Lecture 8: Ownership Structure Recap The birth of modern corporate governance Corporate Governance Theory Agency Theory Stewardship Theory Stakeholder Theory Overview Ownership structures and their impact on governance practices The prominent role of family owned firms in many countries, and the evolution of governance in family firms State ownership and the process of privatization Cadbury In 1824, John Cadbury opened a grocer's shop, owned and managed - small family firm = sole trader In 1861, his two sons Richard and George took over. small family firm = partnership between two sons In 1899, Richard Cadbury died, the firm became Cadbury Brothers Ltd, a private limited liability company with 3,000 employees (the board composed of George as a chairman, his two eldest sons and Richard's two eldest sons) - medium/large family firm = private company In 1962, a publicly listed company although a majority of the board were still members of family (>50%) - large family firm = public company with family ownership/control Today, no longer a family firm, professionally-run company with 8 independent directors out of 12 (2/3 independent) and dispersed shareholder base. Ownership Structure Dispersed Ownership System: is characterized by strong securities markets, rigorous disclosure standards, and high market transparency, in which the market for corporate control constitutes the ultimate disciplinary mechanism (Bebchuk, 1999). Concentrated Ownership System: is characterized by controlling blockholders, weak securities markets, high private benefits of control, and low disclosure and market transparency standards, with only a modest role played by the market for corporate control (Bebchuk, 1999). Concentrated ownership World-wide, firms generally have more concentrated ownership (\"block-holders\") than they do dispersed ownership Reduced 'principal-agent' problems Conflict of interest between controlling shareholders and minority shareholders Protection of minority shareholders is required Dispersed ownership A modern corporation is characterised by a dispersed ownership structure - Berle and Means (1932) Large Western corporations are characterised by dispersed ownership A 'principal-agent' problem A 'free-rider' problem: Louis Brandeis in Louis K. Liggett Co. v. Lee, 53 S.Ct. 487 (1932): \"There is no such thing to my mind as an innocent stockholder. He may be innocent in fact, but socially he cannot be held innocent. He accepts the benefits of the system. It is his business and his obligation to see that those who represent him carry out a policy which is consistent with public welfare\" Corporate governance systems Corporate governance environments are often analysed in terms of \"insider\" and \"outsider\" environments The US and UK have the only \"true\" outsider systems: i.e. widely dispersed ownership, strict disclosure requirements, strong protection of small shareholders Most Continental European and East Asian countries have \"insider\" systems Reforms in South Korea and Japan since 1997 have acted to reduce \"insider\" focus Ownership and control The ultimate ownership of the 20 largest listed companies in the 27 richest economies in 1999: Controlling shareholders have control rights in excess of cash flow rights, esp. when families are the controlling shareholders Controlling families often participate in company management Banks do not exercise much control over firms Other large shareholders generally do not actively monitor the controlling shareholders Common law countries have better legal protection for shareholders and less concentrated ownership structures (La Porta et al. 1999) Legal protection Common law (Anglo-Saxon countries) Relies on independent judges and juries and legal principles supplemented by precedent-setting case law Civil law (Continental Europe) Judges often are life-long civil servants who administer legal codes which consist of specific rules (Schleifer and Vishny 1997, Mees and Ramsay 2008) Ownership and control Majority shareholders can \"oppress\" minority investors related party transactions (tunneling*) (Johnson et al. 2000) - the transfer of corporate assets for the benefit of controlling shareholders Principal-Principal problem (Young et al 2008) Cash rights vs. control Dual-class shares Pyramidal structures (Bebchuk et al. 2000) Pyramidal structure APEX COMPANY 51% FIRM A Apex Company votes 51% Apex Company owns 51% Examples: Parmalat & Enron 51% FIRM B Apex Company votes 51% Apex Company owns 26% (51% of 51%) 51% FIRM C Apex Company votes 51% Apex Company owns 13% (51% of 26%) 51% FIRM D Apex Company votes 51% Apex Company owns 6.5% (51% of 13%) 49% 49% PUBLIC SHAREHOLDERS 49% 49% The separation of ownership and control in East Asia In 1999, the largest ten families controlled more than half of the corporate assets in Indonesia (57%) and the Philippines (53%), followed by Thailand (46%), Hong Kong (32%), Korea (37%), Singapore (27%), Malaysia (25%), Taiwan (18%) and lastly Japan (2.4%) The weakest legal protection at the same time was in the Philippines, then Indonesia, followed by South Korea, Thailand, Malaysia, Hong Kong, Taiwan and Singapore Family-owned firms Family firms: companies are primarily owned and managed by members of a family Family-owned business can encompass sole traders, partnerships, private companies and public companies Large family firms are commoner in Asia and continental Europe than in the US, UK and Australia More family owned firms poorer governance and less shareholder protection Family Owned Firms A dominant form of business around the world Family firms: companies primarily owned and managed by members of a family. What's if it is either owned or managed? Family owned business can encompass sole traders, partnerships, private companies, and public companies Whatever size, good governance is beneficial Studies on Family Firms Two important studies on a large scale: Corporate Ownership Around the World (La Porta, Lopez-de-Silanes and Shleifer, 1999) The Separation of Ownership and Control in East Asian Corporations (Claessens, Djankov and Lang, 2000) Family-owned firms Family-owned firms usually fare better during economic downturns in Western countries (their managers are less likely to overreact to short-term problems) (Lee 2006) Family-owned firms often fail after their founder retires (Morck and Yeung 2003) Family-owned companies usually have poorer corporate governance (family firms were more likely to fail during the East Asian financial crisis than more widely held companies) (Lemmon and Lins 2003) Governance structure in family-owned firms Small family firm: the founder and other family members run the firm - there is no separation between ownership and control, there is a shortage of capital and a 'take problems home' attitude to conflict resolution - family assembly/council Medium-sized family firm: more capital is needed, there is more need for professional management experience and outside advice - advisory board Large family firm: significant working capital, company can raise capital from the open market, its ownership is usually spread more widely, the family may pass on the control rights - board of directors (including independent directors) Governance structure in family-owned firms Advantages: Minimum agency costs Less monitoring of management activity Better protection of shareholders interests Less driven by the short-term demands More inclined to focus on the longevity of the firm Disadvantages: Conflict of interests among family members Insufficient knowledge and skills of family members High exploitation of the interests of minority shareholders Three important issues in family-owned firms 1. Pyramid Ownership - little knowledge about the actual patterns of crossholding and how they enable a family to successfully acquire or maintain near absolute control of firms. 2. Nominee Directors - Directors representing major shareholders. Heavy concentration of stock ownership in Singapore, the practice of using nominee (or representative) directors is common. Conflict of interest, as directors are required by the law to represent all shareholders. Nominee directors can potentially obscure the decisionmaking process in the boardroom because of their own agendas. ( Mak and Phan 2001) Three important issues in familyowned firms 3. Nominee Accounts - Shareholders representing other shareholders Ownership structure in Singapore and many countries difficult to capture accurately due to nominee accounts. Companies for example in Singapore are not required to disclose the identity of their major shareholders, that is, direct ownership information is not reported. United Overseas Bank Limited 20 Largest Shareholders as at 11 March 2005 20 Largest Shareholders No. Of Shares Percentage DBS Nominees Pte Ltd 260,839,096 16.98 Raffles Nominees Pte Ltd 191,116,709 12.44 United Overseas Bank Nominees (Private) Limited 146,535,656 9.54 Wee Investments Private Ltd 110,909,184 7.22 Citibank Nominees Singapore Pte Ltd 100,299,955 6.53 HSBC (Singapore) Nominees Pte Ltd 85,329,720 5.55 Wah Hin & Company Pte Ltd 81,221,771 5.29 Tai Tak Estates Sdn Bhd 67,445,739 4.39 Overseas Union Enterprise Limited 48,337,728 3.15 C Y Wee & Co Pte Ltd 31,645,653 2.06 Overseas Union Bank Nominees (Private) Limited 17,088,276 1.11 Wee Cho Yaw 16,390,248 1.07 Macquarie Securities (S) Pte Ltd 12,321,748 0.80 DB Nominees (S) Pte Ltd 12,038,775 0.78 Tee Teh Sdn Berhad 10,519,954 0.68 Oversea-Chinese Bank Nominees Private Limited 6,149,202 0.40 Merrill Lynch (Singapore) Pte Ltd 5,679,420 0.37 Kwan Tee Holdings Pte Ltd 5,562,892 0.36 Overseas Union Insurance, Limited - Offshore Insurance Fund 5,425,760 0.35 Ho Sim Guan 5,111,000 0.33 1,219,968,486 79.40 Total Governance structure in family-owned firms Small family firm: the founder and other family members run the firm - no separation between ownership and control, shortage of capital, and 'take problems home' - Family Assembly/Council Medium family firm: grow in size, more capital needed, need for professional management experience and outside advice - Advisory Board Large family firm: expand working capital, raise capital from the open market, ownership spread more widely, may pass the control rights - Board of Directors (including independent directors) Corporate Ownership around the World Investigate ultimate ownership of the 20 largest listed companies in the 27 richest economies Controlling shareholders have control rights in excess of cash flow rights, - families are the controlling shareholders Controlling families often participate in company management Banks do not exercise much control over firms Other large shareholders do not actively monitor the controlling shareholders The Separation of Ownership and Control in East Asian Corporations Ownership structure of nine East Asian countries The largest ten families controlled more than half of the corporate assets in Indonesia (57%) and the Philippines (53%), followed by Thailand (46%), Hong Kong (32%), Korea (37%), Singapore (27%), Malaysia (25%), Taiwan (18%) and lastly Japan (2.4%) Low corporate transparencies and accountability Asian financial crisis (1997) Stock market and property speculation in South East Asia led to a bubble that burst in 1997 The Asian \"tiger economies\" were badly affected as well as developing countries such as Indonesia, Malaysia and Thailand Most of the companies that collapsed had poor corporate governance Up to 20% of cash-flow value was silently transferred to block-holder interests during the crisis Singapore High ownership of shares by blockholders (generally defined >5% of shares) by families (e.g Creative, Osim, UOB) and government Mak & Li (2001) study shows Govt owned 20% in more than 10% of Singapore listed companies. World Bank (2006) study - 12 Govt Linked Companies (GLCs) on Singapore stock exchange produce 12% of GDP and 20% of market capitalization Privatisation Most communist countries (China, Russia, Eastern Europe) had outlawed private ownership - hence they had neither public nor family firms. Privatisation generally occurs either by granting/selling shares to the public (IPO), to employees or to foreign firms. The state often retains significant blocks. Many privatised (or partially privatised) firms in formerly Marxist countries have performed poorly since privatisation. State-controlled firms Generally, poor governance structures Boards are often filled with political appointees with little business experience Political intervention can frustrate business policy Can be \"captured\" by their employees Lower performance, higher agency (monitoring) costs In Singapore, State-controlled firms generally equivalent to government-linked companies (Estrin 1998) News Corporation Rupert Murdoch inherited a controlling interest in News Ltd from his father, Sir Keith Murdoch in 1952 Murdoch launched The Australian in 1964, bought the Daily Telegraph in 1972 and the Herald (now Herald-Sun) in 1987 Expanded into Britain in 1968 (News of the World, The Sun, The Times) News Corporation Ltd was created in 1980 to serve as a holding company for News Ltd News expanded into the US from the 1970s (Fox) News Corporation moved from Adelaide to the US in 2004, becoming News Corporation Inc The Murdoch family holds a minority of shares (c. 33%) in News Corporation, but the majority of those shares are voting shares BHP Billiton The Broken Hill Mining Company was founded in 1883 by a syndicate of seven investors (contributing 70 each) to operate mining leases at Broken Hill, NSW The company's shares were listed on the Melbourne Stock Exchange in 1885 after three of the original investors sold out The Broken Hill Propriety Company Ltd later diversified into steel (1915) and petroleum (1968) The \"Big Australian\" also expanded offshore from the 1980s (PNG, South America etc.) BHP merged with Anglo-Dutch mining company Billiton plc in 2001 Parmalat Parmalat was founded by Calisto Tanzi in Parma in 1961 In 2003, Parmalat SpA and associated companies were placed in bankruptcy Tanzi was arrested in 2004 - 25+ years jail 55 defendants have been charged with defrauding 100,000 investors of an estimated 14bn Parmalat SpA has accused five foreign banks of complicity in the Tanzi family's tunnelling (Melis 2005) Conclusions Concentrated V Dispersed, Ownership and Control Family ownership is the prevalent form of ownership in many countries The advantages and disadvantages of a family firm's governance structure Problems arising from researching on familyowned business Privatisation and State controlled firms Other ownership - sole trader, partnership, trust Case Study: Satyam (1) 1. Satyam began as a family firm but became publicly listed in Bombay and New York. What is the role of corporate governance role within such a firm? 2. What corporate governance theory most explains the CG practices at Satyam, and why? 3. Discuss Satyam's corporate governance from the perspective of minority shareholders and describe the conditions that gave rise to these problems? Are they principal-agent problems, or principal-principal problems (Young et al 2008)? Case Study: Satyam (2) 4. \"India Inc.\" is often claimed to be dominated by family interests, but in his resignation letter, Ramalinga Raju explained that he only owns a small personal holding in Satyam. Do you think that cultural factors may have had a role in the Satyam scandal? 5. The Securities and Exchange Board of India (SEBI) has been widely criticised in light of the Satyam fraud. What effect do you think the Satyam scandal may have had on Indian business more generally? Review Questions 1. 2. 3. 4. 5. Explain the difference between dispersed ownership and concentrated ownership. How might concentration of ownership affect corporate governance vis--vis dispersed ownership? Why is family ownership of companies so widespread in the world? What are the advantages and disadvantages of family-owned firms? What is the role of corporate governance in a family-owned company? How might corporate governance develop in a family firm? Is there a role for corporate governance in state-owned enterprises and not-for-profit organisations? References Bebchuk, L 1999, 'A rent-protection theory of corporate ownership and control', National Bureau of Economic Research, Research Working Paper 7203, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=168990. Bebchuck L et al. 2000, 'Stock pyramids, cross ownership and dual class equity', in R. Morck (ed.), Concentrated Corporate Ownership, Chicago, University of Chicago Press, pp. 295315. Cadbury, A 2000, Family Firms and their Governance: Creating tomorrow's companies for today, Zehnder, London. rru.worldbank.org/Documents/PapersLinks/family_firms.pdf. Estrin, S 1998, 'State ownership, corporate governance and privatisation', in Corporate Governance, State-owned Enterprises and Privatisation, OECD, Paris, pp. 11-32 Johnson et al. 2000, 'Tunneling', American Economic Review, v. 90, n. 2, pp. 22-27. La Porta, R et al. 1999, 'Corporate ownership around the world', Journal of Finance, v. 54, n. 2, pp. 471-517. Lee, J 2006, 'Family firm performance', Family Business Review, v. 19, n. 2, pp. 103-114. Lemmon, LL and Lins, KV 2003, 'Ownership structure, corporate governance, and firm value', Journal of Finance, v. 58, n. 4, pp. 1445-68. Mees, B and Ramsay, IM 2008, 'Corporate regulators in Australia (1961-2000)', Australian Journal of Corporate Law, v. 22, n. 3, pp. 212-55. Melis, A 2005, 'Corporate governance failures: to what extent is Parmalat a particularly Italian case', Corporate Governance: An international review, v. 13, n. 4, pp. 478-88. Morck, R and Yeung, B 2003, \"Agency problems in large family business groups', Entrepreneurship: Theory and Practice, v. 27, n. 4, pp. 367-82. Shleifer, A and Vishny, RW, 1997, 'A survey of corporate governance', Journal of Finance, v. 52, n. 2, pp. 737-83. Young, M. N., Peng, M. W., Ahlstrom, D., Bruton, G. D., & Jiang, Y. (2008). Corporate Governance in Emerging Economies: A Review of the Principal-Principal Perspective. [Article]. Journal of Management Studies, 45(1), 196-220. Week 8 Ethics & Governance: Ownership structure Case study: Satyam Satyam Computer Services Ltd was founded by two brothers, B. Ramalinga Raju and B. Rama Raju, in Hyderabad, India, in 1987. It quickly grew to become the largest IT outsourcing company in the world, employing over 40,000 staff across a dozen countries. A public company listed on the Bombay Stock Exchange since 1991, Satyam also listed its securities on the New York Stock Exchange in 2001. By early 2008 Satyam (which means \"truth\" in Sanskrit) had become a US $7bn company, including names as well known as General Electric, Ford, Nestl and Sony among its 600 or so international clients. In December, 2008, four members of the Satyam board resigned, however, after differences had arisen over the proposed acquisition of Maytas Properties and Maytas Infrastructure, two companies owned by Satyam chairman Ramalinga Raju's sons. Satyam's share price immediately dropped by 50%, halving Satyam's market capitalisation, and the decision to acquire the Maytas companies was reversed. Yet as Ramalinga Raju informed Satyam employees: \"The board arrived at its decision to bid for Maytas by following all required processes and procedures and while there was a spirited discussion among members, their vote to approve the motion was unanimous.\" In January 2009, however, Ramalinga Raju himself resigned from the Satyam board, admitting to US $1bn in accounting irregularities. Ramalinga Raju explained that he had resigned due to pressures arising from the global financial crisis and that he and his brother Satyam CEO Rama Raju (who also resigned) had perpetrated the fraud in order to stop Satyam from becoming a takeover target. Indian police have since announced that the Rajus seem to have sequestered hundreds of millions of dollars from Satyam, hiding the stolen moneys in a web of up to 300 companies controlled by family members. Satyam's share price has subsequently fallen to less than a tenth of its previous value and offers are currently being sought by a newly appointed Satyam board for buyers of the company. India's Central Bureau of Investigation intend to file multiple charges against those accused of involvement in the fraud. Among those charged are the Raju brothers, two auditors and an adviser who are said to have conspired with Satyam executives to overstate the company's earnings. The charges will include counts of cheating, criminal conspiracy, forgery of accounts and destruction of evidence. Last month, Satyam was rumoured to be in talks with IBM over a possible acquisition. Watch: The Consequences of Satyam - Wall Street Journal https://www.youtube.com/watch?v=jvQWD6KcZcY Satyam Video Case by Dr Wing Lam - U21 Global https://www.youtube.com/watch?v=bauzUSu2v5k Questions 1. Satyam began as a family firm but became publicly listed in Bombay and New York. What is the role of corporate governance role within such a firm? 2. What corporate governance theory most explains the CG practices at Satyam, and why? 3. Discuss Satyam's corporate governance from the perspective of minority shareholders and describe the conditions that gave rise to these problems? Are they principal-agent problems, or principal-principal problems (Young et al 2008)? 4. \"India Inc.\" is often claimed to be dominated by family interests, but in his resignation letter, Ramalinga Raju explained that he only owns a small personal holding in Satyam. Do you think that cultural factors may have had a role in the Satyam scandal? 5. The Securities and Exchange Board of India (SEBI) has been widely criticised in light of the Satyam fraud. What effect do you think the Satyam scandal may have had on Indian business more generally? Review Questions 1. How might concentration of ownership affect corporate governance vis--vis dispersed ownership? 2. Why is family ownership of companies so widespread in the world? What are the advantages and disadvantages of family-owned firms? 3. What is the role of corporate governance in a family-owned company? How might corporate governance develop in a family firm? 4. Is there a role for corporate governance in state-owned enterprises and notfor-profit organisations