The Transformation of Family Firms in Taiwan Under Initial Public Offerings *

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The Transformation of FamiLy Firms in Taiwan under Initial Public Offerings[*]

Yunshi Liu and Kuang S.Yeh

In his seminal book, the Visible Hand, Alfred D. Chandler (1977) proposed that “as the multiunit business enterprise grew in size and diversity and as its managers became more professional, the management of the enterprise became separated from its ownership” (p.9). Since Adolf A. Berle, Jr. and Gardiner C. Means (1932) raised the issue of separation of ownership and control 60 years ago, corporate governance remains one of the most exciting research topics in various disciplines, including law, economics, and organization theory (Blair 1995). With the increasing importance of business sectors in developing countries, study of the evolution of governance structure should be one of the most important research topics in institutional development.

Virtually all of Taiwan’s private businesses were established after World War Two when the Nationalist government took over Taiwan’s sovereignty from Japan. A great number of these businesses are still under the original founders’ control. However, as time passes, many of these founders are gradually relinquishing control to their successors. Many of these firms are in fact in the process of transformation from traditional small family-managed systems to modern large professionally-operated business systems in which the demands for capital and organizational expertise are serious issues that must be dealt with. Although firms can become more professional no matter whether they remain private or not, the regulatory and institutional environment in Taiwan makes it difficult for unlisted private firms to raise capital and recruit qualified professionals.As a company goes public, it can greatly increase its funding capability through public capital markets. In order for a private firm to become a public company, however, it has to fulfill strict regulatory requirements which require the company to follow certain managerial professional standards. Thus, the standard which companies must ultimately achieve in order to benefit from initial public offerings (IPOs) allows them to concurrently solve both capital and management problems.

Through interview with representatives from 20 public companies, five private companies, one accounting firm, and three underwriters, Kuang S.Yeh et al. (1996) have found that the IPO incentive has been an institutionalizational force for transforming management practices in Taiwan’s business community. After IPO, a firm can rapidly raise needed expanding capital and increase its size.[1] That is, the IPO is a process that increases the legitimacy, and thus survival chances, of companies (Meyer and Rowan 1977). This process includes the rational and non-rational issues of diversification of capital-funding sources, improving the company's image, and increasing the owner’s “face,” or prestige. Moreover, all three of the institutional processes described by Paul DiMaggio and Walter W. Powell (1983), namely coercive, mimetic, and normative are involved in the IPO process. Firms preparing for IPOs experience coercive government influence, mimetic influences from companies which have carried out IPOs successfully, and normative influences from professionals such as underwriters. Therefore, for Taiwanese companies, the IPO can be a very important event or opportunity for organizational changes or developmental processes. This research thus continues the work of Yeh et al. (1996) and Yeh (1997) by looking at the effect of the IPO process on Taiwan’s businesses, specifically inquiring as to whether family members decrease their board participation, paving the way for the separation of ownership and management. Further, because regulatory requirements and constraints are much more strict for public companies than for private firms, and because listed public companies are subjected to all kinds of scrutiny from various investors, in this paper we also examine whether the transformation process continues after companies have become public institutions. To our knowledge, no other research on Taiwan has dealt with the issues with which we are here concerned.

It is difficult to define and categorize what “family-owned business” means exactly (Litz 1995). Here we define a family-owned business as a firm whose major executives are members of one or several families, and most likely are related to the firm’s founder(s). The families are also major shareholders of the company. In other words, a family-owned business is owned and controlled by a family or a few families. Hereafter in this paper, we use the above definition, unless otherwise specified. For the sake of efficacy, we simply use the phrase family firm to mean family-owned and controlled firms.By this definition, most Taiwanese companies are family firms, regardless of their size, public or private, although it is possible that a family might own less than 50% of a public company’s stock and the company still be considered a family firm. Based on an examination by Huai-Chen Peng (1989), of 46.3 per cent of the top 200 manufacturing companies, the chairman of the board and president are either father and son or these positions are held by the same person whose family is most likely the largest non-institutional shareholder. In the top 50 companies, the ratio of companies with the chairmanship of the board and presidency held by father and son (or the same person) is even bigger, at 63.4 per cent. Yeh and Tsao (1996) investigated succession processes for top management of the top 25 firms in 1972, and found that by 1992, 23 out of 25 firms had either completed or were in the process of completing the succession by transferring the management control from father to son. It is thus clear how entrenched family-owned companies are in Taiwan.

As Taiwan’s economy is moving from entrepreneurial capitalism, where most firms are owned and managed by entrepreneurs, to managerial capitalism, where most firms are managed by professional managers, it is important and interesting to know whether corporate governance structures move fromtraditional family-owned to modern professionally managed styles. Will the IPO process allow the interests of companies to become independent of families, promote the appointment of talented professionals into important management positions, and decrease the role of the family, thus rationalizing the companies’ management? In other words, will the separation of ownership and management become more institutionalized in Taiwan’s business community? This question is the crux of this paper.

To answer the question raised above, this research attempts to gain an understanding of the nature and composition of the companies' boards. In this paper, we first classify the board types based on directors’ relationships, and then try to discover if the distribution of the board types has changed through the IPO processes. We then use the proportion of family members or close friends on the board as an indicator of the changing processes. We attempt to explore whether companies tend to become less family-controlled through the IPO processes, specifically addressing the question of whether or not the proportion of traditional types of boards and family members/friends tends to decrease after companies go through IPO processes.

Below, a brief description of the institutional environment of IPOs and boards of directors in Taiwan is followed by a literature review, descriptions of relationships, board classification and data collection.An analysis of the evolutionary change of board composition is then presented, followed by a discussion of our findings and conclusions.

Institutions of the IPO and the Board in Taiwan[2]

a) Institutions of the IPO

The Taiwan Security Exchange (TSE), which includes the Taiwan Stock Market, was established in 1961. The Market officially began operations the following year when only 16 companies had carried out IPOs at the time. Before 1985, the Market was not very active, with only about 100 companies listed. The Taipei Composite Index (Taiex) had been below 1,000 points for a long period, and the trading value was only about US$ 100 million. On average, no more than 10 companies went public each year. There used to be a saying in the business community that “a good company will not go public, only those bad companies who need to suck money from the capital market will go public.” Many firms interviewed by us stated that one major reason for them to keep private in the old days was the following way of thinking: “Why do we want to share our profits with other people?”

Beginning in 1986, however, fluctuations in the stock market grew in range due to Taiwan’s rapid economic growth and to the maturity of Taiwan’s capital market. The Taiex rose tenfold, from 839.73 to over the 10,000 in 1989 alone. The Taiex plunged to 3,000 points the following year, however. Since then, the Market has been steadily fluctuating between 3,000 and 10,000 points each yearfrom 1991 to the present. With the maturity of the capital market, the belief that “a good company will not go public” has been gradually reversed. Now, the general public believes that only good and qualified companies are capable of going public. Interviews in Yeh et al. (1996) indicate that one major reason for companies to go public is “to enhance corporate image.”(p.22) After a company successfully carries out IPO, the pressure for maintaining corporate performance and image is much greater than the pressure on a private firm. Due to this change of concepts and beliefs, there has been a sharp increase of IPO firms since 1985. Calculating statistics from various issues of two official series, Taiwan Stock Exchange Materials and Taiwan Securities and Futures Management, about 30 firms on average have gone through IPOs each year since 1985.As of the end of 1996, the trading volume on the Taiex has expanded to about 4 billion U.S. dollars, and 385 Taiwanese companies were listed on the Market. It is estimated that there are still about 300 companies that are presently “under guidance” in preparation for being listed on the market. Of these companies, it is estimated that one-half to two-thirds will be approved to go public.

Compared to the USA, Hong Kong, and Singapore, Taiwan has relatively strict procedures and regulations for companies going public[3] (Tung 1996). To get approval for an IPO, companies must meet the requirements of the Securities Exchange Commission (SEC). According to the regulations, companies which plan to go public have an obligation to reveal their financial information first. The companies must then choose an accounting firm and security underwriter(s) to guide them for a 2-year-minimum term of IPO preparation. When a company is ready, the company will then file an IPO application, which includes auditing and evaluation reports from the accounting firm and underwriter(s). After 1-2 months of documental review and on-the-spot auditing carried out by the TSE, the report produced by the TSE investigators must be submitted to and get approval from (in that order) TSE’s IPO department, review committee, and board of directors. After the company completes the review process, it must submit the IPO agreement to the SEC, and begin the public offering. This entire process lasts approximately two and a half years. Going through all necessary requirements, firms have to show tenacious patience to prepare and adjust to many operational routines, such as an internal control system and auditing procedures. Many of those adjustments are necessary because traditional family-owned firms are used to mixing the family property with that of the business. When the application goes to TSE’s review committee, executives from the applicant firms have to stand for “oral examinations.” Questions regarding the firm’s future business plans, relationships between directors and executives, investment status, and related issues are raised in the oral examinations. According to Ji-Ping Yang (1996), the review committee is especially concerned about the possibility of directors using company’s resources to advance personal interest. On the other hand, some firm owners also like to use IPOs as a justification or opportunity for pressuring employees to make the company more competitive,since employees might have to change their work habits to get IPO approval (Yeh et al. 1996). Thus, it is clear that the IPO can be an institutionalization vehicle for corporations to engage in organizational change.

b) Institutions of the Boards of Public Companies

Regulations are fairly strict in terms of the position and stock holdings of the directors of public companies. These regulations stipulate that the board members of companies must also be shareholders, often very large shareholders, and that they must maintain their positions as shareholders during their terms as directors. According to government regulations, total shares owned by theentire members of the board have to be larger than 15 per cent for companies having less than NT300 million capital, larger than 10 per cent for companies having capital between NT300 million and NT 1 billion, larger than 7.5 per cent for companies having capital between NT 1 billion and 2 billion, and larger than 5 per cent for companies having capital larger than NT 2 billion. At the end of 1996, there were 385 public companies and 86.5 per cent of these firms’ board holdings were more than or equal to 10 per cent. One has to be reminded that most of these directors are non-institutional investors. Thus, directors’ share holdings are quite large. In essence, it appears that discouragement of the separation of ownership and management is the spirit of the stock holding regulations. Therefore, it is difficult to demonstrate whether or not IPOs can cause firms’ ownership to be separated from management.

In Investor Capitalism, Michael Useem (1996) argues that institutional investors such as fund managers can now exercise tremendous power on board structures in theUnited States. The situation is very different in Taiwan. The total holding of institutional investors only accounts for about 4 per cent of total stock market capitalization, and typical trading volume is only around 8 per cent to 10 per cent of the total trading volume.[4] In other words, most stock holdings and trading are held and exercised in the hands of individual investors in Taiwan. Firms and their boards, therefore, are more likely to be under family or individual control in such situations. Through complicated arrangements, such as cross share-holding, the controlling family can effectively command many resources from the company and other related businesses.

To protect minority shareholders’ interests, public firms are required to have independent auditors who are to perform tasks similar to that of an auditing committee in a U.S. public company’s board of directors. Auditors have to be shareholders of the company and cannot exercise voting power on the board. Auditors, however, represent shareholders in supervising corporate financial operations. They have the right to investigate any financially related corporate matters. However, many auditors are relatives of directors, and it is very unlikely that auditors perform their required functions independently.However, the common practice in Taiwan is for auditors to be equated with directors; therefore, in this paper we do the same.

A board needs to have at least 3 directors and 1 auditor who are elected by the shareholders in a general meeting. As indicated earlier, directors have to be stockowners and they are required to be reelected every three years. The size of boards varies from 4 (required minimum of 3 directors and 1 auditor) to more than 20 directors. Most of the companies have about 6 to 10 directors. Usually, the controlling family uses complicated tactics to control every seat of the board often by proxy. When the controlling family invites institutional investors to invest in the family business, some seats of the board might be yielded to institutional investors. Sometimes, the controlling family does not have enough votes and loses some seats to individual investors. Occasionally, the controlling family might even lose control of their firm. This process may be construed as being a form of merge and acquisition (M/A) Taiwanese style. M/A are not strategic competitions between firms, but more likely to be competitions between individuals or families.

Literature Review

There is much academic research that investigates Taiwanese businesses (Gereffi and Pan 1994; Hamilton and Biggart 1988). This is especially true following the increased vitality visible in Taiwanese businesses and Taiwan’s growing political and economic influence, which has sparked great interest among scholars. Literature on board structure and composition in Taiwan, however, is very limited. In the following, we focus on family businesses and boards in general. Since the IPO is an institutional process, this research employs perspectives from institutionalism to study the evolution of governance structures. Literature on institutionalism, therefore, is also reviewed.

a) Family Businesses

Family businesses are the predominant form of enterprise around the world (Gersick et al. 1997). In overseas Chinese businesses, the family form is also the most important and common form of organization, even among large public corporations (Redding 1993). Taiwan is not an exception. One would not be able to understand the actual operations of Taiwanese businesses without a discussion of family businesses. As is mentioned in the introduction, most Taiwanese companies are family businesses by the definition employed in this paper, regardless of their size and public or private status. Family businesses have advantages such as very fast decision making and action taking. However, some less positive characteristics of Taiwan’s family businesses are apparent: protection and favoritism among relatives, business succession based on kinship ties, a family-style way of conducting business, autocratic management, a confused organizational structure, and a non-systematic distribution of labor and specialization (Hwang 1988; Wong 1985; Negandhi 1973).