When is excess control of a business group too much?

A new study provides a more nuanced view of the pros and cons

Tightly held majority control of a group of businesses is often understood to be a benefit, something that offers competitive advantage.

After all, it allows for the greater flexibility and cost-savings offered by centralised management. It creates the opportunity for negotiation across a broader spectrum, as opposed to each entity managing its own lesser requirements. It also promotes a consistency of management, starting from one entity that was successful enough to spawn another.

However, the assumption that such 'excess control' of a business or a group of businesses is a positive has been questioned in a research study by a team of academics from UNSW Business School.

As an illustration of the purpose of their work, they observe a 2007 incident that rocked the Taiwanese business community.

Two companies, both part of the Rebar Asia-Pacific Business Group, filed for insolvency protection due to extraordinary losses and caused a run on the group's Chinese bank.

The Rebar Group was a large, market-leading conglomerate originally established in 1959 and contained six listed companies as well as more than 100 affiliates. The group's assets in 2005 exceeded US$10 billion.

After an investigation, the Taiwanese government charged 107 suspects, including nine members of the Wang family which had excess control over the group through executive positions and board seats. They had illegally siphoned US$2.2 billion throughout the preceding decade, then applied for large loans using dummy companies.

By the time the case was investigated, five of the six listed businesses were suffering heavy financial losses.

‘We have discovered that the relationship between excess control and performance is not as clear cut as has been presented in the past’

GAVIN SCHWARZ

Business governance in Asia

The dangers of excess control – in which an individual or a small group of people or, indeed, a state, hold control of an organisation or group of businesses far in excess of their ownership and cash flow rights – are not restricted to intentional criminal activity.

Sometimes the negative issue is simply a lack of focus, as some argue was caused by the Masters failure in Australia being managed by already-busy executives within the Woolworths Group.

There are several issues that investors, analysts and related businesses must be aware of. Such issues will become more important as the Australian market integrates more closely with Asia's.

Business groups – networks of legally independent firms – under the rule of excess ownership are common throughout Asia, such as in Taiwan, The Philippines, South Korea and Japan.

Of course, in our own vicinity we have similar entities, they are simply not as numerous. Names such as Packer and Murdoch loom large across various industry groups because they operate in a similar manner.

"This is one of the very popular forms of business governance in the Asian region," says Gavin Schwarz, an associate professor at UNSW Business School and one of the authors of A multi-level analysis of the performance implications of excess control in business groups.

"It is very important for us, particularly in Australia, to understand that we operate in that market. This knowledge has real value in terms of understanding business groups in the Australasian region.

"We have been deconstructing how these business groups form and looking into what affects their performance related to market competitiveness. We have discovered that the relationship between excess control and performance is not as clear cut as has been presented in the past."

Past ambiguous research, Schwarz says, shows that some firms within a business group benefit at the expense of others. Other studies demonstrate discrepancies around the links between ownership practices and firm efficiencies.

An inverted U-shaped relationship

In this latest study, the researchers looked into the performance of 106 Taiwanese business groups to confirm that the effects of excess control are double-edged.

"Essentially, the effects of excess control are varied," Schwarz says. "Interestingly, despite the example of the Rebar Group being family owned, we found that detrimental effects of excess control are far less pronounced in family owned groups."

Excess control can sometimes represent risk. Cross-holding among affiliated companies and pyramidal structure, the academics point out, make ownership and control in business groups difficult to trace and understand. This means the desired performance effect of excess control becomes unpredictable as firm-level and group-level decisions lose their specificity and clarity.

Also, they say, various types of excess control tend to have different effects on performance. As mentioned, family controlled business groups (very common in Asia) generally perform better than non-family groups.

The reason is not yet clear, though it may have something to do with common management philosophies and a sense of responsibility to manage the business appropriately for future family generations.

In general, the study identified an inverted U-shaped relationship between group-level excess control and group-level performance.

In other words, the greatest financial performance was experienced by business groups that had an average level of excess control. Very low levels and very high levels of excess control both resulted in lower group performance.

The empirical results of the study deviated from the traditional view of excess control as always being a positive in terms of competitiveness.

When shareholders or other stakeholders seize disproportionate control in excess of their ownership, Schwarz says, the intention is most often to keep the group as competitive as possible. But that is not always the result.

"Our results show that the prevalence and severity of this expropriation of controlling shareholders within pyramidal groups is far from clear-cut, and that the negative effect of excess control rights is less pronounced in family owned groups," he says.

‘These results suggest that a direct effect of excess control cannot occur without necessarily considering contingent situations’ 

GAVIN SCHWARZ

Contingent situations

What does it all mean in a practical sense? Any consideration of an independent business, whether for investment, analysis or other business relationship purpose, must be taken with a clear understanding of the level of group ownership and control the independent business operates within.

"In contrast to the assumption that the controlling shareholders magnify the separation between ownership and control, our findings indicate a more nuanced perspective and underscores a need to distinguish better firm performance from group performance in business group settings," the authors say.

"This finding is especially pertinent in emerging economy environments where family based business groups are the dominant organisational form for managing large businesses."

It is also important to note the positive links between excess control and performance, Schwarz says. Shareholder expropriation and powerful controlling groups have sometimes, and particularly in the Australian business environment, developed a negative reputation for the 'seizing' of power and the over-ruling of the wishes of board members.

Such controllers can be seen as troublesome and meddlesome, but the study also emphasises the benefits of a balanced level of excess control, particularly in family groups, though it obviously didn't work out too well in the Rebar Group case study.

"The negative effect of firm-level excess control is significant only under certain circumstances, such as when excess control at the group level is high and when the business groups are not governed by family," Schwarz says.

"These results suggest that a direct effect of excess control cannot occur without necessarily considering contingent situations."