Pyramids and the separation between direction and ... - Springer Link

J Manag Gov (2014) 18:835–872 DOI 10.1007/s10997-013-9257-6

Pyramids and the separation between direction and control of non-financial Italian family companies Emiliano Di Carlo

Published online: 9 March 2013 Springer Science+Business Media New York 2013

Abstract This paper uses a multiple case study analysis of ten Italian business groups controlled by families to answer the following research questions: Does the controlling shareholder, through the parent company at the top of the pyramidal group, always exercise the direction activity of the subsidiaries? If not, why does the parent company not exercise that activity, delegating it to its subsidiaries? What is the degree of separation between control and direction within the group? A high percentage of our sample declares not to be directed by the parent company. However, the presence of family members on the subsidiaries’ boards and the low boards’ independence makes the separation between direction and control more apparent than real. The credibility of the separation is questioned mostly for those non-directed subsidiaries that operate in the same sector. Our analysis suggests some elements, in order to understand in which cases the direction activity by the parent (or its delegation to the subsidiaries) should be interpreted positively or negatively in terms of controlling shareholder expropriation, by proposing to use the degree of separation between direction and control as a proxy to assess indirectly the degree of that expropriation. Keywords Corporate governance Family ownership Pyramidal group Subsidiary board

1 Introduction Pyramidal group structure is one of the mechanisms, together with cross-ownership, golden shares and dual class equity, that is used to achieve the separation between E. Di Carlo (&) Department of Business Government Philosophy Studies, University of Rome ‘‘Tor Vergata’’, Via Columbia 2, 00133 Rome, Italy e-mail: [email protected]

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ownership and control, allowing the dominant shareholder to control an elevated amount of resources with a limited investment in the equity (Almeida and Wolfenzon 2006; Claessens et al. 2000; La Porta et al. 1999). In a pyramidal group, and more generally in a business group, the controlling owner has the power to direct the subsidiaries, considering them as a single economic entity. This happens particularly when the subsidiaries operate in the same sector, within which they have strong business ties. There are at least two perspectives through which to interpret the decision-making power over the subsidiaries: opportunistic and efficient. The former refers to the likelihood that the dominant shareholder, positioned at the top of the control chain, has an incentive to divert resources at the expense of the minority shareholders (Almeida and Wolfenzon 2006; Claessens et al. 2000; Faccio et al. 2001; Friedman et al. 2003; Morck 2005). The latter is connected to the fact that the corporate group performs more efficiently than is possible through the market governance of transactions (Coase 1960; Williamson 1985). Indeed, the business group is considered as a firm network, an intermediate economic institution between markets and hierarchies (Holmstrom and Tirole 1989). In both perspectives, normally researchers seem to assume that the dominant shareholder, through the controlling parent company at the top of the pyramid, directly exercises the decision-making power of all subsidiaries. In other words, he/ she does not only have the power but also exercises that power. So far, studies on pyramidal groups have not adequately taken into account the possibility that the dominant shareholder may have delegated his/her power, giving to each subsidiary the defences necessary to protect minorities (e.g. truly independent board members), ensuring separation between control and direction, and consequently reducing the degree of opportunistic behaviour. The aim of this paper is to answer the following three research questions: Does the controlling shareholder, through the parent company at the top of the pyramidal group, always exercise the direction activity of the subsidiaries? If not, why does the parent company not exercise that activity, delegating it to its subsidiaries? What is the degree of separation between control and direction within the group? In doing so we focus our attention on the Italian business groups. Indeed, according to the Regulation introduced by the Italian Corporate Law Reform of 2003, subsidiaries have an obligation to disclose if they are directed and coordinated by their parent company. In other words, for Italian companies that belong to a business group, there is the possibility of knowing if the dominant shareholder separates the control from the direction activity. Moreover, the Italian group Regulation provides that the company (the ‘‘directing company’’), when directing other companies (the ‘‘directed companies’’), acts in its or others’ interest in violation of the principles of fair corporate and business management of the directed companies, shall be directly responsible to the outsiders (minorities shareholders and creditors) of the directed companies for the prejudice caused. In order to answer our research questions, an explanatory multiple case study analysis (Yin 2003) of ten Italian business groups controlled by families will be presented. Using a group structure, these families control 28 listed companies.

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These companies are all subsidiaries because they all have a controlling parent company. A high percentage of our sample declares not to be directed by the parent company. However, the presence of family members on the subsidiaries’ boards and the low boards’ independence makes the separation between control and direction more apparent than real. The credibility of the separation is questioned mostly for those non-directed subsidiaries that operate in the same sector. Our analysis suggests some elements to understand regarding which cases the direction activity by the parent (or its delegation to the subsidiaries) should be interpreted positively or negatively, and proposes to use the degree of separation between control and direction as a proxy to assess indirectly the degree of expropriation by the dominant shareholder. The remainder of this study is organized as follows. The next section discusses the differences between ownership, control and direction within a business group. Section three is focused on the perspectives suggested by the literature for the interpretation of the direction activity by the parent company. Section four discusses the relevance of the interest of the whole group, and the separation between control and direction in Italy. Some propositions are thus formulated. The research design and methods are presented in section five. Section six describes the characteristics of the sample. The results from the case study analysis and the main findings are subsequently discussed in section seven. Section eight concludes with a summary of the basic results and a discussion of potential implications for researchers, practitioners and regulators. This section also presents the limitations of the study.

2 Separation between ownership, control and direction within a business group Many scholars have documented the presence of business groups around the world (Claessens et al. 2000; La Porta et al. 1999; Morck 2006). The literature proposes different definitions of what a business group is (Cuervo-Cazurra 2006). For this study we adopt that of Chang and Hong (2002, p. 266), who define the business group as a ‘‘gathering of formally independent firms under single common administrative and financial control’’. That definition is particularly useful for our purpose because, despite the presence of formally independent legal entities, the business group is considered as a single economic entity. This concept is often recalled for accounting reasons, especially with reference to consolidated financial statements, i.e. ‘‘the financial statements of a group presented as being for single economic entity’’ (IAS 27). To be consolidated, a legal entity must be controlled by the parent company. According to IAS 27 ‘‘control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities’’. Therefore, the accounting standard asks the parent to consolidate a subsidiary legal entity when it is ‘substantially controlled’, even if the parent does not exert its power. Indeed, control is the power to govern while direction is the exercise of the control power, i.e. the exercise of the decisionmaking power. In this paper we state that within a business group control is separated from management when the parent company delegates the exercise of the

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decision-making power to the boards of its subsidiaries. Subsidiary autonomy can be defined as the decision-making rights that are granted by the parent (Gammelgaard et al. 2012). A subsidiary possesses high autonomy when it exercises the power to direct the operational and/or strategic decisions. Low autonomy arises when the parent largely makes such decisions. Control of a company generally exists by reason of the ability to elect the majority of the board of directors—de jure control. The concept of control also includes what is often referred to as de facto control. An example of de facto control might be a situation in which a parent holds \50 % of the voting rights of a subsidiary but it is enough to force the latter to act in accordance with the parent’s wishes. In the case of control, it cannot be said with certainty that the controlling party also exercises the direction activity. Moreover, pursuant to IAS 27, de jure and de facto controls are only indicators of a potential substantial control, i.e. the power to govern. Indeed, there could be exceptional circumstances where it can be clearly demonstrated that possession of de jure and de facto controls does not constitute substantial control (IAS 27). Scholars use cash flow rights to measure corporate ownership and voting rights for control (Faccio and Lang 2002). However, for the control in this study, we prefer to use the definition of IAS 27. Thus, we consider that a legal entity is controlled when it is consolidated. In other words, we move from formal control to substantial control. Figure 1 shows a business group with a complex legal entity map; some companies are de jure controlled while others are de facto controlled. For each company the fraction of the cash flow rights (CFR) of the ultimate owner is

Fig. 1 The identification of the business group. Source: Adapted from Bianchi and Bianco (2006)

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indicated. Within the group there are legal entities that are not just controlled but also directed by the controlling company (e.g. C, E, L). Bianchi and Bianco (2006) clarify that ‘‘listed group includes all companies (listed and not listed) which are linked by a control relationship to the listed company, i.e. those that control or are controlled by the listed company itself’’. The presence of more than one listed company within the business group ‘‘signals a potentially high level of separation between ownership and control, because it increases the possibility to involve minority shareholders in the ownership of the group, in particular if listed companies are at different levels of the chain of control’’. The listed companies represented in Fig. 1 are under the common control of parent company A. Listed companies X, Y and W control at least one company and then, according to IAS 27, each of them is required to prepare consolidated financial statements. In particular, the consolidated financial statements of the group controlled by the listed company X are the combined financial statements of the parent company X and its subsidiaries, i.e. firms C, listed Y, E, listed W and L. The consolidated statements of the listed company Y contain firms E, listed W and L, while those of listed company W contain only firm L. Some of these companies are just substantially controlled; this means that under IAS 27 the controlling company has the power to govern their financial and operating policies, while in some other instances it exercises its decision-making power through the direction activity.

3 How to interpret the direction activity within a pyramidal business group: opportunistic and efficient perspectives There are at least two perspectives through which to interpret the direction activity of the parent company over the subsidiaries: opportunistic and efficient. The opportunistic perspective is based on agency theory (Jensen and Meckling 1976) and interprets the direction as a potential tool of expropriation by insiders, i.e. managers, dominant shareholders or both, to extract private benefits at the expense of outsiders. The private benefits of control are those that controlling parties do not share with other shareholders (Dyck and Zingales 2004; Nenova, 2000). These benefits include, among others, exorbitant salaries, perquisites, empire-building power, and tunnelling. Tunnelling is undoubtedly one of most studied ways to extract private benefits. Johnson et al. (2000) define ‘tunnelling’ as the ‘‘transfer of resources out of a company to its controlling shareholder (who is typically also a top manager)’’. Frequently the phenomenon of tunnelling is associated with that of pyramidal groups (Almeida and Wolfenzon 2006; Friedman et al. 2003), where the dominant shareholder, at the top of the control chain (e.g. the ultimate owner in Fig. 1), may have an incentive to divert resources through related party transactions. This in turn could lead to significant private benefits at the expense of minority shareholders.

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The opportunistic perspective requires the examination of the different interests that characterize a business group. In particular we refer to three interests, expressed by: the parent company, subsidiaries, and the whole group (Gambino 1993). The interest of the parent and that of subsidiaries is to create value for their respective shareholders. However, the holding company could be tempted, for example, to use intragroup transactions and transfer pricing in order to divert resources from the subsidiaries, in which its percentage of ownership is lower, towards those where it is higher (e.g. in Fig. 1 transactions between L and listed company X). The interest of the whole group is the equilibrium point, i.e. the centre of convergence between the interest of the parent and that of the subsidiaries (Gambino 1993). The interest of the group is to ensure the so-called ‘system effect’, so that the whole (i.e. the group) is higher than the sum of the parts (i.e. the single legal entities). The problem arises when, in order to reach the system effect, some subsidiaries are penalized for the benefit of the group (e.g. in the case of transfer pricing to reduce group taxation). The efficient perspective interprets the direction activity as favourable to the firm and its outsiders. The main assumption is that considering a business group as a single economic entity allows the reduction or even the removal of important transaction costs (Coase 1960; Williamson 1985). The reduction of these costs is one of the reasons for the establishment of business groups, especially in developing economies, where markets have a high degree of inefficiency (Claessens et al. 2006; Goto 1982; Khanna and Palepu 1999; Khanna and Yafeh 2007; Leff 1978). For example, intragroup transactions can be spared the obstacles or delays that often occur in negotiating contracts with third parties (Loon 2009). Within the efficient perspective we can also include the intragroup transactions aimed at achieving scope and scale economies, arising from the centralization of corporate functions shared by multiple legal entities (e.g. personnel management, financial resources, know-how).

4 The interest of the group and the separation between control and direction in Italy 4.1 Institutional background in Italy Like those of most other continental European countries, the ownership and control of Italian companies is characterized by an ownership concentration, for both unlisted and listed companies (Bianchi et al. 2001; Bianchi and Bianco 2006), as well as by the presence of pyramidal business groups controlled and managed by families via a complex chain of holding companies (Aganin and Volpin 2003) with a high degree of separation between ownership and control. Banks and other financial institutions have a limited role in the corporate governance because of their not having a significant ownership in the companies, even if the banking system is the main source of outside corporate financing (Di Pietra et al. 2008). Scholars have shown the poor investor protection that

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characterized Italian listed companies (Melis 2000; Volpin 2002; Zingales 2008) and the risk of minority expropriation through related party transactions (e.g. tunnelling), especially in complex group structures (Johnson et al. 2000; Kirchmaier and Grant 2005). However, during recent years there have been many efforts to align Italy with other countries that present a greater investor protection. Implementation of IAS/ IFRS, Corporate Law Reform (Legislative Decree No. 6/2003), Savings Protection Law (Law No. 262/2005) and Consob (the Italian Security Exchange Commission), have introduced important innovations in this area, requiring the reporting of any potential conflict of interest transactions. In particular, we refer to: IAS 24 concerning the disclosures on related party transactions; Art. 2497-bis, paragraph 5, of the Italian Civil Code (introduced by the reform of company law, Legislative Decree No. 6/2003) that requires the reporting of the relationships and the effects of transactions among subsidiaries directed and coordinated by the parent company; Consob Regulation on transactions with related parties (No. 17221 of 03/12/2010) where the key points are: 1) strengthening the role of independent directors in all phases of the decisional procedure on related party transactions; and 2) transparency requirements (see www.consob.it). 4.2 The interest of the whole group and the holding liabilities: from the separation between ownership and control to that between control and direction The Italian Legislative Decree No. 6/2003 introduced a set of corporate rules (the ‘Corporate Law Reform’) for the regulation of business groups. These rules were added to Article 2497 and the subsequent articles of the Italian Civil Code (ICC). In business groups, especially those in which subsidiaries are located in the same country and integrated with each other because of their related businesses, the headquarters/subsidiaries relationship is often based on the centralization of the decision-making power of the parent company, in order to manage the group as if it were a single economic entity, allowing subsidiaries to bring different benefits (e.g. scope and scale economies, financial synergies). However, complying with the group’s policy may have negative consequences, for example when the interest of the group conflicts with that of a single subsidiary. The purpose of the Italian group Regulation is not to prevent the possibility of the parent company to manage its subsidiaries, but rather to discourage the ‘group policy’ imposed by the parent without consideration for the interests of the subsidiaries and their stakeholders (Pernazza 2010). Under Article 2497 of the ICC, a specific liability of parent companies with managing and coordinating power (directing company) over their subsidiaries (directed legal entities) for damages incurred by the latter is expressly maintained. In particular and pursuant to Article 2497, ‘‘Legal entities which, in carrying out management and coordination activities on other companies, act in the interest of their own or third parties’ business, in breach of the principle of correct corporate management, are directly liable: (1) with the minority shareholders of the directed and coordinated companies […] and (2) with the creditors of the same companies’’. For instance, in Fig. 1 if sub-holding X, in order to achieve its private interest,

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orders to directed subsidiary Y, which is controlled with 51 % of the shares, to sell goods to company C, totally owned, at a lower price than the market price, then X could be directly liable towards outsiders (minority shareholders and creditors) of subsidiary Y. Consequently, we propose the following. Proposition 1 The dominant shareholders tend to show that the controlling company does not exercise the direction activity of its subsidiaries in order to avoid the liability under the business group Regulation and to lower the risk of expropriation as perceived by minority shareholders. Under Article 2497-sexies of the ICC, it is presumed that, unless otherwise proved, the management and coordination activity of companies is exercised by the entity that is required to consolidate the same in its accounts or which, in any case, controls the former company. The law, however, does not define the concept of management and coordination activities. Italian case law has identified ‘management’ as the direction of the group as a whole and ‘coordination’ as a specific means of implementing a single management by creating links between the management of all the group entities. Coordination generally refers to collaborative actions taken to achieve a unity of effort within the organization (Lawrence and Lorsch 1967). Thus, the management and coordination activity (referred to within this paper as ‘direction activity’) consists of giving a unitary operational direction to different companies, by applying a common financial policy and strategy, and managing them as a unique entity. Consequently we could expect a direction activity by the parent when its subsidiaries operate in the same sectors. Moreover, Article 2497 provides that: ‘‘In the light of the overall outcome of the management and coordination activity, the liability of the parent company is excluded if no damage occurs, or such damage is entirely removed/eliminated, including by means of transactions targeted to such purpose’’. Therefore, as part of a group, certain detrimental transactions to the subsidiaries and their outsiders, ordered by the parent company, could be justified by benefits that expropriated subsidiaries and outsiders receive because of belonging to a business group. This concept encompasses the so-called theory of ‘compensatory advantages’ that have led to heated discussions in Italian law doctrine (Cariello 2006; Denozza 2000; Fasciani 2007; Rossi et al. 2002), for which the prejudicial impact of the parent company’s decision may eventually be offset by the benefits arising from the directed companies’ participation in the group structure (such as easier access to financing, participation in cash pooling agreement, and the possibility of sharing services within the group, as well as exploiting scale economies). Consequently, the apparent diseconomy of intra-group transactions, viewed as isolated transactions, may find its justification in the context of costs and benefits of achieving the interest of the whole group. For example, in Fig. 1, if parent company A orders to directed subsidiary X to sell goods to company O at a lower price than the market price, because of the latter being in financial distress and also because it is important to do that in the interest of the group (also benefiting the listed subsidiary X), the liability of parent A may be excluded.

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4.3 The publicity of direction activity and the separation between control and direction One of the most interesting aspects of the group Regulation is to consider the possibility that the controlling company could also delegate the exercise of decisionmaking powers to its subsidiaries. Indeed, controlled subsidiaries can communicate that, despite the control of the parent, they are not subjected to its direction activity. Literature on pyramidal business groups seems not to consider the separation between ownership and direction as an important element in assessing the likelihood of expropriation. However, we can suppose a higher risk of expropriation in the case of both a high separation between ownership and control, and a centralized direction activity by the parent company at the top of the pyramid. The ICC allows analysis of the parent/subsidiaries relationship in order to understand whether the controlling company also directs its subsidiaries. In particular, the ICC requires that subsidiaries must expressly indicate the eventual submission to direction activity in the company’s correspondence and official documents, including the notes to the financial statements and to the management report of the directors (Article 2497-bis, ICC). If they fail to do so, the directors are liable for damages borne by the shareholders and third parties for not having been made aware of the existence of direction activity. Furthermore, the directed company must include in a specific section of its financial statements a summary of the essential data of the most recently approved financial statements of the directing company. Finally, the directors of the directed company must indicate in their annual report the relationships with the directing company and with the other directed companies, as well as the consequences that such relationships have produced on both the exercise of the activity of the directed company and on its financial performance. The business group disclosure is crucial in our reasoning, especially in the pyramidal groups, because the risk that the controlling shareholders expropriate minorities is particularly elevated, with a high degree of separation between ownership and control (Grossman and Hart 1988; La Porta et al. 1999; Shleifer and Vishny 1997; Wolfenzon 1999). Literature on corporate governance uses the separation between ownership and control as a proxy to assess indirectly the degree of expropriation (Claessens et al. 2000; Faccio et al. 2001). A high cash flow ownership can serve as a credible commitment that the controlling owner will not expropriate minority shareholders (Claessens and Fan 2002; Gomes 2000). In case of high separation between ownership and control, the gain deriving from the private benefits of control exceeds the cost of the reduced value of the controlling owner’s share (Claessens and Fan 2002). In that situation, we could expect that for the controlling shareholder it will be more useful to signal to the market that there is a separation between control and direction activity, in order to convince them that he/she will not be able to extract private benefits. When a group is directed by the company at the top of the pyramid, as a single economic entity, the perception of risk by outsiders could be extremely high. Based on this reasoning we suggest the following proposition:

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Proposition 2 The tendency to show that the controlling company does not exercise the direction activity of its subsidiaries is higher in case of a high degree of separation between ownership and control because of the higher risk perceived by the minority shareholders. If minorities of subsidiaries are persuaded that the controlling shareholder cannot extract private benefits, they will not discount the stock price; in that way, the controlling shareholder will be sure that his/her majority share value will not be reduced and he/she may also retain the private benefits (Claessens and Fan 2002; Djankov et al. 2008). Moreover, following the ICC, if subsidiaries declare they are not directed, the holding liability is excluded in case of damage to their outsiders. Obviously this happens when in the case of damage, the court finds a real separation between control and direction. However, the simple declared separation between control and direction would not convince outsiders about the lack of any risk of their expropriation, especially when they believe that the separation is more apparent than real. 4.4 Subsidiaries’ board composition and independence: degree of separation between control and direction Following agency theory, the board of directors is one of the mechanisms designed to monitor conflicts of interest (Fama and Jensen 1983; Jensen and Meckling 1976), which occurs among shareholders (principals) and managers (agents), stemming from the separation between ownership and control. In contrast to the widely held firms, in those with concentrated ownership the dominant shareholder protects his/her interests against managerial abuse, because the marginal benefits of improved performance exceed the marginal costs of monitoring (La Porta et al. 1999). The controlling shareholder generally controls the composition of the board of directors and influences the corporation’s activities. That situation gives a high probability to the implementation of actions which can be advantageous to the controlling shareholders but cause damage to minority ones through the extraction of private benefits of control (Type II agency problem). Hence, in firms with concentrated ownership, to alleviate the conflict of interest between dominant shareholder and minorities, it is necessary to have boards of directors with a double independence: independence both from management and controlling shareholders (Huse 2007). The risk that the controlling shareholders expropriate the outsiders is particularly elevated in the case of high separation between ownership and control. In that case the dominant shareholder could find it useful to persuade minorities that he/she is not able to extract private benefits, in order to avoid the share price discount (Claessens et al. 2000). Therefore, the dominant shareholder may show to the outsiders a more independent board, especially when he/she sits on the board of the subsidiaries that potentially could be expropriated. But what happens in a subsidiary board, i.e. the board of a subsidiary company (Huse and Rindova 2001), in the case of both separation between ownership and control as well as between control and direction? We could expect an interest in

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showing not just the subsidiary board independence but also the subsidiary board autonomy from the parent, in order to provide evidence of an actual and effective separation. Conversely, in the case of direction activity, the subsidiary board independence should be reinterpreted, considering the lack of board autonomy from the directing parent company. In fact, in this case, independent subsidiary directors should evaluate whether direction activity is done in the interests of the firm. If not, then two interests could motivate the detrimental effect of the direction activity: the interest of the group and the private interest of the dominant shareholder. In the former case, independent directors could allow the direction activity when, according to ICC, the subsidiary receives ‘compensatory advantages’ (see Sect. 4.2); in the latter case, they must forbid the transactions which have been ordered purely for the extraction of private benefits. Thus, independent directors have important roles in both directed and non-directed (autonomous) subsidiaries. It seems clear that the only way to have more truly independent directors (both from management and controlling shareholders) is to appoint them through a minority shareholders’ vote. This is rare, because independent directors are generally appointed and influenced by the controlling shareholders (Morck 2008). In Italy, outside directors are often selected to serve as directors based on their affiliation (e.g. friendship ties) to the controlling shareholder (Di Pietra et al. 2008). Therefore, even if there are formally independent directors, in reality the controlling shareholder may reduce their degree of independence. Board independence becomes more critical when the controlling shareholder is the CEO, especially if he/she is in a situation of duality (i.e. is also the chairman of the board). Indeed, CEO duality represents a conflict of interest in which a CEO who is responsible for the overall strategic management of a firm is also able to evaluate the effectiveness of that strategy (Finkelstein and D’Aveni 1994). Thus, the role of the chairman becomes essential in reducing the asymmetric information between inside and outside directors. Therefore, the chairman runs the board while the CEO runs the business. This separation of roles generates different relationships between the chairman and the CEO (Stewart 1991). With duality, even if independent directors are truly independent, it may be difficult for those directors to effectively monitor the insiders, especially if they are not kept well informed by the chairman. The Italian corporate governance code states that ‘‘the chairman of the Board of Directors shall use his/her best efforts in order to ensure that the material information and documents for enabling the board to take its decisions are made available to its members according to adequate procedures and timing’’ (Borsa Italiana 2006). As pointed out by Morck (2008), genuinely independent directors are rare, because the CEO, through personal contacts or friendships, recruits directors classified as independent. Hence, when the controlling shareholder is in a situation of duality he/she dominates the board completely. Moreover, the presence of controlling family members on the subsidiary board questions the credibility of the actual separation between control and direction, especially when they have executive roles and they have appointed the other affiliated board members. Thus, we follow Claessens et al. (2000) who studied the separation of control and management by investigating whether a member of the

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controlling family is the CEO, chairman, honorary chairman, or vice-chairman of the company. Hence, we propose the following. Proposition 3 The delegation of direction to subsidiaries is low because a de facto direction is exercised through the appointment of independent directors and the presence of the controlling family members on the subsidiaries’ board as Ceo, chairman, honorary chairman or vice-chairman.

5 Methods This paper builds on explanatory multiple case studies. According to Eisenhardt (1989), case study research can be defined as ‘‘a research strategy, which focuses on understanding the dynamics present within single settings’’ (p. 534). Following this definition, case study research is often said to be mainly suitable for research seeking to answer ‘‘how’’ and ‘‘why’’ questions (Yin 2003). The analysis is of ten non-financial Italian business groups controlled by wealthy families. We chose the Italian context because of the peculiar business group law (i.e. among others, subsidiaries have an obligation to disclose if they are directed by the parent). We selected those family groups because they have a pyramidal structure with at least two listed companies, which signals a potentially high level of separation between ownership and control (Bianchi and Bianco 2006). Moreover the groups selected have different degrees of separation between ownership and control and different publicity for direction activity by the subsidiaries. Thus, we can answer our research questions by observing groups that have different characteristics for the aspects under our observation. The analysis follows three main directions: (1) business group profile; (2) ownership structure and separation between ownership and control; and (3) degree of separation between control and direction of the subsidiaries.

5.1 Business group profile This point focuses on the listed companies that belong to each family group, showing their primary industry and sector (Table 1). Identifying the businesses in which the firms operate is important because we could expect that, if they are related, the eventual direction activity by the parent could be interpreted as a way to obtain synergy effects and to easily reach the interests of the group (see the efficient perspective in Sect. 3). Moreover, we report the total assets and number of employees, taken both from the consolidated and separate financial statements (i.e. the financial statements of the parent). The consolidated statements are used in the case of the listed company is a sub-holding of a sub-group (e.g. listed companies W and Y in Fig. 1). In that case the number of consolidated companies is also indicated. The number of employees and subsidiaries disclosed in the consolidated statement refers to that of the holding company plus all its consolidated subsidiaries.

123

Boroli– Drago

Berlusconi

Consumer services

Financials

Lottomatica

Dea Capital

Consumer services

Mondadori

Consumer services

Autogrill

Consumer services

Industrial

Atlantia

Mediaset

Consumer goods

Consumer services

Juventus

Benetton group

Consumer goods

Fiat

Benetton

Financials

Exor

Agnelli

Primary industry

Listed companies

Controlling families (ultimate owner)

Table 1 Business group profile

Financial services

Travel & leisure

Media

Media

Travel & leisure

Industrial goods and services

Personal & household goods

Travel & leisure

Automobiles & parts

Financial services

Sector

901

6,963

1,884

7,307

3,943

25,033

2,925

n.a.

73,442

78,707

Total assets of the group (in € mln)

-2.4

5.5

6.1

11.2

6.5

7.1

6.0

n.a.

1.5

2.5

ROA of the group (%)

3.3

1.9

7.2

11.3

16.2

19.5

6.9

n.a.

4.8

3.8

ROE of the group (%)

60

7,602

3,649

6,285

11,521

9,528

9,469

n.a.

196,723

211,636

No of employees of the group

3

145

26

33

231

40

73

n.a.

433

229

No of consolidated companies

855

5,193

1,300

5,241

2,594

16,459

2,087

291

11,544

4,870

Total assets of the parent (in € mln)

16

1,165

1,204

224

n.a.

6

335

85

144

42

No of employees of the parent

1.6

2.3

5.1

-1.1

2.2

-0.1

-0.3

1.8

1.8

-1.5

ROA of the parent (%)

1.9

1.4

4.0

4.1

6.3

3.1

2.5

-3.8

2.5

2.8

ROE of the parent (%)

Direction and control 847

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123

De Benedetti

Industrial

Industrial

Consumer goods

Consumer services

Cofide

C.I.R

Sogefi

L’Espresso

Consumer goods

Consumer services

Caltagirone Editore

Piaggio

Industrial

Vianini Industria

Consumer goods

Industrial

Vianini Lavori

Immsi

Industrial

Cementir

Colaninno

Industrial

Caltagirone

Caltagirone

Primary industry

Listed companies


Table 1 continued

Media

Automobiles & parts



Automobiles & parts

Automobiles & parts

Media

Constructions & materials




Sector

1,395

739

7,622

7,714

1,546

2,310

1,002

112

803

1,951

3,562


4.6

5.7

2.8

2.7

7.2

4.1

1.4

0.1

3.9

1.2

1.8


1.1

8.8

4.9

5.1

9.7

1.5

0.7

0.9

4.8

1.5

1.5


2,894

5.67

12.88

12,911

7,601

7,952

1,079

37

252

3,289

4,457


22

28

132

134

26

33

13

2

3

5

27


1,056

432

1,291

628

1,304

654

689

112

666

875

671


919

29

28

4

4.059

14

9

n.a.

42

38

9


4.5

-1.2

-1.6

-0.4

-0.1

-0.3

-0.2

0.1

4.7

-0.1

-0.3


5.5

2.9

-1.1

-0.6

1.5

2.6

-0.9

-3.8

3.4

-1.5

0.5


848 E. Di Carlo

Pirelli & Co.

Provera

Consumer goods

Financials

Industrial

Italcementi

Camfin

Industrial

Italmobiliare

Tronchetti

Pesenti

Insurance

Automobiles & parts

Financial services



Financials

Financials

Financials

Fondiaria-Sai

Milano Assicurazioni

Sector

Financial services

Premafin Finanziaria

Ligresti

Primary industry

Financials

Listed companies


Table 1 continued

5,618

754

10,021

12,094

11,497

42,956

43,035


7.2

-0.5

3.5

3.1

-6.6

-2.3

-2.4


0.2

5.9

4.0

3.2

-51.2

-36.4

-41.8


29,573

18

20,763

22,262

1,963

8,191

8,046


98

1

33

205

10

82

85


1,878

863

3,350

1,529

11,034

19,099

957


n.a.

4

2,657

46

1,597

n.a.

n.a.


-2.1

-0.3

-3.9

24.9

-6.0

-4.1

-1.4


5.5

4.2

-1.0

3.2

-36.3

-34.9

-17.7



123

850

E. Di Carlo

5.2 Ownership structure and the separation between ownership and control For the ownership structure we indicate the following (Table 2): name of the direct controlling company or individual; company or individual at the top of the ownership chain that declares the voting rights in the firm; type of control or influence (e.g. de jure or de facto control); possibility of launching a hostile takeover (i.e. the contestability of control); percentage of shares owned by the largest shareholder, by the second largest shareholder and by the non-relevant shareholders (\2 %). In concentrated/controlled firms, the possibility of launching a hostile takeover is extremely important, as dominant shareholders typically have managerial or board representation. The risk of expropriation by the controlling shareholder could be counterbalanced by the risk of a hostile takeover (Jensen 1985; Shleifer and Vishny 1997). In order to measure the separation between ownership and control we use the cash flow rights owned by the ultimate owner (Faccio and Lang 2002). 5.3 The degree of separation between control and direction of the subsidiaries The aim of this third point is to show if the parent companies at the top of the groups, and/or their sub-holdings, exercise control over their listed subsidiaries, or instead, the former delegate their decision-making power (i.e. the direction activity) to the latter. To measure the separation between control and direction of the listed subsidiaries, we use the publicity they gave in accordance with the Italian Regulation (see Sect. 4.3 and Table 3). In order to investigate the degree of separation between control and direction, we use the presence of the controlling family members on the subsidiaries’ boards (Claessens et al. 2000), and the independence of those boards (Table 4). Independence characteristics of the board are measured using two ratios: the outsider ratio and the independent outsider ratio. Moreover, we also consider the presence of the CEO-duality, independent directors elected by minorities and lead independent directors. As suggested in the Italian corporate governance code: ‘‘In the event that the chairman of the Board of Directors is the chief executive officer of the company, as well as in the event that the office of chairman is covered by the person controlling the issuer, the board shall designate a lead independent director, who represents a reference and coordination point for the requests and contributions of non-executive directors and, in particular, those who are independent’’ (Borsa Italiana 2006). The analysis is based on secondary data collected using the consolidated financial statements of the groups and those of the sub-groups, as well as the separate financial statements of the respective holdings and sub-holdings, Borsa Italiana (the Italian Stock Exchange) and Consob websites, annual reports on corporate governance, all for the year ending 31 December 2010. As the analysed companies are listed, they all adopt the IAS/IFRS.

123

–

Exor SpA (60.0 %)

–

Juventus

Average

Boroli– Drago

Berlusconi

Benetton

Giovanni Agnelli Sapa

Exor SpA (30.4 %)

Fiat

Edizione Srl –

Schematrentaquattro Srl (59.3 %)

–

Autogrill

Average

B&D Holding Sapa –

De Agostini SpA (58.3 %)

–

Dea Capital

Average

B&D Holding Sapa

De Agostini SpA (53.8 %) ? DEA Partecipazioni (5.9 %)

–

–

Average

Lottomatica

Berlusconi Silvio

Berlusconi Silvio

Fininvest SpA (39 %)

Fininvest SpA (50.1 %)

Mediaset

Mondadori

Edizione Srl

Schemaventotto (33.3 %) ? Sintonia (8.9 %)

Atlantia

Edizione Srl

Edizione Srl (67.1 %)

Benetton group

Giovanni Agnelli Sapa

–

Giovanni Agnelli Sapa (52.7 %)

Exor

Declarer companies or individuals at the top of the ownership chain

Agnelli

Direct controlling companies or individuals and their voting rights

Listed companies

Controlling Families (ultimate owner)

Table 2 Ownership structure and separation between ownership and control

–

De jure

De jure

–

De jure

De facto

–

De jure

De facto

De jure

–

De jure

De facto/ significant influence

De jure

Type of control or influence

–

No

No

–

No

Yes

–

No

Yes

No

–

No

Yes

No

Contestab ility of control

59.0

58.3

59.7

44.6

50.1

39.0

56.2

59.3

42.2

67.1

47.7

60.0

30.4

52.7

% of the direct controlling company (voting rights)

8.8

4.8

12.7

7.9

12.4

3.4

3.6

2.0

6.7

2.2

7.3

7.5

4.8

9.5

% of the 2nd largest shareholder

27.0

29.1

24.8

38.2

24.9

51.5

33.5

38.7

36.9

25.0

38.7

32.5

52.8

30.7

% of the dispersed ownership (\2 %)

2.0

4.0

0.0

4.9

6.0

3.8

2.6

0.0

2.0

5.7

2.7

0.0

3.2

5.0

% of Treasury shares

57.8

58.3

57.2

44.6

50.1

39.1

52.7

59.3

31.7

67.1

33.8

31.6

17.0

52.7

Cash flow rights (%)


123

Finanziaria Italia 2005 (53.9 %) ?Partecipazioni Finanziarie 4 (31.7 %) ? Others (2 %)

Gamma (2.2 %) ? Vianini Industria (1.6 %) ? Lav 2004 (25.5 %) ? Calt 2004 (30.1 %) ? Caltagirone (1.6 %) ? Pantheon 2000 (2.8 %) ? Caltagirone Francesco Gaetano (0.8 %) ? Chupas 2007 (2 %) ? Caltagirone Francesco (1.6 %)

Pantheon 2000 SpA (0.7 %) ? Capitolium (6.4 %) ? Caltagirone SpA (50 %) ? Finanziaria Italia 2005 (7 %) ? Caltagirone Francesco Gaetano (2.8 %)

Capitolium (12.6 %) ? Caltagirone SpA (54.1 %) ? Caltagirone Francesco Gaetano (0.2 %)

Gamma Srl (7.2) ? Parted 1982 (35.6) ? Caltagirone Francesco Gaetano (18) ? Caltagirone Gaetano (2.4)

–

Caltagirone

Cementir

Vianini Lavori

Vianini Industria

Caltagirone Editore

Average

Caltagirone

Direct controlling companies or individuals and their voting rights

Listed companies

Controlling Families (ultimate owner)

Table 2 continued

123 –

Gaetano; Caltagirone Gaetano

Caltagirone Francesco

Caltagirone Francesco Gaetano

Caltagirone Francesco Gaetano

Caltagirone Francesco; Caltagirone Francesco Gaetano

Caltagirone Francesco Gaetano; Caltagirone Edoardo


–

De jure

De jure

De jure

De jure

De jure


–

No

No

No

No

No


70.6

63.1

66.9

67.0

68.3

87.6


0.4

2.2

0.0

0.0

0.0

0.0


29.0

34.7

33.1

33.0

31.7

12.4


0.0

0.0

0.0

0.0

0.0

0.0


60.7

63.1

60.2

60.7

31.7

87.6


852 E. Di Carlo

Ligresti

De Benedetti

Carlo De Benedetti e Figli Sapa (51.6 %)

Cofide (45.9 %)

C.I.R. (56.6 %)

C.I.R. (53.9 %)

–

Cofide

C.I.R

Sogefi

L’Espresso

Average

Premafin SpA –

Fondiaria Sai (60.6 %)

–

Milano Assicurazioni

Average

Premafin; FondiariaSai

Premafin (37.6 %) ? Finadin (4.1 %) ? Milano Assicurazioni (8 %) ? Sai Holding (1 %)

Fondiaria-Sai

Ligresti Gioacchino Paolo; Ligresti Giulia Maria; Ligresti Jonella

Limbo Invest SA (10 %) ? Canoe Securities SA (10 %) ? Hike Securities SA(10 %)

Premafin Finanziaria

–

Figli Sapa; Cofide

Carlo De Benedetti e

Figli Sapa; Cofide


Figli Sapa


–

Omniaholding SpA –

Immsi (53.6 %)

–

–

De jure

De facto

De facto

–

De jure

De jure

De jure

De jure

–

De jure

De jure

Omniaholding SpA

Average



Piaggio

Omniainvest Spa (43.8 %) ? Omniaholding (6.3 %)

Immsi

Colaninno

Direct controlling companies (direct shareholder)

Listed companies

Controlling families

Table 2 continued

–

No

No

Yes

–

No

No

No

No

–

No

No


47.9

60.6

53.2

30.0

52.0

53.9

56.6

45.9

51.6

51.9

53.6

50.1


7.3

0.0

2.0

20.0

11.9

11.7

7.2

11.4

17.2

5.0

5.0

5.0


38.4

39.4

40.2

35.7

24.5

30.0

23.6

29.7

14.8

41.1

37.3

44.9


0.9

0.0

2.6

0.0

1.4

0.0

0.0

5.4

0.0

0.0

0.0

0.0


23.1

18.2

21.2

30.0

25.4

12.8

13.4

23.7

51.6

32.3

22.5

42.0



123

123

Average

Tronchetti Provera Marco –

Camfin SpA (25.5 %)

–

Pirelli & Co.

Average

Provera

Tronchetti Provera Marco

Camfin

Tronchetti

GPI (41.7 %)

Efiparind BV –

Italmobiliare SpA (60.3 %)

–

Italcementi

Efiparind BV

Privital (14.6 %) ? Cemital (16.2 %) ? Finanziaria Aureliana (16.0 %) ? Efiparind BV (0.5 %)

Italmobiliare


Pesenti

Direct controlling companies (direct shareholder)

Listed companies

Controlling families

Table 2 continued

–

De facto/ Significant influence

De facto

–

De jure

De facto


–

Yes

Yes

–

No

Yes


33.6

25.5

41.7

53.8

60.3

47.3


8.8

5.5

12.1

6.1

2.2

10.0


41.3

51.3

31.2

28.3

35.4

21.2


0.0

0.0

0.0

1.1

2.1

0.0


14.4

5.8

22.9

37.9

28.5

47.3


854 E. Di Carlo


855

6 Characteristics of the sample Table 1 summarizes some aspects of the business group profiles. Using a group structure, ten Italian families (Table 1, column 1) control 28 listed companies (Table 1, column 2) that represent 11.4 % of the total number of non-financial listed companies in Italy. All listed companies (except for Juventus) of Table 1 are subholdings of sub-groups. The Agnelli family owns the largest group in terms of total assets, number of employees and number of controlled companies. Some groups have listed companies that operate in the same primary industry and sector (e.g. Berlusconi, Pesenti and Caltagirone) while others are more diversified (e.g. Agnelli, Benetton, De Benedetti, and Tronchetti Provera). Table 2 shows the ownership structure and the separation between ownership and control. All family groups have a pyramidal structure because of the presence of an ultimate owner who indirectly owns shares in the firm and at least one publicly traded company in the chain of intermediary firms (La Porta et al. 1999). Thus, families have control rights in firms in excess of their cash flow rights. All listed companies are controlled by families through non-listed companies at the top of the respective groups. For example, the Agnelli family controls, through Giovanni Agnelli & Co., the listed company Exor, which in turn controls two listed companies: Fiat and Juventus. Caltagirone is the group with the more concentrated ownership (the average of voting rights in its listed companies is 70.6 %); while the Tronchetti Provera group is less concentrated (on average 33.6 % of the voting rights). The Caltagirone group is also the group with the lowest presence of relevant minority shareholders (i.e. those with more than 2 %). The De Benedetti group has the longest control chain. Indeed, between the ultimate owner (i.e. the De Benedetti family) and the company at the bottom of the group (e.g. non-listed companies controlled by Sogefi and L’Espresso) there are three levels of listed companies. Tronchetti Provera, Ligresti, De Benedetti, Colaninno and Agnelli are the groups with the highest separation between ownership and control, having on average cash flow rights lower than 50 %. The declared separation between control and direction activity is shown in Table 3, while board composition and independence is given in Table 4. In order to summarize and better discuss the results of Tables 3 and 4, two matrices were built (Fig. 2). Using the results of Table 3, Matrix I represents the degree of separation between ownership and control (‘‘high’’ if the cash flow rights are lower than 50 %, ‘‘low’’ otherwise) and the declared separation between control and direction (‘‘yes’’ if the listed subsidiary, following the Italian Regulation, declares that its parent company does not exercise direction activity, ‘‘no’’ otherwise). Matrix II has the same y-axis as Matrix I whereas for the x-axis it uses the results of Table 4, showing the degree of separation between control and direction (‘‘low’’ if one or more members of the controlling family are executive directors, chairman, honorary chairman or vicechairman, ‘‘high’’ otherwise). Each listed subsidiary is positioned within one of the

123

123

Boroli– Drago

Berlusconi

De Agostini

–

De Agostini

–

Average

De Agostini

De Agostini

Dea Capital

–

–

Average

Lottomatica

Fininvest

Fininvest

Mondadori

Fininvest

Fininvest

Mediaset

–

–

Average

Schemaventotto

Schematrentaquattro

Edizione Srl

Edizione Srl

Autogrill

Edizione Srl

None

Atlantia

Edizione Srl

–

Average

Benetton group

–

Giov. Agnelli Sapa

Juventus

Benetton

Exor SpA

None

Fiat

Giov. Agnelli Sapa

Giov. Agnelli Sapa

Exor

Agnelli

Direct consolidating company

Listed companies


Consolidating company at the top of the ownership chain

Table 3 Separation between control and direction

–

De Agostini

De Agostini

–

None

None

–

None

None

None

–

None

None

None

Directing company

21.3

27.3

15.4

10.7

7.1

14.3

21.7

16.7

6.7

41.7

15.3

9.1

13.3

23.5

% of family members in the board

16.7

0.0

33.3

20.8

25.0

16.7

16.7

0.0

0.0

50.0

38.9

33.3

33.3

50.0

% of executive family members on total number of executives

13.6

27.3

0.0

3.6

0.0

7.1

16.1

16.7

6.7

25.0

8.1

0.0

6.7

17.6

% of non executive family members on total number of non executives

–

No

No

–

No

Yes

–

No

No

Yes

–

Yes

Yes

Yes

Controlling shareholder (family member) as executive Chairman

–

No

No

–

Yes

No

–

Yes

No

No

–

No

No

No

Controlling shareholder (family member) as nonexecutive Chairman

–

No

No

–

No

No

–

No

No

No

–

No

No

Yes

Controlling shareholder (family member) as CEO

856 E. Di Carlo

–

Finanziaria Italia

Finanziaria Italia

Finanziaria Italia

–

Vianini Lavori

Vianini Ind.

Caltagirone Ed.

Average

Colaninno

Caltagirone

Finanziaria Italia

Cementir

–

–

Piaggio

Average

Omniainvest

Immsi

Omniaholding

Omniaholding

Immsi

Caltagirone

Caltagirone

Caltagirone

Finanziaria Italia 2005

Finanziaria Italia

Caltagirone


Caltagirone


Listed companies


Table 3 continued

–

Immsi SpA

None

–

None

None

None

None

None

Directing company

30.3

27.3

33.3

32.9

45.5

20.0

11.1

33.3

54.5


100.0

100.0

100.0

45.0

50.0

50.0

25.0

25.0

75.0


14.6

18.2

11.1

14.4

18.2

0.0

0.0

26.7

27.3


–

Yes

Yes

–

Yes

Yes

No

Yes

Yes


–

No

No

–

No

No

No

No

No


–

Yes

Yes

–

Yes

No

No

Yes

Yes



123

123

–

De Ben. e Figli Sapa


–

Sogefi

L’Espresso

Average

Ligresti

C.I.R.


C.I.R

Fondiaria Sai

–

Premafin

–

Milano Assic.

Average

Premafin

Premafin

FondiariaSai

None

None

Premafin Fin.

C.I.R.

Cofide



Cofide


De Benedetti


Listed companies


Table 3 continued

–

None

None

None

–

C.I.R.

C.I.R.

Cofide


Directing company

18.2

15.8

15.8

23.1

17.7

18.2

11.1

21.4

20.0


58.3

25.0

50.0

100.0

75.0

50.0

50.0

100.0

100.0


5.3

10.5

5.3

0.0

9.2

9.1

0.0

14.3

13.3


–

Yes

Yes

Yes

–

Yes

Yes

No

No


–

No

No

No

–

No

No

Yes

Yes


–

No

No

Yes

–

No

No

Yes

Yes


858 E. Di Carlo

–

–

Average

GPI

None

Pirelli & Co.

Provera

GPI

None

Camfin

Tronchetti

–

–

Average

None

Italcementi

None

Italcementi


Italmobiliare

Pesenti


Italcementi

Listed companies


Table 3 continued

–

None

None

–

Italmobiliare SpA

None

Directing company

11.9

10.5

13.3

13.1

9.5

16.7


100.0

100.0

100.0

83.3

66.7

100.0


3.3

0.0

6.7

0.0

0.0

0.0


–

Yes

Yes

–

Yes

Yes


–

No

No

–

No

No


–

No

No

–

Yes

Yes



123

123

Caltagirone

Boroli– Drago

Berlusconi

Benetton

3

2.7

11

14.3

Juventus

Average

2

1

2.3

12

13.0

Autogrill

Average

4.0

10.2

Average

2

6

5

11

4

Caltagirone Ed.

9

Vianini Lavori

4

4

Vianini Ind.

11

15

Caltagirone

4.0

12.0

Average

Cementir

2

11

Dea Capital

6

13

Lottomatica

5.0

14.0

Average

6

4

14

14

Mediaset

Mondadori

2

15

Atlantia

4

12

Benetton group

3

17

15

(b) No of executive directors

Exor

Agnelli

(a) No of directors

Fiat

Listed companies


Table 4 Board composition and independence

6.2

5

3

5

11

7

8.0

9

7

9.0

10

8

10.7

11

13

8

11.7

8

12

15

(c) No of non executive directors

1.2

0

0

0

4

2

5.0

4

6

5.0

6

4

5.0

6

5

4

5.7

4

8

5

(d) No of independent directors

1.8

3

1

1

1

3

1.0

0

2

1.0

1

1

0.7

0

0

2

1.0

1

1

1

(e) No of controlling family members as executive directors

1.8

2

0

0

4

3

1.5

3

0

0.5

0

1

2.0

2

1

3

1.3

0

1

3

(f) No of controlling family members as non executive directors

59.6

45.5

60.0

55.6

73.3

63.6

67.8

81.8

53.8

64.3

71.4

57.1

81.7

91.7

86.7

66.7

68.2

36.4

80.0

88.2

(g) Outsider ratio (c/a) (%)

9.0

0.0

0.0

0.0

26.7

18.2

41.3

36.4

46.2

35.8

42.9

28.6

38.9

50.0

33.3

33.3

39.7

36.4

53.3

29.4

(h) Independent outsider ratio (d/a) (%)

–

Yes

No

No

Yes

Yes

–

No

No

–

No

No

–

No

No

No

–

No

No

Yes

CEO duality

0.4

1

0

1

0

0

0.0

0

0

0.0

0

0

1.0

0

3

0

0.0

0

0

0

No of directors elected by minorities

–

No

No

No

Yes

No

–

Yes

Yes

–

No

No

–

Yes

No

No

–

Yes

No

Yes

Lead independent

860 E. Di Carlo

2

1.5

9

11

12.3

Sogefi

L’Espresso

Average

1

C.I.R

4

3.7

19

17.0

Milano Assic.

Average

3

1.5

17.0

Average

1

2

15

19

Camfin

Pirelli & Co.

Provera

2.5

16.5

Average

2

3

12

21

Italmobiliare

Italcementi

4

13

19

Premafin Fin.

Fondiaria-Sai

2

1

15

14

Cofide

Tronchetti

Pesenti

Ligresti

De Benedetti

1.5

10.0

Average

2

1

9

11

(b) No of executive directors

Immsi

Colaninn

(a) No of directors

Piaggio

Listed companies


Table 4 continued

15.5

17

14

14.0

18

10

13.3

15

15

10

10.8

9

7

13

14

8.5

10

7

(c) No of non executive directors

7.5

10

5

8.0

12

4

5.7

8

6

3

6.0

5

5

7

7

3.5

4

3

(d) No of independent directors

1.5

2

1

2.0

2

2

2.0

1

2

3

1.0

1

1

1

1

1.5

1

2

(e) No of controlling family members as executive directors

0.5

0

1

0.0

0

0

1.0

2

1

0

1.3

1

0

2

2

1.5

2

1

(f) No of controlling family members as non executive directors

91.4

89.5

93.3

84.5

85.7

83.3

78.3

78.9

78.9

76.9

86.5

81.8

77.8

92.9

93.3

84.3

90.9

77.8

(g) Outsider ratio (c/a) (%)

43.0

52.6

33.3

45.2

57.1

33.3

32.3

42.1

31.6

23.1

49.5

45.5

55.6

50.0

46.7

34.8

36.4

33.3

(h) Independent outsider ratio (d/a) (%)

–

No

No

–

Yes

Yes

–

Yes

No

Yes

–

No

No

No

No

–

Yes

Yes

CEO duality

2.0

4

0

0.0

0

0

0.0

0

0

0

0.3

1

0

0

0

0.0

0

0

No of directors elected by minorities

–

Yes

Yes

–

Yes

Yes

–

No

No

Yes

–

Yes

Yes

Yes

Yes

–

Yes

Yes

Lead independent


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Fig. 2 Separation between ownership, control and direction

quadrants, indicating the controlling family and in brackets the percentage of cash flow rights. Moreover, in Fig. 2 the underlined subsidiaries are contestable, i.e. there is the possibility of launching a hostile takeover. Among the 28 listed companies, just seven are contestable and are all positioned in quadrant III, of Matrix I. The information given by the two matrices is important for the outsiders of the single subsidiary. Indeed, according to Italian group Regulation, the directing companies of the subsidiaries positioned in Quadrants II and IV are liable in case of damage caused to shareholders or creditors of those directed subsidiaries as a consequence of the direction activity, unless the damage is adequately compensated. Instead, for the outsiders of the subsidiaries inserted in Quadrants I and III, the liability is limited to those companies and so it is not extended to their controlling parent companies.

7 Results In this section, the results of our case study analysis are shown. In Sect. 4, analysis of the Italian Regulation for business groups, as well as the theoretical debate on pyramidal business groups and board independence, led us to the formulation of three propositions. These propositions are used below as a template for the case study discussion, evidencing similarities and differences in the way family groups act.

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The first research question asks whether the controlling shareholder, through the parent company at the top of the pyramidal group, always exercises the direction activity of the subsidiaries. In proposition 1 we suggest that the dominant shareholders tend to show that the controlling company does not exercise the direction activity of its subsidiaries in order to avoid the liability under the business group Regulation and to lower the risk of expropriation as perceived by minority shareholders. From the analysis, it emerges that 71.4 % of our listed companies declare to be not directed by their parent companies (so they are positioned in Quadrants I or III, of Matrix I), even if some of them (see Table 1) operate in the same industry or sector (e.g. Mediaset and Mondadori in the Berlusconi group; Caltagirone, Cementir, Vianini Industria and Vianini Lavori in the Caltagirone group). The second research question asks why the parent company does not exercise the direction activity, delegating it to its subsidiaries. Part of the answer is in proposition 1, and part is related to a theoretical argument. Indeed, in proposition 2 we state that the tendency to show that the controlling company does not exercise the direction activity of its subsidiaries is high in case of a high degree of separation between ownership and control because of the higher risk perceived by the minority shareholders. From Matrix I it emerges that 60 % (12 firms) of the non-directed companies (20 firms) are characterized by a high separation between ownership and control. Some of those companies declare to be not consolidated by their parents. We refer to Fiat, Premafin, Pirelli and Italmobiliare. Despite the ultimate owner having sufficient voting rights to (de facto) control these subsidiaries, their controlling parties do not consolidate. According to IAS 27, this means that the companies are not substantially controlled, being only subjected to significant influence. In particular, Exor considers Fiat as an investment in an associate (IAS 28) rather than an investment in a subsidiary, even if Exor is the largest shareholder of Fiat with 30.4 % of the shares, and the second largest shareholder owns just 4.8 %; 52.8 % is owned by non-relevant minorities that have no more than 2 % (see Table 2). Thus, Fiat seems to be presented to the market as a public company, even though the Agnelli family members sit on the Fiat board of directors with important roles (see Table 4). The Agnelli family has the lowest cash flow rights in Fiat (17 %), thus probably it is important not only to demonstrate the separation between control and direction, but also that between ownership and control, minimizing the perception of outsiders that the controlling shareholder could dominate the affiliates where there is a high risk of expropriation (Grossman and Hart 1988; La Porta et al. 1999; Shleifer and Vishny 1997; Wolfenzon 1999), as well as the risk of share price reduction. We believe that these conclusions are also applicable to Pirelli & Co., Premafin and Italmobiliare; indeed, all three are neither directed nor consolidated by their parent companies. As with Fiat for the Agnelli group, these companies present the lowest cash flow rights in their respective groups, and the ultimate owners have important roles on their boards. Indeed, the family members represent 100 % of the executive board members in all these three companies (Table 3).

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Not all families seem to find it useful to declare the separation between control and direction (Quadrants II and IV, of Matrix I). The Colaninno family controls two listed companies: Immsi and Piaggio, having respectively 42 and 22.5 % of their cash flow rights. Immsi declares not to be directed by the controlling company Omniaholding, whereas Piaggio declares to be directed by its parent, Immsi. These two companies operate in the same primary industry and sector. We find the same situation in the Pesenti family who control Italmobiliare and Italcementi with respectively 47.3 and 28.5 % of cash flow rights. Also in this case the company that claims to be directed (Italcementi) is the one in which the dominant shareholder has the lowest cash flow rights. Italmobiliare and Italcementi operate in the same primary industry and sector. The De Benedetti group has the longest control chain, with low cash flow rights in the company at the bottom of the group (23.7 % in Cir, 13.4 % in Sogefi, 12.8 % in L’Espresso). De Benedetti’s subsidiaries (Cofide, Cir, Sogefi and L’Espresso) all declare to be directed by their respective controlling company, even though they operate in different industries and sectors. Also the Boroli and Drago families control and direct, through the parent De Agostini, Lottomatica and DeaCapital, even though they operate in different sectors. When the parent companies communicate to exercise the direction activity over their subsidiaries, they also tend to describe the benefits arising from that activity. As stated in the annual report of Sogefi (De Benedetti group): ‘‘The Company has a cash pooling system with subsidiary companies that satisfies the interest of the company. This situation enables the Group’s finances to be centralised, thus reducing the need to utilise funding from banks, and therefore minimising financial charges’’. Sogefi annual report (2010). According to the ICC, the benefits that the subsidiaries directed by Sogefi receive could compensate for the eventual detrimental transactions ordered by the directing company (see Sect. 4.2). In this regard, the annual report of L’Espresso directed by CIR is also interesting: ‘‘L’Espresso receives from its parent company CIR services and consultancy on various strategic, administrative, financial and tax matters. It is emphasized that the performance of these services by the parent is considered preferable to the services rendered by third parties because of, among other things, the extensive knowledge gained over time in the company and the market in which L’Espresso operates’’. L’ Espresso annual report (2010). We could expect that directing companies do not have a problem with showing their direction activity to the outsiders of subsidiaries, when the latter are oriented to interpret the direction activity and the intragroup transactions in the light of the efficient perspective (see Sect. 3). Therefore, for companies positioned in Quadrants II and IV (Matrix I), contrary to what is observed for those in Quadrants I and III (Matrix I), it seems that declaration of the direction activity serves as a commitment that dominant

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shareholders will not expropriate minorities, given that for the ICC the directing company is liable for the eventual damage caused to the outsiders of the directed subsidiaries. All companies positioned in Quadrant IV are not contestable, consequently the controlling shareholder could have a high incentive to extract private benefits, because of the high separation between control and direction, and of the impossibility of the market to discipline its behaviour with the risk of takeover. The third research question asks: What is the degree of separation between control and direction within the business group? In proposition 3 we state that the delegation of direction to subsidiaries is low because a de facto direction is exercised through the appointment of independent directors and the presence of the controlling family members on the subsidiaries’ board as Ceo, chairman, honorary chairman or vice-chairman. Pirelli & Co. shows the highest outsider ratio (91.4 %) and the lowest cash flow rights (5.8 %), whereas Caltagirone has the highest cash flow rights (87.6 %) and one of the lowest outsider ratio (18.2 %). In some groups, the independence of the subsidiaries’ boards seems particularly important to give credibility to the separation between control and direction, especially for firms that communicate that even if they are controlled and/or consolidated by the controlling companies, they are not subjected to their direction activity. Subsidiaries that declare not to be directed (Fig. 2, Quadrants I and III) tend to show high board independence as well as those boards being autonomous from their parent companies. Below are examples from Mediaset and Italmobiliare (i.e. the Berlusconi and Pesenti families), respectively controlled by Fininvest and Efiparind. They are all positioned in Quadrant III of Matrix I (Fig. 2). ‘‘Mediaset SpA defines its own strategies independently and that it has total organisational, operational and transactional autonomy, not being subject to absolutely any directional or coordinating actions by Fininvest, regarding its own business activities. Specifically, Fininvest does not issue any directives to Mediaset nor does it carry out any technical, administrative or financial support or coordination activities on behalf of Mediaset and its subsidiaries’’. Mediaset annual report (2010). ‘‘Although Efiparind B.V. […] has a sufficient number of voting rights to exercise a dominant influence in the ordinary Meeting, albeit indirectly, it does not set, nor has it ever set, the Company’s strategic policies to follow in the management of its business’… ‘The Board of Directors of Italmobiliare SpA, therefore, has always taken its decisions in full autonomy without any interference whatsoever by the relative majority shareholder’’. Italmobiliare annual report (2010). Also, directed companies seem to find it useful to underline the independence of their boards even if they are not autonomous from the directing company. For example, in the annual report of CIR and Sogefi (Fig. 1, Matrix I, Quadrant IV)— directed listed subsidiaries of the De Benedetti group—it is pointed out that:

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‘‘The Board of Directors of the Company, out of a total of 14 members, has 7 who possess the requisites of independence and are thus sufficient to guarantee that their judgment has a significant weight in the decision-making process of the Board’’. CIR Annual Report (2010). ‘‘The Company’s Board of Directors comprises 9 members, 5 of which meet the independence criteria, and therefore a sufficient number to guarantee that their contribution has an adequate weight when taking board decisions’’. Sogefi Annual Report (2010). However, the ways followed by the non-directed (autonomous) companies to point out board independence are different when compared to those of the directed companies. In the former case (Mediaset and Italmobiliare) board independence is accompanied by the evidence of board autonomy from the parent. Indeed, it is underlined that the boards take their decisions in ‘full autonomy’. In the latter case (CIR and Sogefi), because of the direction activity, board independence is not oriented to guarantee the board autonomy from the parent, but rather to balance the interest of the subsidiary with that of the group in the board decision-making process, and so prevent the direction activity being used to expropriate outsiders. Therefore, board independence is necessary to monitor the transactions between directed firms, allowing the beneficial transactions and prohibiting the detrimental ones, unless such latter transactions are motivated by the interest of the group and are compensated by the advantages that the damaged subsidiary receives from belonging to the group (see Sect. 4.2). However, the declared separation between control and direction would be not enough to convince outsiders that controlling shareholders will refrain from extracting private benefits. The subsidiaries’ boards’ independence and the presence of family members on those boards are important indicators that give credibility to that separation. Among the 28 listed firms analysed, only five have independent directors appointed by minorities (Table 4), even if the percentage is extremely low. CEO duality is present in ten listed companies. Despite in many subsidiaries the controlling family members being both chairman and/or executive directors, lead independent directors were often not appointed. From the analysis of Table 4, it clearly emerges that almost all the companies of our sample have limited board independence, since controlling shareholders have enough power to control the boards of their business groups through the affiliated directors. Taking into account the analysis of the boards’ independence and composition (Table 4), Matrix II of Fig. 2 shows that the only firm in which the declared separation between control and direction seems to be real is Atlantia. In that company no member of the family is executive, chairman, honorary chairman or vice-chairman of the board. Obviously, we cannot exclude that the non-family board members may still have ties to the family of a different nature (e.g. professional ties). Family members of our sample sit on the boards of all their listed companies.

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The Caltagirone group presents the highest family board ratio (32.9 %), the Berlusconi group the lowest (10.7 %). In eight listed subsidiaries, the family members represent 100 % of the executive directors, even though five of the same subsidiaries declare not to be directed by their parent companies. Family members are not the chairman of the board in only four subsidiaries (Atlantia, Lottomatica, Dea Capital and Vianini Lavori). Based on our theoretical discussion, the presence of the family could be motivated by the purpose of the dominant shareholder to monitor the managers of subsidiaries. However, in some of the analysed groups, dominant family members sit on the boards of subsidiaries as executive directors. In these cases family members sit on the subsidiaries’ boards not only with a monitoring and ratification role (Fama and Jensen 1983), but also with a service role (Huse and Rindova 2001). That is why, in Fig. 2, companies positioned in Quadrants I and II of Matrix I were moved into Quadrants I and III of Matrix II. Thus the declared autonomy of the subsidiaries’ boards seems to be more apparent than real.

8 Conclusions and limitations 8.1 Conclusions This study examines why, in pyramidal business groups, the parent company delegates exercising the controlling power (i.e. direction activity) to the subsidiaries and what is the degree of separation between control and direction within the business group. In order to answer the research questions we have used a theoretical framework on pyramids and the Italian Regulation on business groups. We have then formulated three propositions discussed through a multiple case study analysis on ten Italian business groups within which operate 28 listed companies. Multiple case studies have shown similarities and differences in the way family groups communicate the direction activity of the controlling companies positioned at various levels of the pyramidal structure. The analysis also suggests some elements to understand whether the separation between control and direction, or instead the concentration of the directing activity in the parent company, should be interpreted positively or negatively. The results have revealed that 71.4 % of the sample (20 companies) declare not to be directed by the parent company (Fig. 2, Matrix I, Quadrants I and III). This declaration of the non-exercise of direction activity may have at least two reasons: (1) to persuade the outsiders of subsidiaries that there would not be extractions of private benefits of control by the dominant shareholder; (2) to exclude the parent company from liability in the case of damage caused by subsidiaries to their outsiders (minority shareholders and creditors). However, analysis of the board composition and independence shows that the separation between control and direction activity seems to be real in just one case. Indeed, the low degree of board independence and the presence of family members on the subsidiaries’ boards as executive directors, reduces the credibility of the

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actual separation and that of the defences against expropriation by the dominant shareholders. The credibility of the separation is questioned, mostly for subsidiaries that operate in the same sector. In this case, the parent company apparently seems to refuse the possibility to reach the system effect, often recalled by the existing literature on business groups (Khanna and Palepu 1999; Khanna and Yafeh 2007; Leff 1978) and that of transaction costs (Coase 1960; Williamson 1985). It does not mean that, in the case of non-direction activity by the parent, the group does not have the possibility to reach the system effect, but rather that this effect is reached just when subsidiaries decide autonomously to collaborate. We can assume that the negative consequences of not using the directing activity of subsidiaries to achieve the system effect of the group may be counterbalanced by the beneficial effect in terms of reduction of the degree of expropriation perceived by the outsiders and of the cost (share price discount) associated with their sceptical reaction. However, in the case of only apparent separation between control and direction, outsiders will not be persuaded, interpreting the declared separation in a negative way, in the sense that the dominant shareholder may want to maintain the possibility of extracting private benefits, excluding the parent company from liabilities, according to Italian group law. Indeed, we can assume that if the dominant shareholder does not have opportunistic intentions, the controlling company at the top of the pyramid should not have problems declaring the directing activity, and consequently taking responsibility for the outsiders. This assumption is also confirmed by the fact that, pursuant to the Italian Civil Code, the financial statements of the directed subsidiary must disclose explicit information on dealings with both the directing company and the other directed companies, explaining the reasons that led to such transactions. A low percentage of the sample (28.6 %, eight subsidiaries) declares to be directed by the controlling company (Fig. 2, Matrix I, Quadrants II and IV). In all these subsidiaries the direction activity seems to be not just apparent but real. We have found direction activity by the parent even in subsidiaries that operate in different sectors and industries. In this case, we can assume that the direction activity is a commitment that the controlling shareholder will not expropriate the outsiders of the subsidiaries, because of the cost associated with the holding liability, according to Italian Regulation. Therefore, the provision of the parent liability and of the transparency of transactions with the directing company and with the other directed companies, in the case of direction activity, leads us to interpret the declared separation between control and direction in a negative way when it is just apparent and not real. Conversely, the direction activity should be interpreted positively even in the case of high separation between ownership and control, because the holding liabilities and the business group transparency provided by Italian law may counterbalance the negative effect of the declaration of direction activity over subsidiaries where a high risk of expropriation is present. As frequently emphasized, the literature uses the separation between ownership and control as a proxy to assess indirectly the degree of expropriation by the

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dominant shareholder (Claessens et al. 2000; Faccio et al. 2001). According to our results, we suggest also using the separation between control and direction, especially for pyramids that are located in countries such as Italy, where the law provides the holding liability and the transparency of the subsidiary’s transactions that are directed by the same holding. These two elements seem to be firstly a disincentive to the establishment of a pyramidal group with expropriation purposes, and then a suggestion for regulators. In this regard, Bianchi and Bianco (2006) observe, for both Italian listed and unlisted companies, some changes in the instruments used to ensure stability of control during the period 1990–2005. In particular, ‘‘in listed companies the objective was reached in the past through an extensive use of pyramids, more recently by establishing shareholders’ coalitions of various nature, with an increasing relevance of bank-firm relationships’’ (p. 6). We believe that the Italian group Regulation, introduced in 2003, could be one of the reasons for that change. This study also contributes to the debate on the relevant role of independent directors of subsidiaries. The genuine independence of directors is necessary for both directed and non-directed (autonomous) companies, especially for those characterized by an elevated separation between ownership and control. Independent directors of directed subsidiaries have to protect the outsiders when the directing parent company asks the management of the same subsidiaries to sacrifice the subsidiaries’ interest in the exclusive interest of the parent or the dominant shareholder. Instead, according to Italian group Regulation, when detrimental transactions are ordered in the interest of the group, they have to assess the eventual compensatory advantages that the damaged subsidiaries receive because of belonging to the group. In the case of non-direction activity, the truly independent directors guarantee actual separation between control and direction. Thus, there could be a further suggestion for the regulators: favouring the entry of directors appointed by minorities (considered by the literature as genuine independent directors) and thus the independence of the subsidiaries’ boards, could be seen as another way to discourage the establishment of pyramidal groups, especially those where controlling shareholders have opportunistic purposes. 8.2 Study limitations Even if the study had been focused on more firms, there is the risk that the results would have been closely idiosyncratic of particular cases, because the case study is ‘‘a research strategy, which focuses on understanding the dynamics present within single settings’’ (Eisenhardt 1989). The need for an econometric verification on a larger sample to extend the results is thus strong. In fact, Eisenhardt (1989) even states: ‘‘Perhaps ‘grand’ theory requires multiple studies—an accumulation of both theory-building and theory-testing empirical studies’’. Thus the multiple case study analysis should be followed by an econometric verification, so as to ensure the generalizability of the results, notwithstanding that they may be valid only within the Italian context, given its special features, such as for example, the high level of private benefits of control and the distinctive business group law.

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Author Biography Emiliano Di Carlo is Assistant Professor in business management at the University of Rome ‘‘Tor Vergata’’ (Italy), Department of Business Government Philosophy Studies. His research interests are in the area of finance and governance of business groups, international accounting standards, corporate governance, conflict of interests, corruption, corporate social responsibility.

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