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Transfer of Control and Ownership Structure in Family Firms.

Dr. Hojong Shin is Assistant Professor of Finance. Below is a summary of his new research, "Transfer of Control and Ownership Structure in Family Firms.

In exchange for these financial contributions, prosecutors say, Ms. Choi colluded with Ms. Park to ensure government backing for several deals, most notably a controversial merger of two Samsung affiliates in 2015 that helped Mr. Lee consolidate his hold over Samsung Electronics. The merger changed Samsung’s intricate cross-holding structure and, prosecutors said, allowed Mr. Lee to avoid a steep inheritance-tax bill as he sought to succeed his father at the top of the conglomerate. (Wall Street Journal, August 25, 2017)
This anecdote illustrates how, in practice, family firms indirectly transfer control to heirs through intra-group mergers. When controlling families transfer their control through direct ownership inheritance, heirs inherit the family ownership by paying an inheritance tax. This is what we generally expect when we talk about the transfer of control in family firms. However, heirs are exposed to the risk of their equity value decreasing due to heavy inheritance taxes when control is transferred through ownership inheritance. Thus, controlling families are incentivized to use tax-minimizing succession strategies to ensure that the heirs maintain sufficient control over the entire business group. A common tax-saving strategy to avoid taxes during the transfer of control in business groups is for family firms with heavy inheritance tax burdens to acquire target firms owned by heirs. The heirs then convert the target shares into family firms’ shares. Through this merger, heirs can obtain large controlling stakes in a key strategic firm owned by the controlling family while avoiding inheritance taxes.
Transfer of control is a tremendously important issue in any organization. Succession is the preeminent issue for family firms as it determines their firms’ fate. Only 30% of family firms carryover into a second generation, 12% remain viable into a third, and 3% operate into a fourth generation or beyond. Given the importance of family firms, succession has attracted attention in recent literature and has been studied from numerous angles. However, there is little detailed evidence regarding the effect of personal inheritance tax on corporate outcomes and the implications of different succession processes for family firms. Shin has identified a novel channel of transfer of control in family firms.
Shin used information from Korean chaebols because they report highly detailed inter-firm ownership information among their affiliates with the Korean Fair Trade Commission since the mid-1990s. However, the story in my paper is not limited to Korea. Any family firm with an inheritance tax has its own incentive to use tax-minimizing succession strategies.
Avoiding inheritance tax is the motivation behind intra-group mergers in Korea. The tax reform increased personal inheritance tax by 25%. Thus, firms burdened by a high personal inheritance tax are likely to increase merger activities between group member firms during the post-tax-reform period. This result suggests that family firms with heavy inheritance tax burdens acquire target firms owned by heirs who then convert their target shares into family firm’s shares while avoiding the inheritance tax.
What Shin did next was investigate the characteristics of target firms in relation to merger activities. Shin found that heirs of chaebol families received large dividends from their private firms in which they already have large ownership stakes. Heirs can take these dividends because they have substantial voting rights with which they can determine the corporate policy in target merger firms. These firms become the target of mergers. Since heirs only own the target firms that are merged with acquired firms (owned by the family), these heirs prefer short-term gains in wealth over long-term investment commitments.
These results suggest that to avoid inheritance tax burdens, heirs might first prefer to own private firms where they can increase cash dividends and then try to merge private target firms to their fathers’ firms.
Tunneling is more prevalent in emerging economies where controlling shareholders can exercise their discretionary power to extract private benefits by transferring assets and profits out of firms. While the heirs of controlling families benefit from personal tax savings, minority shareholders suffer losses from these tax-motivated intra-group mergers as these mergers create few operating synergies and thus cause investors to exit their stocks. This finding represents a new piece of evidence of tunneling caused by heavy inheritance tax burdens in a specific institutional setting. Similar personal tax-saving efforts implemented for the controlling family’s benefits are likely to be observed in many alternative institutional contexts.
Shin, Hojong (2019). Transfer of Control and Ownership Structure in Family Firms.