(Authors: Maximiliano González, Alexander Guzmán, Carlos Pombo and María-Andrea Trujillo)
Executive Summary prepared by Andrew Hier, senior partner, Cambridge Advisors to Family Enterprise, FFI Fellow
How does family involvement affect dividend policy in closely-held firms? To study this important question, the authors used a database of 458 Colombian companies spanning the period from 1996 to 2006 to examine the effects of family involvement on dividend policy in closely-held firms with some level of ownership dispersal. The authors note that Colombian firms share several characteristics with other emerging markets: high ownership concentration, family business groups owning multiple firms and low investor protection.
Family involvement in control occurs when families use various control-enhancement mechanisms that enable a family’s voting rights to exceed its relative cash distribution rights based upon ownership, including: multiple share classes, pyramids (allowing control of a firm through one or more intermediate firms that are not totally owned by the family), cross-holdings, voting agreements and disproportionate board representation. An array of variables were tracked in this study including a) Family Involvement in Management (FIM), defined only as a family member CEO; b) Family Involvement in Ownership (FIO), looking at both concentrated ownership where the founding family is the largest shareholder and the impact of minority shareholders; c) Pyramidal Family Control where the family’s holding company might control intermediate firms that they do not wholly own which in turn control an operating firm; and d) Majority Family Board Control if the participation of family members on the board of directors is more than 50%. The frequency and magnitude of dividends were studied over the relevant time period.
In the related discussion about agency theory, the authors discuss the role of dividends in responding to agency conflict between majority and minority shareholders, and in regard to agency costs which begin to appear as ownership and management are separated. One important dimension is the potential for free cash flow to be directed toward higher compensation for executives and other executive benefits, nepotism, related party transactions and investment in empire building ambitions, versus current dividends for all shareholders.
Economic factors were of obvious impact; the authors found that dividend-paying firms are older, larger, less leveraged and more profitable than nonpaying firms. Furthermore, dividend paying firms have larger boards on average, a higher participation of outside directors and higher contestability across blockholders (meaning how concentrated minority shares are held and how much legal protection is given to minority investors).
The primary findings of the study relating to family involvement and dividends are:
- Dividend policy did not differ significantly on average between family firms with a family CEO versus family firms with a non-family CEO.
- Family Involvement in ownership with majority control tends to reduce the level of dividends, particularly in a country like Colombia with weak legal protection for minority shareholders.
- Family involvement in control through pyramidal structures reduces the likelihood of dividend payments and their level.
- Majority family board representation tends to increase dividends. This finding seems at odds with the earlier findings that dividend levels are lower on average where there is majority ownership by a founding family and where there is ownership control through pyramidal means. The authors imply that a majority of family membership on the board may give more voice to family member minority shareholders who might tend to seek a higher dividend level.
Practitioners understand that dividends are an important balancing factor between the interests of shareholders not involved in management and those who gain other benefits through management control. A critical work stream is to facilitate the development and implementation of a dividend policy that aligns the priorities of owners and the board of directors to resolve the myriad of competing interests for cash flow between operating needs, long term reserves/investment, retention of executive and employee talent, expansion/acquisitions and an appropriate return for investor/family shareholders. This article will help practitioners understand the impact of a number of governance variables on dividend levels.