Why Credit Ratings Serve a Greater Role in Emerging Economies than Industrial Nations: A Comparative Analysis between Family Firms and Concentrated Ownership Structures in South Asia

Why Credit Ratings Serve a Greater Role in Emerging Economies than Industrial Nations: A Comparative Analysis between Family Firms and Concentrated Ownership Structures in South Asia

Marianne Ojo (North-West University, USA & Accounting Research and Legal Scholarship Networks, USA)
Copyright: © 2016 |Pages: 19
DOI: 10.4018/978-1-5225-0004-9.ch007
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Abstract

The agency problem attributed to dispersed ownership is also principally regarded as being that of the control over powerful management. Whilst there are conflicting views in respect of the degree of agency problems which arise under dispersed and concentrated ownership structures, it appears that additional or greater agency problems will eventually necessitate the need for greater monitoring. In recommending the external auditor's expertise as appropriate for addressing agency problems, this chapter draws attention to the audit committee's roles, presenting them both as vital and complementary corporate governance tools.
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Introduction

The agency problem attributed to dispersed ownership is also principally regarded as being that of control over powerful management. Whilst there are conflicting views in respect of the degree of agency problems which arise under dispersed and concentrated ownership structures, it appears that additional or greater agency problems will eventually necessitate the need for greater monitoring. Ownership of shares definitely also has a role to play in ensuring greater monitoring – however where a more harmonious relationship exists between principal and agent – particularly based on trust and long term relationships, the principal may see no reason to undertake “unnecessary” levels of monitoring – which may be considered costly. In other words, the traditional professional business like principal-agent relationship is transformed over a long period of term during which the long term harmonious relationship is sustained. In this respect, the traditional principal agent relationship in concentrated ownership systems and structures, would exist not between dominant shareholders and the agent – rather between the agent and the minority shareholders. The minority shareholders, unfortunately, are unable to afford or commit the same level of control or funds (as that available to dominant shareholders), necessary to monitor the agent.

Emerging market corporate governance is typically characterized by high insider ownership and a predominance of family ownership. Emerging markets, where there is concentrated ownership, family ownership and weak legal protection, family members with majority shares, are able to engage in window- dressing, expropriating minority shareholders. The concentrated family ownership is the root cause of Principal-Principal-Agency (PPA) problems in Sri-Lankan public listed companies. (Wellalage & Locke: 2011)

Reasons highlighted for “prevalent inside ownership” in emerging economies are as follows:

  • Founder managed firms being reluctant to share core competences and vital information with outsiders

  • Weak legal protection

  • Under developed nature of financial markets - which restricts access to external financing and results in family pre-dominant concentrated ownership.

According to Eun and Resnick (2009:81), in many countries with concentrated ownership, conflicts of interests are greater between large controlling shareholders and small outside shareholders, than between managers and shareholders. They also make reference to studies undertaken by La Porta, Lopez-de-Silanes, Shleifer, and Vishny (LLSV) which document „sharp differences between countries“ in respect of:

  • Corporate Ownership Structures

  • Depth and Breadth of Capital markets

  • Access of firms to External Financing

  • Dividend Policies

It has been argued in many studies, that bank capital ratios and several other financial indicators do not serve as effectively in emerging market economies as is the case with industrial nations.

According to Rojas-Suarez (2002), the capital-to-asset ratio, has under-performed as an indicator of banking crisis related problems in Latin America and Asia. Two reasons which have been put forward as explanations for this are:

  • Severe deficiencies in the accounting and regulatory framework in these jurisdictions;

  • Lack of liquid markets for bank shares, subordinated debt and other bank liabilities and assets which are required to confirm and justify the actual worth of a bank – rather than merely its accounting value.

To which it will also be added that audits, which serve as vital signaling mechanisms in capital markets - as well as those nations which are pre-dominantly based on dispersed ownership structures, have limited roles in many emerging economies than is the case with industrial nations.

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