Family control, board structure and performance: Evidence from an emerging economy

Mohammad Badrul Muttakin Arifur Khan Nava Subramaniam

School of Accounting, Economics and Finance, Deakin University, Australia

Corresponding Author: Dr.Arifur Khan

School of Accounting, Economics and Finance Deakin University Burwood, Victoria 3125 Australia Email: Arifur.khan@deakin.edu.au

Family control, board structure and performance: Evidence from an emerging economy

Abstract We investigate the relation between board structure and firm performance of family firms in an emerging economy using Bangladesh as a case. We argue that ownership in Bangladesh is largely concentrated in the hands of a few people and top shareholders belong mostly to controlling families. Since prior studies suggest that minority shareholders rely on corporate board to monitor and control familys opportunism, using an instrumental variable regression we examine the impact of board structure on performance of family firms in an emerging economy. We find that some board structure variables, namely; board independence, board size, proportion of foreign directors and female directors; have significant weaker impacts on the performance of family firms than non-family firms. However, we document a significant stronger impact of CEO duality on the performance of family firms than their non-family counterparts. Our findings offer new evidence on board structure performance relation, in particular with reference to the family firms in South Asia. Overall, these findings suggest that family knowledge, commitment to the business and influence on the board are likely factors in affecting firm performance of Bangladeshi family firms.
Keywords: family control, agency problem, board structure, firm performance, Bangladesh.

Family control, board structure and performance: Evidence from an emerging economy
1. Introduction We investigate the relation between board structure and performance of family firms in an emerging economy setting, using data from listed non-financial companies in Bangladesh during the period 2005-2009. The issue of ownership structure and firm performance has been widely researched (Davies et al., 2005; Morck et al., 1988). Further, for a long time, it was a common perception that ownership structures of corporations are diversified. However, research during the last decade has come to

completely change this picture. In fact, looking at the ownership structure around the world, most firms have large shareholders, who in many cases are powerful enough to control firm decisions (La Porta et al., 1999). These shareholders are commonly referred to as controlling shareholders. An important group of controlling shareholders in particular is families. These shareholders might, for example, be the founders of the firms, their heirs, or private investors. Research in the field of family business has drawn significant attention in recent times indicating the growing recognition of the importance of family-controlled business in economic activity including their role in generating GDP, creating jobs and financing new ventures (Glassop and Waddell, 2005). For example, in United States and Latin America 80 per cent to 95 per cent and in Europe and Asia, about of business 80 per cent enterprises are family-owned and family-controlled (Poza, 2007). The study of the extent of separation and control in nine East Asian countries, Claessens et al. (2000) find high levels of family ownership and control in more than half of the East Asian companies. Family firms assume a significant role in economic development, and a better understanding of the governance of family firms is thus both essential and timely. 3

Agency theory presents a mixed perspective on agency problems in family firms. On the one hand, families are assumed to be superior monitors of managers than other types of large shareholders, suggesting that lack of alignment between managers (agents) and owners (principal) which is referred to as Agency Problem I, might be less prevalent in family than non-family counterparts (Anderson and Reeb, 2003). Conversely, controlling families may have a strong incentive and power to extract private rents at the expense of minority shareholders which are referred to as Agency Problem II (Fama and Jensen, 1983; Shleifer and Vishny, 1997). Accordingly, Villalonga and Amit (2006) reveal that controlling families have strong incentives for better monitoring as well as

expropriation, and consequently Agency Problem II may overshadow Agency Problem I in family firms. The presence of family controlled firms around the world (La Porta et al., 1999) and familys strong incentive to extract private rents raises the question of how to actually manage Agency Problem II. Prior research suggests that the board of directors and its monitoring is considered to be the most essential internal governance mechanism to control managers from self-satisfying behaviour (Fama and Jensen, 1983). Anderson and Reeb (2004) document that board of directors can monitor and restrict opportunistic behaviour of controlling families. Prior studies suggest that characteristics of board structure of family firms, namely board independence, board size and CEO duality affect performance (Anderson and Reeb, 2004; Setia-Atmaja et al., 2009; Ibrahim et al. 2011). Therefore, the characteristics of board structure are likely to be the governance factors that are of importance to the family firms. This study therefore, examines the relation between board structure and performance. Previous study by Carter et al. (2003) argues that gender diversity improves monitoring resulting in better performance. Additionally, Oxelheim and Randoy (2003) find that foreign board members signal a higher commitment to corporate monitoring and transparency which leads to an 4

increase in firm performance. Whilst gender diversity and

foreign directorship are two important board characteristics, no previous study investigate their impact on the performance of family firms. This study addresses this gap and considers the impact of these two additional aspects of board structure on family firm performance. Although previous studies have been conducted on board structure and performance, research on family firms is scant and limited and none of them are focused on Bangladesh. The findings of Imam and Malik (2007) suggest that family dominance is very common in Bangladesh. They find that ownership in Bangladesh is largely concentrated in the hands of a few people and top shareholders belong mostly to controlling families. In most cases controlling families dominate the board and take important decisions. The boards for 73 per cent of the non-financial companies listed on the Dhaka Stock Exchange are dominated by close family members (Sobhan and Werner, 2003). Additionally, controlling families fill the position of executive directors and CEO, which may increase the possibilit y of managerial entrenchment. Hence, there is a risk of expropriation of minority shareholders wealth by families. Given that minority shareholders rely on corporate board to monitor and control familys opportunism, board characteristics of a firm is an important issue of internal governance mechanism especially for family firms in Bangladesh. As a constituent of Common-law regime, Bangladesh represents poor-quality law enforcement unlike other common-law economies of wealthy nations (Farooque et al. 2007). Poor investor protection and weak legal system increases the possibility of wealth expropriation by controlling families. The institutional, regulatory and corporate governance practices differences among Bangladesh and the other developing economies motivate this research to examine the relation between board structure and performance of family firms empirically. We investigate the relation between board structure and firm performance of family firms in an emerging economy using Bangladesh as a case. Our results indicate that in 6

family controlled firms board independence has a significant weaker impact on performance than

non-family firms. The possible explanation of this result is that families who have power to appoint and replace independent directors, may reduce the effectiveness of monitoring by independent directors (Setia-Atmaja et al., 2009). We also find that board size of family firms has a significant weaker impact on performance than their non-family counterparts. This implies that smaller board size is a superior governance mechanism for family firms than non-family firms (Ibrahim et al., 2011). Our results suggest that CEO duality in family firms has a relatively stronger impact on performance implying that it might improve strategic decisions because of greater degree of CEO discretion (Braun and Sharma, 2007). Additionally, we document that foreign directors have a relatively weaker impact on performance in family firms which is consistent with the notion that additional monitoring by such directors can be unnecessary and costly as such monitoring may be replicating the monitoring already being performed by the family members (Chen and Nowland, 2010). We contribute to the literature in a number of ways. First, we examine the impact of board structure on firm performance on family firms in an emerging market setting. Our findings offer new evidence on board structure performance relation, in particular with reference to the family firms in South Asia. Second, while examining the impact of board structure in family firms we consider two additional aspects of board, namely gender diversity and foreign directorship. Overall this study helps us to increase our level of understanding with regards to family firms in Bangladesh. Particularly, this study uses a sample of Bangladeshi public listed firms and the findings of this study may be useful to make a comparison with family firms in other countries. The rest of the paper is structured as follows. Section 2 provides institutional background of Bangladesh. Section 3 reviews related literature and develops hypotheses. Section 4 describes research methodology. Section 5 presents empirical results followed by robustness tests in section 6. Section 7 concludes the paper. 8

2. Institutional background of Bangladesh Bangladesh is one of the developing countries in the South-Asia region, with a vast segment of population living below the poverty line. Bangladesh emerged as an independent and sovereign state on 16 December, 1971. It has a boundary on the west, north, and east with India, on the southeast with Myanmar, and the Bay of Bengal is to the south. The high population density, low economic growth, corruption, lack of institutional infrastructure, an incentive dependence on agriculture and agricultural products, geographical setting, and various other factors, all contribute to make the country weak in its economic development and quality of life (UNDP Report, 2005). Despite sustained economic prospects, Bangladesh remains a developing country with an emerging economy. After its independence in 1971, Bangladesh inherited a private sector

dominated economy. The new government was committed to socialism. This, along with the ownership vacuum created by the then West Pakistani owners of the industries, who fled the country during the liberation war resulted in nationalisation of almost all the major industries. However, owing to inefficiency in the public sector, and pressures from the donor agencies such as the World Bank, the Bangladesh government opened its economy. As the donor agencies started sanctioning loans against conditions of privatisation, the government took initiatives to quickly privatise a number of industries. Uddin and Hopper (2003) report that although few numbers of privatised firms were large, it was the small firms that got privatised as these were easier to privatise. Not surprisingly, most of these privatised firms were actually purchased by a single owner or a family. Most of the privatised companies as reported by Uddin and Hopper (2003), were in the jute and textile sectors was actually purchased by single families. Good corporate governance is a function of sound institutional framework. Some of the major legislative and regulatory requirements mandating Bangladeshi companies 9

include:

10

The Companies Act 1994, Bangladesh Bank Order 1972, The Bank Companies Act 1991,The Financial Institution Act 1993, The Securities and Exchange Ordinance 1969, The Securities and Exchange Commission Act 1993, and The Bankruptcy Act 1997 (Sobhan and Werner, 2003). Presently five established institutions in Bangladesh are working for corporate governance regulations such as the Institute of Chartered Accountants of Bangladesh (ICAB), the Bangladesh Enterprise Institute (BEI), the Securities and Exchange Commission (SEC), stock exchanges (Dhaka Stock Exchange and Chittagong Stock Exchange) and the Registrar of Joint Stock Companies (RJSC). Legal and regulatory framework and its enforcement are relatively poor in Bangladesh which critically hinders the markets potential growth. Moreover, the judicial system of Bangladesh is not competent enough to deal with corporate affairs. Unlike other common-law economies of wealthy nations, it represents poor-quality law enforcement (Farooque et al. 2007). Therefore, minority shareholders have poor protection as property rights are not well defined and/or not well protected by judicial system (Shelifer and Vishny, 1997). The overall corporate governance system as it currently exists in Bangladesh can be described as the weak form of Anglo-American corporate governance system. Farooque et al. (2007) contend that even though Bangladesh has a market-based system like Anglo American firms, it lacks an active market for corporate control, strong incentive contract for management and outside directors. In the absence of market-based monitoring and control measures, ownership based monitoring and control has been established in Bangladesh as a core governance mechanism. They also report that in Bangladesh, private sector firms have highly concentrated ownership. Most firms are either family-owned or controlled by the substantial shareholders (corporate group or government) and 11

managements are effectively just extensions of the dominant owners. They are closely-held small and medium-sized firms

12

where corporate boards are owner-driven. Consequently, most of the companies have executive directors, CEO and chairman from the controlling family or government. The above features of the corporate firms create the inevitable conflict

(Agency problem II) between dominant shareholder(s) and minority shareholders. There are plenty of opportunities for controlling shareholders to expropriate wealth from outside shareholders. This is central to the quality of corporate governance in Bangladesh impacting firm performance as predicted by agency theory. 3. Theoretical Background and Development of Hypotheses 3.1 Board independence and Performance Previous research on board structure has focused on the independence of the board and its impact on monitoring. (Agrawal and Knoeber, 1996; Dahya and McConnell, 2005). It is argued that a higher proportion of independent directors should lead to better firm performance since it reduces the conflict of interests between controlling shareholders and minority shareholders and makes management more effective through better monitoring (Andres et al., 2005). The findings of previous studies document mixed evidences with respect to the relation between board independence and performance in family firms. For example, Anderson and Reeb (2004) find positive relation between board independence and performance of family firms. They argue that independent directors can mitigate conflicts between controlling shareholders and minority shareholders through better monitoring in family firms. They also argue that independent directors enforce structural constraints on the family by restraining their involvement in board subcommittees and prevent family members from expropriating the wealth of firms through excessive compensation, special dividends, or unwarranted perquisites. Some non-US studies, on the other hand, suggest that board independence do not have any significant impact on performance of family firms which is in 13

contrast to the findings of Anderson and Reeb (2004). For example, Chen et al. (2005), Ibrahim et al. (2011) and Ng (2005) find that board independence do not have any significant impact on performance in family firms. They contend that independent directors sometimes are not truly independent. Moreover, the number of independent directors may not be sufficient to monitor the board. The ratio of family directors to independent directors may be an important aspect in determining the boards ability to monitor and protect minority shareholders from opportunism by family members. SetiaAtmaja et al. (2009) in their sample of Australian family firms find that board independence is negatively related with firm performance. They argue that a strong presence of family dominance in family firms influence the appointment and replacement of independent directors which may reduce the effectiveness of their monitoring resulting in a negative impact on firm performance. Family firms provide an interesting case for examining whether independent directors play an important role for better firm performance. Independent directors provide better monitoring which alleviate conflicts between controlling families and outside shareholders and leads to better firm performance. On the other hand,

controlling families sometimes choose a person as an independent director who is either a friend or someone who will always act as per direction (Uddin and Chowdhury, 2008), thus reduce the effective monitoring by independent directors and leads to poor performance. Given that previous research documents mixed evidence in regards to the relation between board independence and performance of family firms, it is not possible to predict a specific pattern. We therefore, hypothesise: H1: There is a significant relation between the board independence and performance in family firms. 3.2 Board Size and performance Dalton et al. (1999) contend that board size is a significant determinant of effective 14

corporate governance mechanism. Board size is important as its size is a function of the costs

15

and benefits involved with the board functioning. While inclusion of more directors increases the boards monitoring capacity, the incremental cost of poor communication and decision making associated with larger groups may outweigh the benefits. Accordingly, Lipton and Lorsch (1992) argue that a larger board may face poor coordination due to the large number of potential interactions among group members and free riding problem. They recommend limiting the board member to a maximum of ten people, with a preferred size of eight to nine. Similarly, Jensen (1993) argues that larger boards can be less effective and are easier for the CEOs to control when board composed of more than seven to eight people. The empirical evidence supports this contention by showing an inverse relation between board size and firms performance (see for example, Yermack, 1996). Previous studies have also examined the impact of board size on performance in family firms. For example, Mishra et al. (2001) and Ibrahim et al. (2011) find significant relation between small boards and performance in family firms. They conclude that smaller board size might be a superior corporate governance mechanism for family control firms. Astrachan et al. (2002) and Setia-Atmaja et al. (2009), on the other hand, argue that larger board affiliated with the controlling family may enhance performance because they have valuable business experience, expertise, skill and social and professional network

which might add substantial business resources to the family firms. The limited research available on this issue is mixed and therefore, the second hypothesise is non-directional and is stated as follows: H2: There is a significant relation between the size of the board and performance in family firms. 3.3 CEO duality and firm performance Agency theory argues that CEO duality is likely to create abuse of power, since this person will be very powerful without effective checks and balances to control her or him. 16

Consequently, this theory predicts that firms with separation of the CEO and the chair of the board perform better than their counterparts without separation (Solomon, 2007; Finkelstien and D Aveni, 1994). Pfeffer and Salancik (1978), on the other hand, contend that CEOs with greater discretion such as CEO duality would be able to improve their strategic decisions, and more likely to overcome organizational inertia. Moreover, CEO duality might increase CEO discretion by providing a broader power base and control authority, and by weakening the relative power of other interest groups (Hambrick and Finkelstein, 1987). Consistent with this contention previous empirical literature also finds that CEO duality improves firm performance (Pearce and Zahra, 1991, Boyd, 1995; Lin, 2005). Additionally, there is also a group of literature which finds that CEO duality has no significant impact on firm performance (Baliga et al., 1996; Elsayed, 2007). They argue that the impact of CEO duality on firm performance varies with industry type and it will benefit some firms while separation will be more worthy for others. In family firms family members have dominant control over board and may hold top management position, such as CEO and/ or Chairperson (La Porta et al., 1999). Therefore, CEO duality is likely to be more common in family controlled firms than non family firms (Lam and Lee, 2008). Lam and Lee (2008) argue that CEO duality in family controlled companies provides greater opportunities for managerial entrenchment and expropriation of minority shareholders and find that CEO duality has a negative impact on performance in family controlled firms. Moreover, the separation of CEO and board chair as a monitoring device plays a vital role in protecting minority shareholders from wealth expropriation by the family. In the light of the mixed findings discussed above in regards to the relation between CEO duality and performance in family firms we propose following hypothesis: H3: There is a significant relation between the CEO duality and performance in family firms. 17

3.4 Female performance

directors

and

firm

Gender diverse board enhances better monitoring and it increases board independence (Carter et al., 2003). Adams and Ferreira (2009) document that female board members improve board inputs- have higher board attendance, improve board attendance of male directors, and are more likely to take up monitoring positions on audit. Moreover, they are more likely to hold CEOs accountable for poor performance. There have been several empirical studies that document significant positive relation between gender diversity and firm performance (Erhardt, et al., 2003; Carter et al., 2003). They argue that the presence of females as directors on the board is rewarded with a market value premium since they play a vital role in effective monitoring and maintaining the efficiency of a board of directors. On the other hand, the findings of Shrader, et al. (1997) suggest a negative relation between the proportion of female directors on board and performance. They argue that female board members may be appointed on the board as a sign of tokenism, and their contributions to board activities may be marginalized. In addition, Bohern and Strom (2010) find a negative relation between female board membership and firm value for Norwegian firms. Rose (2007) argues that board members with a non-traditional background who are in the socialization process instinctively adopt the ideas of the majority of conventional board members. This results in non-materialization of potential performance. The presence of female directors on the board of family firms may mitigate the possibility of expropriation through their monitoring and efficient management. Ruigrok et al. (2007) argue that female directors are more likely to be affiliated to the firm management through family ties and they act as a monitor and family delegate in family firms. Overall, their presence can give dynamism to the board in terms monitoring and functioning which may improve the performance. However, it can also be argued that 18

female directors could be appointed just as a sign of tokenism in family firms. They may have lack of knowledge and

19

skills. Additionally, sometimes they might be appointed from families as well to enhance the dominance of family members. The two competitive arguments discussed above suggest that the relation between gender diversity (proportion of female directors) and performance in family firms is an empirical issue and therefore, we propose following hypothesis: H4: There is a significant relation between proportion of female directors on the board and performance in family firms. 3.5 Foreign directorship and firm performance It is argued that foreign directors bring valuable knowledge related to

contextual issues in foreign markets and are able to increase the quality of strategic decision making (Zahra and Filatotchev, 2004). Moreover, foreign directors are less likely to be affiliated to the firms and its management and hence they are more likely to be independent (Van der Walt and Ingley, 2003). Therefore, from an agency theory perspective nationality diversity on the board may improve monitoring resulting in better firm performance. Oxelheim and Randoy (2003) find that foreign board members have

significant positive impact on firm performance. They argue that having a foreign member on the board signals a higher commitment to corporate monitoring and transparency and enhance reputation in the financial market which leads to an increase in firm value. It is argued that foreign directors in family firms can bring valuable knowledge and expertise. They can make the board more efficient in terms of monitoring. Their monitoring may obstruct family directors to get entrenched and protect the interest of general shareholders. They can also improve the accountability process in the light of their foreign experience and knowledge. Thus it can also be argued that foreign directors can make the board of a family firm more effective and efficient resulting in a better

performance. However, it can also be argued that the dominance of family members may obstruct the 20

monitoring activities of foreign directors. They may not as active as they are in non-family firms. Additionally, monitoring by such directors can be unnecessary and costly as such monitoring may be replicating the monitoring already being performed by the family members. Therefore, we propose the following hypothesis: H5: There is a significant relation between proportion of foreign directors on the board and performance of family firms. 4. Research Design 4.1 Data The sample selection procedure is reported in Panel A of Table 1. The sample consists of all the non-financial companies listed with Dhaka Stock Exchange (DSE) in Bangladesh from 2005 to 2009. We have excluded 14 non-financial firms due to missing information. Our final sample comprises of the remaining firms with a total of 141 nonfinancial firms, yielding 654 firm-years observations. Consistent with the prior literature, financial and utility firms are excluded since they are controlled by different

regulations and likely to have different disclosure requirements and governance structure. The data for our analysis comes from multiple sources of secondary data. We collect the financial data from the OSIRIS database and the annual reports of the sample companies listed on the stock exchange. Stock price data is obtained from the DataStream database. The family ownership and other corporate governance data was hand collected from the corporate governance disclosures, shareholding information and directors report contained in annual reports. From Panel B of Table 1, it is observes that family firms are present in 64.07per cent of the total sample. The family firms are prevalent in various sectors such as cement (17), ceramics (13), engineering (62), food (68), information technology (11), jute (9), paper and printing (10), miscellaneous (22), pharmaceuticals (62), service and real estate (12), tannery (9) and textile (124). This study control industry affiliations for empirical analysis. 21

<Table 1 about here>

4.2 Measuring family ownership and control In this study one of our primary concerns is the identification of family firms because, prior literature provides no commonly accepted measure or criterion for identifying a family firm. La Porta et al. (1999) argue that 20 per cent cut off point is usually enough to have effective control of firm. Moreover, a number of previous studies use a 20 per cent cut off point to identify family firms (Bartholomeusz and Tanewski, 2006; SetiaAtmaja et al., 2009). Therefore, we define a firm as a family controlled firm where an individual, or group of family members, hold at least 20 per cent of a firms share (voting rights). We use a dummy variable to identify the firms and set equal to 1 if the firm is considered to be family firm and 0 otherwise. Family relationships and shareholdings pattern has been collected from prospectus of the listed companies, annual reports and company websites. Under the SEC notification, the listed companies are required to disclose the pattern of shareholdings. This includes number of shares held by parent/ subsidiary/associate companies, the directors, Chief Executive Officer, Company Secretary, Chief Financial Officer, Head of Internal Audit and their spouse and minor children. If a firm has at least one such shareholder or family members controlling 20 per cent or more shareholdings, it is considered as a family firm. For example, in the 2008 Annual report of Beximco pharmaceuticals limited the founder Sohel Rahman and his brother Salman Rahman own 2.75 per cent of shares and their associate companies (two other shareholders), Beximco holdings limited and Bangladesh Export Import Company limited own 11.36 per cent

and 6.01 per cent of shares, respectively. Therefore, the total family shareholdings of Beximco pharmaceuticals limited is 20.12 per cent and thus it is classified as a family firm. In contrast, the 2006 annual report of Kay and Que Bangladesh limited reports total 5.14 per cent of shareholdings of founders family members 22 and parent/

subsidiary/associate companys shareholdings is nil. Kay and Que

23

Bangladesh Limited is therefore, classified as a non-family firm though it is run by a founder family member. 4.3 Model specification The following model is used to test Hypotheses H1, H2, H3, H4and H5 Performance (Tobins Q) = + 1 Family control + 2 Board independence + 3 Board size+ 4CEO duality + 5 Female director + 6 foreign director + 7 Board independence * family control + 8 Board size * family control + 9 CEO duality * family control + 10 Female director * family control + 11 Foreign director * family control + 12 Firm size + 13Firm age + 14 Leverage + 15 Risk + 16 Board ownership + 17 Growth + 18 Industry dummies + 19 Year dummies + To address endogeneity problems we used two-stage least squared regression analysis and instrumental variables. To test for endogeneity in the model, the method of generalised instrumental variable estimation is used. Firstly, each of the potentially endogenous variables is individually regressed on a set of available instruments and the truly exogenous variables in the model. These represent a series of single reduced form or artificial equations, where the instruments are one and two period lagged values of the potentially endogenous variables. Then, the Wu-Hausman procedure is used to identify which variables are endogenous, correcting with the instruments where required. Finally, we have undertaken the Sargan- Basmann test which provides a measure of the adequacy and effectiveness of these instrumental variables to solve the problem (see Chang, 2003, for a detailed discussion of this methodology). The dependent variable is Tobins Q. Tobins Q is defined as the market value of equity plus the book value of total debt divided by book value of total assets (Adams et al., 2009). Moreover, Chung and Pruitt (1994) show this approximation to be very close to more theoretically correct, and complicated, models. We define board independence as the proportion of independent directors on the board, who do not have any material interest into the firm (denoted as board independence) (Anderson and Reeb, 2004), whereas board size is 24

defined as the number of directors on the board (denoted as board size) (Setia-Atmaja et al.,

25

2009). CEO duality refers to the situation where the same person serves the role of the CEO of the firm as well as the Chairman of the board. Consistent with the prior study this study uses the CEO duality variable as a dummy, which is equal to 1 if the CEO and Chairman are the same person and 0 otherwise (Boyd, 1995). Consistent with prior study (Carter et al.,2003; Adams and Ferreira, 2009), female directors is measured as the proportion of female directors on the board (denoted as female director) and foreign directors is measured by proportion of foreign directors on the board (denoted as foreign director) (Oxelheim and Randoy, 2003). We use five interaction variables to measure the impact of board structure (board independence, board size, CEO duality, female directors and foreign directors) on Tobins Q for family and non-family firms. We control for a number of standard variables that may affect firm performance such as firm size, firm age, risk, leverage, board ownership, growth. Firm size-Larger firms may have fewer growth opportunities (Morck et al., 1988) and more coordination problem (Williamson, 1967) which may negatively influence its performance. Firm size is measured as a natural logarithm of total assets (Yarmack, 1996). Firm age- Boone et al. (2007) argue that complexity increases with the firm age. Therefore, uncertain relationship of firm age on board characteristics as well as firm performance is expected. Shleifer and Vishny (1997) find that with the increase of firm age performance of a family firm gets worse relative to a nonfamily firm. Age of the firm is calculated by taking the natural log of the number of year since the firms inception (Anderson and Reeb, 2003). Risk- Demsetz and Lehn (1985) argue that the greater level of risk in the business environment, the greater the impact of board structure on firm value. Therefore, we expect a negative sign for the coefficient of risk. Consistent with previous literature this study measures firms risk as the standard deviation of the firms daily stock return over the prior 12-month period (Boone et al., 2007). Leverage- The leverage of a firm could lead to 26

external

27

corporate control (Chen and Jaggi, 2000). Debt holder would actively monitor the firms capital structure to protect their own interest (Hutchinson and Gul, 2004). Therefore leverage influences firm performance through monitoring activities by debt holders. On the other hand, a negative relation could be expected between leverage and performance according to the pecking order theory whereby, a firm prefers to fund operations through retained earning rather than debt of equity (Myers, 1984). Leverage is measured by taking the ratio of book value of total debt to book value of total assets (Agrawal and Knoeber, 1996; Anderson and Reeb, 2003). Board ownership- Consistent with prior studies we use the board ownership variable as the percentage of directors total shareholdings on the board (Anderson and Reeb, 2003). Growth- Faster growth is more likely to be positively correlated with financial performance. The growth of a firm is measured by taking the firms assets growth ratio. Finally we use year dummies and industry dummies for manufacturing and

processing, services, information technology (IT) and other sectors. 5. Results 5.1 Descriptive Statistics Table 2 presents three panels of descriptive statistics for the full sample. Panel A provides means, medians and standard deviations for the main variables in the sample. Panel B shows the results of difference of means tests between family and non-family firms. Panel A of Table 2 shows that the number of directors average around 7, of which 6.30% are independent director, 16.90% are female directors and 4.70% are foreign directors. Average firm performance (Tobins Q) is 1.508. With regard to ownership structure, board of directors and family members hold an average of 29.20% and 29% of shares respectively in all firms. The average firm in the sample is nearly 23 years old and the average firm size is 28

6.74 (natural assets).

logarithm

of

total

29

Panel B of Table 2 presents difference of means tests for key variables between family and non-family firms. Family firms represent 64.07% of the sample. Family firm has smaller However, boards (6.4 versus 7.4 directors) than non-family firms.

board independence is statistically indistinguishable between family and non-

family firms. On average, non-family firms exhibit better performance than family firms (Tobins Q: 1.362 versus 1.769). The univariate analysis also shows that several variables differ significantly between family and non-family firms such as, board ownership, age, CEO duality, proportion of female directors and proportion of foreign directors. <Table 2 about here> Table 3 provides a simple correlation matrix for the variables. Family control has a positive correlation with Tobins Q and ROA. Moreover, consistent with previous analysis, this study finds that family ownership is negatively related with firm size; firm age and risk (see Anderson and Reeb, 2003). The correlation matrix also shows that board size and foreign directors are positively and significantly related with firm performance. However, proportion of independent directors has a positive but insignificant relation with Tobins Q, and a significant positive relation with ROA. The proportion of female

directors has a significant negative relationship with Tobins Q, however, a significant positive relation with ROA.
<Table 3 about here>

5.2 Hypotheses test results: The main focus of our analysis is to examine the impact board structure on firm performance in family firms. The results are reported in Table 4. As discussed before we use instrumental variable regression to address the issue of endogeneity. In model l we examine the impact of board independence on firm performance in family firms. We find that board independence in general improves firm performance. However, when we interact board independence with family firm we find a negative and significant coefficient ( = 30

-3.131,

31

p<0.01). This implies that the impact of board independence on performance is weaker for family than non-family firms. This is consistent with the findings of Setia-Atmaja et al. (2009). They argue that families who have power to appoint and replace independent directors, may reduce the effectiveness of monitoring by independent directors. We also find that family control variable is positive and significant ( = 0.016, p < 0.05). This is consistent with the findings of Anderson and Reeb (2004) and suggests that family firms in Bangladesh perform better than non-family firms. The fact that the coefficients of some other control variables are statistically significant suggests that performance is also influenced by other factors. Specifically, performance is positively related to leverage and negatively related to firm age. In model 2 we investigate the impact of board size on firm performance in family firms. We find a positive significant coefficient of board size ( = 0.110, p < 0.01). This indicates that larger boards improve the performance of Bangladeshi firms. However, the coefficient on the interaction term between family control and board size is negative and significant ( = -0.080, p < 0.05), which implies that board size on performance is weaker for family than non-family firms. This result is consistent with Ibrahim et al. (2011). They argue that smaller board size might be a superior corporate governance mechanism for family control firms. Moreover, larger boards affiliated with the controlling family

face poor governance and have lower firm performance in family firms because of entrenchment effects (Anderson and Reeb, 2004). The result for the impact of CEO duality on performance of family firms is presented in model 3. The coefficient of CEO duality is negative and significant ( = -0.705, p < 0.01). This indicates that in firms where the same person undertakes a dual role of CEO and chairperson perform poorer. This is consistent with the argument provided by Kang and Zardkoohi (2005) that CEO duality reduces firm performance due to entrenchment effect. 32

However, the coefficient of the interaction term between family control and CEO duality is positive and significant ( = 0.763, p < 0.01), which suggests that CEO duality has a stronger effect on performance of family than non-family firms (Braun and Sharma, 2007). This is consistent with the notion that CEOs who have dual role in Bangladeshi family firms are concerned about reputation, more committed to their businesses and run the business accordingly to improve performance. In model 4 we examine the impact of female directors on performance. We find that proportionate female director has a positive and significant impact on firm performance ( = 0.605, p > 0.05). However, we fail to find a significant coefficient of family control interaction variable with proportionate female director variable (i.e., = -0.484, p > 0.05). This implies that gender diversified board does not influence performance in family firms. Thus it suggests that in Bangladesh, female directors could be appointed just as a sign of tokenism in family firms (Shrader et al., 1997). They may not have sufficient knowledge and skills to oversee the activities of family members and improve firm performance. In model 5 we investigate the influence of foreign directors on firm performance. We document a positive and significant coefficient of proportionate foreign director variable ( = 3.061, p < 0.01). This indicates that foreign directors may improve performance of Bangladeshi firms through their monitoring. However, a negative and significant coefficient of the interaction term between family control and foreign directors suggest a weaker effect on performance of family than non-family firms ( = -2.909, p < 0.01). This is consistent with the argument that additional monitoring can be unnecessary and costly as such monitoring may be replicating the monitoring already being performed by the family members (Chen and Nowland, 2010).

33

We regress performance on all board structure variables in model 6 to test the impact of all the hypothesised variables. The coefficients of the hypothesised variables in model 6 suggest the results consistent to the results we obtain from models 1 to 5
<Table 4 about here>

6. Further Analysis 6.1 Alternative measure of firm performance We use an alternative approach to measure performance such as ROA. RO A is measured as earnings before interest and taxes (EBIT) to book value of total assets (Anderson and Reeb, 2004; Jackling and Johl, 2009). ROA is an indicator informing the user about how profitable a company is relative to its total assets. ROA is directly related to managements ability to efficiently utilize corporate assets, which ultimately belong to shareholders. We run all the models using ROA as the measure of performance. The results are reported in Table 5. Our results are qualitatively similar to our main findings reported in Table 4. <Table 5 about here>
6.2 Other

First, we use an alternative definition of family firms. In particular, we define a firm as family controlled firm where an individual, or group of family members, hold at least 50% of a firms share (voting rights) (Ang et al., 2000; Van den Berghe and Carshon, 2002). We use a dummy variable to identify the family firms and set equal to 1 if the firm is considered to be family firm and 0 otherwise. When we use this alternative ownership threshold number of family firms come down to 171. We run all the regressions that we report for in Table 4 and find results that are qualitatively similar to our main findings. Second, it may be argued that family ownership may be endogenously determined by the unobserved firm heterogeneity. Therefore, we repeat all the analyses using a random effect model and fail to find any qualitative difference to our main findings. 34

Finally, it may be argued that contemporaneous relations are not appropriat e to examine a causal relation between board structure of family firms and performance. Accordingly, we lag the board structure variables by one year to allow for the effect of any change in board structure to show up in firm behaviour and performance and do not find any qualitative differences to the results reported earlier. 7. Discussion and Conclusions We examine the relation between board structure and performance in

Bangladeshi family firms. We argue that ownership in Bangladesh is largely concentrated in the hands of a few people and top shareholders belong mostly to controlling families. Since prior studies suggest that minority shareholders rely on corporate board to monitor and control familys opportunism, we explore the impact of board structure on performance of family firms in an emerging economy. Using Tobins Q as a measure of performance we find that family firms perform better than non-family firms. Our analysis indicates that board size has weaker impact on performance of family firms than non-family firms, which implies that smaller board is preferable for Bangladeshi family firms. We document that the impact of board independence on performance is weaker for family firms than nonfamily firms, implying that independent directors do not add value to family firms in Bangladesh. It is possible that families have significant influence on selection and appointment of independent directors and as such the so called independent directors are not truly independent. We also reveal that CEO duality has a stronger impact on performance of family firms than their non-family counterparts. This is consistent with the notion that CEOs who have dual role in Bangladeshi family firms are concerned about reputation, more committed to their businesses and run the business accordingly to improve performance. We find that gender diversified board in Bangladeshi family firms have relatively weaker 35

impact on performance than non-family firms. This implies that female directors could be appointed just

36

as a sign of tokenism in family firms. Moreover, female directors may have lack of expertise and given that women participant at the board-level in developing countries may be recent phenomena, hence the lack of experience is not surprising. Finally, we document that foreign directors have a significant weaker impact on performance of family firms than non-family counterparts. This result implies that in family firms additional monitoring can be unnecessary and costly as such monitoring may be replicating the monitoring already being performed by the family members. We contribute to the literature in a number of ways. First, we investigate the impact of board structure on performance of family firms in an emerging market setting. Second, while examining the impact of board structure in family firms we consider two additional aspects of board, namely female directors and foreign directorship which were not examined by previous studies. Overall this study helps us to increase our level of

understanding with regards to family firms in Bangladesh. The findings of this study may be useful to make a comparison with family firms in other countries. The outcome of the study may have implications for the policy makers and regulators in understanding the impact of board structure on the quality of corporate governance practices in family firms. It can help the regulators to adopt an appropriate balance of legislation, regulatory reform and their enforcement to make improvements in the corporate governance practices in the family firms.

37

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46

Table 1: Sample description Panel A Number of firms Less: Financial and Utility companies 282 127

Companies without necessary information for corporate governance 14 and family ownership data Total Panel B Sector Cement Ceramics Engineering Food IT Jute Paper & Printing Miscellaneous Pharmaceuticals Services Tannery Textile Total 141 Family (Firm-year) 17 13 62 68 11 9 10 22 62 12 9 124 419 Non-family (Firm- year) 20 6 40 45 17 5 0 30 30 14 16 12 235 Total (Firm- year) 37 19 102 113 28 14 10 52 92 26 25 136 654 Percent Family firms in Industry (Firm-year) 45.95 68.42 60.78 60.18 39.29 64.29 100.00 42.31 67.39 46.15 36.00 91.18

31

Table 2: Summary statistics

Panel A and B provide summary statistics for the data of our analysis. The data is consisting of 654 firms year observations from 2005 to 2009 listed at Dhaka Stock Exchange. Family firms are those where the family members holds at least twenty percent equity ownership otherwise firms are considered as non-family firms. Tobins Q is the market value of equity plus the book value of total debt divided by book value of total assets. Board size is defined as the number of directors on the board. Board independence calculated as the number of independent directors scaled by the size of the board.CEO duality is a dummy variable equal to one when the chairperson is the CEO and zero otherwise. Female and foreign directors are measured by the proportion of female and foreign directors on the board respectively. Board ownership is the percentage of directors total shareholdings on the board. Firm age is the natural log of number of years since firm inception. Leverage is calculated as the ratio of book value of total debt to book value of total assets. Risk is the standard deviation of the firms daily stock return over the prior 12-month period. Firm size is the natural log of book value of assets. Growth of a firm is measured by taking the firms assets growth ratio. Panel A provides summary statistics for full sample. Panel B provides difference of means tests between family and non-family firms. Finally, Panel C provides the correlation data for variables used in our analysis.

Panel A: Sample
Varia ble Firm size Tobins Q Leve rage Firm age

Descriptive Statistics for the Full

Mean 8.696 1.508 0.749 22.989 0.292 6.742 0.107 0.028 0.290 0.278 0.063 0.047 0.169

Median 8.684 1.118 0.604 23.000 0.300 6.500 0.087 0.027 0.319 0.000 0.000 0.000 0.143

Std. Dev. 0.659 1.200 0.789 10.940 0.202 2.073 10.354 0.024 0.219 0.448 0.077 0.147 0.183

Observations 654 654 654 654 654 654 654 654 654 654 654 654 654

Board ownership Board size Growth Risk Family ownership CEO duality Board independence Propo rtion of foreign dire ctor Propo rtion of female dire ctor

Panel B: Difference of Means Tests

Varia ble Board size Board ownership Risk Tob ins Q Growth Firm age Firm size Board independ ence CEO du ality Propo rtion of N foreign dire ctor Propo rtion of female dire ctor Family 6.35 8 0.35 3 0.02 6 1.36 2 1.72 7 21 .30 3 8.65 0 0.06 1 0.29 7 0.03 0 0.24 0 419 Non family 7.42 6 0.18 5 0.03 2 1.76 9 0.34 9 25 .99 6 8.77 8 0.06 7 0.15 2 0.10 2 0.05 0 235 P value 0.00 0 0.01 0 0.12 6 0.00 0 0.10 0 0.00 0 0.27 9 0.40 5 0.00 0 0.00 0 0.00 0

32

Table 3: Correlation matrix

Board independence Board independence Prob Board ownership Prob Board siz e Prob C E O duality Prob Family control Prob Foreign directors Prob Female directors Prob F irmsize Prob Growth Prob F irmage Prob Leverage Prob Tobins Q Prob RO A Prob R isk Prob 1.000 -----0.053 0.177 0.114 0.004 -0.157 0.000 -0.038 0.338 0.083 0.036 -0.012 0.764 0.065 0.098 0.033 0.402 0.103 0.009 -0.127 0.001 0.031 0.438 0.146 0.000 0.085 0.032 1.000 -----0.081 0.040 0.131 0.001 0.383 0.000 -0.077 0.051 0.311 0.000 -0.329 0.000 -0.001 0.987 -0.135 0.001 -0.033 0.397 -0.124 0.002 0.005 0.898 -0.077 0.052 1.000 -----0.175 0.000 -0.250 0.000 0.164 0.000 -0.167 0.000 0.306 0.000 0.025 0.531 -0.045 0.252 -0.067 0.091 0.092 0.020 0.179 0.000 0.007 0.865 1.000 ----0.176 0.000 0.013 0.742 0.068 0.084 -0.024 0.540 0.087 0.028 0.051 0.201 0.049 0.214 -0.046 0.242 -0.018 0.645 -0.082 0.037 1.000 -----0.169 0.000 0.472 0.000 -0.075 0.057 0.054 0.167 -0.097 0.013 -0.068 0.086 0.155 0.000 0.084 0.033 -0.117 0.003 1.000 -----0.110 0.005 0.241 0.000 0.136 0.001 -0.149 0.000 -0.088 0.025 0.134 0.001 0.146 0.000 -0.034 0.385 1.000 -----0.184 0.000 0.020 0.614 -0.047 0.236 -0.083 0.034 -0.088 0.026 0.099 0.012 -0.078 0.047 1.000 ----0.189 0.000 -0.041 0.301 -0.179 0.000 -0.090 0.023 0.139 0.000 0.017 0.663 1.000 -----0.068 0.082 -0.053 0.178 -0.006 0.884 0.102 0.009 0.025 0.522 1.000 ----0.075 0.058 0.007 0.861 0.010 0.798 -0.004 0.913 1.000 ----0.582 0.000 -0.409 0.000 0.021 0.589 1.000 -----0.015 0.712 0.040 0.311 1.000 -----0.130 0.001 1.000 ----Boa rd ownership Board size C E O duality F amily control Foreign directors F emale directors Firmsize Growth Firmage Leverage Tobins Q RO A R isk

33

Table 4: IV 2 SLS Regression results: Firm performance (Tobins Q), board structure and family control
The following table reports the regression results relating board structure and firm performance in family firms. Tobins Q is the market value of equity plus the book value of total debt divided by book value of total assets. Family control is binary variables that equals one if the firm is considered to be family firm. Board size is defined as the number of directors on the board. Board independence calculated as the number of independent directors scaled by the size of the board. CEO duality is a dummy variable equal to one when the chairperson is the CEO and zero otherwise. Female and foreign directors are measured by the proportion of female and foreign directors on the board respectively. Board ownership is the percentage of directors total shareholdings on the board. Firm age is the natural log of number of years since firm inception. Leverage is calculated as the ratio of book value of total debt to book value of total assets. Risk is the standard deviation of the firms daily stock return over the prior 12-month period. Firm size is the natural log of book value of assets. Growth of a firm is measured by taking the firms assets growth ratio. Number of observation is 654. The reported results are heteroskedasticity and autocorrelation consistent.
Model 1 Variable C Family control Board ownership Board independence Board size CEO duality Proportionate female director Proportionate foreign director Firm age Leverage Risk Firm size Growth Family control*board independence Family control*board size Family control*CEO duality Family control*Proportionate female director Family control*Proportionate foreign director Adjusted R-squared F-statistic
Year and industry dummies included in these models.

Model 2 Coefficient Prob. 1.289 0.018 -0.573 0.110 0.037 0.062 0.010 0.000 0.014 0.049 0.025 0.000

Model 3 Coefficient Prob. 1.840 0.036 -0.571 0.002 0.000 0.009

Model 4 Coefficient 1.474 0.023 -0.569 Prob. 0.015 0.034 0.011

Model 5 Coefficient Prob. 2.366 0.035 -0.615 0.000 0.070 0.004

Model 6 Coefficient 2.178 0.029 -0.680 2.288 0.065 Prob. 0.000 0.032 0.002 0.005 0.022 0.003 0.145 0.000 0.268 0.000 0.493 0.001 0.877 0.079 0.050 0.003 0.227 0.000 0.435 30.098

Coefficient Prob. 1.447 0.016 -0.490 3.700

-0.705

0.000 0.605 0.314 3.061 0.000 0.169 0.000 0.310 0.009 0.923 0.131 0.000 0.766 0.676 0.993 -0.007 0.888 1.540 -0.162 0.000

-0.552 0.832 2.762 -0.005 0.902 1.028 -0.207 0.000 -1.786 -0.025

-0.009 0.903 0.070 -0.051 0.000 -3.131

0.067 0.000 0.964 0.409 0.961 0.003

-0.006 0.875 0.566 -0.099 0.000 -0.080

0.242 0.000 0.717 0.129 0.921 0.037

-0.007 0.848 0.011 -0.050 0.000

0.164 0.000 0.995 0.418 0.947

-0.007 0.868 0.471 -0.027 0.000

0.763

0.000 -0.484 0.456 -2.909 0.000 0.410 50.709 0.349 39.946

0.632 -0.745 -2.622

0.370 43.049

0.364 42.598

0.364 42.544

34

Table 5: IV 2 SLS Regression results: Firm performance (ROA), board structure and family control
The following table reports the regression results relating board structure and firm performance in family firms. ROA is the ratio of profit after tax and book value of total assets. Family control is binary variables that equals one if the firm is considered to be family firm. Board size is defined as the number of directors on the board. Board independence calculated as the number of independent directors scaled by the size of the board. CEO duality is a dummy variable equal to one when the chairperson is the CEO and zero otherwise. Female and foreign directors are measured by the proportion of female and foreign directors on the board respectively. Board ownership is the percentage of directors total shareholdings on the board. Firm age is the natural log of number of years since firm inception. Leverage is calculated as the ratio of book value of total debt to book value of total assets. Risk is the standard deviation of the firms daily stock return over the prior 12-month period. Firm size is the natural log of book value of assets. Growth of a firm is measured by taking the firms assets growth ratio. Number of observation is 654. The reported results are heteroskedasticity and autocorrelation consistent. Model 1 Variable C Family control Board ownership Board independence Board size CEO duality Proportionate female director Proportionate foreign director Firm age Leverage Risk Firm size Growth Family control*board independence Family control*board size Family control*CEO duality Family control*Proportionate female director Family control*Proportionate foreign director Adjusted R-squared F-statistic
Year and industry dummies included in these models.

Model 2 Coefficient Prob. -0.002 0.040 -0.016 0.009 0.968 0.094 0.409 0.000 0.926 0.022 0.921 0.002

Model 3 Coefficient Prob. 0.016 0.003 -0.011 0.766 0.090 0.628

Model 4 Coefficient -0.019 0.014 -0.014 Prob. 0.711 0.037 0.475

Model 5 Coefficient Prob. 0.057 0.028 -0.009 0.260 0.001 0.612

Model 6 Coefficient Prob. 0.027 0.055 -0.022 0.114 0.008 0.611 0.036 0.253 0.014 0.002 0.070 0.001 0.000 0.094 0.000 0.005 0.797 0.475 0.048 0.023 0.079 0.004 0.000 0.254 13.881

Coefficient Prob. 0.005 0.022 -0.002 0.223

-0.026

0.032 0.144 0.005 0.187 0.000 0.153 0.000 0.005 0.532 0.309 0.068 0.000 0.001 0.013 0.381 0.001 -0.044 -0.377 0.003 0.000

-0.009 0.168 0.176 0.001 -0.042 -0.375 -0.001 0.000 -0.062 -0.002

0.000 -0.043 -0.471 0.010 0.000 -0.157

0.260 0.000 0.001 0.071 0.384 0.080

0.001 -0.045 -0.455 0.005 0.000 -0.003

0.049 0.000 0.001 0.364 0.486 0.019

0.001 -0.047 -0.482 0.011 0.000

0.095 0.000 0.057 0.047 0.000

0.001 -0.045 -0.455 0.014 0.000

0.029

0.055 -0.133 0.018 -0.208 0.000 0.220 21.181 0.192 18.250

0.016 -0.157 -0.200

0.195 18.277

0.204 19.568

0.197 17.265

35