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Does family control help or hinder a company's value in China?
(knowledgeatwharton.com.cn)
Updated: 2010-02-04 17:52
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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 Xiaolu 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."
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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."
First published on Feb 3,2010. Reproduced with permission from China Knowledge@Wharton (http://www.knowledgeatwharton.com.cn). © [2010] The Trustees of the University of Pennsylvania. All rights reserved.
