International Journal of Business and Society, Vol. 17 No. 3, 2016, 429-446 CORPORATE GOVERNANCE AND FINANCIAL CONSTRAINTS IN FAMILY CONTROLLED FIRMS: EVIDENCE FROM MALAYSIA Ei-Yet Chu Universiti Sains Malaysia Tian-So Lai Universiti Utara Malaysia Saw-Imm Song Universiti Technologi Mara ABSTRACT The hypothesis of financial constraints suggests that firms will be denied profitable investment due to inaccessible to external capital markets as debt and equity financing are no longer perfect substitutions after firms utilize internal capital. In view of reduced investments during global financial crisis in 2008-2009, the study investigates 157 firms, whether they face the issues of financial constraints in Malaysia. In general, non-family firms rely heavily on the external debt market while family controlled firms utilizing internal cash and reducing their dependence on debt market for their investments, confirming financial constraints in family firms. However, the presence of CEO duality does not exaggerate the problem of financial constraints, but rather leads family firms to become stagnant in their investments. Independent directors appear to be ineffective in governing family firms in issuing finances for investment. Apparently, their presence in family firms reduces firms’ investment opportunities either through internal cash and external debt financing, which could reduce shareholders’ value in the long-term. Keywords: Investments; Financial Constraints; Corporate Governance; Duality; Independent Director; Family Controlled firms. 1. INTRODUCTION In the literature of finance, the pecking order theory suggests that firms may follow the hierarchy of financing on the conjecture that there is a perfect substitution among the sources of financing. However, firms may not able to follow the hierarchy system because of the problem of information asymmetry. Moreover, debt and equity financing are not Corresponding author: email: [email protected]; [email protected]. Tel: 04-6535914. Fax: 04-6532792
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International Journal of Business and Society, Vol. 17 No. 3, 2016, 429-446
CORPORATE GOVERNANCE AND FINANCIAL
CONSTRAINTS IN FAMILY CONTROLLED FIRMS:
EVIDENCE FROM MALAYSIA
Ei-Yet Chu Universiti Sains Malaysia
Tian-So Lai Universiti Utara Malaysia
Saw-Imm SongUniversiti Technologi Mara
ABSTRACT
The hypothesis of financial constraints suggests that firms will be denied profitable investment due
to inaccessible to external capital markets as debt and equity financing are no longer perfect
substitutions after firms utilize internal capital. In view of reduced investments during global
financial crisis in 2008-2009, the study investigates 157 firms, whether they face the issues of
financial constraints in Malaysia. In general, non-family firms rely heavily on the external debt
market while family controlled firms utilizing internal cash and reducing their dependence on debt
market for their investments, confirming financial constraints in family firms. However, the
presence of CEO duality does not exaggerate the problem of financial constraints, but rather leads
family firms to become stagnant in their investments. Independent directors appear to be
ineffective in governing family firms in issuing finances for investment. Apparently, their presence
in family firms reduces firms’ investment opportunities either through internal cash and external
debt financing, which could reduce shareholders’ value in the long-term.
Notes: * Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. t-statistics
are in parentheses.
Corporate Governance and Financial Constraints in Family Controlled Firms: Evidence from Malaysia
Ei-Yet Chu, Tian-So Lai and Saw-Imm Song 443
In contrast, independent directors appear to be an ineffective corporate governance
mechanism as cash flow positively explain investments in family firms. Independent
directors appear to be weak corporate governance as their presence in family firms
FAMSCFINDti
1,increases a percent of cash flow towards 18% in investment
vis-à-vis non family firms of 11% in model 1 ( Table 6).
The finding is consistent as we extend the variables to include external debt financing in
model 2, Table 6. The presence of independent directors in family firms
FAMKDINDti
1,, will result in any one per cent reduction in external debt financing
and subsequently reduce the investment by 3.4%, while the magnitude of cash flow
towards investment in family firms FAMSCFINDti
1, is now at 13.2% as compared
to 18.6% in model 1. In non-family firms, with the presence of independent directors,
[ FAMKDINDti
1,, when Fam=0 ], it is found that an increment of 1% in external
financing will lead to the investment of 6.4% (model 2).
The findings clearly confirm that the presence of independent directors in family firms
leads to financial constraints as they rely on internal financing rather than external
financing. The reduction in investment when using debt and cash flow financing clearly
confirms the presence of financial constraints. This confirms hypothesis 3 that in the
scenario of weak corporate governance mechanism, independent directors lead to
financial constraints in family firms.
5. CONCLUSIONS
The study explains whether there is an issue of financial constraints in Malaysian family
firms. Apparently, family firms prefer to utilize internal cash flow rather than external
debt or equity market for their investments. In contrast, non-family firms rely heavily on
debt financing for investments. The presence of CEO’s duality in family firms is rather
ambiguous towards investments as shown by insignificant used of internal financing and
external debt equity for investments. Lastly, independent directors appear to be weak
governance mechanism as it encourages internal financing but reducing firms to relying
on external market. Their presence in family controlled firms significantly reduces firms
financing especially through debt equity method. Independent directors’ role in non-
family firms appears to use external financing for investment purposes.
From the study, family firms face financial constraints as they reduce their dependence
on external financing to protect their private interest. The presence of weak governance is
obvious in Malaysia family controlled firms as it discourages efficient investments. The
presence of CEO duality leads firms to be rather conservative as they do not show the
interest of using internal cash flow or external capital financing for investments. There
444
may be other better reasons such as CEO’s controlling interest, or their compensation
benefits, which may affect the finding. Another issue of weak independent directors in the
governance system clearly reduces the effectiveness of investments in the country. Their
presence clearly reduces the opportunities for investments, which may benefit
shareholders. Therefore, the corporate governance mechanisms need to be enhanced in
view of poor investments by family controlled public listed firms.
ACKNOWLEDGEMENT
The authors gratefully acknowledge the short-term grant from Universiti Sains Malaysia
304/PPAMC/6313056.
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Corporate Governance and Financial Constraints in Family Controlled Firms: Evidence from Malaysia