Does family ownership, control or management help or hinder the value of a company? The answer depends on a lot of factors, some of which aren’t always in a company’s control and could have just as much to do with where a company is based as with who is running it. According to research conducted in 2006 by Raffi Amit of The Wharton School and Bella Villalonga of Harvard Business School, family ownership in the U.S. does indeed have a positive impact on the value of a company, as it also does when a company’s founder is its CEO. However, it’s a different — less positive — situation when a family wields more management control over a company than its share ownership permits and when a founder hands over a company to subsequent generations to manage. With other research finding similar results for companies in Europe, Amit and Villalonga decided to look further afield. Their next port of call? China.
The two professors recently wrote a paper along with Ding Yuan and Zhang Hua of the China Europe International Business School (CEIBS) in Shanghai, titled, “The Role of Institutional Development in the Prevalence and Value of Family Firms,” which aims to shed light on China’s family firms. They studied 1,453 listed companies in the country in 2007 — 491 of which were family firms and 962 were non-family firms, with the latter group comprising 896 state-owned enterprises (SOEs) and 66 that were neither family- nor state-controlled. For each firm, the researchers looked at the market value of its tradable equity plus the book values of non-tradable equity and net debt (liabilities minus liquid assets), divided by total assets.
The result? “Our research suggests that family firms do not inhibit growth and development as is sometimes argued,” says Amit. “These findings are particularly relevant for China as it continues its transition from a centrally planned system to a market economy.”
And the research comes at a time when China’s family firms are raising their profile, inside and outside the country. Meanwhile, more family-run industry leaders are on the way. Family businesses are expected to emerge much faster and more actively thanks to Chinext, the new stock exchange opened last year in Shenzhen. Chinext is seen as China’s answer to Nasdaq by providing a new alternative for the country’s smaller companies to get public financing. Among the 50 companies listed on the new exchange currently, more than 90% are family businesses, with the largest shareholder stake belonging to one family.
Testing Ground, China
The effect of family ownership on Chinese firms is very similar to elsewhere. “First, family ownership is positively and significantly related to value, and second, family control in excess of ownership, which in China is primarily achieved through pyramid control structures, is negatively and significantly related to value,” says Amit. “Third, family management, which in China is primarily exercised by founders, bears no significant relation to value in the full research sample,” but does in the parts of the country with less-developed institutions.
Indeed, a critical part of the research looked at the role of institutional development — that is, the quality and enforcement of local laws as well as the competence and fairness of government institutions – in the proliferation of family firms and value of having family members involved in one way or another. “The presence of family control is a response to institutional development, not to cultural differences,” asserts Amit. “Moreover, the relatively higher prevalence of these firms in regions with high institutional efficiency suggests that family firms do not inhibit growth and development as is sometimes argued.”
Previous research attempted to explore institutional differences in the value of family businesses by comparing countries. “However, when comparing countries, a lot of noise, including cultural differences, is hard to control,” explains Ding of CEIBS.
Some key assumptions are hard to test when comparing different countries. These include the investor protection theory, which argues that in a country with less investor protection, family ownership is the best way to resolve the “agency conflicts” that arise between shareholders and managers. Another includes the internal market theory, which contends that in an undeveloped economy with scarce resources such as capital and labor, a family business is more efficient. “Although these are important explanations, they are not complete, as there are a lot of complicated cultural elements that are hard to control,” says Ding.
But some forms of analysis are easier in China, as the researchers learned. While its laws and culture are more or less uniform, there’s an enormous disparity between institutional development from one region to the next. “That makes China an ideal setting to analyze our research question about the role of institutional development in the prevalence and value of family firms,” says Ding. “For all the listed companies in China, the legal [environment], including regulations and financial disclosure, are the same.”
From One Region to Another
The regional economic and social disparities in China are often stark. Using the so-called Gini coefficient and generalized entropy measures of inequality, the inland-coastal disparity in income, health and education have risen sharply since 1984, according to the paper.
Other measures show similar inequalities. Notably, research of the investment climate in 120 Chinese cities from the World Bank in 2006 found that the average per capita GDP in southeastern China was more than 50% higher than in the northeast, and 150% higher than central and southwest China. Similarly, per capita foreign direct investment (FDI) in the southeastern provinces was 130% higher than in the northeast, more than seven times the average for Central China and more than 25 times the average for Western China. This World Bank study was a key part of the research by the four professors. Southeast and Bohai — the two regions where the headquarters of 836 of the sample companies are based — were cited by the paper as having high institutional efficiency; Central China, Northeast, Southwest and Northwest of China are home to the remaining 617 companies, which the paper says are regions with low institutional efficiency.
The second measure of institutional efficiency used in the research was based on previous work from 2006 by Fan Gang and Wang Xiao Lu of National Economic Research Institute in Beijing. This work involved developing an index of the market development of Chinese provinces, which took into account such factors as the relationship between the government and market and the development of the private sector, labor market and the legal environment, particularly in terms of protecting entrepreneurs, employees, consumers and intellectual property. The index then ranked the provinces according to their levels of institutional efficiency.
Fan and Wang’s research showed that there are a greater number of family firms in the more developed provinces. “This finding seems difficult to reconcile with either the investor protection theory or the internal markets theories, both of which [contend] that family firms should be more prevalent when institutions are relatively less developed,” says Ding. Yet it “reinforces our earlier conclusion that institutional efficiency plays a positive role in the formation and survival of family firms, contrary to what the investor protection and internal markets arguments lead us to expect,” What’s more, “family firms do not seem to inhibit growth and institutional development. Rather, they contribute to it and continue to thrive in more developed environments.”
The research found that family ownership and voting control in excess of shareholder stakes are very much associated with both Tobin’s q (a measure of the ratio of a firm’s market value to the replacement cost of its assets) and its return on assets, positively in the case of ownership and negatively in the case of control. However, these results were driven by the samples in regions with low institutional efficiency, says the paper. In contrast, in the high-efficiency regions, none of the measures of family ownership, control and management were significantly related to a firm’s value, while in regions with low-efficiency regions, both the positive effects of family ownership and the negative effects of family control in excess of ownership were much more prominent.
The results suggest that institutional development does affect the value of family firms in a way that is consistent with both the views of investor protection and the internal markets. According to the paper, “As labor is limited and the labor market is more inefficient, competent professional managers are a scarce resource, and family managers become a more attractive option – sometimes even the only one – for family firms.”
Open for Business
What’s striking is that family firms in China are still mostly managed by their founders, not heirs, given that China’s private sector is still so young. “Thus, the investor protection view may, in fact, agree with the prediction of the internal markets view in this setting,” says Amit.
“We found that in a not-too-good environment, in which labor or product markets are not efficient, family ownership increases value, but excessive control destroys value more prominently,” says Ding. What’s more, it’s important to bear in mind that China’s economy is just beginning to move up the evolutionary curve. “In coastal regions in China, the economy is more developed than in inland regions, although it’s still an emerging market compared with developed countries,” he explains. “Family businesses in costal regions are booming and [the affect of being family owned] on a firm’s value is not as evident since everyone is [reaping the benefits of being] in a relatively better, fairer environment.”
The way Ding sees it, the development of modern enterprises, and subsequently family businesses, can be divided into four stages. While in the first stage, all companies are SOEs, the market is opened to private investment and private family businesses emerge in the second stage. In the third, the number of private businesses continues to grow, and finally in the fourth stage, the dilution of controlling shareholders begins both for state controlled and family controlled firms, and most become public companies with dispersed shareholders. “China’s coastal regions are in the third stage, and the inland regions are in the second stage, while the U.S. is in the fourth stage. In the longer term, China will have more public companies with diversified shareholder structures,” Ding predicts.
As for how China’s institutions will evolve, Ding says, much depends on the country’s market reform. “The eastern coastal regions are more open and developed in terms of policies toward the market reform as well as the implementation of the reform,” he notes. “As the inner provinces develop, there will gradually be more institutional development in these provinces as well.”
