Organization Science
informs
Vol. 19, No. 3, May–June 2008, pp. 404–418
issn 1047-7039 eissn 1526-5455 08 1903 0404
®
doi 10.1287/orsc.1080.0360
© 2008 INFORMS
Ownership Structure and the Relationship
Between Financial Slack and R&D Investments:
Evidence from Korean Firms
Hicheon Kim
Korea University Business School, Seoul, 136-701, Korea, [email protected]
Heechun Kim, Peggy M. Lee
W.P. Carey School of Business, Arizona State University, Tempe, Arizona 85287
{[email protected], [email protected]}
W
e use agency theory to examine the influence of ownership structure on the relationship between financial slack
and R&D investments, highlighting how that relationship might differ depending on the identity of the owners, and
their potentially different interests. In doing so, we extend the scope of agency theory by examining the principal-principal
conflicts of interests that may exist among different types of owners. Using a sample of Korean manufacturing firms
in R&D-intensive industries between 1998 and 2003, we find that financial slack has an inverted U-shaped relationship
with R&D investments. Furthermore, that relationship varies depending on the presence of different types of owners.
Family ownership positively moderates the relationship between financial slack and R&D investments, whereas domestic
institutional investors and foreign investors negatively moderate that relationship. Our results show that distinguishing
among different types of owners is instrumental in enhancing our understanding of the nature of the relationship between
financial slack and R&D investments.
Key words: ownership structure; agency theory; organizational slack; R&D investments
History: Published online in Articles in Advance April 7, 2008.
Corporate governance research spans multiple disciplines, including law, economics, finance, and management. In all of these literatures, the dominant paradigm
has been agency theory. Nonetheless, several scholars
have argued that the agency-theoretic view of corporate
governance is incomplete. Specifically, this view tends
to miss the principal-principal problems that exist, especially in governance systems of emerging economies
(Dharwadkar et al. 2000). For example, Douma et al.
(2006) find that foreign owners have different interests
than domestic owners in the Indian economy, resulting in
differing performance implications. It follows that who
the owner is may have other firm consequences as well.
In particular, principal-principal conflicts may result
in differing preferences for the allocation of slack resources. The agency problem, perhaps, is most pronounced in the presence of organizational slack or excess
resources, which can be applied for many different
purposes without jeopardizing firm survival. Viewing
organizational slack as a source of agency problems,
agency theorists argue that slack breeds inefficiencies,
inhibits risk taking, and hurts performance (Jensen
1986, 1989). In other words, organizational slack may
discourage managers from implementing risky strategic initiatives while allowing managers to pursue their
personal agenda. On the other hand, organizational
slack provides firms with a safety net and the additional resources necessary to explore new solutions and
opportunities, thereby leading to greater risk taking and
R&D investments (Cyert and March 1963, Greve 2003).
Underlying this debate regarding organizational slack
is the implicit assumption that all the firms have the
same ownership structure or that different types of shareholders have the same preferences in allocating organizational slack (e.g., George 2005). However, given
the principal-principal goal incongruence and the discretionary nature of organizational slack, this may not be
the case. To the extent that different shareholders have
different preferences in allocating organizational slack,
incorporating ownership structure is crucial to deepening
our understanding of the effects of organizational slack.
This study examines the moderating effects of different types of owners on the relationship between financial
slack and R&D investments.1 In doing so, we extend
the scope and boundaries of agency theory to include
the interests of differing principals. After all, different
types of shareholders may have different interests in
R&D investments (e.g., Kochhar and David 1996). As
such, we argue that organizational slack influences R&D
investments differently depending on who the investor is.
For example, family owners may have different interests
than outside investors. This principal-principal conflict
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Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
of interest may result in disparate preferences for levels of R&D investments. Furthermore, this extends the
work of Dharwadkar et al. (2000) who argue that firms
in emerging economies are especially prone to principalprincipal goal incongruence and that principal-principal
conflicts result in differences in firm performance. It
follows that these principal-principal conflicts may also
result in differing preferences for the allocation of slack
resources.
For the purpose of our study, we focus on financial or unabsorbed slack for several reasons. First,
financial slack represents excess uncommitted financial
resources, including cash and receivables (Bourgeois and
Singh 1983, Greve 2003, George 2005). These financial resources are highly flexible and can be applied
to a wide range of activities, thereby constituting highdiscretion slack (Sharfman et al. 1988, George 2005).
Financial slack gives decision agents the greatest degree
of freedom in allocating it to alternate uses and is more
easily redeployable than other types of slack in support
of R&D investments (Nohria and Gulati 1996). As such,
allocation of financial slack would be amenable to the
influences of different types of investors as a means of
alleviating agency problems. Second, financial slack has
been the focus for many previous studies (Bourgeois
and Singh 1983, Greve 2003, George 2005, Nohria and
Gulati 1996), providing both a theoretical and empirical
consistency. Finally, financial slack more closely represents the agency-theoretic concept of free cash flow
and in turn allows for a more accurate test of agencytheoretic predictions (Jensen 1986).
To test our hypotheses, we use a sample of publicly traded Korean firms in R&D-intensive industries
during the 1998–2003 period. South Korea offers an
interesting context for several reasons. First, Korean
firms are global players in various industries, including
semiconductors, electronics, and automobiles. Korean
firms began to compete by imitating the technological capabilities of their counterparts from developed
economies. However, they have since successfully transformed themselves from imitators to creative innovators
by building their own technological capabilities (Kim
1997). This transformation is made possible in no small
part by Korean firms’ extensive investments in R&D
(Kim 1997, Cho et al. 1998). Indeed, Korea has spent
more than 2% of its GDP on R&D in the last decade,
which is much higher than other emerging economies
(Mitchell 1999, Varsakelis 2001). It is intriguing to
examine who drives Korean firms’ R&D investments—
the very investments that lay the foundation of their technological capabilities—when financial slack is available.
Second and more importantly, Korean firms provide
a unique context in international corporate governance
research. In contrast to the Anglo-American system of
corporate governance, many Korean firms are run by
405
family members. In these firms, agency costs are mitigated simply because family members often assume
executive positions and have incentives and the power
to closely monitor and influence managerial decisions
(Anderson and Reeb 2003; Demsetz and Lehn 1985;
Schulze et al. 2001, 2003). Controlling shareholders
such as family members, however, generate another
unique set of problems among various types of owners
(La Porta et al. 1999). In Korea, traditional principalagent problems between shareholders and managers may
be supplanted by principal-principal problems between
family members and outside shareholders. Furthermore,
in Korea, outside investors, including domestic institutional investors and foreign investors, can potentially influence how financial slack is allocated. Thus,
Korean firms represent an interesting hybrid of ownership structures—especially with the dramatic changes
that have occurred since the 1997 Asian financial crisis.
In addition, compared to developed economies, emerging economies such as Korea suffer from limited disclosure of firm information, few mechanisms to protect
the minority shareholder, and irregular enforcement of
corporate governance laws (La Porta et al. 2000b). Such
differences in broad national governance contexts would
affect incentives, investment horizons, and capabilities
of different types of shareholders to monitor and influence firm management. Thus, the Korean context offers
an opportunity to enhance our understanding of the roles
that different inside and outside shareholders play in
firms’ R&D investments in the national governance context of an emerging economy.
This paper is structured as follows. In the next section, we first propose the main hypothesis about the relationship between financial slack and R&D investments,
and then develop hypotheses to examine the moderating effects of ownership structure on this relationship.
Next, we present the results of our analyses. Finally,
we conclude with implications and directions for future
research.
Theory and Hypotheses
Financial Slack and R&D Investments
Financial slack provides firms with the autonomy and
resources necessary to explore new solutions and opportunities, thereby facilitating risk taking. Cyert and March
(1963) suggest that increased organizational resources
allow firms to engage in more experimentation, risk taking, and innovation. R&D investments are a case in
point. R&D investments often entail search into unknown territories, and their outcomes are neither immediate nor certain. They may not result in any payoff
(they may be entirely unproductive), or may translate
into profits only after many years. Under these circumstances, excess resources and safety nets offered
by financial slack enable firms to pursue new ideas
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Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
and projects that require longer investment horizons,
and whose outcomes are more uncertain and remote
in time and space (Bourgeois 1981, March 1991). To
the extent that financial slack promotes experimentation, risk taking, and long-term orientation, it can facilitate R&D investments. In a similar vein, O’Brien (2003,
p. 420) argued and found evidence that financial slack is
important to firms competing on the basis of innovation
because it “helps to provide insulation against cash flow
volatility and ensures that investments in R&D are maintained even during bad times.” Others have argued that
slack enables firms to purchase and adopt innovations
(Damanpour 1987, 1991).
However, as financial slack increases further, a negative picture of financial slack may emerge. That is, financial slack—rather than providing the excess resources
and safety nets necessary for experimentation and risk
taking—nullifies the firm’s incentives to adapt to environmental shifts and to engage in risky projects that
can rejuvenate its competitive advantage. For instance,
Jensen (1986) argues that free cash flow, which is conceptually close to financial slack in this study, allows
firms to invest in dubious projects, such as unrelated
diversification. In fact, fewer resources—rather than
more resources—may induce firms to be efficient and
innovative in mobilizing and allocating resources (Baker
and Nelson 2005, George 2005). This view claims that,
equipped with too much slack, firms may become complacent and overly optimistic, and feel less compelled
to make investments in R&D. In other words, too much
financial slack breeds organizational complacency and
inertia, thereby dampening incentives for experimentation and risk taking.
Thus, it is likely that the effects of financial slack on
experimentation and risk taking vary depending on the
level of financial slack. Up to a certain level, financial
slack encourages R&D investments; however, beyond
that point, financial slack discourages R&D investments.
In a similar vein, Nohria and Gulati (1996) find that the
effect of organizational slack on innovation is curvilinear, or inverted U-shaped.2 Thus, we hypothesize that:
Hypothesis 1 (H1). Financial slack will have an
inverted U-shaped relationship with R&D investments.
Role of Different Owners
The corporate governance literature distinguishes between insiders and outsiders because insiders are more
likely to gain access to critical information and to exert
a strong influence on strategic investments than are
outsiders (Baysinger and Hoskisson 1990). Because of
differences in access to inside information and the ability to influence firm management, different investors
might have different investment horizons and incentives to monitor the firm, thereby preferring different
ways of using organizational slack (Fiss and Zajac 2004,
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
Ramaswamy et al. 2002). Alternatively, there may simply be differences in opinions among investors over
whether financial slack exists and/or how financial slack
should be used. Thus, we propose that how financial
slack is allocated for R&D investments is contingent on
the identity of the owners and their potentially different
interests. Specifically, we distinguish among four types
of owners: family members, affiliated firms, domestic
institutional investors, and foreign investors. Using the
traditional insider-outsider distinction (Baysinger and
Hoskisson 1990), founders and family members are
categorized as insiders, whereas domestic institutional
investors and foreign investors are outsiders.
Group-affiliated firms in the same business group
in emerging economies are legally independent from
one another and could technically be classified as outside owners. However, they are often linked through a
cross-shareholding mechanism. Family members often
have the control over firms in excess of their cash-flow
rights (La Porta et al. 1999, Chang 2003a). For example, Chang (2003a) reported that, with only 14.1% of
the group’s total equity, the Chey family controlled the
fifth-largest Korean business group, SK, as of 1997.
Similarly, Chairman Chung of Hyundai Motor Group
enjoyed absolute power over the second-largest Korean
business group with only 5.2% of the total equity of
Hyundai Motor through cross shareholdings (BusinessWeek 2006b). Furthermore, because of the interlocking
nature of ownership stakes among business groupaffiliated firms, these affiliated owners are able to gain
access to high-quality inside information as well as
to be involved in the strategic decision-making process (Chang and Hong 2000). Thus, we classify business group-affiliated firms as inside owners. Below, we
develop the hypotheses about how these different types
of owners moderate the relationship between financial
slack and R&D investments.
Inside Owners—Family Ownership. Many Korean
firms are classified as family firms. Founders and their
family members possess a large proportion of equity
ownership, and serve as CEOs, chairpersons, or other
members of the top management team. Family members,
as inside owners, have access to firm-specific information and exert a strong influence over how slack is allocated among competing demands. Such informational
and control advantages put family members in an advantageous position to use financial slack to pursue their
interests. Some recent studies maintain that family members often abuse their information and controlling advantages to pursue private gains, often at the detriment of
minority shareholders; such expropriation is more profound in emerging economies where there is often weak
protection of outside investors (La Porta et al. 2000a).
For instance, Bertrand et al. (2002), Bae et al. (2002),
and Baek et al. (2006) reported that family members of
Indian and Korean business groups tunnel profits out of
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
member firms where they have low cash-flow rights to
member firms where they have high cash-flow rights,
thereby increasing their private gains and expropriating wealth from outside investors. These studies indicate that substantial conflicts of interests exist between
family members and outside investors in the context of
rent appropriation (Chang 2003a, Coff 1999). Insofar as
family members have incentives to expropriate financial
slack to their benefit, it is plausible that they are reluctant to convert greater portions of financial slack into
R&D investments.
However, family members play different roles with
respect to rent generation. To the extent that family
wealth is closely linked to firm wealth, family members have substantial economic incentives to maximize
firm value (Anderson and Reeb 2003, 2004). Family
members tend to be long-term investors (Anderson et al.
2003), often hoping to pass control of the firm to their
descendants rather than to consume wealth during their
lifetime (Casson 1999). Because family members are
strongly identified with their firms, exiting from the firm
by selling off their holdings may hurt their reputation
as capable and trustworthy business partners. Furthermore, exiting from the firm reduces the shares that future
generations will inherit, and entails significant emotional
costs associated with lost legitimacy, reduced status, and
contradicting family expectations (Casson 1999). Thus,
family members have longer investment horizons than
other shareholders, suggesting a willingness to invest in
long-term projects such as R&D.
Furthermore, family members are reluctant to rely on
external sources to mobilize funds necessary for risky
projects to the extent that they are eager to maintain and
ensure control over the firm (Mishra and McConaughy
1999). Because external investors tend to lack inside
information to evaluate and monitor R&D projects,
external investors are more likely to demand a risk premium (Jensen and Meckling 1976, Myers and Majluf
1984). These problems are more prevalent in emerging
economies where external capital markets are underdeveloped. In this situation, financial slack serves as an
internal source of capital and provides more flexibility
and strategic options to family members. Given that the
interests of family members are aligned with the longterm performance of the firm, family members, as residual claimants, are more likely to convert greater portions
of financial slack for R&D investments. Accordingly, we
hypothesize:
Hypothesis 2 (H2). Family ownership will positively
moderate the relationship between financial slack and
R&D investments such that the positive side of the
inverted U-shape will become stronger and the negative
side will become weaker for firms with higher levels of
family ownership.
407
Insider Owners—Affiliated Ownership. As mentioned earlier, because many Korean firms are part of
business groups, group-affiliated firms tend to feature
interlocking ownership structures, where one groupaffiliated firm owns another group-affiliated firm, and
vice versa (Joh 2003). These group-affiliated firms are
able to gain access to inside information and share
resources within the business group (Chang 2003a,
Chang and Hong 2000, Chang et al. 2006). As such,
group-affiliated firms may enjoy the same information and control advantages regarding financial slack as
do family members. Furthermore, group-affiliated firms,
which are bound together by formal and informal ties,
tend to share resources and coordinate business activities
(Granovetter 1994, Khanna and Rivkin 2001).
Prior studies indicate that diversified business groups
serve as internal capital markets (Leff 1978, Khanna and
Palepu 1997). In the internal capital market, a groupaffiliated firm can draw upon financial resources under
the control of other group members as well as its
own financial resources. Conversely, the group-affiliated
firm’s financial resources can be tapped into by other
group members as well as by the focal firm. Thus, in
the internal capital market, financial decisions in the
group-affiliated firm may be driven by groupwide considerations as much as by the focal firm’s considerations. Group-affiliated firms may take into consideration
investment opportunities of other group member firms as
well as those of the focal firm in their decisions about
how to allocate financial slack. By sharing and transferring financial resources, affiliated firms of the business group can invest more than what they can afford,
thereby overcoming liquidity constraints (Hoshi et al.
1991). Indeed, Shin and Park (1999) reported that the
investment of the Korean group-affiliated firm is sensitive to the cash flows of other group members, rather
than to its own cash flow.
In transferring financial resources among business
group-affiliated firms, those with excess cash flows are
likely to be providers and those facing liquidity constraints are likely to be recipients (Scharfstein and Stein
2000, Lincoln et al. 1996). Under such internal financing operations, the effect of ownership by affiliated
firms varies depending on the level of financial slack
available to the focal firm. For firms with high levels of financial slack, affiliated ownership encourages
the focal firm to save higher portions of financial slack
for other members. Accordingly, the focal firm is less
capable of converting financial slack into R&D investments. In contrast, for firms with low levels of financial slack, affiliated ownership may serve as a conduit
to transfer additional capital necessary for long-term
investments from other members. Thus, the focal firm
is more capable of converting financial slack into R&D
investments because affiliated ownership is less likely
to encourage the focal firm to save higher portions of
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Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
financial slack for other members. Taken together, we
hypothesize:
Hypothesis 3 (H3). Affiliated ownership will negatively moderate the relationship between financial slack
and R&D investments such that the positive side of the
inverted U-shape will become weaker and the negative
side will become stronger for firms with higher levels of
affiliated ownership.
Outside Owners—Domestic Institutional and
Foreign Ownership. Unlike family members and
affiliated firms, outside owners, in general, suffer from
informational and control disadvantages (Williamson
1975). Nonetheless, institutional investors may be
“sophisticated” and “active” investors compared to individual investors. Indeed, domestic institutional investors
have strong incentives to incur the cost of monitoring
firms because they often hold substantial ownership
blocks in firms. Similarly, foreign investors in emerging economies tend to be predominantly institutional
investors from U.S. and European financial institutions
(Choe et al. 1999). With the changes in regulations after
the financial crisis, these investors are able to voice
their concerns and influence managerial decisions more
effectively.
Before the Asian financial crisis in 1997, foreign
investors in Korea were not allowed to own more than
7% of shares in a domestic Korean firm, limiting their
penetration into the Korean capital markets. However,
such barriers have been lifted since the financial crisis.
As a consequence, foreign ownership in Korean firms
increased from about 13% of publicly listed firms in
1997 to 42% in 2006 in terms of market capitalization
(BusinessWeek 2006a). With the increased equity holdings in Korea, these foreign owners now exercise a larger
influence on the corporate governance system than ever
before (Joh 2003, Gillan and Starks 2003). Thus, foreign investors may have the same incentives to monitor
and influence as domestic institutional investors. Furthermore, foreign investors often bring in the notion of
“shareholder capitalism” into countries in which they
invest (Useem 1998, Ahmadjian and Robbins 2005).
Unfettered by prior business and social relationships
with firms in which they invest, foreign investors are
“pressure-resistant” (Brickley et al. 1988, Yoshikawa
et al. 2005).
In developed economies such as the United States,
insofar as institutional investors are “active” as well as
“sophisticated” investors, they are less likely to evaluate corporate executives on the basis of short-term earnings alone and are more likely to support value-creating,
long-term projects (Kochhar and David 1996). Several
empirical studies have corroborated this view. In the
study of four research-intensive industries in the United
States, Hansen and Hill (1991) found that high levels of
institutional ownership are associated with greater R&D
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
expenditures. Baysinger et al. (1991) reported the same
finding on a sample of 176 Fortune 500 firms. In a similar vein, David et al. (2006) reported the positive effect
of foreign ownership on long-term investments such as
R&D and capital investments in Japanese firms with
high growth opportunities.
However, in emerging economies, domestic institutional investors and foreign investors tend to be shortterm oriented because of the poor protection that they
receive (La Porta et al. 2000a). Facing the expropriation hazard by controlling shareholders, these outside
investors may prefer to obtain immediate gains through
dividends from financial slack (Easterbrook 1984, Jensen
1989, La Porta et al. 2000b, Shefrin and Statman 1984).
To the extent that outside investors prefer short-term
gains such as dividends over long-term gains through
R&D investments, financial slack is less likely to lead
to R&D investments as their ownership increases. Thus,
we hypothesize:
Hypothesis 4 (H4). Domestic institutional ownership will negatively moderate the relationship between
financial slack and R&D investments such that the positive side of the inverted U-shape will become weaker
and the negative side will become stronger for firms with
higher levels of domestic institutional ownership.
Hypothesis 5 (H5). Foreign ownership will negatively moderate the relationship between financial slack
and R&D investments such that the positive side of the
inverted U-shape will become weaker and the negative
side will become stronger for firms with higher levels of
foreign ownership.
Methods
Sample
The sample consists of Korean manufacturing firms
in R&D-intensive industries that were listed on the
Korea Stock Exchange (KSE) between 1998 and 2003.
Using two-digit Korean Standard Industrial Classification (KSIC) codes, we identify multiple industries
including chemicals (KSIC Codes 24 and 25), machinery (KSIC Codes 29, 34, and 35), and electronics (KSIC
Codes 30, 31, 32, and 33). In these R&D-intensive
industries, R&D investments constitute a crucial decision that may be affected by financial slack and ownership structure. The data come from the Korea Investors
Services (KIS) database, which reports firm profile,
financial information, and ownership information. This
database has been used in previous studies that employed
a sample of Korean firms (e.g., Chang 2003a). We first
identify a total of 262 firms, but 9 firms report incomplete information on firm profile, financial information,
and ownership information. Therefore, we drop them
and have a usable sample of 253 firms and 1,314 firmyear observations during the 1998–2003 period (unbalanced panel data). We take a one-year time lag between
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
independent and control variables, and our dependent
variable. As such, the independent and control variables cover the 1998–2003 period, whereas the dependent variable covers the 1999–2004 period.
Variables
Dependent Variable. We use R&D intensity, measured as the ratio of R&D expenditures to total sales.
This measure has been widely used in previous studies
(e.g., Greve 2003, Lee and O’Neill 2003).
Independent Variables. As noted earlier, we focus on
financial slack. Financial slack is measured as the ratio
of quick assets (cash and marketable securities) to liabilities (e.g., Singh 1986, Greve 2003). Following previous
studies (Chang 2003a, Baek et al. 2004), we measure
ownership structure as follows: (1) Family ownership is
the sum of equity ownership by family members, including founders and descendants; (2) affiliated ownership
is the sum of equity ownership by firms and financial institutions that belong to the same business group;
(3) domestic institutional ownership is the total percentage of equity ownership held by domestic institutional
investors composed of insurance companies, securities
firms, and merchant banks, which do not belong to the
same group as the firm being examined. We exclude
domestic financial institutions belonging to the same
group from this category. (4) Foreign ownership is measured as the percentage of equity ownership held by both
foreign firms and foreign financial institutions following
Khanna and Palepu (2000).
Control Variables. Previous studies have shown that
several variables can influence the level of R&D investments; these include previous investments in R&D
(Hansen and Hill 1991), stock concentration (Lee 2005),
firm performance, business group affiliation (Mahmood
and Mitchell 2004), and product diversification (Hansen
and Hill 1991). Thus, our control variables also include
lagged R&D (R&D intensity from the previous year),
stock concentration (measured as the total percentage
of stock held by large shareholders with at least 5%
of a firm’s stock), and firm performance, measured as
return on assets (ROA). To control for the effect of business group affiliation on R&D investments (Mahmood
and Mitchell 2004), we use a dummy variable. Although
business groups are defined as organizations with more
than two group-affiliated firms, not all business groups
exert the same influence. In particular, the top 30 business
groups in Korea not only represent Korea’s most prominent business groups, but also are subject to stricter regulations (Bae et al. 2002). Accordingly, if a firm belongs
to one of the top 30 business groups, it is coded 1, and
otherwise 0. We identify the top 30 business groups using
a ranking provided by the Korea Fair Trade Commission,
which provides annual rankings based on the size of the
409
total assets of all group-affiliated firms (Shin and Park
1999). To control for the effect of product diversification on R&D investments (Hansen and Hill 1991), we
use the imputed weighted diversification index measure
of product diversification based on the market segment
data from Worldscope and KIS (Gedajlovic and Shapiro
1998, Wan and Hoskisson 2003). This is calculated
as
follows: Degree of product diversification = Pi × dij ,
where i = a firm’s primary market segment; j = a firm’s
secondary market segment; dij = 0 if the firm operates
in only one four-digit industry, dij = 1 if the j is in the
same three-digit industry as i, dij = 2 if the j is in the
same two-digit industry as i, and dij = 3 if i and j are in
different two-digit industries; and Pi = a weight imputed
to each industry, assumed to decline geometrically: 1, 2,
4, 8, and 16.
We also control for firm size and firm age. Firm
size is measured by the natural logarithm of total sales
(Baysinger et al. 1991). Firm age, measured as the difference between the year when a firm is observed in our
sample and the year when the firm was founded, is also
controlled for. Because demand conditions and stage of
product life cycle of a firm’s products may affect R&D
investments, we control for sales growth, measured as
the percent change in annual total sales. We control for
the effect of firm risk, measured as the standard deviation of monthly stock returns for the prior 60 months
(Anderson and Reeb 2003). Although we are interested
in the relationship between financial slack and R&D
investments, we also control for the effects of absorbed
slack and potential slack on R&D investments (e.g.,
Bourgeois and Singh 1983, Singh 1986, George 2005,
Greve 2003). Absorbed slack is measured as the ratio
of selling, general, and administrative expenses to total
sales and considered for the possible curvilinear effect
on R&D investments. Potential slack is measured as the
ratio of total liabilities to total equity and considered
for the possible curvilinear effect on R&D investments.
We control for industry effects on R&D investments in
two ways. First, we control for industry average R&D
investments based on two-digit KSIC codes. Second, we
control for other industry effects by using eight industry dummy variables based on two-digit KSIC codes.
Finally, we include five calendar-year dummies to control for year effects.
Model Specification
Because we have cross-sectional time-series data, the
ordinary least squares (OLS) method is not appropriate
because it does not correct for within-firm autocorrelation and cross-sectional heteroscedasticity. To control
for these issues, we employ the generalized least squares
(GLS) method. Furthermore, a Hausman test reveals that
the estimated panel error is not correlated with independent variables, an assumption necessary for use of a
random-effects model. Thus, we test our hypotheses by
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Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
using a random-effects generalized least squares (GLS)
regression (Wooldridge 2002).
Results
The means, standard deviations, and correlations are
reported in Table 1. We examine the variance inflation
factors (VIFs) to detect multicollinearity. All of the VIF
scores are below 3 and the mean VIF score is 1.55.
Because a commonly used rule of thumb for multicollinearity is 10 or fewer, our analyses are unlikely to
have a serious problem with multicollinearity (Cohen
et al. 2003). We also center the interaction variables to
avoid multicollinearity.
The results of the analyses are shown in Table 2. H1
predicts that financial slack has an inverted U-shaped
relationship with R&D investments. The result of
Model 2 shows a positive coefficient on the financial
slack term and a negative coefficient on its squared
term. Both of these coefficients are statistically significant (p < 005). Thus, our results support H1 and are
consistent with the findings of Nohria and Gulati (1996).
In H2, we predict that family ownership positively
moderates an inverted U-shaped relationship between
financial slack and R&D investments. Model 3 suggests
that H2 is marginally supported (p < 010). To illustrate the complex interaction effect, we rely on a surface
plot using three standard deviations from the means of
financial slack and family ownership, as illustrated in
Figure 1. In the front of the figure, financial slack has an
inverted U-shaped relationship with R&D investments.
As family ownership increases, the positive relationship
between financial slack and R&D investments becomes
stronger, and the negative relationship between financial
slack and R&D investments becomes weaker, eventually
turning positive. Figure 1 provides additional supporting
evidence of H2.
H3 posits that affiliated ownership negatively moderates an inverted U-shaped relationship between financial
slack and R&D investments. As reported in Model 4,
we find that H3 is not supported. Although the coefficient on the interaction term is negative and consistent with H3, it fails to reach statistical significance.
By grouping family ownership and affiliated ownership
together into inside ownership, we conduct an additional
analysis that examines the moderating effect of inside
ownership on an inverted U-shaped relationship between
financial slack and R&D investments. We find that inside
ownership does not moderate an inverted U-shaped relationship between financial slack and R&D investments.
It seems that the opposite moderating effects of family ownership and affiliated ownership wash out, thereby
leading to the insignificant moderating effect of inside
ownership. This suggests that grouping family ownership and affiliated ownership together may give rise to
misleading findings; that is, not all inside owners are
identical—who the owner is matters.
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
Lastly, we test H4 and H5, which predict that domestic
institutional ownership and foreign ownership negatively
moderate an inverted U-shaped relationship between
financial slack and R&D investments. Consistent with
our predictions, Models 5 and 6 show that domestic
institutional ownership and foreign ownership negatively
moderate the relationship between financial slack and
R&D investments (p < 005; p < 005). This provides
support for both H4 and H5. As in H2, we rely on a surface plot using three standard deviations from the means
of financial slack, domestic institutional ownership, and
foreign ownership to better understand the moderating
effects. Both Figures 2 and 3 show that as domestic institutional ownership or foreign ownership increases, the
positive relationship between financial slack and R&D
investments becomes weaker (i.e., less positive), and the
negative relationship between financial slack and R&D
investments becomes stronger (i.e., more negative). Figures 2 and 3 provide additional supporting evidence of
H4 and H5.
Furthermore, we provide additional analysis by grouping domestic institutional and foreign ownership into
outside ownership to show the moderating effect of outside ownership on an inverted U-shaped relationship
between financial slack and R&D investments. We find
that outside ownership negatively moderates an inverted
U-shaped relationship between financial slack and R&D
investments (p < 005). The findings suggest that unlike
inside owners, outside investors raise the same voice
toward R&D investments.
Among control variables, both absorbed and potential slack are found to have an inverted U-shaped relationship with R&D investments. Whereas Greve (2003)
found a statistically significant positive relationship
between absorbed slack and R&D investments and no
relationship between potential slack and R&D investments, our findings suggest that, as with financial slack,
too much absorbed or potential slack is also detrimental
to R&D investments. As Thompson (1967) pointed out,
too much slack tends to insulate the firm from exogenous shocks, thereby creating complacency. Our findings
confirm that this is true for all types of organizational
slack.
Stock concentration and business group affiliation are
found to have no bearing on R&D investments. These
findings may indirectly attest to the significance of identity of owners in understanding levels of R&D investments. The notion of stock concentration neglects the
identity of shareholders, as does the notion of business
group affiliation. However, our findings indicate that the
identities of shareholders matter above and beyond stock
concentration and business group affiliation. In addition, our findings show that family ownership, affiliated
ownership, and domestic institutional ownership have
no main effects on R&D investments, whereas foreign
ownership is positively related to R&D investments. In
R&D investments
Financial slack
Family ownership
Affiliated ownership
Domestic institutional
ownership
Foreign ownership
Prior R&D investments
Stock concentration
Firm performance
Business group
Product diversification
Firm size∗
Firm age
Sales growth
Firm risk
Absorbed slack
Potential slack
Industry average R&D
687
195
3576
258
015
079
1876
3331
1096
020
016
336
192
192
036
2050
1131
827
Mean
1237
342
1817
1360
036
049
147
1418
8784
006
019
2655
121
261
059
1667
1581
1114
S.d.
012
085
−007
002
008
003
009
−008
−000
000
014
−001
034
026
001
−007
003
1
014
036
005
015
−017
−002
−014
−011
−002
−013
−001
−006
030
017
−009
−001
2
−015
002
019
011
−034
−001
−028
−002
−002
−015
−004
−007
−005
−046
−024
3
020
−006
041
003
027
−005
024
−005
002
−011
−008
005
−006
−003
4
012
003
013
010
021
007
035
007
−002
−006
−006
−002
000
5
007
013
014
022
006
042
−006
001
−021
−008
−005
001
6
−006
−003
008
002
004
−011
−003
002
014
−002
041
7
019
−003
−005
006
−021
−001
−013
−008
000
−009
8
−001
000
011
−003
005
−010
−013
−020
−015
9
019
066
−005
−001
−005
−010
−001
002
10
022
007
003
−002
−004
−004
−007
11
010
−001
−023
−025
−001
−001
12
−004
−003
018
002
−012
13
011
−002
−000
−004
14
013
003
005
15
−001
006
16
−001
17
Notes. N = 1314. Correlations greater than or equal to 0.07 are significant at p < 001 (two-tailed). Correlations greater than or equal to 0.06 are significant at p < 005 (two-tailed).
∗
Logarithm.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
1.
2.
3.
4.
5.
Variable
Table 1 Descriptive Statistics and Correlations
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
411
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
412
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
Table 2
Results of GLS of R&D Investments on Organizational Slack and Ownership Structure
Variable
Intercept
Prior R&D investments
Stock concentration
Firm performance
Business group
Model 1
Model 2
Model 3
Model 4
Model 5
Model 6
∗
∗
∗
∗
∗
−1881∗
0895
−2194
0888
0630∗∗∗
0013
−0001
0003
0008∗∗
0003
−2005
0895
0691∗∗∗
0016
−0001
0003
0008∗∗
0003
−1882
0882
0690∗∗∗
0016
−0002
0003
0008∗∗
0003
−1992
0889
0691∗∗∗
0016
−0001
0003
0008∗∗
0003
−2000
0895
0688∗∗∗
0016
−0002
0003
0008∗∗
0003
0687∗∗∗
0016
−0001
0003
0008∗∗
0003
−0072
0148
−0079
0146
−0098
0146
−0090
0147
−0090
0145
−0086
0146
Product diversification
0015
0081
0018
0079
0018
0079
0019
0080
0017
0080
0016
0079
Firm size
0127∗∗
0043
0109∗
0043
0107∗
0043
0109∗
0043
0113∗∗
0043
0108∗
0043
Firm age
0000
0003
0001
0003
0001
0003
0001
0003
0002
0003
0001
0003
Sales growth
0000
0000
0000
0000
0000
0000
0000
0000
0000
0000
0000
0000
Firm risk
0112
0736
0278
0740
0235
0740
0277
0740
0138
0741
0296
0739
Absorbed slack
1497∗∗∗
0409
0960∗
0412
0932∗
0412
0953∗
0412
0958∗
0411
0957∗
0411
−0174†
0096
−0163†
0097
−0173†
0097
−0171†
0096
−0176†
0096
0009∗
0004
0009∗∗
0003
0009∗
0003
0009∗∗
0003
0009∗∗
0003
0009∗∗
0003
Potential slack squared
−0000†
0000
−0000†
0000
−0000†
0000
−0000†
0000
−0000†
0000
−0000†
0000
Industry average R&D
−0367∗∗∗
0058
−0275∗∗∗
0059
−0285∗∗∗
0060
−0275∗∗∗
0059
−0285∗∗∗
0059
−0282∗∗∗
0059
0002
0004
0001
0003
0002
0003
0001
0003
0001
0003
0001
0003
Affiliated ownership
−0004
0004
−0004
0004
−0003
0004
−0004
0004
−0003
0004
−0004
0004
Domestic institutional
ownership
−0003
0004
−0003
0004
−0003
0004
−0003
0004
−0006
0004
−0003
0004
0006†
0003
0006
0004
0006†
0004
0006
0004
0006
0003
0006†
0004
0203∗
0109
0097
0107
0129
0106
0185∗
0103
0203∗
0108
−0085∗∗∗
0015
−0087∗∗∗
0015
−0086∗∗∗
0016
−0092∗∗∗
0016
−0090∗∗∗
0016
Absorbed slack squared
Potential slack
Family ownership
Foreign ownership
−0273∗∗
0096
Financial slack
Financial slack squared
0007†
0006
Financial slack ×
Family ownership
Financial slack ×
Affiliated ownership
−0003
0007
−0019∗
0008
Financial slack ×
Domestic institutional
ownership
−0008∗
0005
Financial slack ×
Foreign ownership
Wald 2
350722∗∗∗
367010∗∗∗
367362∗∗∗
366769∗∗∗
368822∗∗∗
367741∗∗∗
Notes. Dummy variables for year and industry were included in models but are not reported in the table. Unstandardized regression coefficients are shown. Standard errors are in parentheses.
†
p < 010, ∗ p < 005, ∗∗ p < 001, ∗∗∗ p < 0001 (one-tailed tests for hypothesized effects).
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
413
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
Figure 1
Testing Hypothesis 2 (Moderating Effect of Family
Ownership)
Figure 3
Testing Hypothesis 5 (Moderating Effect of Foreign
Ownership)
2.2
2.1
R&D investments
R&D investments
2.8
2.6
2.4
2.2
2.0
1.9
1.8
1.7
1.6
1.5
1.8
40
60
2.0
40
Fam
1.5
ily o
wne
1.0
20
rshi
p
0
0
0.5
ack
cial sl
Finan
particular, intriguing findings are that although foreign
ownership is positively related to R&D investments, it
negatively moderates the relationship between financial
slack and R&D investments. As shown in Figure 3, foreign ownership is positively related to R&D investments
when financial slack is small. However, foreign ownership becomes negatively related to R&D investments as
financial slack increases. The findings suggest that the
relationship between foreign ownership and R&D investments depends on levels of financial slack. Conversely,
these findings indicate that our understanding of the relationship between financial slack and R&D investments
is enhanced by incorporating ownership structure.
Discussion and Conclusions
Drawing primarily on agency theory, we examine and
show how, in the presence of financial slack, different
Figure 2
Testing Hypothesis 4 (Moderating Effect of
Domestic Institutional Ownership)
2.0
R&D investments
2.0
1.5
1.0
0.5
0
– 0.5
40
Do
me
stic
2.0
30
ins
1.5
titu
20
tio
nal
1.0
10
ow
ner
0.5
0
shi
p
0
ck
l sla
F
cia
inan
30
For
2.0
eig
20
no
1.5
1.0
wn
ersh 10
ip
0
0
0.5
ack
l
cial s
Finan
types of owners affect R&D investments in emerging
economy firms. To do so, we first explored the nature of
the relationship between financial slack and R&D investments. Consistent with Nohria and Gulati (1996), we
found an inverted U-shaped relationship between financial slack and R&D investments in emerging economy
firms. That is, both too much and too little financial slack
may inhibit R&D investments.
However, the main-effect finding cannot explain why
and how some firms are more likely than others to
encourage or discourage R&D investments, especially
when financial slack is available. We developed and
found general support for the proposition that different
types of owners affect how financial slack is allocated.
Specifically, we found that family ownership positively
moderates the relationships between financial slack and
R&D investments. In other words, family ownership
leads to investing a greater portion of financial slack
in R&D. Our findings suggest that family members are
indeed long-term investors and generate rent through
R&D investments.
In a sense, our findings can be viewed as contradictory to those of some recent studies that focus on
expropriation of outside investors by family members in
emerging economies (e.g., Johnson et al. 2000). They
emphasize substantial agency problems between family
members and outside investors in the context of rent
appropriation (Chang 2003a, Coff 1999). Family members, however, appear to play different roles with respect
to rent generation. Although family members can expropriate value at the expense of outside investors, they
are also instrumental in generating rent by converting a
greater portion of financial slack into long-term investments. Korean firms are increasingly becoming global
players in various industries through their aggressive
R&D investments (Kim 1997, Cho and Lee 2003, Cho
414
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
et al. 1998). Our findings suggest that it is family members who drive Korean firms to invest in R&D investments. Although their reasons may be to pass a larger,
healthier firm onto their descendants, the resulting tendency is to invest more in R&D. However, once the rent
is generated, there may be serious conflicts of interests
over how it is distributed among different types of shareholders (Coff 1999). Thus, family ownership, in and of
itself, may not be problematic insofar as the broad corporate governance context allows outside investors to
monitor and discipline family members (Anderson and
Reeb 2003). Increasing transparency and legal protection of outside investors also contribute to enhancing
value-creating potentials of family ownership in the rent
generation process and nullifying its value-expropriation
potential. Comparative studies across countries with different national governance systems would reveal how the
effects of family ownership are contingent upon differences in national governance systems.
Contrary to our hypothesis, results show that affiliated ownership has no moderating effect on allocation of
financial slack. We hypothesized that, as affiliated ownership in a firm increases, the firm is more able to draw
on financial resources from some members and transfer financial resources to other members. However, it
is plausible that the firm may become part of the business group’s internal capital market operation insofar
as it is under control of family members regardless of
affiliated ownership levels. In fact, business groups in
Korea—with controlling families—are more akin to the
U.S. conglomerate firm. They typically have powerful
group headquarters assisted by a large staff and elaborate control systems (Chang 2003b). Collaboration and
coordination are thus achieved on the basis of “hierarchical fiat,” rather than “mutual recognition” (Nakatani
1990). In other words, it may be controlling families,
not levels of affiliated ownership, who dictate the flow
of financial resources among affiliated firms.
We also show that both domestic institutional ownership and foreign ownership negatively moderate the
relationship between financial slack and R&D investments. These findings are different from the prior studies
primarily based on the U.S. data. In general, research
based on U.S. firms suggests that institutional investors
are long-term investors (Allen 1993, David et al. 2001).
However, our findings suggest that the effects of domestic institutional ownership and foreign ownership may
vary depending on the broad national governance system (Dharwadkar et al. 2000). In the presence of
strong disclosure requirements and legal protection of
outside investors as in developed economies, institutional investors can serve as “sophisticated” and “active”
investors, promoting long-term investments. However,
in emerging economies, the governance system often
offers weak protection of outside investors. With weak
protection, these outside investors, such as domestic
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
institutional investors and foreign investors, may become
short-term oriented. Facing the expropriation hazard by
controlling shareholders, outside investors may avoid
making long-term investments and prefer short-term
rather than long-term gains.
Our findings also show that the effect of ownership
structure on R&D investments increases as levels of
financial slack increase. For instance, in the absence of
financial slack, neither family ownership nor domestic
institutional ownership has an impact on R&D investments. However, when there is financial slack of 1.54%
(mean plus two standard deviations), a 10% increase in
family ownership leads to a 0.10% increase in R&D
intensity; similarly, a 10% increase in domestic financial
ownership leads to a 0.28% decrease in R&D intensity.
With average R&D intensity of 1.92% in our sample (see
Table 1), these figures represent 5% and 15% changes
in R&D intensity. These findings indicate that principalprincipal goal incongruence is aggravated in the increasing presence of financial slack.
Policy and Managerial Implications
This study emphasizes the importance of strong legal
protection of outside investors to encourage them to
become long-term investors (La Porta et al. 2000a).
Many emerging economies, including Korea, are still
known as countries with weak legal protection for
outside investors despite recent amendments to its legal
system (Solomon et al. 2002). Under weak legal protection, outside investors may not be able to afford longer
time horizons in their investment decisions. Thus, in
the absence of strong legal protection, the increasing
presence of domestic institutional investors may generate unintended consequences. Facing pressures for shortterm profitability by domestic institutional investors,
firms may forgo long-term investments, and may lose
global competitiveness over time. Similarly, without
strengthening legal protection of outside investors, opening up domestic capital markets to foreign investors may
have similar consequences. Thus, in understanding the
effects of outside investors, the nature and extent of
legal protection in place may be at least as important
as the identity of outside investors. It is important for
policy makers to recognize that, depending on the broad
national governance system, outside investors could have
a different impact on resource allocation and risk-taking
propensities, which ultimately have crucial implications
for national competitiveness.
Firm-level governance attributes within a single country may also influence investment horizons of outside investors. Disclosing high-quality firm-specific and
accounting information would reduce information asymmetries between family members and outside investors,
possibly resulting in more long-term oriented outside
investors (Baek et al. 2004, Fan and Wong 2002, Mitton
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
2002). Adopting governance practices that provide better protection of outside investors may also have the
same effects (Black et al. 2006). Thus, firms can enhance
investment horizons of outside investors by embracing
high-quality disclosure and governance practices.
Contributions and Limitations
We contribute to the literature on financial slack by
providing evidence about how financial slack relates
to R&D investments. Agency theorists emphasize the
discretionary nature of financial slack, arguing that it
is subject to managerial opportunism (Jensen 1986),
whereas others argue that financial slack serve as a
buffer from environmental contingencies, which allows
the firm to engage in experimentation, risk taking, and
R&D investments (e.g., Cyert and March 1963). Our
findings suggest that financial slack has an inverted
U-shaped relationship with R&D investments. Consistent with Nohria and Gulati (1996), this study serves
to reconcile the theoretical debate over the relationship
between financial slack and R&D investments, especially in an emerging economy context.
More importantly, our findings show that the identity
of the owner matters; different types of owners have different preferences over how financial slack is allocated
in competing demands. Whereas family members prefer to make long-term investments and wait for longterm gains, domestic financial institutions and foreign
investors seem to prefer short-term gains. Some of the
agency problems that managers are believed to engender might actually be a reflection of conflicts of interests
among different types of shareholders. In the presence of
principal-principal conflicts, actions that managers take
are likely to please some shareholders more than others. Thus, under such circumstances, traditional agency
conflicts between shareholders and managers may be
overstated, or managers are wrongly accused of being
opportunistic. More research investigating the effects of
different types of shareholders might shed more insights
into complex agency problems around firms.
Underlying agency theory is the implicit assumption
that different types of shareholders and managers know
how financial slack should be allocated, despite conflicts
of interests among themselves (Allen 1993). However,
this assumption may not be valid in situations entailing
high complexity and uncertainty, such as R&D-intensive
industries. There may simply be differences in opinions among investors over how financial slack should be
used (Davis and Stout 1992). They may even disagree
over how much slack there is. For instance, two U.S.
financiers, Carl Icahn and Warren Lichtenstein, pressed
KT&G (formerly the state-owned Korean Tobacco &
Ginseng) to spin off and list the firm’s fast-growing
ginseng unit, sell holdings of property, sell stakes in
a convenience-store chain, and boost dividend and buy
back shares (Economist 2006). They believed that KT&G
415
possessed high levels of organization slack, which should
be returned to shareholders; KT&G executives, however,
had different views. Because the firm’s monopoly in
the ginseng market ended in 2002, executives believed
that more work was necessary to make the ginseng unit
competitive enough to face new entrants. Likewise, they
viewed their stake in the convenience-store chain as a
source of important complementary assets, not as unnecessary slack. The conflicts between foreign investors and
management may be a reflection of both different perceptions and different interests. Where such perceptual
differences come from and how they interact with differences in interests would both complement and extend the
corporate governance literature.
Our study is based on an emerging economy, Korea.
As such, our findings may be limited in generalizability.
Our findings indicate that national governance contexts
may be germane to understanding the implications of
firm-specific governance issues. For instance, whereas
institutional investors in the United States appear to be
long-term oriented (Hansen and Hill 1991), we found
that domestic institutional investors as well as foreign
investors are more short-term oriented in Korea. One
explanation for this is that legal protection of outside
investors is weak, resulting in a focus on short-term
gains. Comparative studies that incorporate both variations in national governance attributes and firm-level
governance attributes would be a fruitful arena for future
research.
Our findings are also limited to firms in R&D-intensive
industries, and, as such, may not be generalizable to other
settings. For instance, our findings indicate that family members are more willing to support for long-term
projects such as R&D investments—in R&D-intensive
industries where R&D is essential to the firm’s competitive advantages. However, in mature and/or declining industries, it may be plausible that family ownership
may have no or negative association with R&D investments and risk taking. It awaits further conceptualization
and analysis of how family and other types of ownership influence the firm’s resource allocation and strategy
differently depending on industry attributes.
Our study examines principal-principal conflicts in the
context of R&D investments. Principal-principal conflicts also exist with respect to other corporate strategies.
For example, product and international diversification
are growth strategies, whereas corporate refocusing is a
contraction strategy. It is intriguing to examine how different types of owners are more or less likely to support
differing types of corporate strategies. In addition, different types of ownership may complement each other.
For example, inside owners such as family members
can bring firm-specific expertise and long-term orientation to corporate governance, but they also have controlling power to expropriate minority shareholders. In
contrast, outside owners, such as domestic institutional
416
Kim et al.: Ownership Structure and the Relationship Between Financial Slack and R&D Investments
investors and foreign investors, can bring stronger discipline and objectivity. Thus, the presence of inside and
outside owners offers complementary skills in the context of corporate governance, and, as such, the effects
of family ownership would be contingent upon the existence and levels of outside ownership. Good corporate
governance may require a prudent balance of different types of ownership. Future research should explore
principal-principal conflicts in the context of different
corporate strategies in order to fill these gaps that we
leave unanswered.
In sum, the governance literature presumes that “governance problems are largely a result of the agency problems that arise from the separation of ownership and
control in the large-scale, public corporation” (Bradley
et al. 1999, p. 11). Our study shows that this assumption
may be problematic, especially in an emerging economy. In the presence of controlling shareholders, the
principal-principal conflicts, rather than the principalagent conflicts, become an important source of agency
problems. Often, different shareholders have different
incentives, investment horizons, and abilities to monitor and control firm management. Indeed, our findings
indicate that different shareholders have disparate preferences for R&D investments, thereby differently moderating the relationship between financial slack and R&D
investments. Examining the identity of shareholders and
the potential principal-principal conflict is necessary in
enriching our understanding of how ownership structure
in particular, and corporate governance in general, affect
the firm’s resource allocation, strategy, and performance.
Acknowledgments
The authors appreciate the valuable comments from Ed Zajac,
the three anonymous reviewers, and the seminar participants at
Arizona State University, Korea University Business School,
and Northwestern University. The first author acknowledges
the financial support of the Korea University Grant and of the
IBRE Research Fund at Korea University Business School.
Endnotes
1
One implicit assumption in our study is that R&D investments are beneficial in the creation of firm-specific advantages
and shareholder wealth. In the strategy literature, R&D investments have been used as a proxy of intangible assets, which
constitute sources of competitive advantages (e.g., Chang and
Hong 2000, Song et al. 2005). In the finance literature, several
studies document a relationship between R&D investments and
stock price. For example, McConnell and Muscarella (1985)
and Chan et al. (1990) find that stock prices respond positively
to announcements of capital and R&D expenditures. A more
recent study by Eberhart et al. (2004) finds that R&D increases
are beneficial investments, leading to positive long-term abnormal operating performance. Thus, R&D investments appear
to be beneficial to creating competitive advantages and shareholder value in both the short and long term.
2
Note that, using survey data, Nohria and Gulati measured
innovation broadly to include “any policy, structure, method
Organization Science 19(3), pp. 404–418, © 2008 INFORMS
or process, product or market opportunity that the manager of
the innovating unit perceived to be new” (1996, p. 1251).
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