Corporate Opacity and Cost of Debt for Family Firms

Abstract

This paper uses a sample of Chinese firms to examine the impact of corporate opacity on the relationship between family control and firms’ cost of debt. We find that family control is associated with a lower cost of debt on average, and a negative impact exists mainly in firms with relatively low corporate opacity. We further provide evidence that the moderating effect of corporate opacity becomes more pronounced when investors’ perception of controlling families’ moral hazard of expropriation is higher. Our results are robust to alternative opacity proxies and controlling for endogeneity of family control using the instrumental variable method. Our study highlights that controlling families are heterogeneous in their impact on the shareholder–debtholder relationship in family firms, and debtholders view corporate opacity as an important reference in assessing the extent of potential agency conflicts in China.

Acknowledgements

We are grateful for the guidance from Professor Laurence van Lent (the editor). Thanks also to the anonymous reviewer for the constructive comments. We would like to thank the participants at the 25th Australasian Finance & Banking Conference (Sydney, 2012) and the 22nd European Financial Management Association Annual Conference (Reading, 2013) for their helpful comments. We appreciate Professor Joseph Fan for his useful comments on an earlier draft. All errors remain ours.

Notes

¹For instance, in a 2006 report the World Bank surveys investment climate of 120 cities (and 12,400 firms) across 30 provinces (i.e. all provinces excluding Tibet) in China and finds wide cross-region variation in investment climate. For example, per capita GDP in Southeast China averages more than 150% above Central and Southwest China. Firms in the 10th percentile of cities (in terms of government intervention and efficiency) spend an average 36 days per year interacting with major bureaucracies, compared to 87 days for firms in the bottom 10th percentile cities. Fan, Wang, and Zhu (2011) largely confirm the inequality in economic and market development as well as government efficiency at the province level.

²Of our 3320 firm-year observations, 1092 satisfy our definition of family firms. If we relax the definition by removing the 20% threshold for control rights, the number of family firms increases to 1210. As an additional test, we run all regressions using this alternative definition. Our main results remain qualitatively unchanged. If we remove the second criterion, the number of family firms remains the same. In other words, when the founding family holds at least 20% of control rights, no other blockholders hold more than 20% control right. This also implies that concentration of equity ownership is even higher in family-controlled firms.

³However, those results are available on request.

⁴Recall that in constructing the corporate opacity index, we rank each of the four components into deciles (from 0 to 9) and divide the sum by 36. Thus, a zero opacity index value does not indicate zero information asymmetry; rather, it means each of the four components is in the lowest decile of opacity.

⁵The international Big Four include Deloitte, E&Y, KPMG, and PwC. The six largest domestic auditors are Shanghai Lixin, Xinyong Zhonghe, Yuehua, Daxin, Dahua, and Zhongshen.