Coordination, Control, or Charade? Board Ties Among Members of an Italian Business Group

1. Coordination, Control, or Charade?Board Ties Among Members of an Italian Business Group Fabio ZonaBocconi University Brian BoydArizona State University

2. Study Focus • Italian business groups are a key feature of the Italian corporate landscape • There are many interlocks, or shared board ties, across members of these groups • No studies have examined what role, if any, is played by these board ties

3. Corporate Governance in Italy • Italian system is unique relative to both theAnglo-Saxon model and German system • Classified in Latin subgroup, which is characterized by controlling shareholders and weak capital markets (DeJong, 1997) • Banks and institutional investors are typically not key shareholders • Stock market plays a limited role (Melis, 2000) • Two-tier board: Statutory auditors evaluate the performance of the main board • Extensive reforms in the form of commercial law and governance code, starting in late 1990s

4. Italian Business Groups • Many flavors of business groups – such as keiretsu and chaebol • Pyramids are legally independent firms, controlled by a unidirectional chain of ownership • Dominant form for Italian industrial firms • Majority of firms traded on the Milan Stock Exchange use pyramidal organization • In 2002, there were 52,000 Italian business groups, covering 4.9 million employees • One-third of groups have fewer than 500 employees • Pyramids can be found in other countries as well. Also used by US railroad companies in 1800s.

5. Cementeriede Sardegna owns78% (cement) Italcementi owns45% owns54% (cement) owns74% Italmobiliare owns62% CementerieSiciliane (diversifiedinvestments) PesentiFamily (cement) Franco Tosi (steam turbines) Other holdings include food packaging, banking, insulation, others A Simplified Pyramidal Group Pesenti family is able to control Sardegna and Sicliane with lesser investment than if held directly. The ownership of Italmobilaire is the weakest link, as the family does not own or control 51%. Source: Volpin (2002) JFE 64: 69

6. Pros Historically, financial markets in Italy are underdeveloped – stock exchange is a relatively recent phenomenon. Pyramids allow firms with access to capital. Pyramids can facilitate access to resources and other transactions across firms Together, firms may be better able to withstand financial crises Ability to focus on long-term outcomes Cons Creates a greater imbalance between ownership and control Potential for firms at lower end of pyramid to suffer in order to support higher level members Blockholder may pursue interests other than maximizing returns ‘Tunnelling’ and other unethical or illegal activities Are Pyramids Beneficial or Harmful? Overall, there is no evidence that a pyramidal form is inherently harmful.

7. What Role Do Boards Play? • Coordination: Boards work as a tool to manage environmental constraint. Key roles include providing access to resources and information. • Control: Boards work as representatives of owners, and provide monitoring and control roles. • Charade: Boards are window dressing and serve no useful purpose. These exist because of legal requirement and to enhance legitimacy.

8. Evidence on Italian Boards • 2002 code of best practice highlight both agency and resource dependence roles • Monitoring, strategy, and resource roles all contribute to firm performance (Zona & Zattoni, 2007) • Broad range of activity across firms – some craft strategy, others are rubber stamps (Ravasi & Zattoni, 2006) • 83 percent of directors act as agents of blockholders, despite reform guidelines • Mixed results on use of interlocks across studies

9. Related Research:Subsidiary Boards Key Roles • External • Acquire local information and resources from host country • Internal • Coordination with other subsidiaries, • Conduit for management oversight (Leskell & Lindgren, 1982; Kriger, 1988) Findings • Historically, SB’s have been exemplars of ‘rubber stamp’ model • SB’s becoming more active over time • Boards of subsidiaries with partial ownership more active than WOS

10. Hypotheses • H1: Interlocks between pyramid boards serve as a monitoring mechanism, and will be driven by ownership (agency explanation). • H2: Interlocks between pyramid boards serve as a mechanism to procure information and resources, and will be driven by financial transactions between members (resource dependence explanation). • Null: Pyramid boards are rubber stamps. Lack of support for hypotheses can be construed as indirect support for this rationale.

11. Board Ties: A Network View • Most studies use counts of interlocks to measure board ties across firms • Simple tie counts assume that all interlocks are equally valuable • Network analysis allows assessment of the value of an individual interlock based on its position in a broader system of ties • Consequently, we use network centrality as the dependent variable for hypothesis tests

12. Network Characteristics

13. Network Characteristics Measures of Centrality: Power: Taps the range of direct connections available to an actor (degree centrality) Betweenness: Role as a unique intermediary between other actors Reach: Taps the range of total connections available to an actor through intermediaries

14. Network Characteristics:Betweenness 4 1 3 2

15. Network Characteristics:Power 2 1 6 2 2 2

16. Network Characteristics:Reach 4 1 3 2 4 4 4

17. Geographic Structural Holes DENMARK IRELAND GREAT BRITAIN POLAND GERMANY CZECH REP. UKRAINE FRANCE SLOVAKIA AUSTRIA HUNGARY ITALY ROMANIA PORTUGAL SPAIN

18. Hypothesis 3 • Internationalized firms have greater information and resource requirements • Pyramids have many foreign members • Lateral ties in MNCs used to acquire market information, supplier and customer contacts, access to local capital • Indirect/secondary ties have high information value • Geographic diversity of TMTs facilitates learning and decision-making • H3: Boards of foreign members will be more densely connected to the pyramid network

19. Sample We obtained proprietary data from a large Italian corporate group. Key characteristics: • 2005 revenues of 30 billion euros, assets of 96 billion euros • 155 companies operating in five business units • 63 percent of companies headquartered outside Italy, mainly in Europe and South America

20. Variables • Board centrality: Used UCINET to creates measures of betweenness, power, and reach centrality for each firm. • Financial dependence: Analyzed over 8,000 cross-firm transactions to identify resource exchange across group members • Ownership: Counted inward, outward and overall ownership links for each firm • Nationality: Whether firm is headquartered in Italy or foreign • Firm size: Net sales

21. Descriptive Statistics • Board characteristics: A typical firm had 4 directors, and interlocks with 6 – 7 other firms • 26 firms were isolates (no ties to other firms) • One firm was tied to 27 other pyramid members • Financial dependence: A typical firm reported having financial transactions with 5 other firms • 32 firms reported no transactions with other members • One firm had transactions with over half (57%) of pyramid members • Ownership: Firms had between one and five owners, with an average of slightly over one owner per firm. • One firm had a direct ownership stake in 40 other pyramid members • Nationality: 63 percent of firms headquartered outside Italy

22. Interlocks Ownership Nationality Size Structural Model of Hypotheses FinancialTies Power Between Reach

23. Global Fit: 2 = 36.84 2 /df = 4.6 GFI = 0.94 RMSR = .07 Predictive Power: CEDseq = 0.29 R2between = 0.28 R2power = 0.91 R2reach = 0.66 Mean R2dv = 0.62 Financial Ties Power Between Reach Interlocks Ownership Nationality Size Summary Statistics A single-factor null model reported a 2 =117.17 (14df).

24. Interlocks Ownership Nationality Size Tests of Hypotheses FinancialTies .25 (2.8) Power 1.0 .09 (1.0) .56 (6.7) Between -.27(3.6) .86(10.7) .28(3.4) Reach

25. Implications • To date, no studies have addressed the role of board ties among pyramid members. This project is a first step toward resolving that gap. • Evidence points strongly toward the board as a resource role • Our results consistent with positive versus negative arguments for pyramids.

26. Future Research • Normative models – how do high performing firms act? • Replication – other pyramids in Italy, and board ties within other types of business groups. • Compare board roles for small and large pyramids • Kriger’s work on subsidiary boards used both archival and survey data. Desirable to study perceived roles of pyramid directors