A Theory of Pyramidal Ownership and Family Business Groups

We provide a rationale for pyramidal ownership (the control of a firm through a chain of ownership relations) that departs from the traditional argument that pyramids arise to separate cash flow from voting rights. With a pyramidal structure, a family uses a firm it already controls to set up a new firm. This structure allows the family to 1) access the entire stock of retained earnings of the original firm, and 2) to share the new firm's non-diverted payoff with minority shareholders of the original firm. Thus, pyramids are attractive if external funds are costlier than internal funds, and if the family is expected to divert a large fraction of the new firm's payoff; conditions that hold in an environment with poor investor protection. The model can differentiate between pyramids and dual-class shares even in situations in which the same deviation from one share-one vote can be achieved with either method. Unlike the traditional argument, our model is consistent with recent empirical evidence that some pyramidal firms are associated with small deviations between ownership and control. We also analyze the creation of business groups (a collection of multiple firms under the control of a single family) and find that, when they arise, they are likely to adopt a pyramidal ownership structure. Other predictions of the model are consistent with systematic and anecdotal evidence on pyramidal business groups.

Do CEOs matter?

Estimating the value of top managerial talent is a central topic of research that has attracted widespread attention from academics and practitioners. Yet, studying the impact of managers on firm performance is difficult because of endogeneity and omitted variables concerns. In this paper, we test for the impact of managers on firm performance in two ways. First, we examine whether top executive deaths have an impact on firm performance, focusing on the manager and firm characteristics that are associated to large manager-death effects. Second, we test for the interaction between the personal and professional activities of managers by examining the effect of deaths of immediate family members (spouses, parents, children, etc) on firm performance. Our main findings are three. First, CEO deaths are strongly correlated with declines in firms operating profitability, asset growth and sales growth. Second, the death of board members does not seem to affect firm prospects, indicating that not all senior managers are equally important for firms' outcomes. Third, CEOs' immediate family deaths are significantly negatively correlated to firm performance. This last result suggests a strong link between the personal and business roles that top management plays, a connection that is present even in large firms. Overall, our findings demonstrate CEOs are extremely important for firms' prospects.

Investor Protection and Equity Markets

We present a simple model of an entrepreneur going public in an environment with poor legal protection of outside shareholders. The model incorporates elements of Becker's (1968) "crime and punishment" framework into a corporate finance environment of Jensen and Meckling (1976). We examine the entrepreneur's decision and the market equilibrium. The model is consistent with a number of empirical regularities concerning the relation between investor protection and corporate finance. It also sheds light on the patterns of capital flows between rich and poor countries and on the politics of reform of investor protection

Corporate Governance, Economic Entrenchment and Growth

Around the world, large corporations usually have controlling owners, who are usually very wealthy families. Outside the U.S. and the U.K., pyramidal control structures, cross shareholding and super voting rights are common. Using these devices, a family can control corporations without making a commensurate capital investment. In many countries, such families end up controlling considerable proportions of their countries'' economies. Three points emerge. First, at the firm level, these ownership structures vest dominant control rights with families who often have little real capital invested creating agency and entrenchment problem simultaneously. In addition, controlling shareholders can divert corporate resources for private benefits using transactions within the pyramidal group. The result is a poor utilization of resources. At the economy level, extensive control of corporate assets by a few families distorts capital allocation and reduces the rate of innovation. The result is an economy-wide misallocation of resources, and slower economic growth. Second, political influence is plausibly related to what one controls, rather than what one owns. The controlling owners of pyramids thus have greatly amplified political influence relative to their actual wealth. They appear to influence the development of both public policy, such as property rights protection and enforcement, and institutions like capital markets. We denote this phenomenon economic entrenchment. Third, we conceive of a relationship between the distribution of corporate control and institutional development that generates and preserves economic entrenchment as one equilibrium; but not the only one. Based on the literature, we identify key determinants of economic entrenchment. We also identify many gaps where further work exploring the political economy importance of the distribution of corporate control is needed.

Dissecting the Effect of Credit Supply on Trade: Evidence from Matched Credit-Export Data

We estimate the elasticity of exports to credit using matched customs and firm-level bank credit data from Peru. To account for non-credit determinants of exports, we compare changes in exports of the same product and to the same destination by firms borrowing from banks differentially affected by capital-flow reversals during the 2008 financial crisis. We find that credit shocks affect the intensive margin of exports, but have no significant impact on entry or exit of firms to new product and destination markets. Our results suggest that credit shortages reduce exports through raising the variable cost of production, rather than the cost of financing sunk entry investments.

Should Business Groups be Dismantled?The Equilibrium Costs of Efficient Internal Capital Markets

We analyze the relationship between conglomerates’ internal capital markets and the efficiency of economy-wide capital allocation, and identify a novel cost of conglomeration that arises from an equilibrium framework. Because of financial market imperfections engendered by imperfect investor protection, conglomerates that engage in “winner-picking” (Stein, 1997) find it optimal to allocate scarce capital internally to mediocre projects, even when other firms in the economy have higher productivity projects that are in need of additional capital. This bias for internal capital allocation can decrease allocative efficiency even when conglomerates have efficient internal capital markets, because a substantial presence of conglomerates might make it harder for other firms in the economy to raise capital. We also argue that the negative externality associated with conglomeration is particularly costly for countries that are at intermediary levels of financial development. In such countries, a high degree of conglomeration, generated for example by the control of the corporate sector by family business groups, may decrease the efficiency of the capital market. Our theory generates novel empirical predictions that cannot be derived in models that ignore the equilibrium effects of conglomerates. These predictions are consistent with anecdotal evidence that the presence of business groups in developing countries inhibits the growth of new independent firms due to lack of finance

Dissecting the Effect of Credit Supply on Trade: Evidence from Matched Credit-Export Data

This paper presents evidence on the effect of credit supply shocks on exports. Capital flow reversals in Peru during the 2008 financial crisis induced a decline in the supply of credit by domestic banks with high share of foreign-currency denominated liabilities. We use this variation to estimate the elasticity of exports to bank credit. We use matched customs and firm-level bank credit data to control for non-credit related factors that may also affect the level of exports: we compare changes in exports of the same product and to the same destination by firms borrowing from different banks. Exports react strongly to changes in the supply of credit in the intensive margin, irrespectively of the firms' export volume. In the extensive margin, the negative credit supply shock increases the probability of exiting a product-destination export market, but does not significantly affect the number of firms entering an export market. The magnitude of the respective elasticities, as well as their heterogeneity across firm and export flow observable characteristics, are estimated.

Corporate Governance, Economic Entrenchment and Growth

Around the world, large corporations usually have controlling owners, who are usually very wealthy families. Outside the U.S. and the U.K., pyramidal control structures, cross shareholding and super voting rights are common. Using these devices, a family can control corporations without making a commensurate capital investment. In many countries, such families end up controlling considerable proportions of their countries’ economies. Three points emerge. First, at the firm level, these ownership structures vest dominant control rights with families who often have little real capital invested creating agency and entrenchment problem simultaneously. In addition, controlling shareholders can divert corporate resources for private benefits using transactions within the pyramidal group. The result is a poor utilization of resources. At the economy level, extensive control of corporate assets by a few families distorts capital allocation and reduces the rate of innovation. The result is an economy-wide misallocation of resources, and slower economic growth. Second, political influence is plausibly related to what one controls, rather than what one owns. The controlling owners of pyramids thus have greatly amplified political influence relative to their actual wealth. They appear to influence the development of both public policy, such as property rights protection and enforcement, and institutions like capital markets. We denote this phenomenon economic entrenchment. Third, we conceive of a relationship between the distribution of corporate control and institutional development that generates and preserves economic entrenchment as one equilibrium; but not the only one. Based on the literature, we identify key determinants of economic entrenchment. We also identify many gaps where further work exploring the political economy importance of the distribution of corporate control is needed

Governance Problems in Close Corporations

More than 90 percent of all US firms are close corporations, and these firms account for 51 percent of the private sector output and 52 percent of all private employment. Understanding governance issues and agency problems facing these firms is therefore of considerable importance. The legal and finance literature argues that the main governance problem in close corporations is not so much between the management and the shareholders as between the majority and the minority shareholders. As a solution, this literature recommends that the main shareholder in close firms surrender some control to minority shareholders at the outset. With shared control rights, no shareholder can take unilateral actions for her own benefit at the expense of the firm and other shareholders. We test this hypothesis using two independent novel datasets of close corporations. We find that shared ownership firms report substantially larger return on assets (up to 14 percentage points) and lower expense-to-sales ratios and these findings persist after we control for the endogeneity of ownership structure. We thus provide one of the first evidence on the presence of governance problems among shareholders in close corporations as well as the effectiveness of shared ownership as a solution

The Family Behind the Family Firm: Evidence from Successions in Danish Firms

This paper uses a unique dataset from Denmark to examine the impact of owners’ family characteristics (size, gender composition, divorce, etc) on the decision to appoint internal (family) or external chief executive officers (CEOs). In contrast to common perceptions, we find that conditional on observing family CEO transitions, within cohort (spouse, siblings) successions are at least as prevalent as subsequent generation transitions. When assessing the impact of family characteristics on subsequent generation CEO appointments, we find that the probability of observing a family succession increases with the number of children, decreases with the ratio of female children, and decreases with divorce, particularly when it is accompanied with a new marriage and a new family. To show that these results are not spurious, we use instrumental variables. Overall, we find that family dynamics play a significant role in firm decision-making even when families are not the sole owner of these firms