Like father, like son? Diversification decision and related performance of family firm successors – Evidence from Taiwan

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Like father, like son? Diversification decision and related performance of family firm successors – Evidence from Taiwan Shu-Ching Chou ∗ , Chia-Jung Shih Department of Graduate Institute of Finance, National Yunlin University of Science & Technology, 123, Section 3, University Road, Touliu, Yunlin, 640, Taiwan

a r t i c l e

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Article history: Received 1 July 2017 Received in revised form 25 February 2019 Accepted 23 April 2019 Available online xxx JEL classification: G34 M14 J1 Keywords: Family firm Diversification Successors Second generation Hired CEO

a b s t r a c t This study investigates diversification decisions and related performance of family firms in Taiwan. In particular, this study categorizes the successors of family founders into three types: second-generation (i.e., children), non-second-generation (i.e., those of the same generation as the founder or other relatives), and hired professional managers from outside the family (i.e., family-hired CEOs). The results indicate that family firms, whether led by founders or family successors, exhibit a level of product diversification similar to non-family firms and the diversification performance of family firms does not significantly differ from that of non-family firms. Family firms in which a family member succeeds as chairman and an outside individual is hired as CEO tend to engage in less product diversification than non-family firms; however, when such firms engage in diversification, they achieve higher firm value than non-family firms. These findings suggest that hired CEOs may make careful strategic decisions and exhibit superior skills in diversification under the supervision from family owners. The decision quality of family firm successors is emphasized in recent literature. This study provides new evidence on the role of hired CEOs in enhancing firm value through diversification decisions after succession. © 2019 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.

1. Introduction One-third of the top 500 companies in the United States are family owned (Anderson & Reeb, 2003a; Chen, Chen, & Cheng, 2008), whereas, in Western Europe, over two-thirds of companies are family owned, accounting for 44% of listed firms (Faccio & Lang, 2002). Similarly, in China, many firms are entrepreneurand family-controlled because of the institutional environment or cultural norms (Amit, Ding, Villalonga, & Zhang, 2015). Thus, family ownership is a common form of corporate organization, and family firm management is a widespread global practice that substantially influences the global economy (Villalonga & Amit, 2010). In traditional Chinese culture, keeping and extending the family’s control rights are essential characteristics of family firms. Moreover, the founders of family firms commonly bequeath the management of their enterprises to family members (Xu, Yuan, Jiang, & Chan, 2015; Yeh, 2017). The presence of family members who will inherit the business can facilitate the maintenance of a deep organizational culture, including the founder’s philosophy,

∗ Corresponding author. E-mail address: [email protected] (S.-C. Chou).

vision, and knowledge as well as the shared experiences of employees, which can help the long-term development of family firms. This cultural advantage is considered a “family special asset,” which family members own through retention and sharing (Yeh, Morten, Joseph, & Fan, 2015). The successors to founders are likely to transform or expand their businesses either through advancing the firm to a later stage of the business life cycle or by facing changes in customer demands because of severe global competition. Product or service innovation through diversification might provide a solution to the challenges faced by founders’ successors. The unique cultural advantages of family businesses, such as unique talents and skills (Bennedsen, Joseph, Minh, & Yin-Hun, 2015) and political connections (Xu et al., 2015), may enable these firms to effectively use enterprise resources and enhance diversification performance. However, successful diversification usually requires organizational changes or restructuring (Zahra, 2005), whereas family businesses tend to have rigid personnel systems in which family members may not have the technical skills or knowledge necessary for successful diversification (Hall, Melin, & Nordqvist, 2004). On the basis of these arguments, this study investigates the attitudes of family members toward diversification and examines diversification performance according to successor type.

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The sample includes companies listed in Taiwan during 2000–2014. Taiwan experienced an economic boom during the 1960s and 1970s; thus, many firms are currently in the middle or late stage of their life cycles, and diversification investment is a potential method for them to enhance firm competitive advantage (Maksimovic & Phillips, 2008). The unique entrepreneurial conditions of Taiwan facilitate investigating the association between family firm succession and family firm diversification. Because of Chinese culture norms, family ownership and succession by heirs to extend family management is prevalent in Taiwan (Yeh, 2017). As Claessens, Fan, and Lang, (2000) and Chou, Hamill, and Yeh, (2016) report, Taiwanese family firms usually have concentrated ownership to reinforce control rights over the family business. Diversification provides a means of reducing the portfolio risk of large family shareholders. However, it may diminish family members’ equity ratio and control rights because it may require external funding and knowledge from outside professionals. We categorize family members into four types: founders, second-generation successors (i.e., children), non-secondgeneration successors (i.e., those in the same generation or other relatives of founders), and family-hired chief executive officers (CEOs). We use GMM estimator to account for endogeneity. The results demonstrate that no family member, neither founders nor family successors, engage in a significantly different level of product diversification than non-family firms. When family founders and family successors engage in diversification activities, the performance of the family firms is not significantly different from that of non-family firms. However, family firms in which a family member succeeds as chairman and an outside CEO is hired tend to engage in less product diversification than non-family firms, and such family firms achieve a higher valuation in terms of Tobin’s Q than non-family firms when they engage in diversification activities. The findings correspond to those of Villalonga and Amit (2006) and Karaevli (2007), who propose that hired CEOs improve family firm value. Finally, we conduct an additional test on related and unrelated diversification on the basis of merger and acquisition (M&A) deals among Taiwanese public firms. The results indicate that most family members generally engage in acquisitions similar to non-family firms. Company value improves only when unrelated acquisitions are conducted. This finding is in agreement with that of Khanna and Palepu (2000), who propose that families improve value by reducing firm risk through unrelated acquisitions. Our findings provide new evidence on firm diversification and family management. First, conventional agency theory predicts that family members bear high wealth risk due to concentrated ownership (Demsetz & Lehn, 1985; Faccio, Lang, & Young, 2001), that predicts that family firms may seek diversification to reduce family members’ portfolio risk. By contrast, the behavior agency model (BAM) predicts that family firms aspire to avoid losing socioemotional wealth (SEW) (Gomez-Mejia, Makri, & Kintana, 2010) and therefore have lower levels of diversification. Our results show that family firms led by founder or family successors exhibit diversification and performance levels comparable to non-family firms. These findings imply that the diversification decisions by family members might be an endogenous result dependent on the net effect of the benefits and costs of diversification as mentioned in Fauver, Houston, and Naranjo, (2003). Second, Anderson and Reeb (2003a) find that family firms led by founders, successors, or hired-CEOs engage in less diversification, and the valuation discount from diversification is not significantly different between family and non-family firms. Instead of overall performance analysis, we identify different types of family successors and find that family firms with hired-CEOs exhibit a lower diversification level but higher diversification performance than non-family firms. Rajan, Servaes, and Zingales, (2000) claim that

diversification may cause inefficient cash flow transfer and inferior performance. Our findings suggest that hired CEOs may make careful strategic decisions and exhibit superior skills in diversification within family firms. These findings suggest that large family shareholders may play a role in supervising the diversification activities conducted by hired CEOs. In addition, Bennedsen et al. (2015) and Villasalero (2017) emphasize that the expertise of CEOs and the decision quality will influence the performance of family firm in post-succession. Villalonga and Amit (2006) propose that family ownership creates value only when the founders serve as CEOs or family firms hire outside CEOs. This is because a hired CEO may have similar or superior ability as a founder. Our results demonstrate that family firms with founders or family member successors do not achieve superior diversification performance to non-family firms, but family firms with hired CEOs do. The findings contribute to provide new supporting evidence that hired CEOs working under a family member’s supervision might possess adequate knowledge for making highquality diversification decisions that improve the value of family firms. This finding offers insights that can be applied to improve corporate governance mechanisms in regions where family value and control is prioritized, such as East Asia. This study is organized as follows. Section 2 focuses on literature review and hypotheses development. Section 3 describes the research methods, and Section 4 presents the summary statistics. Section 5 reports the results of the regression analysis. Section 6 presents the conclusion and discussion.

2. Literature Review 2.1. Diversification and performance Amihud and Lev (1981) propose that company diversification can reduce business risk and create value. Booz, Allen, and Hamilton, (1985) state that diversification investment is intended to reduce a firm’s risk by developing new business through mergers and acquisitions (M&As), joint ventures, or authorization. In addition to reducing firm risk, diversification can be a useful method for a company to extend its core business to other products and markets (Hirshleifer, Hsu, & Li, 2013). Vertical integration of the original and newly diversified businesses can expand the scale of a company and increase market share (Jensen & Murphy, 1990). New products can enter the market more easily by virtue of a company’s existing reputation and consumer brand loyalty (Encaua, Jacquemin, & Moreaux, 1986). As sales increase, a firm’s superior operating performance can enable the firm to assume more debt, which will lower its tax burden, thereby increasing company value (Lewellen, 1971). As such, business diversification can reduce risk and create value for a company. Some scholars believe that business diversification may adversely affect company performance. A survey conducted by Aggarwal and Samwick (2003) reveals that diversification cannot significantly reduce the risks of a company if managers use diversified investments to pursue their own personal interests. Shin and Stulz (1998) report that a department’s performance deteriorates when its operations are closely related to those of other departments. They claim that the resulting dependence on other departments cannot result in favorable investment opportunities but instead impairs efficiency. Lang and Stulz (1994) report that the Tobin’s Q value of a diversified company is usually lower than that of a non-diversified company. Schoar (2002) reports that production efficiency decreases for firms acquiring other plants, whereas the production efficiency of newly acquired firms increases. She explains that this is because management focus shifts from existing segments toward new ones. In addition, Campa and Kedia (2002)

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report that company value decreases if a company engages in business diversification. Berger and Ofek (1995) find that on average a diversified company has approximately 13%–15% lower value than a non-diversified company in the same industry. On the basis of this “diversification discount,” Matsusaka (2001) states that companies should abandon their diversification efforts and instead prioritize specialized production to maximize firm value. 2.2. Diversification and performance in family businesses 2.2.1. Diversification in family businesses Family members often face a high risk in relation to personal wealth management (Demsetz & Lehn, 1985; Faccio et al., 2001). On the basis of agency theory (Shleifer & Vishny, 1986), Anderson and Reeb (2003a) predict that family firms have higher incentives than non-family firms to engage in diversification and seek to reduce their portfolio risk due to concentrated ownership. However, by using a sample of Standard & Poor’s 500 industrial firms, Anderson and Reeb (2003a) find that family firms engage in lower level of diversification. They report that the diversification discount of family firms is not significantly different from that of non-family firms and that family firms have higher aggregate value than do nonfamily firms. However, the behavior agency model (BAM) predicts that family firms possess lower levels of diversification. Jones, Makri, and Gomez-Mejia, (2008) propose that family members typically have nonfinancial connections with family firms, including authority in decision-making, controlling rights, and a feeling of belonging and intimacy. They term such nonfinancial connections socioemotional wealth (SEW) and state that a primary reference point for family firm decisions is SEW loss. Gomez-Mejia et al. (2010) hypothesize that family firms diversify less than non-family firms. They claim that this is due to family member’s aversion to losing SEW, because diversification may entail resource allocation, greater uncertainty, and delegation. In addition, diversification investment typically requires obtaining external funding, either through issuing new stock or debt financing. The new funding providers may exercise stricter supervision of family controlling shareholders and influence their control rights. In addition to their concentrated ownership, the higher leverage from the funding of diversification investment results in greater portfolio risks for family shareholders (Gomez-Mejia et al., 2010). As Fauver et al. (2003) mention, whether family firms make diversification decisions is an empirical question that depends on the net effect of the benefits and costs. Founders, who typically act as entrepreneurs or firm controllers (Bennedsen et al., 2015), are expected to focus on their business specialty and have high tendency to protect socioemotional wealth. The founder also likely has experience of the early stage of a product’s life cycle (Maksimovic & Phillips, 2002). In this case, founders have lower intention and need to engage in diversification. We thus construct the first hypothesis as follows: Hypothesis 1. Founder-family firms engage in less diversification than non-family firms. The successors of family firms, either the family’s second generation, other family members, or family-hired professionals, may confront managerial problems, including outdated products left by the founders and the threat of new competitors, both of which become more likely as the family firm ages. As mentioned by Stein (2003), old firms have greater incentives to diversify. Therefore, the inheritors of such firms, in contrast to the founders, are more likely to engage in diversification to develop new products and enter a new market to survive and resist new competition. However, as Yeoh (2014) documents, family firms traditionally pass their

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ownership and grant control rights to family successors. Under Chinese norms, family members, including founder’s generation or other family members are likely to assume managerial position when founders step down. Since diversification usually requires getting external funds, new knowledge and authority delegation (Gomez-Mejia et al., 2010), family successors may have a conservative attitude toward diversification to keep their endowed family assets and control rights. We thus construct the second hypothesis as follows: Hypothesis 2. Family firms succeeded by either a secondgeneration heir or other family member engage in less diversification than non-family firms. Outside professionals that succeed to the CEO position in family firms tend to possess superior managerial expertise than family successors (Bennedsen, Nielsen, Perez-Gonzalez, & Wolfenzon, 2007) and are likely to pursue firm growth (Yeh, 2017). However, family hired-CEOs might face difficulties in assuming influential managerial jobs in family businesses if the family members have strong control rights (Zahra, 2005). Consequently, although nonfamily successors in family firms may aspire to pursue growth through diversification, family dominance and concern for SEW loss may hinder the diversification decisions of non-family successors. Furthermore, large family shareholders may influence nonfamily successors’ diversification decisions from a long-term benefit maximization perspective. Diversification is considered a pattern causing inefficient cash flow transfer between divisions and businesses, thus resulting in inferior performance (Rajan et al., 2000). Jensen (1986) proposes that concentrated ownership could reduce the agency cost of free cash flow. Shleifer and Vishny (1986) claim that family members monitor managers to ensure firm value maximization because of their large equity ratio. From this perspective, large family shareholders may supervise the diversification decisions proposed by hired successors and limit diversification activities to avoid inefficient cash flow transfer. Outside CEOs hired by family firms are thus less likely to pursue diversification than those in non-family firms due to possible scrutiny by large family shareholders. Based on these arguments, we formulate the third hypothesis as follows: Hypothesis 3. Family firms that hire an outside CEO as successor engage in less diversification than non-family firms. 2.2.2. Diversification performance in family firms Few studies have investigated firm performance by family firm diversification; additionally, their results are inconclusive. The resource-based theory suggests that firms create value through acquisitions and diversification. Diversification is a source of internal capital market that enables firms to allocate capital more efficiently (Stein, 1997). This enables firms to continue growing, terminate unprofitable segments, and invest in growing segments. Additionally, diversification facilitates information distribution to other companies (Kuppuswamy & Villalonga, 2012). These benefits are essential for family firms in emerging markets with imperfections because they are less likely to obtain external resources due to investors’ concerns regarding their possible entrenchment and low information transparency (Purkayastha, Manolova, & Edelman, 2012). For example, Khanna and Palepu (2000) report that Indian diversified group firms exhibit higher performance than nondiversified group firms. Masulis, Pham, and Zein, (2011) investigate 45 family-controlled businesses worldwide and find that internal equity, investment intensity, and firm value increase in group firms. They claim that these performance improvements reflect financing advantages within family firms. However, some scholars have negative views of the diversifications conducted by family businesses. Zahra, Hayton, and Salvato,

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(2004) propose that successful diversification usually requires new knowledge and organizational structure or management style reforms. Focusing on the family’s core business may prevent family firms from obtaining sufficient new knowledge or technology for new innovation activities (Yeoh, 2014). In addition, a rigid personnel system in family businesses may also hinder the entrance of new employees. Tagiuri and Davis (1996) suggest that some family members receive high salaries and dividends from the family business, which serve as major sources of income, and such practices might deter outsiders from seeking employment at family firms. Due to the restricted resource, either in capital or knowledge, we expect that family members, both founders and successors, perform worse than non-family firms. We formulate the fourth and fifth hypotheses as follows: Hypothesis 4. Diversification led by founder-family firms achieve inferior performance compared with non-family firms. Hypothesis 5. Diversifications led by heir-managed family firms achieve inferior performance compared with non-family firms. As mentioned above, some scholars expect inferior diversification performance of family members relative to non-family firms due to restricted resources within family firm. However, what if the diversification is conducted by a hired CEO rather than a family successor? Karaevli (2007) argues that a non-family CEO introduces a different leadership style, new knowledge, and skills prerequisites for management change. Such managerial expertise should derive from experience in other firms and industries. Villalonga and Amit (2006) find that Fortune 500 family firm in which founders serve or hire outside CEOs are more highly valued. These studies thus suggest that hiring an outside CEO could improve the diversification performance of family firms. In addition, family firms usually pursue long-term firm survival and have long investment horizons that will prevent or alleviate manager’s myopic investment decision. For example, Stein (1997) proposes that large shareholder’s supervision and external intervention mechanisms like hostile takeovers could monitor managers and reduce agency problem of managers. Family-hired CEOs, who have external professional knowledge and are under monitoring by family large shareholders, might make diversification decisions carefully to pursue risk reduction or firm growth. In contrast, as noted in literature (Rajan et al., 2000; Shin & Stulz, 1998), managers in non-family firms likely have low valuation on diversification investment due to inefficient resource allocation. Based on these literature, we propose the sixth hypothesis as follows: Hypothesis 6. Diversifications led by family firms with a hired CEO as successor achieve superior performance compared with non-family firms. 3. Methodology 3.1. Sample This study uses the panel data methodology to control for unobserved heterogeneity and endogeneity. The sample consists of 1913 firms with 18,960 firm-year observations in Taiwan. The sample period is from year 2000 to 2014 because family firm data before year 2000 is incomplete. The financial data and corporate governance variables are derived from a data bank provided by the Taiwan Economic Journal. We perform the following steps for sample collection: (1) Companies with incomplete sales information are excluded, because this would make the measurement of sales diversification infeasible.

(2) Firms in the financial services industry are excluded because of their unique financial structures and accounting reporting systems, which are supervised by the Ministry of Finance. (3) Firms with missing chairman or general manager information or with missing financial data are excluded. (4) To avoid extreme values that affect the results, we exclude observations of 1% extreme value. (5) Firms with less than four consecutive years of data are excluded for panel data estimation. 3.2. Models 3.2.1. Family firm diversification activities and performance We first examine the effects of having a family member as the chairman or CEO on corporate diversification (Diversifying) based on the model provided by Lin and Su (2008). In Eq. (1), Family represents the types of family members that are used for comparison with non-family firms to determine the diversification level. Diversifying i,t = ˛0 + ˛1 Diversifying i,t−1 + ˛2 Familyi,t + ˛3 TaGrowi,t +˛4 Govholder i,t +˛5 Legalholder i,t + ˛6 Controlhoder i,t + ˛7 IndDiversifyi,t +˛8 ROAi,t + ˛9 Dividendi,t + ˛10 Intangiblei,t + ˛11 Leveragei,t

(1)

+˛12 Agei,t + ˛13 Sizei,t + ˛14 Tobin’ s Q i,t + ˛15−37 Industry1−23 +˛38−52 Year 2000−2014 + εi,t

After analyzing the firm diversification activities, we investigate the relation between diversification and firm performance. The performance regression model is based on Lin and Su (2008) and presented in Eq. (2). Both diversification and performance models include Industry and Year dummies to account for the industry and time effects. The industry categories are provided by the Taiwan Stock Exchange (TWSE). 



Tobin s Q i,t = ˇ0 + ˇ1 Tobin s Q i,t−1 + ˇ2 Diversifying i,t + ˇ3 Familyi,t +ˇ4 Familyi,t × Diversifying i,t +ˇ5 Govholder i,t +ˇ6 Controlholder i,t +ˇ7 Largeholder i,t + ˇ8 TaGrowi,t + ˇ9 Intangiblet + ˇ10 Aget

(2)

+ˇ11 Sizet + ˇ12 Leveragei,t + ˇ13−35 Industry1−23 +ˇ36−50 Year 2000−2014 + εi,t

Recent finance research emphasizes the importance of efficient estimation in panel data by using dynamic panel generalized method of moment (GMM) estimators to alleviate endogeneity (Flannery & Hankins, 2013; Wintoki, Linck, & Netter, 2012). Wintoki et al. (2012) propose that two lags of dependent variable as instruments are sufficient for ensuring a complete dynamic relation. The lags used as instruments for the dependent variable in the GMM estimations are lags from t-2 for the equations in differences and from t-1 for the equations in level. As Blundell and Bond (1998) suggested, a set of internal instruments that use the lagged explanatory variables provide proxies for external instruments. For all explanatory variables (except for the lagged dependent variable), we use the lags from t-1 to t-4 both in the equations in differences and in levels. The year and industry dummies are treated as exogenous variables in both models. Following Arellano and Bond (1991) suggestion, we conduct several tests for specification validity. First, we test for autocorrelation of residuals in first differences (AR(1)) and in second differences(AR(2)). For a valid specification, there should be serial correlation in AR(1), but there should be no serial correlation in AR(2). Second, since the dynamic GMM estimators use multiple lags as instruments, we conduct Hansen test of over-identification. The Hansen test provides a J-statistic under the null hypothesis that all instruments are valid. Finally, we conduct Diff-in-Hansen test of exogeneity for instruments used for the equations in levels. The test results show our model specification is valid.

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3.2.2. Variable definitions 3.2.2.1. Dependent variable. (a) Diversifying: Studies define diversification differently, including as product diversification (Fauver et al., 2003; Lin & Su, 2008), geographical diversification (Fauver, Houston, & Naranjo, 2004), and acquisitions of other segments or firms (Arikan & Stulz, 2016; Schoar, 2002). In this study, we focus on sales-based product diversification based on Lin and Su (2008). We first calculate the Herfindahl index by summing the squares of the sales ratios of the departments of a company for each year. The formula for the Herfindahl index is as follows:

 N

Herfindahlt =

j=1

Salesj,t



j

2

Salesj,t

(3)

where Salesj,t refers to the sales revenue of department j in year t of a company. Because diversification is high when its Herfindahl index is low, we multiply the Herfindahl index by minus one to interpret a firm’s diversification activities in a consistent direction. Diversifying i,t = (−1) *Herfindahli,t

(4)

• Tobin’s Q: For performance analysis, we utilize Tobin’s Q as the proxy of firm performance. Tobin’s Q equals the year-end market value of common stock plus the book value of debt divided by the year-end book value of a firm’s total assets. 3.2.2.2. Independent variable (Family). We use the term Family as the proxy of a series of family member variables to investigate the relationship between firm diversification and the statuses of family members. (a) Family: If a corporation is a family firm, Family equals one; otherwise, it equals zero. Studies have different definitions for family firms. Jensen and Meckling (1976) and Shleifer and Vishny (1986) define controlling shareholders as those that own a majority of shares who have strong incentives to monitor managers to maximize firm profits. La Porta, López-de-Silanes, and Shleifer, (1999); Claessens et al. (2000);Faccio and Lang (2002) focus on voting rights. They classify a firm as a family firm if its individual or corporate shareholders have direct and indirect votes over a 20% threshold that is considered sufficiently large for effective control of the firm. Anderson and Reeb (2003b) and Villalonga and Amit (2006) define a family firm as one whose founder or founder’s relatives, either by blood or marriage, are officers, directors, or blockholders, either individually or as a group. Because this study aims to investigate the diversification decisions of founders and successors in family firms, we adopt a definition of family firm based on family succession and management (Anderson & Reeb, 2003b; Villalonga & Amit, 2006; and Bennedsen et al., 2015); that is, the founder passes the chairmanship or CEO position to a relative. We then classify family firms (Family) into four categories as follows: (i) Family Founder: Family Founder presents founder-family firms. If the founder acts as the chairman or CEO, and no external professional is hired as CEO, the dummy variable is one; otherwise, it is zero. (ii) Family Second: Family Second presents family firms with second generations. If the founder passes the position of chairman

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or CEO to second-generation, and no external professional is hired as CEO, the dummy variable is one; otherwise, it is zero. (iii) Family Non-Second: If the founder passes the position of chairman or CEO to a non-second-generation family member or an in-law, and no external professional is hired as CEO, the dummy variable is one; otherwise, it is zero. (iv) Family Hired-CEO: If the founder or a family member serves as chairman and hires an external professional as CEO, the dummy variable is one; otherwise, it is zero. 3.2.2.3. Control variables. (a) TaGrow: TaGrow is equal to the value of the year-end total assets divided by the total assets value at the beginning of the period minus 1, which measures the growth rate of total assets (Lin & Su, 2008; Stowe & Xing, 2006). According to Lin and Su (2008), a firm with greater asset growth has a superior performance and has sufficient funds to invest in diversification activities. (b) Govholder: Govholder represents government shareholdings divided by total shareholdings. According to Sun and Tong (2003) and Lin and Su (2008), government ownership in China is negatively related to diversification and performance due to the complicated agency problem. (c) Legalholder: Legalholder is the shareholdings held by legal institutions divided by total shareholdings. The legal institutions include financial institutions and corporate entities but not government. Lin and Su (2008) find a negative relationship between a company’s diversification and legal entity shareholdings. Pound (1988) argues that legal entities strengthen the board of directors’ supervision, thus preventing it from pursuing its own interests at the expense of others’. McConnell and Servaes (1990) reveal that if the percentage of legal entity shareholdings increases, Tobin’s Q also rises. Therefore, Legalholder is expected to be positively related with performance. (d) Controlholder: Controlholder is the managerial ownership held by controlling shareholders with direct or indirect voting right over 20%, as defined by La Porta et al. (1999). Shares held by the government and legal institutions are excluded. Villalonga and Amit (2006) and Lin and Su (2008) assume that large or controlling shareholders are inclined to reduce their risk exposure through diversification. Shleifer and Vishny (1986) argue that if large shareholders possess majority ownership, their supervisory capability will be superior because they will maximize their interests in line with those of other shareholders. However, La Porta et al. (1999) and Claessens et al. (2000) find that firms whose controlling shareholders have dominant voting rights may entrench firm benefit when their ownership (cash-flow rights) is low. Therefore, the relationship between managerial ownership of controlling shareholders and performance is an empirical problem requiring verification. (e) IndDiversify: IndDiversify is the number of enterprises with high diversification divided by the total number of enterprises in each industry in each year. A firm is expected to have more active diversification activities when more firms engage in diversification in its industry. (f) ROA: ROA is the operating income divided by the book value of total assets. If business performance improves, a company is more likely to make other investments (Jensen, 1986), and the return of investment (ROA) is positively correlated with diversification. (g) Dividendr: Dividendr is annual dividend payment divided by market equity. Dividendr is expected to be positively correlated with diversification (Lin & Su, 2008). (h) Intangible: Intangible is the value of intangible assets divided by total assets. A firm with more intangible assets is likely to have superior competitive capacity and more chances to develop

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6 Table 1 Sample distribution. Industry description

All

Family

Family(%)

All

Family

Family(%)

Media Paper and Allied ()()Products Cement Food Textile Transportation Manu. Manu Plastic and Rubber Glass Products Retail Iron and Steel Chemical Tourist Construction Transportation Biotech Finance Electric Equipment Management Stock Culture Creative Electronics Utility Telecommunication Information technology Others Total

6 8 8 30 63 5 47 5 31 50 45 24 90 29 95 69 114 17 13 916 14 99 45 90 1913

6 7 7 26 53 4 38 4 21 34 32 16 61 22 65 45 72 10 7 503 7 42 17 71 1170

100.00 87.50 87.50 86.67 84.13 80.00 80.85 80.00 67.74 68.00 71.11 66.67 67.78 75.86 68.42 65.22 63.16 58.82 53.85 54.91 50.00 42.42 37.78 78.89 69.89

63 106 110 382 848 74 580 67 336 579 547 227 956 329 716 561 1219 97 108 8569 175 944 435 932 18960

63 105 101 334 704 58 482 63 215 399 385 154 704 234 490 389 787 56 69 4793 92 353 166 738 11,934

100.00 99.06 91.82 87.43 83.02 78.38 83.10 94.03 63.99 68.91 70.38 67.84 73.64 71.12 68.44 69.34 64.56 57.73 63.89 55.93 52.57 37.39 38.16 79.18 71.66

Firm-years

Firms

The table lists the number of firms and firm-years by industry. The data covers the period 2000–2014. Industry classification follows the criteria issued by the Taiwan Stock Exchange (TWSE).

new products or engage in the development of new areas (Lins & Servaes, 2002). Intangible is expected to be positively related to corporate value (Hirshleifer et al., 2013). (i) Leverage: Leverage is the total debt divided by the book value of total assets. According to Doukas and Pantzalis (2003), sufficient external funds can compensate for the lack of internal funds and facilitate diversification promotion. Amihud and Lev (1981) argue that enterprises with high debt financing may reduce risk through diversified operations. Therefore, Leverage is expected to be positively correlated with diversification. (j) Age: Age refers to a firm’s age. Stein (2003) demonstrates that an enterprise’s age is positively correlated with diversification. Thus, Age is expected to have a positive correlation with diversification. Lin and Su (2008) find that younger companies have a higher Tobin’s Q. (k) Size: Size is equal to the natural logarithm of the book value of total assets. A large firm is expected to have more resources and greater risk-taking abilities, which mitigate the requirement to reduce risk through diversification. Moreover, because of the lower unit cost of a product with economies of scale, large firms may enjoy large-scale economic benefits when making diversification-related investments (Berger & Ofek, 1995; Campa & Kedia, 2002; Lins & Servaes, 2002). Therefore, the relationship between diversification and firm size remains an empirical topic. Lin and Su (2008) propose that increasing management complexity in large organizations may impair firm performance. The definitions of the variables are summarized in the Appendix A. 4. Descriptive Statistics 4.1. Sample distribution Table 1 shows the distribution status of the entire sample, family businesses, and non-family businesses by industry. Of the 1913 sample firms, 1170 (69.89%) are family firms. These family businesses are distributed among all industries, accounting for over

85% of firms in the media, paper and allied product, cement and food industries. This indicates that a large percentage of family businesses are engaged in conventional manufacturing industries and the media. Family businesses in the information technology and telecommunication industries account for merely 37.78% and 42.42% of firms, respectively. Overall, Table 1 indicates that approximately 70% of Taiwanese-listed enterprises are family firms, which demonstrates the sizeable influence of such businesses on Taiwan’s economic development. This confirms the view of Villalonga and Amit (2010) that family businesses dominate the development of major industries and play a leading role in the global business environment (Faccio & Lang, 2002).

4.2. Summary statistics 4.2.1. Family firm succession Table 2 shows the succession status of the chairman and CEO of Taiwanese family firms. Panel A in Table 2 presents the replacement status of the chairmen. Notably, about 93% (1087) of family firms did not replace their chairmen in the studied period. Only 83 family firms replaced their chairmen, in 749 instances, which accounted for approximately 6.28% of the total firm-years. The numbers of chairmen of family businesses who bequeathed their positions to second-generation family members (Family Second), non-second-generation family members (Family Non-Second), and hired professionals (Family Hired-CEO) were 128, 77, and 544, respectively, accounting for 1.07%, 0.65%, and 4.56% of the family firm-years. Panel B in Table 2 presents CEO replacement conditions. Approximately 89.14% of the CEOs in family firms were not replaced in the examined period. In total, 127 firms with a frequency of 1480 CEO replacements occurred in Taiwanese family firms, representing 9.84% of the family firm-years. The CEO position was bequeathed to a second-generation family member 54 times, which accounts for 0.45% of the total (Family Second), to other family members 124 times, accounting for 1.04% of the family enterprise sample (Family

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Chairman Non-Change Chairman Change Family Second Family Non-Second Family Hired-CEO Total

Firm

Firm-year

1087 (92.91%) 83 (7.09%)

11,185 (93.72%) 749 (6.28%) 128 (1.07%) 77 (0.65%) 544 (4.56%)

1170 (100%)

11,934 (100%)

1043 (89.14%) 127 (10.86%)

10,760 (90.16%) 1480 (9.84%)

exceeds 5% significance. Tobin’s Q, Legalholder, and Size are negatively and significantly associated with the Herfindahl index. TaGrow, Legalholder, Intangible and ROA are positively and significantly related to Tobin’s Q. IndDiversify, Leverage, Age, and Size are significantly and negatively associated with Tobin’s Q. We conduct variance inflation factor (VIF) tests. No significant collinearity is observed among the variables because no VIF value exceeds 10. The VIF values are listed in Table 5. 5. Empirical results analysis

Panel B CEO replacement CEO Non-Change CEO Change Family Second Family Non-Second Family Hired-CEO Total

7

5.1. Family members and sales diversification 54 (0.45%) 124 (1.04%) 1302 (8.35%) 1170 (100%)

11,934(100%)

The table lists the number of firms and firm-years for the replacement of chairmen and CEOs in Taiwanese family businesses. Family Second, Family Non-Second and Family Hired-CEO present chairman or CEO position passed on to second-generation family members, to a family member who is not second generation and to a nonfamily professional, respectively.

Non-Second), and to hired CEOs 1302 times, accounting for 8.35% (Family Hired-CEO). By comparing Panels A and B in Table 2, we observe that changing the chairman and CEO in family businesses is rare (7.09% and 10.86%), and the frequency at which CEOs are replaced is higher than that for chairmen (1480 vs. 749). Moreover, the proportion of these two positions of non-family is higher than that of family members. Overall, the results in Table 2 indicate that chairmen and CEOs in family businesses tend to be replaced conservatively. However, when it is time to replace the incumbent, the selection of the successor is not limited to family members. 4.2.2. Family and non-family firms Table 3 presents the summary statistics on all observations, and compares the family and non-family firms. The average Herfindahl index is 0.56 for the whole sample. Family firms have similar Herfindahl index to non-family firms (0.56 vs. 0.57). Non-family enterprises perform significantly more favorably than family enterprises in terms of average Tobin’s Q (1.42 vs. 1.30) and ROA (4.32 vs. 3.86), with the difference reaching a 1% significance level. The controlling shareholders (Controlholder) in family firms have larger individual managerial shareholdings at approximately twice those of non-family firms (13.60% vs. 7.57%). Government (Govholder) seem to invest significantly more in non-family firms. Nonfamily firms have higher dividend payment (Dividendr) than family firms, whereas family firms have higher leverage (Leverage), larger size (Size) and greater age (Age) than do non-family firms. (26.45 vs. 20.60 years). Table 3 shows that family firms perform less favorably than nonfamily firms in terms of both Tobin’s Q and ROA; this contradicts the findings of Anderson and Reeb (2003b). This may have been because other studies investigate firms in Western countries where family members typically hold a large number of shares and may closely monitor managers (La Porta et al., 1999). By contrast, in most East Asian countries, including Taiwan, family firms are likely to exhibit inferior performance because of the possible entrenchment by family members because of the divergence between control and cash-flow rights (Claessens et al., 2000). This condition, in contrast to the conventional agency problem, is referred to as the agency problem between a controlling shareholder and minority shareholders (Villalonga & Amit, 2006). Table 4 lists the correlations between the main variables, with bold type indicating that the variables’ association achives or

Tables 5 and 6 present the regression results for diversification by system GMM estimation. The variable Diversifying is the Herfindahl index multiplied by minus one; a high value indicates greater diversification. Because lagged dependent variables are used for GMM estimation, the sample size of Tables 5 and 6 falls from 18,960 to 16,721 firm-year observations. The p values for J statistics of difference in Hansen test for models 1 and 2 are respectively 0.33 and 0.33 as presented in Table 5 and 0.22 and 0.41 as presented in Table 6. These results suggest that the sets of instruments used in the system GMM estimates are valid. The first column of Table 5 shows that the coefficient of Family is insignificant. It indicates that family firm and non-family firm have similar level of product diversification. The second column provides the regression results for the diversification activities of family founders and the various types of successors. The coefficients of Family Founder, Family Second and Family Non-Second are all nonsignificant, indicating that family founders or other family successors engage in a similar level of diversification to non-family firms. Moreover, we find that family firms in which founders or family members pass on their CEO position to outside professionals (Family Hired-CEO) engage in significantly less product diversification than non-family firms (−0.0320, t = −1.76). These findings support Hypothesis 3 but not Hypotheses 1 and 2. Hypotheses 1 and 2 propose that a conservative family culture (Amit et al., 2015) and a family member’s aversion to losing SEW (Gomez-Mejia et al., 2010) may cause family firms to engage in less diversification than non-family firms. With respect to the results regarding Hypotheses 1 and 2, we provide some explanations. As presented in Table 1, Taiwanese family firms tend to hold most of their shares in low-risk businesses. The number of family firms in high-tech industries, such as electronics, telecommunications, and information technology, is much lower than that in other industries, suggesting that family firms have less need to engage in diversification to reduce wealth portfolio risk than non-family firms. We further investigated the controlling status of Taiwanese family businesses. We define the controlling shareholders of a firm based on La Porta et al. (1999) and find that the managerial ownership held by the controlling shareholder in a family firm is 13.60%, which is significantly higher than the 7.57% of managerial ownership held by the controlling shareholder in non-family firms (Controlholder in Table 3). We also find that over half of board seats are obtained by controlling shareholders in family firms (57.76% of Vote in Table 3), and this ratio is significantly higher than the 49.68% of seats held by controlling shareholders in non-family firms. We also observe that the ratio of directors appointed for managerial positions in family firms is approximately 26.70%, which is higher than the 24.39% in non-family firms (Dirduality in Table 3). The higher rates of ownership, board seats, and duality in managerial positions indicate that Taiwanese family firms typically reinforce their control over a business through several mechanisms that have been described by La Porta et al. (1999) and Claessens et al. (2000). Therefore, we conclude the concern for losing SEW through diver-

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8 Table 3 Summary statistics. (a) All firms

Herfindahl Tobin’s Q TaGrow Controlholder (%) Goveholder (%) Legalholder (%) Intangible (%) IndDiversify ROA(%) Dividendr (%) Leverage (%) Age Size Vote Dirduality Number of Firm-years

(b) Family firms

(c) Non-Family firms

Diff. in Means (b)-(c)

Mean

Median

Std. Dev.

Min.

Max.

Mean

Std. Dev.

Mean

Std. Dev.

(b)-(c)

t-stat.

0.56 1.35 0.11 11.37 0.73 37.78 0.01 0.49 4.03 0.03 43.97 24.28 15.29 54.77 25.85

0.51 1.11 0.05 7.39 0.00 35.04 0.003 0.49 4.25 0.02 43.64 22.00 15.03 50.00 20.00 18960

0.27 0.77 0.45 12.74 3.32 22.52 0.03 0.07 8.99 0.03 19.20 12.87 1.58 22.28 17.56

1.00 0.29 −0.88 0.00 0.00 0.00 0.00 0.17 −28.90 0.00 0.58 2.00 9.80 0 0

0.00 6.00 18.00 85.16 26.00 90.00 0.15 0.86 28.27 0.12 45.33 97.00 22.66 100 100

0.56 1.30 0.11 13.60 0.39 37.63 0.01 0.49 3.86 0.02 44.67 26.45 15.33 57.7622 26.70 11,934

0.27 0.72 0.48 13.76 1.82 22.77 0.02 0.07 8.53 0.45 18.90 13.00 1.57 22.60 17.70

0.57 1.42 0.11 7.57 1.32 38.05 0.01 0.48 4.32 0.03 42.77 20.60 15.22 49.68 24.39 7026

0.27 0.83 0.40 9.67 4.86 22.98 0.02 0.06 9.71 0.03 19.64 11.63 1.58 20.73 17.23

−0.01 −0.12 0.00 6.03 −0.93 −0.42 0.00 0.01 −0.46 −0.01 1.82 5.85 0.11 8.08 9.47

−1.50 −10.70*** 0.50 32.31*** −18.79*** −1.24 1.62 1.73* −3.43*** −4.97*** 6.57 *** 31.15** 4.50*** 24.52*** 8.88***

This table provides summary statistics of all observations and compares the difference of family and non-family sub-samples. Variables are defined in Appendix. The asterisks *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively.

Table 4 Correlations.

1 Herfindahl 2 Tobin’s Q 3 TaGrow 4 Controlholder Largeholderltimate 5 Goveholder 6 Legalholder 7 Intangible 8 IndDiversify 9 ROA 10 Dividendr 11 Leverage 12 Age 13 Size

1

2

3

4

1.000 −0.056−0.056 −0.011−0.011 0.047

1.000 0.138 0.010

1.000 −0.002−0.002

1.000

0.016 −0.054 0.014 0.142 0.027 −0.009 0.058 0.130 −0.026

0.009 0.093 0.067 −0.035 0.385 −0.001 −0.183 −0.214 −0.129

−0.008 0.052 0.002 0.023 0.027 0.020 0.022 −0.067 0.041

−0.131 −0.483 0.003 0.037 0.073 0.021 −0.064 0.093 −0.242

5

6

7

8

9

10

11

12

13

1.000 0.209 −0.008 0.025 0.032 0.036 0.017 0.059 0.225

1.000 0.032 −0.011 0.170 0.114 0.079 −0.042 0.363

1.000 −0.028 −0.049 −0.048 −0.042 −0.051 0.001

1.000 0.027 −0.058 0.035 −0.065 0.011

1.000 0.296 −0.301 −0.237 −0.248

1.000 −0.159 0.046 0.097

1.000 0.094 0.345

1.000 0.267

1.000

Variable definitions are in Appendix. Bold text indicates significance at the 0.05 level or better.

sification in family firms might be not a major concern because family firms can reinforce their control and maintain SEW through other controlling mechanisms. With respect to Hypothesis 3, our results demonstrate that family firms passing the CEO position to an externally hired professional (Family Hired-CEO) engage in less diversification than non-family firms. As explained by Zahra (2005), successful diversification operations require funds, professional capabilities, advanced technology, and possibly organizational changes. Family members may be concerned about the diminution of family members’ equity or control caused by diversification activities. In addition, major family shareholders might monitor managers to prevent a free cash flow problem (Jensen, 1986; Shleifer & Vishny, 1986). For the case of Taiwan, controlling shareholders in family firms usually have a higher percentage of ownership than those in nonfamily firms (13.60% vs. 7.57% of Controlholder in Table 3). The high percentage of ownership creates greater incentives for family controlling shareholders to monitor hired professionals to avoid agency cost of cash flow. In addition, because family controlling shareholders tend to, on average, hold more than half the board seats (57.76% of Vote in Table 3), they can exercise more strict oversight of managers’ diversification decisions. These may in turn cause controlling shareholders in family firms to restrict the diversification proposed by hired CEOs. Our regression results correspond with those of Dunn (1996) and Hall et al. (2004) and confirm our Hypothesis 3.

In terms of the control variables, IndDiversify is significant and has positive associations with diversification, indicating that a firm is likely to engage in diversification activities when more firms engage in diversification in its industry. An older firm (Age) is likely to conduct diversification activities. The results are in agreement with the findings of Lin and Su (2008) and Stein (2003). 5.2. Family firm diversification and performance Table 6 presents the performance regression results of diversification activities by family founders and the various types of successors through system GMM estimation. The dependent variable is Tobin’s Q. Table 6 shows that past performance (Tobin’s Q (one-lag)) is significantly positive in all columns. This indicates that past performance explains much of the variation in the current performance, and this is in agreement with the findings of Wintoki et al. (2012). The first column in Table 6 indicates that the coefficient of Diversifying is significantly negative, indicating that more product diversification is related to lower performance than not diversifying for non-family firms (coefficient=-0.9187, t=-1.82). This finding corresponds with those of Lang and Stulz (1994); Matsusaka (2001), and Campa and Kedia (2002), who find that diversified firms have discounted values. The coefficient of Family in first column is significantly positive (coefficient = 0.8437, t = 1.84). Because our definition of family firm is primarily based on whether family members hold chairman or CEO positions, our finding corresponds with

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9

Table 5 Product Diversification by family firms and successors. (1) Expected sign Diversifying(one-lag) + Family Family Founder Family Second Family Non-Second Family Hired-CEO cessort + TaGrow Govholder Legalholder Controlholder IndDiversity + ROA + Dividend + + Intangible + Leverage + Age +/Size + Tobins Q Intercept Industry effect Year effect Observations AR(1) test (p value) AR(2) test (p value) Hansen test of over-identification (p value) Diff-in-Hansen test of exogeneity (p value)

(2)

VIF

Coefficients

t-statistics

Coefficients

t-statistics

1.04 1.05 1.15 1.15 1.04 1.09 1.05 1.12 1.44 1.40 1.02 1.53 1.11 1.03 1.31 1.29 1.54 1.36

0.9179*** 0.0002

(18.39) (0.02)

0.9072***

(17.28)

0.0104 0.0069 −0.0391 −0.0320* −0.0487 0.0044 0.0055*** −0.0016 0.2370*** −0.0005 −0.3169 −1.1089 0.0287 0.0287** −0.0187 0.0176 −0.0685 Yes Yes 16721 (0.00) (0.29) (0.11) (0.33)

(0.45) (0.22) (-1.18) (-1.76) (-0.99) (0.77) (2.07) (-1.22) (6.89) (-0.15) (-0.47) (-3.20) (2.37) (2.37) (-1.47) (0.44) (-0.29)

−0.0542 0.0025 0.0014** −0.0015 0.2420*** −0.0005 −0.3600 −1.1428 0.0019*** 0.0148 −0.0196 0.0126 −0.0471 Yes Yes 16721 (0.00) (0.30) (0.52) (0.33)

(-0.77) (0.43) (1.98) (-1.14) (7.25) (-0.10) (-0.52) (-3.41) (2.63) (1.15) (-1.46) (0.31) (-0.19)

The dependent variable is Diversifying, which is the Herfindahl index multiplied by −1. Family Founder, Family Second, Family Non-Second mean the founder as chairman or CEO, the chairman or CEO position is held by a second-generation family member, or by family member who is not in the second generation. Family Hired-CEO is a dummy variable equal to one if non-family members take over a family firm’s chairman or CEO position. Variables are defined in Appendix. Wald test checks for the joint significance of the explanatory variables. AR(1) and AR(2) are tests for first-order and second-order serial correlation in the first-differenced residual, under the null of no serial correlation. Hansen test of over-identification is under the null of no correlation between the instruments and the error term. Diff-in-Hansen test of exogeneity is under the null that instruments used for the equations in levels are exogenous. Heteroskedasticity-robust corrected coefficients are presented. The asterisks *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively.

that of Anderson and Reeb (2003b), who find that family members with active involvement in management positions improve firm performance. The coefficient of the interaction of Family and Diversifying was positive at a 10% marginal significance level (coefficient = 1.1558, t = 1.60). This indicates that family firms possess higher market performance through product diversification than non-family firms. The second column in Table 6 indicates the relationship between various types of family members and diversification performance. The coefficients of Family Founder, Family Second, Family NonSecond and the coefficients of their interactions with Diversifying are all nonsignificant. By contrast, the Family Hired-CEO coefficient and its interaction with Diversifying are positive and significant at the 5% level (coefficient = 0.8961, t = 2.15 for Family Hired-CEO; coefficient = 1.5493, t = 2.14 for the interaction term with Diversifying), meaning that the Tobin’s Q of a family firm with a hired CEO increases with diversification. For example, in a company with a hired-CEO as successor whose Herfindahl index is 0.4, Tobin’s Q increases by 0.2584 relative to a non-family firm. In a company with hired-CEO and a higher diversification level whose Herfindahl index is 0.2, Tobin’s Q increases by 0.5772 relative to a non-family firms1 . This provides supporting evidence to explain the higher Tobin’s Q in diversified family firms, which is mostly attributable to the effort by hired-CEOs. The findings support Hypothesis 6 but not Hypotheses 4 and 5.

1 Divrsifying= Herfindahl*(-1). In a company with a hired-CEO as successor whose Herfindahl index is 0.4, the increase of Tobin’s Q relative to that of a nonfamily=0.8961+1.5943(-0.4)=0.2584. In a company with a hired-CEO as successor whose Herfindahl index is 0.2, the increase of Tobin’s Q relative to a non-family =0.8961+1.5943(-0.2)=0.5772. A lower Herfindahl index value indicates a higher diversification level.

We provide some explanation for the empirical findings regarding Hypotheses 4 and 5. Hypotheses 4 and 5 predict that family firms led by a founder or a family member successor would have inferior performance because of the restricted knowledge inside family firms. However, as determined by Purkayastha et al. (2012) and Masulis et al. (2011), diversification activities undertaken by family members may obtain more internal funding and information from family group firms, and this higher level of internal resources may balance out the disadvantage of lack of external knowledge for diversification activities. This result implies that the diversification conducted by family members might be endogenous, agreeing with Fauver et al. (2003). By contrast, our results demonstrate that family firms with hired CEOs can improve firm performance by engaging in diversification, supporting Hypothesis 6. This may be because the hired-CEOs as successors make diversification decisions more carefully under family member’s monitoring, and their expertise enhances firms’ diversifying performance. Gomez-Mejia, NunezNickle, and Gutierrez, (2001) state that family CEOs are less accountable to shareholders than are outside professional managers. Zahra et al. (2004) propose that successful diversification requires new knowledge and organizational reform. Our findings agree to their propositions. The findings imply the importance of external managerial expertise and family members’ monitoring to make an appropriate diversification decision. Our performance analysis corresponds with that of Villalonga and Amit (2006), and Karaevli (2007), who state that hired CEOs could improve family firm value. Regarding the control variables listed in Table 6, the coefficient of Size is negative and significant, indicating that Tobin’s Q decreases as firm size grows. This might be a reflection of the fact that large firms tend to have a lower growth rate than small firms or

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Table 6 Product diversification and performance. (1)

Tobin’s Q (one-lag) Diversifying Family Familyt *Diversifying Family Founder Family Founder *Diversifying Family Second Family Second *Diversifying Family Non-Second Family Non- Second *Diversifying Family Hired-CEO Family Hired-CEO*Diversifying Govholder Legalholder Controlholder TaGrow Intangible Age Size Leverage Intercept Industry effect Year effect Observations AR(1) test (p value) AR(2) test (p value) Hansen test of over-identification (p value) Diff-in-Hansen test of exogeneity (p value)

(2)

Expected sign

VIF

Coefficients

t-statistics

Coefficients

t-statistics

+ +/+/+/+ + +/+ + +/+ + +

1.21 2.31 5.63 7.09 5.82 6.30 5.60 5.50 5.37 5.43 6.08 5.50 1.12 1.42 1.38 1.06 1.01 1.28 1.51 1.25

0.6805*** −0.9187* 0.8437* 1.1558*

(10.68) (-1.82) (1.84) (1.60)

0.6752 −0.7758*

(8.44) (-1.62)

0.4986 0.9157 0.0677 0.1444 −0.0829 −0.1155 0.8961*** 1.5943*** −0.0077 0.0024 0.0034 0.2274 0.6778 −0.0117 −0.0533** 0.0035* 0.0663 Yes Yes 16721 (0.00) (0.22) (0.44) (0.41)

(1.42) (1.42) (0.04) (0.05) (-0.06) (-0.05) (2.15) (2.14) (-0.14) (0.97) (0.78) (1.09) (0.79) -(0.46) (-2.46) (1.84) (0.18)

−0.0075 0.0021 0.0017 0.2611 0.1919 −0.0005 −0.0532*** 0.0035*** −0.0268 Yes Yes 16721 (0.00) (0.19) (0.39) (0.22)

(-0.54) (1.14) (0.54) (1.27) (0.26) (-0.02) (-2.95) (2.05) (-0.08)

The dependent variable is Tobin’s Q. Family Founder, Family Second, Family Non-Second mean the founder as chairman or CEO, the chairman or CEO position is held by a second-generation family member, or by family member who is not in the second generation. Family Hired-CEO is a dummy variable equal to one if non-family members take over a family firm’s chairman or CEO position. Variables are defined in Appendix. Wald test checks for the joint significance of the explanatory variables. AR(1) and AR(2) are tests for first-order and second-order serial correlation in the first-differenced residual, under the null of no serial correlation. Hansen test of over-identification is under the null of no correlation between the instruments and the error term. Diff-in-Hansen test of exogeneity is under the null that instruments used for the equations in levels are exogenous. Heteroskedasticity-robust corrected coefficients are presented and t statistics are presented in parentheses. The asterisks *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively.

inefficient operations because of the complexity of management in large firms (Lin & Su, 2008). A firm with higher leverage (Leverage) seems to achieve superior performance. 5.3. Additional test-related and unrelated diversification In recent years, the influence of related and unrelated diversification on firm performance has been noted. Family firms usually have restricted manpower and external financial resources that can hinder the firms’ pursuit of unrelated diversification. The concern for protecting family-based business or its controlling power may prevent firms from pursuing unrelated diversification because new managerial expertise or external funding might be required (Zahra, 2005); this may threaten family members’ controlling rights. Gomez-Mejia et al. (2010) propose that family firms are more likely to choose domestic rather than international diversification. Based on these statements, family firms are expected to have less unrelated diversification than non-family firms. Although related diversification could transfer knowledge efficiently through related acquisitions (Villasalero, 2017), some researchers suggest that unrelated diversification results in superior firm performance than does related diversification. As Khanna and Palepu (2000) state, unrelated diversification develops internal resources that allow business groups to mitigate institutional voids, such as a weak distribution system, legal system, capital markets, or supply-chain mechanisms. On the basis of their observations, they argue that unrelated diversification is particularly suited to the institutional context in most developing countries. Additionally, unrelated diversification helps firms construct and maintain preferred access to the regulatory bureaucracy (Ghemawat & Khanna, 1998), and this helps firms obtain infor-

mation and benefit its business, particularly in weak institutional environments in which relationship-based strategies outperform rule-based strategies (Peng, 2003). On the basis of these arguments, unrelated diversification is expected to create higher value than does related diversification in family firms. As family firms and their members may exhibit different attitudes toward related and unrelated diversifications, we investigate related and unrelated diversification activities and the outcomes of firm performance. Within investment diversification, related diversification is often defined according to industry-based SICs (Arikan & Stulz, 2016; Sambharya, 2000). Because no related or unrelated sales information is available for Taiwanese firms, we use M&A data to investigate related and unrelated diversifications (MA related and MA unrelated) in our sample firms. A deal is defined as a related M&A when the acquirer and target belong to the same industry categories defined by the TWSE. By applying the model developed by Arikan and Stulz (2016), we investigate the M&A activity for 1913 sample firms from 2000 to 2014 by using the negative binominal model to account for overdispersion because the dependent variable is the total number of acquisitions made by firms. Our M&A regression results show that family firms, either led by founders or other family members, do not have significantly different M&A activities than non-family firms. However, family founders exhibit a lower intention to engage in related M&A activities. These findings, which correspond to Anderson and Reeb (2003a), indicate that family founders concentrate on their core business and are less inclined to engage in acquisition deals. We further conduct performance regressions of overall, related, and unrelated M&A activities of family firms by using the interaction terms of Family, MA, MA related and MA unrelated. The results indicate that only the coefficient of the interaction term of Family and

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MA unrelated is positive and significant at the 10%, and the coefficient of other interaction terms are insignificant. One possible explanation is that only approximately 20 family firms engaged in M&A activities during the sample period. In general, the additional test suggests that family firms, particularly when led by their founders, do not acquire other firms. However, only unrelated diversification acquisitions improve firm performance. These findings correspond to neoclassical diversification theory in that unrelated diversification enhances firm value by reducing firm risk (Encarnation, 1989; Khanna & Palepu, 2000). Considering M&A activities are different from product diversification as mentioned above, the regression results are not reported for brevity.

6. Conclusion Because more than 75% of global business is controlled by family enterprises, their corporate governance mechanisms, including the founder-succession policy, and the business strategies of the successors are assessed (PwC, 2016). This study uses Taiwanese enterprises as a sample to investigate whether the founders and various types of successors exhibit different attitudes toward diversification investment and analyzes family business performance in relation to diversification. The results demonstrate that compared with non-family businesses, family firms, led either by a founder or second-generation heir or other family member, exhibit similar level of product diversification relative to non-family firms. Neither founders nor any type of family successors have significantly different performance as compared to non-family firms. By contrast, family firms with an externally hired CEO as the successor tend to undertake less diversification activities than non-family firms but tend to improve firm value when they do engage in diversification. We perform additional test by using acquisitions data. The results indicate that family firms do not undertake significantly different M&A activities compared with non-family firms, and unrelated acquisitions rather related acquisitions improve family firm value in marginal significance. Our results have three management implications. First, traditional agency theory holds that family firms may seek to reduce family members’ portfolio risk, which induces a higher level of diversification. The BAM predicts that the actions taken by family firms may reflect an aspiration to avoid losing SEW (Gomez-Mejia et al., 2010) and thus entail a lower level of diversification. Rather than undertaking an overall performance analysis, we identify various types of family successors and assess their association with diversification performance. Our findings provide evidence that family firms, led by either founders or other family members, exhibit diversification and performance levels similar to those of non-family firms. These findings imply that family members’ engagement in diversification might be an endogenous result that depends on the net effect of the benefits and costs from diversification, agreeing with Fauver et al. (2003). We also find that family firms with hired CEOs may engage in less diversification activities than non-family firms but they create higher value than non-family firms when they do engage in diversification. This finding implies that non-family successors may undertake more careful and better diversification activities under family supervision in family firms. Jensen (1986) and Shleifer and Vishny (1986) argue that major shareholders could monitor managers and reduce the free cash flow problem. Our results provide new evidence that family members may monitor the diversification activities proposed by hired CEOs. Our findings elucidate the relationship between family firm performance and succession. As Martinez and Requejo (2017) state, generational changes pose one of the most substantial challenges

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to the success of family firms. Bennedsen et al. (2015) state that the decision quality of family firm successors is an essential factor that will influence family growth and survival. How family firm successors develop a successful succession plan to enhance firm value is a key management concern for family firms pursuing longevity. Our results are based on a culturally specific sample that was used to address family firm value and controlling rights (Claessens et al., 2000). The findings provide insights into how a hired CEO can enhance the value of a family firm through diversification during the post-succession period. Finally, the interpretation of our research is limited to the specific sample of Taiwan in which founder-family firms are predominant and succession occurs less frequently. This condition stems from the late economic development of Taiwan that began in the 1970s and corporate governance data are only available starting from the year 2000. Future research could extend its scope to encompass other family samples that cover a longer time span. Appendix A Table A1. Table A1 Variables and definitions. Variable

Definition

Family

Dummy variable equal to one if the founder or his/her family member serves as chairman or CEO; zero otherwise. Dummy variable equal to one if a founder acts as the chairman of a family firm; zero otherwise. Dummy variable equal to one if a family firm’s chairman or CEO is the founder’s child; zero otherwise. Dummy variable equal to one if a family firm’s chairman or CEO is one of the founder’s relatives but not a child; zero otherwise. Dummy variable equal to one if the founder or a relative serves as chairman and hires an outside professional for the CEO position; zero otherwise. Diversification index calculated by summing the squares of sales ratios for the departments of a company in each year. The Herfindahl index multiplied by −1. The year-end market value of common stock plus the book value of preferred stock and debt over the year-end book value of a firm’s total assets. The year-end asset value divided by prior year-end assets minus one. Government shareholdings divided by total shareholdings. Shareholdings held by financial institutions and corporate entities divided by total shareholdings. Ownership held by controlling shareholders whose direct and indirect voting rights are over 20%, as defined by La Porta et al. (1999). The ratio of firms with high diversification to the total number of firms by industry. Operating income plus depreciation expenses divided by total assets. Annual dividend payment divided by market equity. Intangible asset value divided by total assets. Ratio of total debt to total assets. Firm age counted from the year it was established to the referenced sample period from year 2000 to 2014. Log value of total assets. The ratio of board seats held by controlling shareholders, as defined by La Porta et al. (1999). The ratio of directors who also serve as managers.

Family Founder Family Second Family Non-Second

Family Hired-CEO

Herfindahl

Diversifying Tobin’s Q

TaGrow Govholder Legalholder Controlholder

IndDiversity ROA Dividendr Intangible Leverage Age Size Vote Dirduality

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Please cite this article in press as: Chou, S. -C., & Shih, C.-J. Like father, like son? Diversification decision and related performance of family firm successors – Evidence from Taiwan. The Quarterly Review of Economics and Finance (2019), https://doi.org/10.1016/j.qref.2019.04.012