Pyramidal Ownership Structure - Coursework Example

PYRAMIDAL OWNERSHIP STRUCTURE By + Introduction The paper studies the significance of pyramidal ownership structure in the creation and development of new businesses. The results from the findings articulates that the pyramid structures arises since they offer a financing advantage in coming up with new companies when the flow of case to outside capitalists is low. The parent firm’s supply inside capital to new company which, due to huge needs of large investment and low pledge able cash flows cannot raise enough cash as an external financing. Pyramidal structure are pervasive in various developed countries, and tends to exists irrespective of whether new companies are developed by smaller organizations or even groups and is crucial to underpin the entrepreneurial activity The organizational structures which various firms are connected through equity financing are ubiquitous in upcoming markets and in majority of developed countries. They are normally arranges as pyramided, where a family or individuals controls an organization, which later controls another company, which could also control another firm, and the chain continues. Despite their control, it is yet to be clear why such firm arise (Almeida and Wolfenzon, 2005). It is normally argues that such ultimate firm owners create pyramid in separating control right from the rights of cash flow and capture private control benefits at the expense of minor shareholders. Discussion Business group describes various types of organization. It is used to describe a set of legally independent companies by single families like family groups in East Asia, Latin America, and Western Europe. The term has also been used for companies with lower stance of core control achieved via interlocking directorates and school ties. Some of the examples of these business group include the Japanese Keiretsu where individual managers have a higher degree of autonomy in their companies but coordinate their tasks through the common main bank and the president council. Another illustration for the loose association is the horizontal financial groups found in Russian which are majorly industry alliances. The paper therefore, concentrates on the family groups. There is a wide economic literature on the business groups of families. The theories have suggested various arguments about the existence of business groups and the reason they use various ownership structures. To achieve that control of the member firms, families hold shared directly in their horizontal structure or alternatively it can control some of the companies through the relations of chain ownership. Majority of the theories explain the existence of business groups as an effective form of organization that adds value to the member companies. According to left, the business groups originated to substitute some of the missing markets for instance the financial and the labor markets. The modern example of this theory is found in Palepu and Khanna (1999), who argue that some of the business groups offer a crucial substitute for the external capital markets found in developing countries. The empirical evidence written by La Porta, Shleifer, and Lopez-de-Silanes is interpreted to be consistent with the argument. According to La Porta, Shleifer, and Lopez-de-Silanes , pyramids are common in nations with lower investor protections which is all evident in financial markets found in less developed countries. The theoretical view of Almeida and Wolfenzon, assuming the pyramidal ownership connection arise due to cash flows pledge ability, then new companies with higher investment needs with negative present value of cash flows need to be set up by the parent firms. On the other hand, those companies with small investment needs with high present values of cash flows, need to be started by standalone companies. Additionally, new companies with parent firms need to receive more funds from inside from their controlling manager that stand alone new companies (Granda Kuffo, 2010). For new companies, their size measured by their asset values capture the investment needs and it is reported that its profit is directly connected to the ability to come up with a pledge able cash flow. Therefore, the analysis of the paper compared the size, inside equity financing, and profitability of new firms with parent companies to those of standalone companies on legal form, industry, age since their corporation and the calendar year. The matching enables people to compare the differences in the features of the new company underlying projects that drive the decision of the organization (Renneboog, 1998). An alternative argument for this suggests some of the business groups add value to the member companies since they are better placed to lobby the nations for considerations. These political economic literatures suggest the business groups need to be more prevalent in nations where the country has a stronger role to allocate resources or in countries that are more corrupt. There is a mixed evident on the effects of direct valuation for member groups. According to Khanna and Rivking (1999), 3 out of the 15 countries that he researched add value to member countries. They found out however that affiliation do not lower the value of any case. Palepu and Khanna analyze the business group’s performance in India and came up with a conclusion that specific members of the larger groups have higher valuations compared to firms that are independent. Middle sized companies have valuation below their independent colleagues. Almeida and Wolfenzon, studied the opportunity of setting up viable new company either by entrepreneurs without wealth of families who wealth controls the stake of the company, so the amount the amount of capital new firms raised equal the PV of cash flows that was pledged to the outside financiers. Assuming the NPV is positive, the new companies can get all the funding from an external source (Colpan, Hikino and Lincoln, 2010). The new company can be developed by the family or by an entrepreneur and the family chose to control the company with direct ownership to shun away from sharing the Net Present Value with the minority owners of the company. This companies are normally termed as new standalone companies. Assuming the Net Present Value is negative, it is only the family members who can set up the companies with the help of the retained earnings. The family can decide to do it with the help of the link of pyramidal ownership to the present firms to a financing advantage. The family tends to supply the company with mode funds and it shares the NOV with minority shareholders of the existing firms. This firms are normally termed as new companies with parent firms (Fauzias Mat Nor and Bany Ariffin., n.d.). Claessens (2002) on the other hand find evidence that companies organized as pyramid have a lower Tobin’s Q. Same outcomes are evident by Lins and Lemmons, Joh, Mitton, and Lins. Finally, empirical study performed by Claessens, Djankov, and Land (2002) on East Asian Countries find that business group affiliation have no impact on the valuation of a firm. From the results, there are cost and benefits for various types of member companies. The slowest firms in the business groups benefit at the expense of the fastest growing companies. On the centrally to value enhancing views, recent studies argue that business groups increase the agency conflicts and therefore detrimental to the value of firms. The main argument is that when a company belongs to a given group, the degree of exproitation of the minority shareholders by the shareholders might rise. Mullanaithan, Betrand, and Mehta (2002) find the evidence to be consistent with the exproitaiton found in Indian business groups from the companies where the controlling shareholders hold a fraction of equity stakes to companies which hold a higher stake. Bae, Kang, Kim (2002) found out that the Korean chaebols use the M and A transaction among the member firms to expropriate the shareholders of the bidding firms and benefit the family in control (Bae, Kang, and 2002)) These outcome raise crucial questions. After compiling a data set from private manufacturing companies in 18 European nations, the study observed if new firm is appended to existing companies through links of ownership or it is developed only by few people. It is also possible to trace the ownership connection among all companies in the industries to which new organization belongs and distinguish various types of parent firms (Riyanto and Toolsema, 2008). The new companies are always small and have a higher ownership concentration. 25 per cent of those companies tends to have a controlling share by parent companies and these new companies with the parent firms account for three quarter of the added assets to the manufacturing companies by all new organization in every year. Interestingly, majority of the parent firms are not linked with business groups. The pyramidal ownership connections are pervasive among new companies, which highlight the desire in understanding why they exist, their significance in financing new companies and the effect they have on the economy (Almeida and Wolfenzon, 2005). The main criteria behind the pyramidal ownership is that the controlling family tends to supply the new firms with capital when setting up new firms indirectly through the parent companies compared when setting up new companies with direct ownership. Therefore, new companies with parent firms should a greater amount of equity financing from the controlling owner. The ability of the firm to offer inside funds to a new firm is dependent on the amount of resources that the company control (Bunkanwanicha, Gupta and Wiwattanakantang, n.d.). According to this view, it is shown that new companies receive a larger amount of equity when the parent companies have more retained earnings compared to firms that are affiliated to larger firms (Fauzias Mat Nor and Bany Ariffin., n.d.). The empirical implication of the theories shows that the family business groups is more prevalent in nations with poor investment protection. This implication is a consequence for the value enhancing section of the theory. It is believed that there is no defined evidence about this literature, but there is a anecdotal and scattered evidence. For instance La Port, Lopez de Silane, and Shleifer illustrates that the pyramided are prevalence in countries that have poor protection for their investments. Additionally, business groups are likely to organize in pyramids. Here the circumstance that are conducive for the pyramids over the horizontal structures are in similar conditions that makes the groups to be more likely (Gavious, Hirsh and Kaufman, 2015). References Almeida, H. (2009). The structure and formation of business groups. Cambridge, Mass.: National Bureau of Economic Research. Bae, K. H., J. Kang, and J. M. Kim, (2002), Tunneling or value added? Evidence from mergers by Korean business groups, Journal of Finance, 2695-2740. Bena, J. and Ortiz-Molina, H. (n.d.). Pyramidal Ownership and the Creation of New Firms. SSRN Journal. Bertrand, M., P. Mehta and S. Mullanaithan, 2002, Ferreting out tunneling: An application to Indian business groups, Quarterly Journal of Economics, 121-148. Bunkanwanicha, P., Gupta, J. and Wiwattanakantang, Y. (n.d.). Family Business Groups and Organizational Structure: A Study of Bank Pyramidal Ownership in Thailand. SSRN Journal. Claessens, S., S. Djankov, J. Fan, and L. Lang, 2002, Disentangling the incentive and entrenchment effects of large shareholdings, Journal of Finance 57(6), 2741-2771. Colpan, A., Hikino, T. and Lincoln, J. (2010). The Oxford handbook of business groups. Oxford: Oxford University Press. Fauzias Mat Nor, and Bany Ariffin., (n.d.). Pyramidal ownership structure, capital structure and investment policy. Gavious, I., Hirsh, N. and Kaufman, D. (2015). Innovation in pyramidal ownership structures. Finance Research Letters. Granda Kuffo, M. (2010). Pyramidal ownership in ecuadorian business groups. [College Station, Tex.: Texas A&M University. Khanna, T., and K. Palepu, 1999, The right way to restructure conglomerates in emerging markets, Harvard Business Review 77, 125-134. Khanna, T., and J. Rivking, 1999, Estimating the performance effects of groups in emerging markets, Harvard Business School working paper. Renneboog, L. (1998). Shareholding concentration and pyramidal ownership structure in Belgium. [S.l.]: [s.n.]. Renneboog, L. (n.d.). Shareholding Concentration and Pyramidal Ownership Structures in Belgium: Stylized Facts. SSRN Journal. Riyanto, Y. and Toolsema, L. (2008). Tunneling and propping: A justification for pyramidal ownership.Journal of Banking & Finance, 32(10), pp.2178-2187. Xie, J. (n.d.). The Agency Cost of Pyramidal Ownership: Evidence from a Pure Incentive Shock. SSRN Journal. Read More