Guests at the table? Independent directors in family-influenced public companies

Journal of Corporation Law, The, Summer, 2008 by Deborah A. DeMott

As is well known, the composition of public-company boards became subject to more specific mandates as a consequence of the Sarbanes-Oxley legislation, SEC rules, and stock-exchange listing requirements, all oriented toward assuring greater presence of independent members on certain board committees and, in many instances, on the board as a whole. (71) Although Anderson and Reeb's study, based on data from 1992 to 1999, necessarily pre-dated these changes, it remains an intriguing demonstration of associations between governance choices and firm performance. (72) Further support for the significance of monitoring that independent directors may provide comes from a recent study of public companies in Hong Kong that were associated with insider trading from 1995 to 1999. Although the authors found a positive association between insider trading and indicia of earnings management, the association lessened with higher percentages of independent directors on company boards. (73) As it happens, this study also suggests circumstances that may compromise independent directors' ability to act as effective monitors. In firms controlled by a family--typical for Hong Kong--the moderating effect of independent directors was especially strong when no member of the controlling family served on the board. Moreover, family-firm directors may perceive tensions between the personalized presence of family shareholders on boards and the more abstract demands of loyalty to the interests of all shareholders.

C. Suggestive Circumstances

Within empirical scholarship related to corporate governance, family-influenced public firms still constitute a relatively recent focus, especially for larger and more comprehensive studies. (74) Nonetheless, one recent empirical study suggests that within at least one cohort of family firms, members of the founding family may not always draw sufficient boundaries between their own entitlements and corporate property. Ronald Masulis et al. focused on companies with dual-class stock. (75) The authors found that, as the wedge increased between insiders' voting and cash-flow rights, dual-class companies that acquired other companies experienced lower abnormal stock returns during the public announcement period associated with the acquisition. (76) Additionally, increases in the wedge were associated with higher compensation for CEOs, (77) plus lower market values assigned to capital expenditures (78) and to corporate holdings of cash. (79) Overall, the authors find these results to be consistent with the hypothesis that "insiders holding more voting rights relative to cash flow rights extract more private benefits at the expense of outside shareholders." (80)

One intriguing aspect of this study is that it is not evident how best to characterize conduct on the ground within family firms that may lead to the study's results. For example, Masulis et al. find that the greater the wedge between voting rights and cash flow rights, the more likely it is that individuals in control of dual-class firms "tend to make shareholder value-destroying acquisitions." (81) Decisions to pursue acquisitions that have this effect may be related to insiders' economic interests if, for example, their compensation is likely to rise as the firm grows larger. Alternatively, the power to pursue a particular acquisition may represent another instance of a nonpecuniary benefit of control, comparable to the power to control a newspaper's editorial policies. As Part III explains, doctrines within the law--not limited to corporate law--necessarily draw sharper distinctions among the benefits associated with control, legitimating some while prohibiting others.