Ownership Structure, Firm Performance, and Business Group Restructuring in Large Family Business Groups in Korea

Abstract

Family business groups are ubiquitous around the world particularly outside the U.S. and the United Kingdom and exhibit a very unique ownership pattern—separation of cash flow rights from control rights. Based on agency theory, the dominant view takes this separation of cash flow rights from control rights as socially undesirable since it has potential to destroy firm value and eventually social welfare by distorting incentive structure of shareholders. An evolving body of literature, however, increasingly realizes that the separation can have much profounder implications than the dominant view simply sets forth for inner-workings and strategic choices of family business groups and that much has yet to be understood. Drawing from the complementary lenses of stewardship theory, internal market hypothesis, and institutional theory, this thesis endeavors to add to this stream of research by delving deeper into ramifications of this unique ownership pattern in the context of Korean large family business groups or Chaebols. Zeroing in on the firm level of analysis, Study 1 investigates the relation between the separation of cash flow rights from control rights and economic performance of firms affiliated with Chaebols. Diverging from the dominant view grounded in agency theory and in keeping with the internal market hypothesis, study 1 entertains the possibility that the separation of cash flow rights from control rights is positively associated with firm performance and value in the context of Chaebols. Using the data between 2003 and 2010, study 1 found that the separation is positively associated with firm (operating) performance, but not with market value. It also found that the effect of the separation is moderated by business group performance, analysts coverage, R&D expenditure, and organizational slack. In order to address the endogeneity, study 1 employed the Arellano-Bond linear generalized method of moments (GMM) estimator in the panel data setting. This study calls into question the dominant explanation that views the separation as inflicting harm on firm performance. In so doing, it calls for attention to family business groups, the context in which the separation generally occurs, in that this context substantially alters the theoretical process put forth by the dominant explanation. This study offers insights to policy makers planning to enforce/revoke the regulation on the separation of cash flow and control rights in pursuit of corporate governance reform especially in countries with poor shareholder protection. Elevating the focus to the business group level, study 2 examines how the unique ownership structure impinges upon restructuring strategy of family business groups in emerging economies. Drawing on the corporate diversification literature, study 2 posits that related as well as vertically integrated business portfolio reduces risk. Then, it argues that family cash flow rights are positively associated with restructuring that increases relatedness and vertical integration of business portfolio because the family as a large shareholder has strong incentive to reduce risk and variability. In addition, study 2 proposes that in the presence of institutional and market pressure for restructuring towards related and vertically de-integrated business portfolio, the separation of cash flow and control rights motivates the family to actively respond to this pressure. Because the family is typically unable to conform to the institutional pressure for good corporate governance, it may attempt to neutralize this pressure by responsively conforming to the other institutional pressure, which I believe pertains to substitution response (Okhmatovskiy & David, 2012). Study 2 empirically tests these hypotheses in the context of Chaebols. The results show that family cash flow rights are positively associated with restructuring that increases relatedness and vertical integration of business portfolio and that the separation of cash flow and control rights is negatively associated with restructuring that increases vertical integration. Taken together, this dissertation enriches our knowledge on the family business groups that has been dominated by agency theory. Bringing to the fore the internal market hypothesis and institutional theory, it systematically unravels how the ownership pattern uniquely observed in family business groups shapes their functioning and dictates their strategic choices and outcomes both at the firm-level and the group-level which have been relatively less understood.