The Journal of Developing Areas, Volume 49, Number 5, 2015 (Special Issue), pp (Article) DOI: /jda

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1 Family Firms, Expropriation and Firm Value: Evidence from Related Party Transactions in Malaysia Liew Chee Yoong, Ervina Alfan, S.Susela Devi The Journal of Developing Areas, Volume 49, Number 5, 2015 (Special Issue), pp (Article) Published by Tennessee State University College of Business DOI: /jda For additional information about this article Access provided by University Of Malaya (18 Oct :00 GMT)

2 T h e J o u r n a l o f D e v e l o p i n g A r e a s Special Issue on Kuala Lumpur Conference Held in August 2014 Volume 49 No FAMILY FIRMS, EXPROPRIATION AND FIRM VALUE: EVIDENCE FROM RELATED PARTY TRANSACTIONS IN MALAYSIA ABSTRACT Chee Yoong, Liew SEGi University, Malaysia Ervina Alfan University of Malaya, Malaysia S.Susela Devi UNITAR International University, Malaysia We examine the relationship between related party transactions (RPTs) and firm value and how this relationship is moderated by ownership concentration using a sample of 379 listed family and 151 non-family firms for the period 2007 to Ordinary Least Square Pooled Model as well as Fixed Effects Model panel data regressions are used in the data analysis. For family firms, we find that RPTs reduce firm value (proxied by Tobin s Q and market-to-book value). Further, controlling shareholders ownership has a significant positive moderating effect on this relationship. However, for non-family firms, there is no significant evidence of firm value reduction and positive moderating effect respectively. We conclude that expropriation via RPTs is stronger in family firms compared to non-family firms. Additionally, an increase in controlling shareholders ownership helps mitigate this expropriation and this mitigating effect is stronger in family firms compared to non-family firms. The implications for the capital market regulator are discussed in this paper. Keywords: corporate governance, expropriation, family firms, agency problems JEL Classification: G34 Corresponding Author s liewcheeyoong@segi.edu.my INTRODUCTION Generally, extant corporate governance literature focuses on the traditional shareholdermanager Agency Problem Type I principal-agent problem (De Cesari, 2012), prevalent in widely held firms (Jensen and Meckling, 1976). However, in firms controlled by one or more shareholders with large stakes (controlling firms), corporate insiders possess incentives to pursue private benefits at the expense of outsider shareholders, resulting in minority shareholder expropriation (De Cesari, 2012), known as Agency Problem Type II principal-principal problem, particularly prevalent in the emerging markets (Ahlstrom et al., 2010). In these circumstances, family controlling shareholders assume control of most businesses and are the incentivized to expropriate minority shareholders (Cueto, 2013). However, reputational effects can mitigate this expropriation problem (Khanna and Yafeh, 2007). In emerging markets, these effects are deemed as poor substitutes for institutional deficiencies (Peng and Jiang, 2010) because even firms with good reputation exploit minority shareholders particularly during periods of financial crisis (Johnson et al., 2000).

3 140 Nevertheless, this line of reasoning is unconvincing in the context of corporate fiascos such as the Transmile case in Malaysia 1. These scandals resulted in strong remedial action by the regulators post We believe, the reputational effect plays a significant role on corporate governance of family firms. For that reason, we question whether reputational effect is a poor substitute for institutional deficiencies. There is still limited evidence on minority shareholder expropriation and Agency Problem Type II (Bjuggren et al., 2011) particularly in emerging markets. Most expropriation studies show the existence of expropriation but they offer very little empirical evidence on how expropriation is conducted (Jiang et al., 2010). Furthermore, there is limited evidence on the role of controlling shareholders ownership on the relationship between expropriation and firm value (Ahrens et al., 2011). We investigate whether controlling shareholders ownership concentration moderates the relationship between RPTs that are likely to result in expropriation and firm value. Prior studies investigated the moderating role of other internal corporate governance mechanisms on this relationship, but evidence on ownership concentration role is limited. Therefore, this study investigates whether RPTs in Malaysia affect firm value and whether controlling shareholders ownership moderates this relationship. The remainder of this paper is organized as follows. Section 2 discusses the corporate governance institutional context in Malaysia, evaluates the extant corporate governance literature and develops the relevant hypotheses; Section 3 explains the research methodology; Section 4 discusses the findings and finally Section 5 discusses the implications of the findings. Section 6 concludes. INSTITUTIONAL SETTING, LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT Malaysian Institutional Setting: Corporate Governance Development and Regulatory Framework A major post-1997 Asian financial crisis corporate governance reform in Malaysia was the introduction of the Malaysian Code of Corporate Governance (MCCG) in This Code was revised in 2007 and MCCG is considered largely ineffective in reducing minority shareholder expropriation due its voluntary nature of adoption (Aguilera and Cuervo-Cazurra, 2009). Intuitively, controlling shareholders in Malaysia may take this opportunity to expropriate minority shareholders, even though, they are still required to state in their annual reports the extent of their compliance, with an explanation for any departure (Securities Commission, 2012). One of the ways controlling shareholders expropriate minority shareholders is through RPTs. Hypotheses Development RPTs, Expropriation and Firm Value RPTs are diverse complex business transactions between a company and its management or owners (Gordon et al., 2004). Cheung et.al (2006) identify RPTs that are likely to result

4 141 in expropriation as asset acquisitions, asset sales, equity sales, trading relationships and cash payments made to a related party. Although there are benefits of RPTs such as communication and contracting efficiencies as well as reduction in holdup problems (Ryngaert and Thomas, 2007), these transactions are more likely to result in negative effects on firm value because they are perceived as mechanisms for controlling shareholders to extract resources from their firms through tunnelling (Djankov et al., 2008). Two main institutional factors in Malaysia, which incentivize expropriation by controlling shareholders through RPTs are: (i) Malaysia s political economy that encourages rent seeking, creating huge resources for controlling shareholders to expropriate via RPTs (Searle, 1999); (ii) regulatory loopholes 2 encourages expropriation through these channels (Thillainathan, 1999). 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. Plausibly family controlling shareholders possess incentives to enhance the interests of their family members through related sales, related lending, loan guarantees and related borrowings (Yeh et al., 2012). Hence, the following hypotheses are developed: H 1: There is a negative relationship between RPTs that are likely to result in expropriation and firm value among Malaysian firms. H 2: The negative relationship between RPTs that are likely to result in expropriation and firm value among Malaysian firms will be stronger in family compared to non-family firms. Moderating Effects of the Controlling Shareholder s Ownership Concentration, Expropriation and Firm Value The role of ownership concentration on expropriation is important, particularly, in emerging markets, due to the prevalence of high ownership concentration in these markets (Morck and Yeung, 2003). In the Malaysian institutional and corporate governance context, arguably post-transmile, reputational concerns may play a role in positively moderating family controlling shareholders ownership impact on expropriation. Reputational concerns are prevalent amongst family owners of large family firms with high equity stakes. These family owners are most likely cognizant of their reputational effect post-transmile. Transmile is a large family-owned Malaysian corporation that attracted significant negative publicity and led to several amendments to the MCCG in Arguably, the reputational effect works as follows: As the family owners shareholding increases, they have greater incentives to ensure their reputational capital by reducing minority shareholder expropriation (Loy, 2010). Thus, reputational effect aligns the family owners interests to those of minority shareholders, thus, reducing Agency Problem Type II. Ultimately, this induces a positive moderating effect of controlling shareholders ownership on the impact of controlling shareholders expropriation on firm value. Hence, the following hypotheses arise: H 3: There is a positive moderating effect of the controlling shareholder s ownership concentration on the relationship between RPTs and firm value, among Malaysian firms. H 4: The positive moderating effect of the controlling shareholder s ownership concentration on the relationship between RPTs and firm value among Malaysian firms is stronger in family compared to non-family firms.

5 142 RESEARCH METHODOLOGY Research Design Sample Secondary data related to the types of ultimate owner, financial information and board statistics is used for the period These period is chosen because family firm reputational effect may be intensified post- Transmile case in The data is obtained from companies annual reports or from Bloomberg database. A total of 379 public-listed family firms are analysed. We define family firms as firms controlled by individuals or families with at least 20% voting rights (Chakrabarty, 2009) as well with at least a family member holding a managerial position (i.e. board member, CEO or chairman, chairman of the syndicate pact) (Cascino et al., 2010). Additionally, a total of 151 public-listed nonfamily firms are analysed. Table 1 explains the proxies used to measure the dependent variables. Variables Definition and Measurement TABLE 1. DEPENDENT VARIABLES AND MEASUREMENT No. Dependent Variable 1 Firm value Proxy 1 (Market-based performance measure) 2 Firm value Proxy 2 (Market-based performance measure) 3 Return On Equity (ROE) Proxy 3 (Accounting-based performance measure) 4 Return On Asset (ROA) Proxy 4 (Accounting-based performance measure) Measurement Proxy is Tobin s Q (Bai et al., 2003). Tobin s Q is measured by using the following ratio: (Total Market Value of Equity + Total Book Value of Liabilities) / (Total Book Value of Equity + Total Book Value of Liabilities) (Anderson and Reeb, 2003). The market to book value (MBV) is also used. MBV is calculated using the following ratio: (The number of equity shares x The closing price of the stock on the last day of the financial year) / Total Book Value of Equity (Reddy et al., 2010). Return on Equity (ROE) is used. ROE is measured as follows: Net Income / Total Common Equity (Rechner and Dalton, 1991). Return on Asset (ROA) is used. ROA is measured as follows: Net Income / Total Assets (Anderson and Reeb, 2003). Table 2 explains the independent variables.

6 143 TABLE 2. INDEPENDENT AND CONTROL VARIABLES AND MEASUREMENT Independent Variable RPTs that are likely to result in expropriation (RPT) Ownership Concentration (OC) Control Variables Description The amount of RPTs that are likely to result in expropriation is used as per the RPTs section disclosure in the annual report to measure RPTs. These transactions are discerned from the type of RPTs based upon Cheung et.al (2006) s definition. This transaction value will be divided by the Total RPTs value to reduce the number of outliers in the distribution. This is extracted from the data of the substantial shareholding in the annual report. It is measured in terms of percentage of total equity held by the largest shareholder (Demsetz and Lehn, 1985). In the context of Malaysian annual reports, the substantial shareholding is calculated by summating the direct and indirect shareholding of the largest shareholder. In line with prior corporate governance literature, we control for twelve variables, namely, (1) Firm size (SIZE); (2) Firm risk (RISK); (3) Leverage (LEV); and (4) Proportion of independent directors (IDR); (5) Firm age (AGE); (6) Non-affiliated blockholders (NAB); (7) Sales growth (SG); (8) R&D expenditure-to-sales (RDS); (9) Capital expenditure-to-sales (CS); (10) Marketing and advertising expenditure-to-sales (MS) and (11) Gross Domestic Product (GDP). (12) Firm Type (for Pooled Model of family and non-family firms only) Research Model For hypotheses testing, Pooled Ordinary Least Square (OLS) regression model and the Fixed Effects Model (FEM) are used. Panel data regression is conducted on family firms, non-family firms and the pooled model (family and non-family firms). The research model is as follows: Family Firm Model and Non-Family Firm Model 1. Q it or MBV it or ROE it or ROA it = β 0 + β 1(RPT) it + β 2(OC) it + β 3(SIZE) it + β 4(RISK) it + β 5(LEV) it + β 6(IDR) it + β 7(NAB) it + β 8(AGE) it + β 9(SG) it + β 10(RDS) it + β 11(CS) it + β 12(MS) it + β 13(GDP) it + β 14(OC) it(rpt) it + µ it Pooled Model (Family and Non-Family Firms) 2. Q it or MBV it or ROE it or ROA it = β 0 + β 1(RPT) it + β 2(OC) it + β 3(SIZE) it + β 4(RISK) it + β 5(LEV) it + β 6(IDR) it + β 7(NAB) it + β 8(AGE) it + β 9(SG) it + β 10(RDS) it + β 11(CS) it + β 12(MS) it + β 13(GDP) it + β 14(OC) it(rpt) it + β 15FT it + µ it

7 144 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 it: 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. OC it: Controlling shareholders ownership concentration in the firm at year t (%) (OC) it (RPT) it: Controlling shareholders ownership concentration in the firm at year t multiplied by the amount of related party transactions that are likely to result in expropriation ratio 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 it 3 : 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

8 145 DESCRIPTIVE STATISTICS, ENDOGENEITY ISSUES AND RESEARCH RESULTS Descriptive Statistics TABLE 3. DESCRIPTIVE STATISTICS FOR FAMILY FIRMS Descriptive Statistics For Full Sample Family Firms Mean Median Standard Maximum Minimum Deviation Tobin s Q ROE ROA Market-to-Book Value (MBV) Related Party Transactions That Are Likely To Result In Expropriation Ratio (RPT) Ownership Concentration Predicted Ownership Concentration Firm Size Ln(Firm Risk) Leverage Independent Directors Ratio Non-affiliated Blockholders Ln(Age) Sales Growth R & D Expenditure-to Sales Capital Expenditure-to Sales Marketing and Advertising Expenditureto-Sales Gross Domestic Product

9 146 TABLE 4. DESCRIPTIVE STATISTICS FOR NON-FAMILY FIRMS Descriptive Statistics For Full Sample Non-Family Firms Mean Median Standard Maximum Minimum Deviation Tobin s Q ROE ROA Market-to Book Value (MBV) Related Party Transactions That Are Likely To Result In Expropriation Ratio (RPT) Ownership Concentration Predicted Ownership Concentration Firm Size Ln(Firm Risk) Leverage Independent Directors Ratio Non-affiliated Blockholders Ln(Age) Sales Growth R & D Expenditureto-Sales Capital Expenditureto-Sales Marketing and Advertising Expenditureto-Sales Gross Domestic Product

10 147 Tables 3 and 4 present the summary statistics of the continuous variables of the family firm and non-family samples respectively. It can be seen that the average RPTs differs. Endogeneity Test We performed the Hausman Specification Test (Hausman, 1978) to investigate whether endogeneity exists in that ownership maybe determined by firm value (Andres, 2008). An instrumental variable (IV) (Gujarati and Porter, 2009), the predicted value of ownership concentration, obtained by regressing the original ownership concentration values against firm size, the square of firm size and firm risk (Himmelberg et al., 1999) provided a control for endogeneity problem. Research Results For family firms, the regression results for the normal pooled Ordinary Least Square (OLS) and Fixed Effect Model (FEM) show that RPTs that are likely to result in expropriation significantly reduce firm value (Tobin s Q and MBV) at 1% and 5% significance level. When ownership concentration moderates the relationship between RPTs and firm value, the firm value (Tobin s Q and MBV) effects turns positive. This is significant at 5% significance level. In the case of non-family firms, the regression results for the normal pooled Ordinary Least Square (OLS) and Fixed Effect Model (FEM) show that RPTs that are likely to result in expropriation do not have a significant relationship with firm value. Additionally, ownership concentration has no significant moderating effect on the relationship between RPTs and the firm value (market and accounting-based performance measures). Tables 5.1 and 5.2 show the results for the pooled model of family and nonfamily firms.

11 148 TABLE 5.1. ACTUAL REGRESSION RESULTS (MAIN RESULTS): NORMAL OLS REGRESSION POOLED MODEL (FAMILY FIRMS AND NON-FAMILY FIRMS) Independent Dependent Variable Independent Dependent Variable Variables Tobin s Q MBV Variables ROE ROA And Intercept And Intercept Coeff. Coeff. Coeff. Coeff. C *** ** C ** *** RPT * * RPT OC OC ** *** SIZE *** SIZE Ln (RISK) *** *** Ln (RISK) *** *** LEV *** LEV *** IDR *** IDR ** ** NAB *** *** NAB Ln (AGE) Ln (AGE) SG SG ** RDS RDS CS CS MS MS GDP GDP OC x RPT ** * OC x RPT FT *** *** FT N N Adjusted R Adjusted R- Squared (%) Squared (%) F-Statistic *** *** F-Statistic *** *** * 10% sig.level ** 5% sig.level *** 1% sig.level

12 149 TABLE 5.2. ACTUAL REGRESSION RESULTS (MAIN RESULTS): NORMAL OLS REGRESSION FIXED EFFECTS MODEL (FAMILY FIRMS AND NON- FAMILY FIRMS) Independent Variables And Intercept Dependent Variable Independent Dependent Variable Tobin s Q MBV Variables And ROE ROA Intercept Coeff. Coeff. Coeff. Coeff. C *** C ** *** RPT ** ** RPT OC * OC ** *** SIZE *** *** SIZE *** *** Ln (RISK) *** Ln (RISK) *** LEV *** LEV IDR ** *** IDR ** ** NAB *** NAB Ln (AGE) Ln (AGE) SG SG ** RDS RDS CS CS MS MS OC x RPT ** ** OC x RPT FT *** *** FT N N Adjusted R- Adjusted R- Squared (%) Squared (%) F-Statistic *** *** F-Statistic *** *** * 10% sig.level ** 5% sig.level *** 1% sig.level In the pooled model (family and non-family firms) results in Tables 5.1 and 5.2, family firms possess a lower firm value (Tobin s Q and MBV) compared with non-family firms. This is significant at 1% significance level. In addition, in the pooled model (family and non-family firms), the joint hypotheses of H 0: β RPTs of family firms and β RPTs of non-family firms = 0 is rejected and has a significant negative relationship with firm value (Tobin s Q and MBV). This is significant at 5% and 10% significance level. Both these results coupled with the significant negative relationship between RPTs and firm value (Tobin s Q and MBV) in the family firm regression results indicate that the negative relationship between RPTs and firm value (Tobin s Q and MBV) is stronger in family firms compared to nonfamily firms. This is because the resulting lower firm value (Tobin s Q and MBV) of family firms in the pooled model (family and non-family firms) regression results is contributed by the significant negative relationship between RPTs and firm value (Tobin s Q and MBV). Likewise, for the joint hypotheses of H 0 : β OC x RPTs of family firms and β OC x RPTs of non-family firms = 0, it can also be concluded that the significant positive moderating effect of

13 150 controlling shareholders ownership on the relationship between RPTs and firm value (Tobin s Q and MBV) is stronger in family firms compared to non-family firms. The overall lower firm value (Tobin s Q and MBV) of family firms in the pooled model (family and non-family firms) indicates a stronger corporate reputational effects in family firms. Additionally, we found that the main research results for family firms and nonfamily firms (i.e. the effect of RPTs on firm value and the moderating effect of ownership concentration on this relationship) are robust against industry effects. The significant results are also restricted to Tobin s Q and MBV. IMPLICATIONS AND DISCUSSIONS Overall, we observe that expropriation through RPTs occurs among Malaysian firms which reduces firm value. All hypotheses are supported but only when firm value is proxied by market-based performance measures. Expropriation via RPTs (which reduce Tobin s Q and MBV) is stronger in family compared to non-family firms within the Malaysian institutional setting. Moreover, there is a significant positive moderating effect of controlling shareholders ownership on the relationship between RPTs and firm value among Malaysian firms.. CONCLUSIONS We show that minority shareholder expropriation through RPTs exists amongst Malaysian firms. Interestingly, we evidence that family firm reputational effect plays a role in reducing minority shareholder expropriation in Malaysian family firms, particularly, in the post-transmile era. A new dimension to agency theory emerges - corporate reputational effect. Our finding contradicts Peng and Jiang (2010) s observation that reputational effects is a poor substitute for institutional deficiencies in emerging markets. On the policy front, we suggest the Securities Commission in Malaysia (SCM) take note that minority shareholder expropriation exists amongst Malaysian public-listed firms. Further, mitigation efforts by SCM on minority shareholder expropriation problems through RPTs ought to focus on family rather than non-family firms and that SCM re-evaluate Part 8, Para of the MCCG 2012 to ensure adequate protection of minority shareholder rights. Lastly, future research could consider analysing the effects of legislation on minority shareholder expropriation particularly in emerging markets. ENDNOTES 1 The Transmile case occurred in late The firm s revenue was inflated in the financial statement (Securities Commission, 2011), denting the reputation of Malaysian family firms. Transmile was one of the prominent family firms in Malaysia. 2 In Section 132C and 132E of the Malaysia Companies Act (1965) (Thillainathan, 1999) which was later amended in 2007 through the Malaysia Companies (Amendment) Act (2007). However, the regulatory loopholes still exist despite the amendments made in 2007 on the Companies Act. 3 GDP could only be included in the Pooled OLS Model and not the Fixed Effects Model due to near singular matrix problems as well.

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