Tunneling: Evidence from Family Business Groups of Pakistan

This paper investigates a critical aspect of agency conflict between dispersed minority and majority (controlling) shareholders in firms affiliated with family business groups. Corporate governance literature indicates that majority shareholders can exploit minority shareholders through tunneling the resources for their benefit or they provide insurance through propping to group firms in distress. For years 2009-2013, the study uses a unique hand-picked data set of 290 non-financial (i.e. 177 family business group and 113 stand-alone or non-group) firms listed on Pakistan Stock Exchange (PSX). The study finds that majority shareholders expropriate minority shareholders by tunneling (transferring) important resources from low cash-flow rights firms affiliated with family business group. While measuring the sensitivities of firms to the industry earnings shocks, the empirical results reveal that about 15% resources of low cash-flow rights firms are tunneled to high cash-flow rights firms in family business groups. It is also confirmed that equity held by directors representing majority shareholders has negative relationship with earnings of minority shareholders in low cash-flow rights firms affiliated with family business groups. These findings have certain policy implications for governance related regulation development, diverse shareholders and firm management.