Family firms play an important role in many economies, yet they can present unique governance challenges. Among these challenges is the risk that family owners—often dominant shareholders—might prioritise their private interests over those of other (minority) shareholders.
In our recent research, we examine how higher levels of corporate transparency in family firms not only reduce tax avoidance but also increase the likelihood that these firms will replace their chief executive officers (CEOs).
The findings have direct implications for policymakers, investors, and family business owners, who can all benefit from understanding how transparent financial and managerial practices strengthen governance in family firms.
Family firms and the “Type II agency problem”
In classical economic theory, agency problems usually arise from disagreements between managers (agents) and shareholders (principals).
However, in family firms, a second type of agency problem often dominates: one involving controlling shareholders (family owners) and minority shareholders. Scholars refer to this as the “Type II agency problem”. For example, a founding family with significant control and board influence might entrench family members or affiliated individuals as the firm’s CEO.
While family control can bring advantages such as a long-term orientation and strong personal commitment to the firm, evidence suggests that family firms frequently resist changing CEOs.
One reason is that family owners often want to keep control within the family circle, even when performance is suboptimal.
This behavior can impair the ability of minority shareholders (and other stakeholders) to ensure the best leadership is in place. As a result, CEO turnover typically occurs less frequently in family firms than in non-family firms.
The role of corporate transparency
A major topic of our research is corporate transparency, which refers to the clarity, quality, and accessibility of a firm’s disclosures and financial reporting.
Transparency lowers information asymmetry. It helps investors, regulators, and other observers fully understand the firm’s performance and managerial decisions. When transparency is low, family owners may be able to conceal activities that benefit themselves at the expense of others.
When a firm is more transparent, it becomes easier to detect questionable practices, including aggressive tax avoidance. This heightened visibility increases the likelihood that minority shareholders and regulators will spot and oppose financially detrimental decisions.
In practical terms, robust disclosure rules and independent audits boost transparency, reducing opportunities for rent extraction by dominant shareholders, such as preferential contracts.
How transparency spurs CEO turnover
Enhanced transparency also appears to increase the likelihood of CEO turnover in family firms.
This finding may seem surprising because, on the surface, one might assume family owners will maintain a tight grip on major decisions (including CEO appointments) regardless.
Yet, greater transparency increases external monitoring pressure on controlling shareholders. For example, when disclosures are transparent, minority shareholders who perceive inadequate governance may apply a discount to the firm’s stock price and gain a stronger basis to push for leadership changes if current management fails to align with broader shareholder interests.
Thus, transparency acts like a governance mechanism: it spotlights rent-seeking or poor corporate decisions, thereby compelling family owners to address problematic leadership arrangements.
Tax avoidance as an underlying mechanism
One of the most striking findings of the study relates to tax avoidance.
Our analysis—based on a large dataset of Taiwanese firms—shows that family firms with high transparency avoid taxes less aggressively and also exhibit higher CEO turnover than those with low transparency.
Why does this happen? Dominant shareholders may use tax avoidance strategies that benefit themselves privately, sometimes risking reputational damage if such practices are exposed. In a transparent firm, these aggressive tax avoidance tactics become more difficult to hide.
Implications for policymakers
Given the finding that increased disclosure can mitigate tax avoidance behaviors, policymakers may wish to strengthen transparency requirements in family firms.
This can include:
- mandating frequent, rigorous external audits to limit opportunities for manipulation in financial statements, thereby improving shareholder confidence, and
- encouraging or compelling companies to disclose effective tax rates in a clear, consistent manner, adding an extra layer of scrutiny and potentially limiting aggressive tax avoidance.
Concluding thoughts
Family firms often embody strong traditions, loyalty, and a sense of community. Yet they also face governance challenges, particularly regarding leadership changes and the potential for rent extraction at the expense of minority shareholders.
By bringing tax avoidance into the discussion, our research highlights a tangible mechanism through which a lack of transparency harms both broader shareholder interests and a firm’s public standing.
Corporate transparency therefore emerges as a powerful tool: it deters aggressive tax strategies and invites public scrutiny, thereby increasing the likelihood of CEO turnover when the top executive is engaging in tax avoidance and exposing the company to reputational risks.
The key takeaway for policymakers, investors, and families themselves is that transparency should not be viewed as a threat but as a vital driver of better governance and stronger long-term performance.
For tax policy, the implications are clear. Regulators seeking to reduce tax avoidance and foster healthier corporate environments might devote special attention to ensuring that family firms meet robust disclosure standards. Such measures, in turn, can enhance trust in capital markets, attract global investors, and bolster economic resilience.
The lesson is that transparent corporate practices not only align with sound tax policy—they also support more effective leadership arrangements, placing family firms on a path toward sustainable growth.
Reference
This post is based on the study “CEO Turnover in Family Firms: The Corporate Transparency Perspective,” by Cheng-Hsun Lee and Sudipta Bose in the China Accounting and Finance Review. We thank Austaxpolicy for sharing this summary and hope it will stimulate further discussion on the intersection of tax policy, governance, and family business practices.
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