Among FCFM firms, controlling family owners (blockholders) bear the primary costs and risks of managing the firm. However, the benefits of this management are also potentially shared by other shareholders who do not invest their time and effort in managing the firm (shared benefits of control). Consequently, controlling blockholders may feel entitled to the private benefits of control for the extra costs they bear in managing the firm (Barclay and Holderness, 1989). This increases the secondary agency costs. These secondary agency issues are exacerbated in the Indian institutional context because the institutional context provides weak de facto protection for minority shareholders' rights and is characterized by very limited external market control mechanisms to mitigate agency conflicts.1 This creates a climate facilitating the imposition of decisions by controlling blockholders/family shareholders on minority shareholders, leading to the expropriation of wealth or private benefits by these blockholders. Specifically, family owners may be reluctant to adopt governance mechanisms that reduce their control over the firm—such as those that permit greater monitoring of their family affiliated agent's activities and/or those that inhibit them from achieving their personal goals. This may occur despite the fact that strategic initiatives like internationalization necessitate certain types of governance mechanisms (Sanders and Carpenter, 1998). We theorize that secondary agency problems (as well as the private benefits of control) are more evident in family firms where the family has both ownership control as well as management control. Family owners of FCFM firms appropriating these private benefits might jeopardize the firm's international expansion initiatives, thereby imperiling the returns for all shareholders.
FCFM firms: Internationalization-governance relationships
As compared to domestic operations, internationalization leads to greater organizational complexity because of greater dissimilarity in languages, variations in business environments and culture, greater variety in interactions between the parent and subsidiaries, discrimination by local governments, and geographic dispersion among regions where the firm's operations are located (Tihanyi and Thomas, 2005). CEOs are compensated more in order to incentivize them to manage this increased complexity (Henderson and Fredrickson, 1996). Sanders and Carpenter (1998) found that an increasing degree of internationalization was positively related to CEO compensation among a sample of U.S. firms. We argue that this relationship is context specific, and is contingent on whether it is a FCFM firm or a FCNFM firm.
Since the CEO is, in all likelihood, a family member in FCFM firms, there are several factors that result in the CEO being paid relatively less (Gomez-Mejia, Larraza-Kintana, and Makri, 2003). First, altruism among family members creates greater goal alignment and inhibits opportunism by family CEOs. Second, the main source of wealth generation for family CEOs would be in the form of dividends or increased market capitalization of the firm. In India, dividends are not taxed, while salary is taxed (as per Section 10 (34) of the Income Tax Act of India, Taxmann, 2011). Therefore, family CEOs might prefer dividends over salary.2 Third, the family may want to signal to other shareholders through limiting CEO compensation that agency costs are less in the firm. Fourth, in accordance with agency theory, family CEOs will trade greater job security deriving from their family affiliation for lower earnings/compensation (Gomez-Mejia et al., 2003; McConaughy, 2000; Schulze et al., 2001). Finally, the private benefits of control (alluded to earlier) may substitute for the need to incentivize the family CEO with higher compensation (Rediker and Seth, 1995; Walsh and Seward, 1990). Cumulatively, these imperatives attenuate the expected positive relationship between internationalization and CEO compensation in FCFM firms. Consequently,
Hypothesis 1a (H1a): The positive relationship between degree of internationalization and CEO compensation is weakened in family controlled and family managed (FCFM) firms.
Boards of directors have a fiduciary responsibility toward shareholders (Fama and Jensen, 1983). Outside directors are more likely to monitor the management's actions and their performance objectively as compared to inside directors (Dalton et al., 2007). In order to better manage the increased complexity and information asymmetries resulting from international operations, a greater proportion of outside directors on the board is recommended. However, the controlling family in FCFM firms may not be receptive to having more outside directors to monitor management's activities (Schulze et al., 2001), as these outside directors would demand greater accountability and transparency from management (Carney, 2005).
Additionally, listed firms in India are required to have at least 50 percent of the board members as outside directors (as per Clause 49 of the Indian listing agreement, Balasubramanian, 2010). But FCFM firms may not voluntarily appoint more outside directors beyond this regulatory requirement, because outside directors might inhibit the FCFM owners' preferences toward expropriation of the private benefits of control (Young et al., 2008). Indian FCFM firms also make mutually acceptable board appointments by trading ‘outside’ directors through interlocking directorates (Veliyath and Ramaswamy, 2000).3 Since these outside directors are beholden to the CEO for their board appointments (e.g., Wade, O'Reilly, and Chandratat, 1990; Westphal and Zajac, 1995), they may be unwilling to countenance decisions that could potentially negatively impact the family-affiliated CEO. To compound matters, minority shareholders are unable to challenge these suboptimal decisions (of not having an adequately higher proportion of outside directors) effectively, as de facto minority shareholders' rights and investor protection rights are relatively lower in the Indian context. Consequently, they are not easily able to seek adequate redress for their grievances for the suboptimal decisions imposed on the firm by the controlling shareholders. Thus, the Indian institutional setting leads to a circumvention of the intent behind governance regulations and facilitates greater family control. Finally, family business owners are concerned with the increased business risk for the firm that accompanies increased internationalization. Since the family's welfare is closely intertwined with that of the firm, they would like to retain greater control over the firm that is engaging in relatively risky strategic maneuvers (such as internationalization) by appointing a greater number of inside directors to the board. All of these arguments suggest a further weakening of the expected positive relationship between internationalization and board structure in FCFM family firms.
- Hypothesis 2a (H2a): The positive relationship between degree of internationalization and board structure is weakened in family controlled and managed (FCFM) firms.
CEO duality, implying that the positions of CEO and the board chair are vested in the same person, is an indication of high CEO power (Zajac and Westphal, 1996). Duality helps establish unity of command and clarifies decision-making authority (e.g., Baliga, Moyer, and Rao, 1996). However, duality compromises the ability of the board to reasonably monitor the CEO's practices, policies, and performance since the CEO also serves as the presiding officer of the board (e.g., Cannella and Lubatkin, 1993; Tuggle et al., 2010). Therefore, duality may not be appropriate during international expansions that increase information asymmetries between the CEO and the board (Boyd, 1995; Sanders and Carpenter, 1998).
However, family owners in FCFM firms who wish to expropriate benefits from minority shareholders by colluding with the family-affiliated CEO may not want an independent board chair who monitors the CEO's activities. Additionally, in high business risk situations like internationalization, the family would prefer to have greater control. Greater control is achieved through CEO duality, especially if the CEO is also a family member. In addition, CEO duality has been argued to affect CEO succession (Cannella and Lubatkin, 1993). Family owners of FCFM firms would prefer that next generation/affiliated members of the family succeed as the CEO of the firm. In addition, family owners in FCFM firms seeking to reap the private benefits of control prefer having the board chair and CEO roles vested in a family member (or affiliated) CEO. For these reasons, and because of the power concentrated in these dual positions, FCFM firms may favor CEO duality. Therefore, the expected negative relationship between internationalization and CEO duality is attenuated in FCFM firms. Consequently,
- Hypothesis 3a (H3a): The negative relationship between degree of internationalization and CEO duality is weakened in family controlled and managed (FCFM) firms.
These three hypotheses highlight the existence of secondary agency issues that could lead to the suboptimization of minority shareholders' interests. The suboptimal governance choices of high CEO duality, low CEO compensation, and lower proportion of outside directors (board structure) that accompany internationalization in these FCFM firms may cause inadequate management of organizational complexity, consequently lowering firm performance. These suboptimal decisions can also erode wealth for all shareholders. However, this is not necessarily the case in FCNFM firms. In the subsequent set of three hypotheses, we trace how the interests of family owners in FCNFM firms would be reflected in a reduced need to appropriate private benefits of control, thereby facilitating the firm's international expansion initiatives.
FCNFM firms: Internationalization-governance relationships
In contrast to FCFM firms, the CEO of the family business in FCNFM firms is an unaffiliated, nonfamily appointee. In such firms, family owners do not invest a similar degree of effort and time in managing the firms. Consequently, there is a reduced motivation to reward themselves with the private benefits of control. Also, the imperative shifts toward monitoring the nonfamily CEO and to ensuring that he/she works toward the goal of shareholders' wealth maximization and distributing the shared benefits of control among all shareholders. Consequently, family owners in FCNFM firms would be receptive to the changes required in governance mechanisms necessitated by internationalization. For all these reasons, we do not expect FCNFM firms to weaken the internationalization-governance relationships. The nonfamily CEO also does not have the job security that a family member has. This risk is compounded by the performance risks associated with internationalization (given the uncertainties associated with the strategy for which he/she will be held accountable). Since the private benefits that accrue to a family CEO are not available to a nonfamily CEO, they are not viable substitutes for the salary of a nonfamily CEO. Therefore, FCNFM firms need to incentivize the CEO with higher compensation to make up for the risks and the complexity associated with internationalization (Henderson and Fredrickson, 1996) and to retain talent in the firm. Consequently, we anticipate that the relationship between internationalization and compensation will not be attenuated in FCNFM firms.
- Hypothesis 1b (H1b): The positive relationship between degree of internationalization and CEO compensation is not weakened in family controlled nonfamily managed (FCNFM) firms.
Because the CEO is not a family member in FCNFM firms, altruism is unlikely to be present, giving rise to a high probability of opportunism by the CEO. Given that internationalization creates greater complexity and information asymmetries, the probability of opportunism by these nonfamily CEOs increases. Consequently, the controlling family would feel a greater need to monitor the nonfamily CEO's activities and prevent opportunistic behavior. A governance mechanism that mitigates such opportunism would be to nominate outside directors who can better monitor the nonfamily CEO and thereby safeguard the shared benefits of control that accrue to all shareholders. Alternatively, they might be better able to monitor the nonfamily CEO's activities, decisions, and practices with an independent nonexecutive Board Chair, i.e., by avoiding CEO duality. Thus, the expected positive relationship between internationalization and board structure and the negative relationship between internationalization and CEO duality would, in both these instances, not be attenuated in FCNFM firms. Consequently,
- Hypothesis 2b (H2b): The positive relationship between degree of internationalization and board structure is not weakened in family controlled nonfamily managed (FCNFM) firms.
- Hypothesis 3b (H3b): The negative relationship between degree of internationalization and CEO duality is not weakened in family controlled and nonfamily managed (FCNFM) firms.