Controlling shareholders and the effect of diversification on firm value: evidence from Indonesian listed firms
| Pages | 362-383 |
| DOI | https://doi.org/10.1108/JABS-12-2016-0165 |
| Published date | 08 July 2019 |
| Date | 08 July 2019 |
| Author | Rayenda Khresna Brahmana,Doddy Setiawan,Chee Wooi Hooy |
| Subject Matter | Strategy,International business |
Controlling shareholders and the effect
of diversification on firm value: evidence
from Indonesian listed firms
Rayenda Khresna Brahmana, Doddy Setiawan and Chee Wooi Hooy
Abstract
Purpose –The purpose of this paper is to investigatewhether the presence of controlling shareholder
affects the value of diversification based on Indonesian listed firms. It further examines whether the
degreeof controlling ownership and the types of controllingownership matter.
Design/methodology/approach –Panel data were used over the period 2006-2010 with dynamic
generalised method-of-moments estimations and it defined diversification as industrial diversification,
internationaldiversification or diversification in both. A few differentthresholds for the control rights of the
largestshareholder are also set.
Findings –The results show that industrial diversification improves firm value but international
diversification does not, while diversified in both strategies discounted firm value. The presence of a
controlling shareholderis found to have a significant diversification discount,and the effect is nonlinear,
where the entrenchmenteffect occurs around 20 to60 per cent threshold of controlling acrossall types of
diversified firms. Last, foreign firms are found to enjoy more value from industrial diversification, but it
takes an adverse turn when theseinvolve both diversification strategies. Governmentfirms do not seem
to be differentfrom family firms.
Research limitations/implications –The studyshows the need to differentiate diversificationstrategies
and accountfor non-linearity and ownership identityin modelling diversification value. Also,the degree of
shareholders’control can be a significant channelto address the agency issue on diversificationvalue.
Practical implications –Under the backdrop of unique Indonesian corporate ownership, the presence of
controlling owners is shown, and their ownership affects the valueof diversification. The entrenchment effect
however appears only at a certain range of ownership. This is a crucial guide for the shareholders to ensure
an appropriate monitoring system is installed to maximize the shareholder’svalue, especially in family firms.
Originality/value –The value of this paper is twofold. At first, the first empirical evidence on the
diversification debate withIndonesian firms for its unique institutional setting is presented. Second,the
standard modellingframework to investigate the types of ownership on diversificationvalue is extended,
which hasrarely been covered in previous investigations.
Keywords Ownership, Family firms, Firm value, Diversification, Controlling shareholders
Paper type Research paper
1. Introduction
Indonesia is the second largest emerging economy behind China and has the tenth largest
GDP in the world. Firms in Indonesia ventured their businesses internationally as early as
the late 1950s, promoted by the “Lighthouse Policy” of President Soekarno. The ASEAN
Free Trade Area(AFTA) has also encouraged Indonesian firms to diversify exponentially
over the past two decades. In fact, Pananond (2008) reported that Indonesian outward
foreign direct investment has increased enormously from US$86m in 1990 to US$6,940m in
2000 and jumped further to US$21,425m in 2007. The increasing trend of international
diversification seems to have continued exponentially as reported in a recent report of
Rayenda Khresna
Brahmana is based at
Universiti Malaysia
Sarawak, Kota Samarahan,
Malaysia. Doddy Setiawan
is based at Universitas
Sebelas Maret, Surakarta,
Indonesia. Chee Wooi Hooy
is based at Universiti Sains
Malaysia, Minden,
Malaysia.
Received 5 December 2016
Revised 30 May 2017
16 August 2017
Accepted 22 August 2017
PAGE 362 jJOURNAL OF ASIA BUSINESS STUDIES jVOL. 13 NO. 3 2019, pp. 362-383, ©Emerald Publishing Limited, ISSN 1558-7894 DOI 10.1108/JABS-12-2016-0165
United Nations Conference on Trade and Development (UNCTAD), in that Indonesian
foreign direct investment totalled US$89,000m or 9 per cent of the GDP during the period
2004-2012, the highest in the region after Singapore. This is also reflected in most empirical
work. For instance, Claessens et al. (2001) documented that Indonesia had a high
percentage (47 per cent) of multi-segment firm-years compared with the USA, which had
only 20 per cent of multi-segment firm-years, and Indonesia-diversified firms had the
highest asset size among its peers in Southeast Asia over the period 1990-1996. Mitton
(2002) also showed that 46 per cent of Indonesian companies were reported as diversified
firms. In a smaller sample, Lins and Servaes (2002) reported that 20 per cent of Indonesian
firms were well diversified.
It has been documented that a majority of thelisted firms in Indonesia were family-controlled
firms (Claessens et al.,2002). These family-controlled firms are closely related to the internal
market hypothesisbecause of their pyramiding and crossholdings, throughwhich funds can
be allocated easily among the firms within the group to facilitate better financial firms
(Anderson and Reeb, 2003;Claessens et al.,2006;Khanna and Palepu, 2000). Moreover,
the Indonesian Government practices protectionism that distorts the value of resources and
makes diversification more viable (Kock and Guille
´n, 2001). Because Indonesia has a less-
developed financial market, firms extract financing through a diversification strategy (internal
market). In addition, Indonesian firms bear a higher currency risk because of the volatile
rupiah. Moreover, the rigidity of the policy may affect the diversification strategy of state-
owned enterprises in Indonesia. Therefore, Indonesia offers a unique environment to
investigatethe value impact of diversification in thecontext of controlling shareholders.
Diversification matches the condition of emerging markets in two modes. First, the
diversification strategy is suitable to the emerging economy because in the growth phase of a
business cycle, companies will tend to expand their business through divers ification (David,
2014). Second, diversification offers companies in emerging economiessuch as Indonesia the
luxury to bypass the external financial market and fund their capital expenditure with their
internal cash flows from their diversified business segments. The use of internal capital market
is beneficial because of the high cost of capital that characterizes the external capital markets
of the emerging economies (Hoskisson et al.,2000). This cheap fin ancing may hypothetically
induce firm performance. Theory of internal market hypothesis is the best explanation on this
diversification–performance link. Internal market hypothesis addresses the channelling of cash
flow among units from segments of diversified companies, upon which these capital/funds are
not necessarily returned to their sources but are redistributed to all units at the d iscretion of the
authorities at the headquarter. Powell et al. (2008) argue that this flow of funds internally
creates investment opportunities which might result in better performance . Lee et al. (2012)
add that this internal fund occurs because of less-developed market and an open capital
market, where companies face high cost of capital in financing their investment by using f unds
from external markets such as capital markets or money markets.
There is two-side coin of diversification strategy in the perspective of internal market
hypothesis. Diversification may induce firm performance, as there are cheaper funds and
less financial constraint, which leads companies to be able to operate efficiently (Stein,
1997). Meanwhile, it is believed that diversification can discount firm performance due to
the agency cost. When managers are not well-monitored in their investment decision,
diversification is best for only the manager’s and not the company’s performance
(Matsusaka and Nanda, 2002;Scharfstein and Stein, 2000). Therefore, it is intriguing and
interesting to test this internal market hypothesis, especially in the context of emerging
countries like Indonesia.
Firms can benefit from diversification through the internal capital market (Williamson, 1979)
or through higher debt capacity (Shleifer and Vishny, 1992). The cost of diversification
stems mainly from the agency problem, which arises when managers diversify because of
their personal interest, such as prestige, remuneration, job-related risk reduction and
VOL. 13 NO. 3 2019 jJOURNALOF ASIA BUSINESS STUDIES jPAGE 363
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