Primary Drivers of Conflict

Dominant Ownership

This aspect of principal—principal conflict has drawn considerable research attention. First, considering reasons for concentrated ownership, one stream of literature discusses that “threshold” firms—those in transition from founder to professional management—experience the need to provide some private information to outsiders (Daily & Dalton, 1992), something that had not been required under the previous governance regimes. This disclosure of information requires that the founding family place its trust (Zahra & Filatotchev, 2004) in a new set of professional managers. This trust may be particularly difficult to achieve in an emerging economic environment (North, 1990). Moreover, institutions that might facilitate such trust may be lacking in emerging economies, which make crossing the threshold from dominant to dispersed ownership more difficult (Young et al., 2008). The second issue cited commonly is the presence of both external and internal corporate governance mechanisms. As discussed above, developed economies are more likely to provide something close to an optimal bundle of mechanisms (Fama & Jensen, 1983) to facilitate smooth corporate governance. Key external governance mechanisms, such as product and labor markets, or markets for corporate control, are more mature in developed economies; in contrast, the governance mechanisms in emerging economies may not be efficient enough with respect to forcing managers to behave in the interest of shareholders (Djankov & Murrell, 2002). Similarly, internal governance mechanisms (board structure and independence, monitoring and control rights) in emerging economies are also weaker (Fama & Jensen, 1983), meaning that firms are forced to rely on dominant ownership to keep potential managerial opportunism in check (Dharwadkar et al., 2000). The social antecedents of dominant ownership have also been studied; Young et al. (2008), for example, identified three sets of institutional antecedents of concentrated ownership: family businesses, business groups, and state-owned enterprises (SOEs).

Family Businesses In emerging economies, controlling ownership is often in the hands of a family (La Porta, Lopez-de-Silanes, & Shleifer, 1999). This has both costs and benefits. On one hand, it reduces agency costs by aligning ownership and control. Family ties assist firms in reducing monitoring costs, which may lead to enhanced performance (Young et al., 2008). On the other hand, family ownership and control may also increase the possibility of expropriation of other minority shareholders by family shareholders, negatively affecting the firm. Further, family owners may not allocate resources efficiently, and may give preference to social relations over efficiency. This inefficiency can be reflected in outcomes such as the appointment of under-qualified family members to key posts (Claessens et al., 2000), non-merit-based compensation, and inefficient strategic decisions.

The net advantage or disadvantage of family control depends upon a myriad of factors. Family firms tend to perform well in low-munificence and complex, but highly dynamic, environments, while struggling in converse scenario (Gedajlovic, Lubatkin, & Schulze, 2004; Young et al., 2008).

Business Groups A business group is “a collection of legally independent firms that are bound by economic (such as ownership, financial and commercial) and social (such as family, kinship and friendship) ties” (Yiu, Bruton, & Lu, 2005: 183). Usually, each of the member firms in a business group is a distinct business entity, in legal terms (Young et al., 2008). In many emerging economies, business groups and family businesses are coalesced; that is, various group companies are owned by different family members. Though business groups are commonplace in many developed economies, they are relatively more widespread in emerging economies (Peng, Lee, & Wang, 2005; Yiu et al., 2005).

A business group structure may provide more advantage in emerging economies (Chakrabarti, Singh, & Mahmood, 2007; Khanna & Palepu, 2000) . Internal resource allocations among constituent firms become particularly important in emerging economies, due to less developed markets for critical resources such as capital. Often, emerging economies lack a well-functioning external capital market. Even if the external capital market is fully functional, firms within a business group are sometimes denied external capital because they are not able to signal value creation from specific projects, especially if group resources are tied up with multiple ongoing projects (Myers & Majluf, 1984). The business group’s internal capital market provides an alternative, and creates value by efficiently allocating resources among member firms (Stein, 1997); nonetheless, business groups also have to bear coordination and administration costs (Claessens et al., 2002).

The business group also escalates the opportunity for expropriating minority shareholders by inefficient and veiled resource transfers, thus affecting minority shareholder interests in some member firms. For example, to help a group firm, inputs from a sister firm may be bought at higher-than-market prices, or output can be sold to a sister firm below market price. Similarly, a group company can invest in projects of other group firms, even if this is not fully economically desirable. This is arguably more likely to happen when the control rights of the controlling shareholders are greater than their cash flow rights, which can lead to a practice known as “pyramiding” (Bertrand, Mehta, & Mullainathan, 2002; Claessens et al., 2002). For example, consider that Firm A has 50 % control over Firm B, which, in turn, has 50 % control over Firm C. In this case, Firm A has a 25 % cash flow right in Firm C, but more like 50 % control right, given its ability to also act through Firm B. Under such conditions, owners have the ability to divert resources from Firm C to Firm A, so as to enjoy better cash rights. The literature on internal capital markets suggests that business groups are prone to over-investment and lobbying costs (Rajan, Servaes, & Zingales, 2000), thereby reducing value.

In summary, principal-principal conflict is viewed as more likely to surface in emerging markets, where business groups are known to give preferential treatment to some member firms, over and above economic and efficiency considerations.

State-Owned Enterprises In emerging economies, for social, political, and historical reasons, many of the largest firms are controlled by the state. For example, Xu and Wang (1999) note that, in China, about two-thirds of the shares in publicly listed companies are owned by the state, either directly or through other SOEs. Dharwadkar et al. (2000) note the prevalence of SOEs in emerging economies, asserting that, even post-privatization, the structure of several SOEs resembles their previous structures, at least in practice, due to rigidities associated with the systematic involvement of insiders, including managers, employees, and the state. This insider dominance in privatized firms risks the creation of principal-principal agency issues (Dharwadkar et al., 2000).

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