Board structure and intragroup propping: evidence from family business groups in Hong Kong

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Date: Fall 2014
From: Financial Management(Vol. 43, Issue 3)
Publisher: Financial Management Association
Document Type: Article
Length: 11,835 words
Lexile Measure: 1690L

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Using earnings announcement events made by group member firms in Hong Kong, this study examines the governance role of boards of directors in curbing propping activities within family business groups. We find that earnings released by group member firms affect the stock prices of their nonannouncing group peers in a manner consistent with intragroup propping. More importantly, this effect is less pronounced when the announcing firms have a larger board or a board with a higher proportion of independent directors, but more pronounced when they have an executive director from their controlling families acting as board chairperson. Furthermore, the monitoring effect of boards of directors is strengthened for firms subject to new regulations increasing board power. Our results suggest that board oversight can mitigate propping activities.

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Family business groups play an important role in many economies around the world, and typically consist of a number of legally independent firms under the common control of the same family (e.g., La Porta, Lopez-De-Silanes, and Shleifer, 1999; Claessens, Fan, and Lang, 2006). (1) One justification for the prevalence of family business groups is that member firms' resources could be transferred by their controlling families to prop up their financially troubled group peers (Friedman, Johnson, and Mitton, 2003; Bae, Cheon, and Kang, 2008; Riyanto and Toolsema, 2008). To the extent that propping transfers wealth from nonfamily minority shareholders in one firm to benefit family ownership in another firm, propping generates an agency problem that may be mitigated by stronger governance structures. We explore this issue in a sample of Hong Kong family owned businesses.

Intragroup propping can be undertaken in both direct and indirect ways. On the one hand, the controlling families may transfer funds directly through various forms of related party transactions from the healthier member firms to the financially distressed ones (Cheung, Rau, and Stouraitis, 2006; Gopalan, Nanda, and Seru, 2007; Jian and Wong, 2010). Such outright expropriation of firm resources by the controlling families directly impairs the interests of minority shareholders of the healthier member firms. On the other hand, the controlling families can inject their share of retained earnings (distributed as dividends) from the healthier member firms into other member firms in financial distress or with better investment opportunities (Gopalan, Nanda, and Seru, 2011). The interests of minority shareholders would be undermined if the (over) distribution of retained earnings impaired the ability of the healthier member firms to pursue value-increasing investment opportunities. Therefore, the controlling families' intragroup propping may benefit the aggregate value of their business groups as a whole or their own welfare at the expense of the minority shareholders of member firms from which resources have been siphoned off. Following Bae, Cheon, and Kang (2008), we measure intragroup propping potential based on the stock price reactions of nonannouncing member firms to earnings announcements of member firms within family business groups. Good news regarding earnings released by member firms indicates a potential increase in the resources available for intragroup propping, while bad news regarding earnings may signal fewer resources...

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Gale Document Number: GALE|A386434249