Independent Directors Tenure, Related Party Transactions, Expropriation and Firm Value : Evidence From Malaysian Firms

Transcription

1 Independent Directors Tenure, Related Party Transactions, Expropriation and Firm Value : Evidence From Malaysian Firms Dr. Liew Chee Yoong, SEGi University, Malaysia Dr. S.Susela Devi, Unitar International University, Malaysia Dr. Ervina Alfan, University Malaya, Malaysia

2 Introduction traditional shareholder- Most corporate governance (CG) problems manager problems or Agency Problem Type 1. Assume that greater insider ownership leads to better CG. This is relevant in most developed economies whereby ownership is diffused. This framework may not work in emerging markets where ownership is highly concentrated and most firms are family-controlled. This result in frequent conflict between controlling shareholders and minority shareholders or Agency Problem Type II.

3 There is still a lot that remains to be understood with regards to Agency Problem Type II and issues of expropriation. In most expropriation studies, expropriation is indirectly indicated e.g. by the effects of separation of ownership and control rights of the firm s controlling shareholder, rate of dividends paid to shareholders, etc. Economists also measure expropriation through the price paid for corporate control or from changes in firms market valuation around specific events. Some economists measure expropriation by the reduction in firm value due to the effects of certain corporate governance variables. While these studies show the existence of expropriation, they offer very little in terms of empirical evidence on how expropriation is conducted due to long tenure of independent directors.

4 The extant of corporate governance fails to evidence the moderating role of internal corporate governance mechanisms in expropriation studies. The moderating effects of internal corporate governance mechanism i.e. controlling shareholders ownership on the relationship between firm value and expropriation avenue for research. Evidence is limited.

5 Contribution It explores a relatively unexplored issue of expropriation i.e. the moderating effect of independent director s tenure on the relationship between related party transactions and firm value. It evidences the moderating role of family ownership on this moderating effect.

6 Malaysian Institutional Setting Major post-1997 Asian Financial crisis corporate governance reforms which is the Malaysian Code of Corporate Governance (MCCG) which was established in Challenge of corporate governance faced by Malaysia include 1. High ownership concentration. 2. Low directors accountability and protection of minority shareholders. 3. Weak role of institutional investors and shareholder activism. The MCCG was revised in 2007 and further revised in 2012.

7 Despite the issuance of the MCCG in 2000, 2007 and 2012, it is not effective in improving corporate governance (CG). This is due to voluntary nature of its adoption. Apart of MCCG, the Kuala Lumpur Stock Exchange (KLSE) listing requirements is another mechanism used to promote good CG. KLSE has the power to reprimand, fine or suspend a listed firm as well as delist the firm. However, the powers of KLSE are subject to judicial review which provide opportunities for expropriation by controlling shareholders. Aside from MCCG and KLSE Listing Requirements, the creation of the Minority Shareholder Watchdog Group (MSWG) important CG development in Malaysia. MSWG monitor and protect the rights of minority shareholders and to promote shareholder activism. Not effective no legal authority to bring cases of minority shareholder expropriation to court. Because of that, the problem of minority shareholder expropriation still exist in this country. Overall, limited evidence to suggest that all the reforms made in this country are effective.

8 Minority Shareholder Expropriation (MSE) Major CG problem in emerging markets. Conflict between the controlling shareholder and the minority shareholders of the firm. One of the way MSE could occur is due to independent directors tenure. Long tenure of independent directors could encourage MSE.

9 Hypotheses Development : The Moderating Effect Of Independent Director s Tenure On The Relationship Between Related Party Transactions And Firm Value There are benefits and costs of long independent directors tenure. Long board tenure enhance the independent directors commitment to fulfill their duties and reduce their turnover. On the other hand, long board tenure entrenchment. Reason : Long tenure independent directors relationship with the management. more likely to possess a friendly As their tenure increase, their independence is likely to be compromised as controlling shareholders possess the incentives to influence the independent directors.

10 This particularly applies to firms in emerging markets with high ownership concentration and mostly family-controlled. Long tenure independent directors loses their independence because they possess strong personal ties with the management due to the influence of the controlling shareholder. As a result, these directors are likely to be re-appointed and survive long-term. If controlling shareholders are able to exert their influence on the independent directors tenure as the latter s tenure increases, this will enable the controlling shareholders to expropriate resources from the firm without significant check and balances from the independent directors; hence expropriating minority shareholders. Long tenure directors less mobile and less employable. It can be argued that entrenchment effects of long board tenure is higher in family firms compared to non-family firms in the Malaysian capital market. Reason : Family controlling shareholders have the incentives to exert more influence on the independent directors due to their interest in managing the firm in their own ways to fulfil their private objectives at the expense of minority shareholders.

11 The negative effects of long tenure of independent directors reflected through higher expropriation by controlling shareholders through related party transactions (RPTs). 2 main institutional factors in Malaysia controlling shareholders through RPTs are i) Malaysia s political economy that encourages rent seeking. Ii) regulatory loopholes incentivize expropriation by The negative effects of RPTs are arguably more severe and prevalent in family firms, where family members are involved in the management, compared to non-family firms. Family controlling shareholders possess incentives to enhance the interests of their family members through related sales, related lending, loan guarantees and related borrowings. Considering the literature, it is likely that long tenure directors will increase the incentives of expropriation through related party transactions by controlling shareholders in Malaysian family firms.

12 Hence, the following hypotheses is formulated : H 1 : There is a negative moderating effect of independent director s tenure on the relationship between related party transactions and firm value among Malaysian firms. H 2 : This negative moderating effect of independent directors tenure on the relationship between related party transactions and firm value among Malaysian firms will be stronger in family firms compared to non-family firms.

13 Hypotheses Development : The Moderating Effect Of Controlling Shareholder s Ownership On The Moderating Effect Of Independent Directors Tenure On The Relationship Between Related Party Transactions And Firm Value The moderating role of ownership concentration on expropriation is important to be examined emerging markets. Reason : High ownership concentration in these markets.

14 In the context of emerging markets, there is a positive moderating effect of ownership concentration on the moderating effect of independent directors tenure on the relationship between RPTs and firm value. Why? Because investors have no choice but to play their role as firm monitors, which they can only exercise effectively by concentrating their equity holdings. Concentrated ownership provide powerful incentives to controlling shareholders to become more involved in governance, as well as a means to influence managers through direct access strategies and through their concentrated voting rights. Hence, increased ownership increased corporate control of controlling shareholders and possibly reduce Agency Problem Type I. This induces a positive moderating effect of ownership concentration on the moderating effect of independent directors tenure on the relationship between RPTs and firm value.

15 In the context of the Malaysian institutional setting and CG environment, it is further argued that after the Transmile case, reputational concerns possibly play a role in influencing a positive moderating effect of family controlling shareholders ownership on expropriation. The Transmile case falsification of financial statements. Family owners would like to improve their reputation after the Transmile case because Transmile is a large family-owned corporation in Malaysia. Large family owners would like to see that their reputation improved because poor corporate corporate reputation can affect them and their family members. Increased ownership provide higher incentives to controlling shareholders to take care of their reputation by reducing minority shareholder expropriation. This reduces Agency Problem Type II.

16 Based upon the previous arguments, the following hypotheses are developed : H 3 : There is a positive moderating effect of controlling shareholder s ownership on the moderating effect of independent directors tenure on the relationship between related party transactions and firm value, among Malaysian firms. H 4 : This positive moderating effect of controlling shareholder s ownership on the moderating effect of independent directors tenure on the relationship between related party transactions and firm value among Malaysian firms is stronger in family firms compared to non-family firms.

17 Research Methodology : Definition of Family Firms Family firms are defined as firms which are controlled by individuals or families with at least 20% voting rights as well as family involvement in their firm s management. This requires at least 1 family member hold a managerial position (i.e. board member)

18 Sample Size For Family Firms Data Description Total Main Market family firms listed on Bursa Malaysia and could be utilized in the research, as at 31 st December, 2007 Minus : Financial related family firms Minus : Family firms with missing data Minus : Family firms with at least 20% family ownership but no family members involved in management Minus : Family firms with less than 20% family ownership Number of Family Firms available for observation Number of Companies

19 Sample Size For Non-Family Firms Data Description Total Main Market non-family firms listed on Bursa Malaysia and could be utilized in the research, as at 31 st December, 2007 Minus : Financial related nonfamily firms Minus : Non-family firms with missing data Minus : Non-family firms with less than 20% ownership by controlling shareholders Number of Non-family Firms available for observation Number of Companies

20 Data Analyses Technique Panel data analyses are used using Normal OLS Regression Model and Fixed Effects Regression Model Analyses are done on family firms, non-family firms and combination of family and non-family firms (Pooled Model).

21 Research Model Family Firm Model Q it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it MBV it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it ROE it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it ROA it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it Non-Family Firm Model Q it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it MBV it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it ROE it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it ROA it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + µ it Pooled Model (Family And Non-Family Firms) Q it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + β 17 FT it + µ it MBV it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + β 17 FT it + µ it ROE it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + β 17 FT it + µ it ROA it = β 0 + β 1 + β 2 + β 3 + β 4 (SIZE) it + β 5 (RISK) it + β 6 (LEV) it + β 7 (IDR) it + β 8 (NAB) it + β 9 (AGE) it + β 10 (SG) it + β 11 (RDS) it + β 12 (CS) it + β 13 (MS) it + β 14 (GDP) it + β 15 + β 16 + β 17 FT it + µ it

22 Q it : Performance measured by Tobin s Q at year t. MBV it : Performance measured by Market-to-Book Value Ratio at year t. ROE it : Performance measured by Return On Equity at year t. ROA it : Performance measured by Return On Asset at year t. RPT : 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. Tenure it : Average tenure of independent directors in the firm at year t. OC it : Controlling shareholders ownership concentration in the firm at year t (%) : Average tenure of independent directors in the firm at year t multiplied by the 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. : Controlling shareholders ownership concentration in the firm at year t multiplied by average tenure of independent directors in the firm at year t multiplied by the 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. Control Variables SIZE it : Firm Size (Ln (Total Assets)) at year t RISK it : ln (Firm Risk (Standard Deviation of monthly stock returns from )) at year t LEV it : ln (Leverage (Long-term Debt/Total Assets)) at year t IDR it : Independent Directors Ratio (No. of independent directors/board Size) at year t NAB it : Non-affiliated Blockholder Shareholding at year t AGE it : ln (Age) at year t SG it : Sales Growth at year t RDS it : Research and Development Expenditure-to-Sales at year t CS it : Capital Expenditure-to-Sales at year t MS it : Marketing and Advertising Expenditure-to-Sales at year t GDP it7 : Gross Domestic Product at year t FT it : Firm type dummy variable at year t, 1 for family firms, 0 for non-family firms. µ it : Stochastic error term at year t

23 Endogeneity Issues The instrumental variable used is the predicted value of ownership concentration which is obtained by regressing the original ownership concentration values against firm size, the square of firm size and firm risk (Himmelberg, Hubbard and Pahlia, 1999).

24 Research Results For family firms, it can be observed that average independent directors tenure significantly increases firm value (ROE and ROA) at 1% significance level. However, when independent directors tenure moderates the relationship between related party transactions and firm value, the firm value (Tobin s Q and MBV) effects turns negative. This is significant at 5% and 10% significance level respectively. In addition, when controlling shareholders ownership moderates the moderating effect of independent directors tenure on the relationship between related party transactions and firm value, firm value (Tobin s Q and MBV) effects become positive. This is significant at 5% significance level. For non-family, it can be observed that average independent directors tenure significantly increases firm value (ROA) firms in Table at 5% significance level. However, there is no significant moderating effect of independent directors tenure on the relationship between related party transactions and firm value. In addition, there is no significant moderating effect of controlling shareholders ownership on the moderating effect of independent directors tenure on the relationship between related party transactions and firm value. In the pooled model (family and non-family firms) results, it can be observed that average independent directors tenure significantly increases firm value (ROE and ROA) at 1% significance level. However, when independent directors tenure moderates the relationship between related party transactions and firm value, the firm value (Tobin s Q and MBV) effects turns negative. This is significant at 1%, 5% and 10% significance level respectively. In addition, when controlling shareholders ownership moderates the moderating effect of independent directors tenure on the relationship between related party transactions and firm value, firm value (Tobin s Q and MBV) effects become positive. This is significant at 5% significance level. Furthermore, in these tables, family firms has a lower firm value (Tobin s Q and MBV) compared to non-family firms and this is significant at 1% significance level.

25 Robustness Test To test the robustness of the research results, technology firms are controlled in this research by excluding them. A firm is classified as a technology firm if one of its primary assets is the possession of technological knowledge used to develop new products or processes (Cordes, Hertzfeld and Vonortas 1999). Robustness test based upon the same regression techniques are performed using the same samples but excluding technology firms. Technology firms need to be excluded because they possess different characteristics as compared with other type of firms in terms of faster rates of firm growth, more research and development (R&D) expenses and higher propensity to take risk (Grinstein and Goldman, 2006). Hence, their firm value may be different from other type of firms. In addition, technology firms with high ownership concentration are associated with higher firm value (Grosfeld, 2009); hence, their firm value is different from other type of firms. Therefore, it is important to exclude technology firms for robustness testing on both family and non-family firms.

26 It is found that the effect of average independent directors tenure on firm value (ROE and ROA) and the moderating effect of independent directors tenure on the relationship between related party transactions and firm value (Tobin s Q and MBV) are robust for the exclusion of technology firms for family firms and the pooled (family and non-family firms) model. In addition, the moderating effect of controlling shareholders ownership on the moderating effect of independent directors tenure on the relationship between related party transactions and firm value (Tobin s Q and MBV) are also robust for the exclusion of technology firms for family firms and for the pooled (family and non-family firms) model.

27 Conclusion Generally, our study shows that expropriation through related party transactions due to long tenure of independent directors exist within Malaysian family firms. This research also prove that expropriation through related party transactions due to long tenure of independent directors is stronger in family firms compared to non-family firms within the context of the Malaysian institutional setting. On the other hand, the significant positive moderating effect of family controlling shareholders ownership on the moderating effect of independent directors tenure on the relationship between related party transactions and firm value in Malaysian family firms suggest that family firm reputational effects is able to reduce minority shareholder expropriation in these firms, particularly in the post Transmile period. This brings a new dimension to agency theory by showing that corporate reputational effects is able to reduce minority shareholder expropriation in family firms during the global financial crisis. This significant positive moderating effect also brings into dispute the argument by Peng and Jiang (2010) that reputational effects is a poor substitute for institutional deficiencies in emerging markets such as Malaysia.

28 There are also certain limitations of this research. This paper only analyse public-listed firms whereby data is available. Non public-listed firms are not accounted for in the analyses. In addition, the analyses only compare family and non-family firms. Further breakdown of the type of non-family firms for comparative analyses with family firms are not conducted. Lastly, future research could consider analysing the effects of legislation on minority shareholder expropriation particularly in emerging markets.