family. When managers cannot be ousted, Morck _et al._ (1988), Stulz (1988), and others say that the firm has an _entrenchment agency problem_ . In the United States and United Kingdom, widely held firms are prone to other people’s money agency problems while firms with dominant insider shareholders are prone to entrenchment agency problems. The firms in pyramids are vulnerable to _both_ at the same time.

Furthermore, pyramid member firms are vulnerable to a third sort of agency problem that is not generally thought of in countries of free-standing firms. This is the intercorporate transfer of wealth among pyramid firms to advantage the controlling shareholder – what Johnson _et al._ (2000) call _tunneling_ . To see this, suppose an asset of Firm F in Figure 2 rises in value by a million dollars. As already noted, only $17,596 of this gain ultimately accrues to the family firm at the pyramid’s apex. The rest belongs to one level after another of public shareholders. However, the family controls Firm F’s board since it controls that of Firm E, which it controls because it controls the board of Firm D, and so on. The Family might order Firm F to sell the asset to a firm in a higher tier of the pyramid at cost. For example, if Firm F sells the asset to Firm A at its old, low price, the additional million dollars shows up in Firm A instead, and now the family’s wealth rises by $510,000 instead of only $17,596. Tunneling, an agency problem where the controlling shareholder moves wealth out of firms whose cash flows mainly go to public shareholders and into firms whose cash flows accrue mainly to the controlling shareholder.

Consistent with all the above points, Morck _et al._ (2000) find that Canadian heir controlled firms, many of which belong to pyramids, underperform United States industry peer firms of comparable size and age, while widely held Canadian firms do not. Claessens, Djankov, Fan, and Lang (2002) investigate the role of pyramids more directly, and find that firm value falls when the control rights of the largest shareholder exceed his cash-flow ownership in a study of Asian firms. Lins (2003) reproduces this finding in a study of control pyramids in emerging economies, and also finds that the effect is weaker in countries with better legal protection for public shareholders and in pyramid firms with large outside shareholders. Presumably, both the law and large independent shareholders prevent tunneling and induce better governance.

Bertrand, Mehta, and Mullainathan (2002) test for tunneling among Indian pyramid group firms by looking for effects of shocks to one pyramid firm in the stock prices of others. They conclude that tunneling is economically important in Indian control pyramids. Bae, Kang, and Kim (2002) report concordant evidence for Korean family run control pyramids, or _chaebol_ . Lemmon and Lins (2003) report that firms low in control pyramids suffered disproportionately in the Asian Crisis of the 1990s, which is consistent with the tunneling of wealth from those firms to firms nearer the apexes. Attig, Fischer and Gadhoum (2003) report evidence consistent with tunneling in Canadian control pyramids.

Faccio and Lang (2002), in contrast, conclude that tunneling is not widespread in Western European control pyramids, and suggest that this might be because the better legal environments constraint controlling owners more tightly in Europe than in Asia or emerging economies.

Thus, the contention that family control pyramids attenuate agency problems seems unlikely for three reasons. First, the lower tier firms in control pyramids, which 7