HONG KONG,CHINA - Media OutReach - 22 October 2019 - Ownershipstructure plays a critical role in the incentives and behavior of businessorganizations. The effects of firm ownership dispersion across managers andinvestors has been examined in past studies. Yet Prof.Joseph P. H. Fan, Professor of School of Accountancyand Department of Finance at The Chinese University of Hong Kong (CUHK)Business School has extended the literature by examining the roles of ownershipstructure within a controlling family.

His research "Theimpact of ownership transferability on family firm governance and performance:The case of family trusts" examined specifically on the familytrust structure, which is commonly used among Fortune 500 family firms.

Companies controlled by family trusts or similar structuresinclude The New York Times,department store chain Wal-Mart and global furniture retailer Ikea.

"Family trusts are typically established forinheritance tax avoidance, asset protection against undesirable events such asdivorce, bankruptcy, taxation and hostile takeovers," says Prof. Fan."The trust structure often locks controlling ownership within a family fora very long period."

In collaboration with Dr. Winnie S. C. Leung from theUniversity of Hong Kong, the study focused on 216 distinct family firms listedon the Hong Kong Stock Exchange, including 72 firms using family trusts and 144firms using direct ownership.

The data was collected over the period from 1990 to 2008,which included the 2006 abolition of inheritance tax in Hong Kong, which endedthe tax advantage of family trusts. 84 of the firms were in manufacturing, 52in finance, insurance and real estate and 44 in wholesale and retail.

TheCost of Family Disputes

Different from prior studies, which almost unanimously focuson conflicts between corporate insiders and outsiders, his study looked at theimpacts of intra-family ownership structures and conflicts between familymembers on firm behaviors and performance.

For example, he found that the sibling structure of afamily, in particular the age gap between the first and last sons of thefounder, could be a source of conflicts.

"When the age gap is large, sons or daughters arguablyhave more diverse interests and very different ideologies for managing familyissues. A large age distance also indicates high conflict potential," hesays.

Prof. Fan says that founders of firms are not always able tocorrectly predict the consequences of adopting a family trust structure. Inparticular, they may underestimate the cost of keeping family harmony, orcounteracting family disputes when a trust ties descendants up in the familybusiness.

"The share transfer restriction may induce familymembers to shirk, making family conflicts difficult to resolve and distortcompany decisions," he says.

Prof. Fan cites a well-known case of Sun Hung Kai Properties,a leading property developer and the second largest business conglomerate inHong Kong.

Its founder, Kwok Tak-seng, transferred controlling interestof the company into a family trust as part of his succession plan before hedied in 1990. The trust was set up in Jersey with a 100-year rule and with hiswife and three sons as the beneficiaries. The trust appointed the three sons toco-manage the family business. Unfortunately, the brothers were not able tostay in harmony after Kwok died.

The Lo family, the founding family of prominent propertydeveloper Great Eagle Group in Hong Kong, is another victim of family fightingin which family trust ownership is at the center of the dispute.

"There was hardly an exit from the family ownershipstructure because the family stakes were locked up in the trust."

"The trust actually prolonged the family infighting,and the corporate value of the business eroded substantially in theprocess," says Prof. Fan.

He further explains that the ability to transfer ownershipis an important mechanism for resolving disputes between family members.

"When family members directly hold ownership, theirincome or dividend and voting rights are clearly delineated. If a family memberdecides to exit the family business, he or she can simply sell his or hershares either back to the family or to outsiders."

In other words, the selling family members can walk awaywith a fortune, while the active buying family members can have a more robustincentive and control over the firm.

"In contrast, the use of a family trust suppresses thetransfer rights of the family ownership and blocks this buyout channel,"he says.

The trust deed typically specifies a long or even indefiniteperiod before the trust can be dissolved and ownership can be transferred.

TheNegative Consequences of Using a Trust

The use of a trust induces the common pool problem. Throughmarriages and having children, the controlling family increases in size andcomplexity over time. More and more family members are added as trustbeneficiaries.

However, in an acute environment where competition is high,trust beneficiaries are inclined to exploit resources from the family businessfor their own benefit and sustain less for future corporate development.

"Our study shows that when family conflict potentialincreases, firms that adopt a family trust tend to have higher dividendpayouts, lower capital expenditures and a worse performance."

Moreover, for firms using a family trust, family managersmay find it hard to consolidate control to make timely critical decisions.

"The results support our hypothesis that a founder'schoice of trust that underestimates the family conflict potential distortsfamily managers' behavior when making company decisions."

As the family's size grows over time, the average cash flowrights of a given family beneficiary shrink. This further tempts familybeneficiaries to focus on the near term.

"When a family trust provides no exit for resolvingconflicts, consolidation of control is difficult. Unhappy families withentrusted ownership can impede corporate development and destroy firmvalue," Prof. Fan says.

Implications

"Our study not only adds to the existing academicliterature, but also informs business owners and practitioners contemplatingthe ownership structures of the firms they serve," says Prof. Fan, addingthat the findings shed light on the direction of future research.

"Owing to a lack of information, we were unable toexamine the role of family governance in mitigating family conflict potential,and look at original trust deeds when they include conflict prevention clauses.Both these important issues merit further research," he says.

Reference:

JosephP.H.Fan and Winnie S.C.Leung, The impact of ownership transferability on family firm governanceand performance: The case of family trusts, Journalof Corporate Finance (2018).

About CUHK Business School

CUHKBusiness School comprises two schools -- Accountancy and Hotel and Tourism Management -- and fourdepartments -- Decision Sciences andManagerial Economics, Finance,Management and Marketing. Established in Hong Kong in 1963, it is the firstbusiness school to offer BBA, MBA and Executive MBA programmes in the region.Today, the School offers 8 undergraduate programmes and 20 graduate programmes including MBA, EMBA,Master, MSc, MPhil and Ph.D.

In the FinancialTimes Global MBA Ranking 2019, CUHK MBA is ranked 57^th. In FT's 2018 EMBA ranking, CUHK EMBA is ranked 29^th in the world. CUHK Business Schoolhas the largest number of business alumni (36,000+) among universities/business schools in Hong Kong -- many of whom are key businessleaders. The School currently has about4,400 undergraduate and postgraduatestudents and Professor Kalok Chan is the Dean of CUHK Business School.

More information is available at www.bschool.cuhk.edu.hk or byconnecting with CUHK Business School onFacebook: www.facebook.com/cuhkbschool and LinkedIn: www.linkedin.com/school/3923680/.