and firm performance.
Methodology
Sample and data
We used a sample of family firms listed on the industrial-product index in BursaMalaysia (the Malaysian stock exchange) during 2003–2006. Financial and stockprice data were collected from Datastream. The corporate-governance data forownership and boards of directors were collected from annual reports. BecauseBursa Malaysia imposes mandatory and full disclosure with regard to the familyrelations of directors and substantial shareholders in annual reports, our samplecontains complete family ownership information. We followed the stipulatedminimum threshold of 10 per cent voting rights of ultimate family owners to identifyfamily firms (Claessens et al, 2002; Carney and Child, 2013). In this regard, the totalownership of family members is family ownership. In addition, we only classified afirm as a family firm when the ultimate family owner appeared to be the largestshareholder in the ownership structure (Tam and Tan, 2007). Finally, we obtainedfirm information, for example firm age and Standard Industrial Classification (SIC)code, from the OSIRIS database.
In addition, we eliminated firms identified by Bursa Malaysia as financiallydistressed during the sample period. The rationale for this is that financiallydistressed firms are exposed to incentives in earnings management, which can resultin the manipulation of financial information (Jaggi and Lee, 2002). Moreover, sharetrading of listed financially distressed firms is restricted, with the condition that fullpayment of transactions is required beforehand.
Choi et al (2012b) suggest that corporate-governance studies should consider thecorporate-governance reforms in the study period because they may lead to bettercorporate performance. In Malaysia, a new regulation was implemented in2002, with the aim of creating truly independent directors on boards. Although weexpect corporate-governance reforms to produce a non-significant impact on firm
performance (see the discussions for Hypothesis 1), we purposefully began thesample period in the year 2003 so that we could examine the economic implicationsof corporate-governance reforms. We selected 2006 as the final year of the sampleperiod to avoid periods of financial crisis. As a result, our final dataset consists of141 family firms, spanning several years. The total number of firm-year observationswas 564 for the sample period 2003–2006.
Measurement
Dependent variableWe used the market-to-book ratio (MB) as the proxy for firm performance. Themarket-to-book ratio is measured as the ratio of the market value of common stockand the book value of preferred shares and debt to the book value of total assets.Claessens et al (2002) and Young et al (2008) suggest that the market-to-book ratio isappropriate for measuring firm performance in emerging economies, becausemarket investors will discount the perceived fair value of stocks owing to principal-principal conflicts.
Independent variablesWe measured family ownership (FamVote) as the voting rights of dominant familyowners who are the largest shareholders in the ownership structure (Tam and Tan,2007). Family ownership is included because the ownership concentration of thelargest shareholder can be regarded as an incentive for shareholders to engage in firmmanagement and monitoring (Tam and Tan, 2007; Grosfeld, 2009). Second, CEOduality (Dual) was measured using a dummy variable that took a value of ‘1’ whendominant family owners occupied the positions of both CEO and Chairman of theboard of directors (Tam and Tan, 2007). Third, board independence (IndB) wasmeasured using the ratio of independent directors to the total number of directors(Haniffa and Hudaib, 2006; Ramdani and Witteloostuijn, 2010). We acknowledge thatthe proportion of independent directors on boards does not necessarily represent trueboard independence (see Hypothesis 1). Finally, we measured control contestability inthe ownership structure by two variables: (i) the ratio of the voting rights of the second-largest shareholder to the voting rights of the dominant family owners (CTR21), and(ii) the ratio of the voting rights of the second to fifth-largest shareholders to the votingrights of the dominant family owners (CTR51) (Attig et al, 2009; Luo et al, 2013).
Control variablesWe included several control variables in the model to avoid model-specificationerrors. First, we included two control variables, ethnicity of independent directorsand political ties, that are relevant to the Malaysian context. We measured ethnicity of
independent directors (MalayB) as the ratio of Malay independent directors to thetotal number of independent directors. Although the Malaysian Code of CorporateGovernance does not impose any requirement pertaining to ethnic composition onboards, we argue that non-Malay family firms may focus on the form of ethnicrequirement imposed by the New Economic Policy in Malaysia. Specifically,Malaysian Chinese family owners may prefer to appoint Malays as independentdirectors and keep silent over their ineffective oversight. In addition, we measuredpolitical ties (State) as a dummy variable with a value of ‘1’ when the state appears tobe the second to fifth-largest shareholder in the ownership structure. The rationale isthat state shareholders may provide political patronage and industry-specificresources to a firm (Fraser et al, 2006), and thus family owners may act boldly inbusiness venturing. Conversely, family owners may be subject to greater controlcontestability from state shareholders with political ties.
Other control variables include firm investment, capital structure, firm size andfirm age. We measured firm investment (CAPEX) as the ratio of capital expenditureto total sales (Claessens et al, 2002). Because firm investment is a value driver forfirm performance, we expect this control variable to be positive. Moreover, wemeasured the capital structure (DTA) as the ratio of total debts to total assets (Choiet al, 2012b). We measured firm size (Size) using total assets (Kowalewski et al,2010). The rationale is that a firm may derive economies of scale from large-sizedassets to increase productivity and sales. Finally, we measured firm age (Age), usingthe number of years since incorporation (Choi et al, 2012a).
Methods
We undertook panel regression to examine the relation between corporate-govern-ance variables and firm market performance, and to control for potential serialcorrelations stemming from omitted time-invariant variables, thus avoiding biasedstandard errors and inefficient estimates. In addition, we utilised clustered standarderrors with the 2-level SIC codes in a panel regression. Thus, our estimationcan produce consistent OLS estimates by addressing potential violations of OLSassumptions in which errors within industries are correlated in some unknown way.Figure 1 presents the research model of the hypothesised relationship between theindependent variables and the dependent variable.
Empirical Findings and Discussion
Descriptive statistics
Table 1 presents the descriptive statistics of the variables, including the mean,standard deviation, minimum and maximum. The mean value of CEO duality is 0.33,
whereas that of family ownership is 37.28 per cent. The average ratio of the votingrights of the second-largest shareholder and the voting rights of the second to fifth-largest shareholders to the voting rights of dominant family owners are 0.33 and 0.73,respectively. These results demonstrate that dominant family owners possess a strongcontrolling position in family firms. The descriptive statistics also show that the meanvalue of the proportion of independent directors on the board is 0.40. On average, thesample firms had more independent directors than the legal minimum threshold.Specifically, Malay independent directors represented approximately 45 per cent ofindependent directors. Finally, state shareholders appear to be minority shareholdersin 48 per cent of the family firms in our sample.
Table 1: Descriptive statistics
Observed variables Mean SD Min. Max.
Market-to-book ratio (MB) 0.71 0.64 0.10 8.83Family ownership (FamVote) 37.28 14.49 10.26 78.04Voting rights of second-largest shareholder-family owners (CTR21) 0.33 0.26 0.01 1.00Voting rights of second to fifth-largest shareholder-family owners (CTR51) 0.73 0.56 0.02 3.49CEO duality (Dual) 0.33 0.47 0.00 1.00Board independence (IndB) 0.40 0.11 0.00 0.83Ethnicity of independent directors (MalayB) 0.45 0.31 0.00 1.00Political ties (State) 0.48 0.50 0.00 1.00Firm investment (CAPEX) 0.09 0.13 0.00 1.33Capital structure (DTA) 0.26 0.24 0.00 3.67Firm size (Size) 5.89 44.08 0.07 1031.55Firm age (Age) 18.02 13.27 1 82No. of observations 564 — — —
Figure 1: Research model of hypothetical relationships among corporate-governance variables and firmperformance.
The correlation matrices in Table 2 show that CEO duality is significantlycorrelated with the ratio of the voting rights of the second-largest shareholder to thevoting rights of family owners, and the ratio of the voting rights of second to fifth-largest shareholders to the voting rights of family owners (P<0.01). There is also ahigh correlation between CEO duality and board independence (P<0.01). Theseresults suggest a potential multicollinearity problem. We performed a collinearityassessment, but none of the variance inflation factors of the independent variablesreached the threshold value of 3.3, indicating the absence of a collinearity problem.
Regression results
We performed a Hausman test and chose a fixed-effects model in panel regressionbecause the Hausman test statistics were significant (P<0.001). The panel regressionincludes firm fixed effects and year fixed effects to control for potential serialcorrelations stemming from omitted time-invariant firm characteristics and unob-served year-to-year variation. The panel regression also captures time-invariantindustry effects in our sample. Table 3 shows the estimates of panel regression withclustered standard errors in this study.
Among the control variables, we found that the presence of the state as a minorityowner in the ownership structure yields a non-significant relationship with firmperformance. By contrast, we found that a higher proportion of Malay independentdirectors yields a positive impact on firm performance. This result corroborates theview that bureaucratic structure in state-controlled entities does not lead to bettercorporate governance (Tam and Tan, 2007). This finding can also be partly explainedby the fact that family firms may prefer to solicit political patronage throughappointing Malay directors. Taken together, we interpret these results as evidencethat Malay independent directors are not involved in firm monitoring. We argue thatfamily firms, especially Malaysian Chinese family firms, may appoint Malaydirectors to solicit informal ties with politically influential individuals to advancebusiness venturing (Gul, 2006; Bliss and Gul, 2012).
The results indicate that control contestability exercised by the second to fifth-largest shareholders has a positive influence on firm performance. In contrast to Attiget al (2009), control contestability exercised by the second-largest shareholders had anon-significant effect on firm performance. We interpret these findings as indicatingthat a group of large shareholders can exercise greater control contestability andmonitoring of family owners compared to the second-largest shareholder. This resultis in line with Gutierrez and Pombo (2009) and Attig et al (2009), who concludedthat greater contestability stemming from multiple large shareholders can be morepronounced to monitor the dominant controlling shareholder.
Consistent with Hypothesis 1, we find that an independent board is not relatedto firm performance; that is independent directors appear to not involve
themselves directly in monitoring management in family firms. Independentdirectors are unable to closely monitor dominant family owners who are wellpositioned in the firm’s controlling structure. Moreover, corporate-governancereform, that is the implementation of new regulations to define independent
Table 3: (Continued )
Variable Model 4 (a) Model 4 (b) Model 5 (a) Model 5 (b)Regression coefficients (absolute t-statistics)
State −0.076 −0.058 −0.090 −0.066(−1.21) (−0.97) (−1.42) (−1.1)
directors, appears to produce non-significant impacts on creating truly independentboards.
In contrast with Hypothesis 3’s expectation, our findings show that a CEO-dualityleadership structure has a non-significant effect on firm performance in family firms.It is possible that such a structure renders family businesses able to operate underweak legal environments and to derive the benefits of relational transactions.Altruism behaviour through CEO duality leadership structure may to some extentalso reduce agency costs in family firms. Essentially, the negative effect of corporate-governance voids neutralises the benefits of CEO duality in family firms.
Consistent with Hypothesis 2, we find evidence that board independencepositively moderates the relationship between control contestability in the ownershipstructure and firm performance. Because board independence is unrelated to firmperformance, the significant interaction of control contestability in the ownershipstructure with board independence suggests that an independent board is a puremoderator in corporate-governance systems. Stated differently, an independent boardinfluences the form of the relationship between control contestability in the owner-ship structure and firm performance. Thus, the role of an independent board becomesa moderating mechanism to strengthen the monitoring effect of non-dominant largeshareholders in emerging economies.
Given that CEO duality was found to have a non-significant moderating effect onthe relationship between control contestability and firm performance, Hypothesis 4 isrejected. Our results rule out CEO duality for consideration as a moderator to weakenthe relationship between control contestability and firm performance. One wouldexpect that family owners could strengthen firm control through CEO duality andignore the interests of outsiders, but this could give rise to control contestabilityand closer monitoring from non-dominant large shareholders. This finding canexplain why family owners may resist weakening control contestability through CEOduality leadership structure in family firms.
Conclusion
This article investigates the governance role of CEO duality, board independence andmultiple large-shareholder structure in family firms. Drawing on principal-principalconflicts and family-business literature, we argue that the effect of governancemechanisms on firm performance can be demystified through causal and moderatinganalyses.
Our findings have implications for governance research in emerging Asianeconomies, highlighting country-specific institutional settings to account for causallinkages between internal governance mechanisms and firm performance. Ourfindings are particularly relevant to many Asian nations that exhibit the character-istics of a relationship-based economic system and that are associated with political
interventions (Gul, 2006; Bliss & Gul, 2012). First, we find that the excessivecontrolling power of family owners through a CEO duality structure yields anon-significant effect on firm performance. This finding suggests that the effect ofCEO duality can not only be explained by a poor corporate-governance perspective,but also be rationalised in observing how family altruism alleviates agency costs(Karra et al, 2006; Kowalewski et al, 2010) and CEO duality structure facilitatesfamily owners in utilising relational transactions in a relation-based economy(Zhou and Peng, 2010). Second, our findings indicate that board independence exertsa non-significant effect, whereas a higher proportion of Malay independent directorspositively affects firm performance. Thus, we have offered rare empirical evidence toexplain why family firms may appoint Malay independent directors to solicit politicalpatronage in a relation-based economy (Gul, 2006; Bliss & Gul, 2012). Clearly,family owners objectively circumvent regulations and avoid instilling genuine boardindependence after Malaysia’s corporate-governance reforms.
In investigating the governance role of control contestability stemming fromnon-dominant large shareholders and board independence, we contribute to theliterature on principal-principal conflicts. Specifically, we addressed knowledgevoids in principal-principal conflicts concerning the precondition for multiple large-shareholder structures to induce effective mutual monitoring (Young et al, 2008;Chen et al, 2011b). First, our results indicate that control contestability stemmingfrom multiple non-dominant large shareholders (but not the second-largest share-holder) exerts a positive influence on firm performance. Thus, our findings suggestthat a structure of multiple non-dominant large shareholders with greater controlcontestability is a precondition for effective firm monitoring. By contrast, the second-largest shareholder has insufficient control contestability to exercise effective firmmonitoring. This can be partly explained by the fact that family owners have highlevels of managerial discretion in technology-based sectors (Cui and Mak, 2002;Grosfeld, 2009). Second, our results indicate that board independence positivelymoderates the relationship between control contestability and firm performance. Inprevious works, scholars have often indicated that independent directors are not trulyindependent and that they have insufficient information to perform firm monitoringin family firms (for example Fahlenbrach, 2009; Gomez-Mejia et al, 2011; Jiang andPeng, 2011). Our conceptualisation of board independence as a moderator ofcorporate-governance systems indicates that non-dominant large shareholders relyon board independence to strengthen firm monitoring, thus alleviating expropriationconcerns caused by principal-principal conflicts.
This study develops a key insight of CEO duality structure in family firms. Family-business scholars have theorised that family owners prioritise firm control and maycontrol boards of directors (Gomez-Mejia et al, 2011; Berrone et al, 2012). However,our study highlights the finding that CEO duality does not weaken the relationshipbetween control contestability and firm performance. As such, we believe that familyowners are reluctant to utilise a CEO duality structure to weaken the firm monitoring
of non-dominant large shareholders, at least during non-crisis periods. Otherwise,non-dominant large shareholders may intensify firm monitoring and threaten the firmcontrol of family owners.
Our article has two limitations. First, our findings are based on a sample of 141publicly listed family firms in the manufacturing sector. Thus, the generalisability ofthe findings may be greater in technology-based companies, because the optimalcorporate-governance structure may differ across industries owing to dissimi-larities in business settings. Extending this research to different industry settingsremains an avenue for further research. Second, the generalisability of our findingsmay not extend to privately held family-controlled firms, as such firms are notforced to comply with the corporate-governance regulations imposed by stockexchanges.
Acknowledgements
We thank the General Editor and anonymous reviewers for their insightful commentsand suggestions. Any errors remaining are the full responsibility of the authors.
About the Authors
Chin Fei Goh is currently a PhD candidate in the Faculty of Management, UniversitiTeknologi Malaysia. He received MSc degrees in Finance from Göteborg University,Sweden, and in Business Administration from the Blekinge Tekniska Högskola,Sweden. His research interests include corporate governance, corporate valuationand family business.
Amran Rasli is a professor at the Faculty of Management, Universiti TeknologiMalaysia. He has a degree in Statistics from California State University and MBAfrom Central Missouri State University (USA), and a PhD from Roskilde University,Denmark. He has served as a visiting professor at Hebei University, adjunct associateprofessor for University of Southern Australia, visiting professor at UniversityCollege of Engineering and Technology, Pahang and academic advisor for the IndianInstitute of Risk Management, Hyderabad. He serves as editor, reviewer and advisorof a number of journals.
Saif-Ur-Rehman Khan is an associate professor at the Faculty of Management,University Technologi Malaysia. His current research lies in the accounting, financeand management domains. He has published several articles in the areas of corporatefinance, accounting, capital markets and business strategies.
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