Foreign investors preferences for family involvement and corporate governance Evidence from Turkey

Foreign investors’ preferences for family involvement and corporate governance: Evidence from Turkey

Pinar Sener

Corporate governance has been recently discussed as an important determinant of investors’ decisions. In countries with weak governance, the rights of investors are poorly protected by law and the acquisition of information is costly (Klapper and Love 2004). Therefore, poor country-level governance may deter investors (Klapper and Love 2004; Min and Bowman 2015). However, country-level investor protection is not binding, as firms may adapt additional provisions not imposed by laws, to reduce investors’ risks and satisfy their need for external financing. For example, firms can select independent boards, increase disclosure and transparency, or use disciplinary mechanisms to prevent controlling shareholders from expropriating minority shareholders (Klapper and Love 2004). Firms’ governance structures influence information asymmetries between foreign and local investors, and foreign investors have a relative informational disadvantage. Monitoring costs of poorly governed firms are likely higher for foreign investors, as it is easier for domestic investors to be informed about governance problems and expropriation activities (Leuz et al. 2009). Thus, foreign investors are more sensitive to corporate governance issues (Kim et al. 2011). Prior literature focused on firm-level governance to explain foreign equity ownership. Studies explored the effect of independent directors on foreign holdings (e.g., Min and Bowman 2015; Kim et al. 2011). Little is known about other board characteristics affecting foreign investors’ risks. Therefore, this work extends existing studies by investigating the impact of board leadership structure and board size, as well as independent directors, on foreign investors’ preferences. Dahlquist and Robertsson (2001) argued that non-resident investors are wary of firms with a dominant owner. Leuz et al. (2009) revealed that U.S. investors, comprising nearly half the global foreign portfolio investment, likely hold fewer shares in firms with high levels of family control in countries with weak disclosure requirements, securities regulations, and outside shareholder rights. However, their study ignored the different ways families may affect governance decisions, as it only focused on ownership. This study separately explores two dimensions of family involvement: ownership and management. This study which examines whether firm-level governance mechanisms affect foreign holdings focuses on Turkey for several reasons. First, country-level investor protection is weak, since it is a French origin civil law country. Thus, firms likely differ in their degrees of investor protection to attract outside financing. Second, foreign investors are dominant in the stock market and their average shareholdings are higher than domestic investors (OECD 2013). Family business groups are the major actors in the Turkish business system. The wedge between ownership and control is substantial in many family firms, increasing investors’ expropriation risk (OECD 2013). This study can explain foreign investors’ preferences in other emerging countries as well, where investor protection is low, and ownership concentration and the use of control-enhancing mechanisms are high. The sample comprises firms listed on the Borsa Istanbul (BIST) between 2006 and 2010. Financial firms and firms with missing data were excluded. The final sample consists of 196 firms and an unbalanced panel of about 825 firm-year observations. In this study, random effects model is preferred because fixed effects model requires within data variation, which this sample lacks due to limited changes in ownership status, board structure, or sector in the study period (Andres 2008). The findings reveal that foreign investors’ decisions are not affected by board structure. In addition, this study shows that foreign investors do not consider family involvement in a firm to be a potential threat, and invest in family firms when families have moderate levels of ownership. However, they are indifferent to the use of control-enhancing mechanisms by family firms. Their preference for larger firms, firms that have higher book-to-market ratio and firms that pay dividends is similar to investor preferences in developed countries.