Long-term Orientation of Family Firms

Joern Block Long-term Orientation of Family Firms

GABLER RESEARCH Innovation und Entrepreneurship Herausgegeben von Professor Dr. Nikolaus Franke, Wirtschaftsuniversität Wien, Professor Dietmar Harhoff, Ph.D., Universität München, und Professor Dr. Joachim Henkel, Technische Universität München

Innovative Konzepte und unternehmerische Leistungen sind für Wohlstand und Fortschritt von entscheidender Bedeutung. Diese Schriftenreihe vereint wissenschaftliche Arbeiten zu diesem Themenbereich. Sie beschreiben substanzielle Erkenntnisse auf hohem methodischen Niveau.

Joern Block

Long-term Orientation of Family Firms An Investigation of R&D Investments, Downsizing Practices, and Executive Pay With a foreword by Prof. Dr. Joachim Henkel

RESEARCH

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Dissertation Technische Universität München, 2009

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Foreword Family firms play an important role in most economies. This fact is due not only to family firms’ share of overall revenues or jobs, but also because they are commonly assumed to be more long-term oriented than comparable non-family firms. This view, however, is largely based on examples and case studies, while large-scale quantitative studies are so far missing. In more detail, we have very limited knowledge about how family and non-family firms compare along various dimensions of long-term orientation such as R&D activity, human resource policy, and incentive pay for executives. Furthermore, it is an open question how the hypothesized long-term orientation of family firms depends on the exact definition of this type of firm, in particular on management by family members and on the extent of family ownership. Jörn Block addresses the above questions in this pioneering book. Well-grounded in theory, he develops hypotheses regarding various dimensions of long-term orientation. Using an impressive data set on US stock-listed firms that draws on several data sources, the author then tests his hypotheses using leading-edge empirical methods. Noteworthy, he not only proceeds by classical null hypotheses testing, but also employs Bayesian econometrics, a so far rather rarely used method. Jörn Block complements his comprehensive empirical work by an elegant principal-agent model of paying a non-family manager in a family firm. The study lends clear support to the hypothesis of a stronger long-term orientation of family firms. At the same time, it becomes clear that this result hinges both on the exact definition of ‘family firm,’ in particular on the distinction between family ownership and family management, and on the respective dimension of long-term orientation under consideration. I leave it to the reader to explore the numerous interesting and important results. This book is Jörn Block’s doctoral thesis at Technische Universität München, and it lays the foundation for a promising academic career. The study provides valuable insights for management as well as for research, and I strongly recommend it to practitioners and academics alike.

Prof. Dr. Joachim Henkel

Preface Family firms represent a large number of businesses in the economy. They are considered a source of patient capital. Some family firms exist for more than 200 years and have been successfully transferred from one generation to the next generation. Some of them have never been owned or managed by non-family members. Still, they are often market leaders in their field. My dissertation analyzes this phenomenon and investigates whether and under which conditions family firms have more long-term oriented strategies relative to other firms. My dissertation would not have been completed without the help of others. I take this opportunity to thank those who have helped me in various ways in creating this dissertation. First of all, I would like to thank Prof. Joachim Henkel, my dissertation advisor, who provided me always with his full support throughout the entire process. His fascination for research and his interdisciplinary approach to social sciences has led to an environment at his chair which is highly stimulating and supportive and which ultimately sets the ground for cutting-edge research. I am also indebted to him for the idea of analyzing employment downsizing in the context of this dissertation (Chapter 7). I am also thankful to Prof. Ann-Kristin Achleitner, my second advisor. She was highly supportive throughout the entire process. She also encouraged a fruitful conversation between me and members of her chair who work on similar topics. Her openness for cooperation contributed very much to the successful joint bid for a DFG grant about the strategies of family firms. Finally, I would also like to thank Prof. Isabell Welpe, who chaired my dissertation committee. I thank her in particular for her insights about the ‘world of academics’ offered to me at various conferences. The selection of the topic and the first steps of the dissertation are of crucial importance. In addition to the intense discussions with my advisors, I also discussed the topic with experts in the fields of entrepreneurship and family business. I would like to thank Prof. Marc Gruber, Prof. Peter Jaskiewicz, and Prof. Sabine Klein for the highly constructive and inspiring discussions about my research ideas. I would also like to thank Prof. Sabine Klein and her team at the EBS European Family Business Center for the great hospitality during my research visits. For similar reasons, I would like to thank Prof. Philipp Köllinger and Prof. Roy Thurik, who hosted me as I worked on my dissertation during my longer research stay at Erasmus University Rotterdam from March to May 2008.

VIII

A large part of this dissertation is empirical in nature. I would like to thank Thomas Daffner, Friedrich Große-Dunker, Andreas Riemann, Frank Spiegel, and Marc Weiglein for their help in collecting the dataset. I also acknowledge support from the SFB 649 “Economic Risk” at Humboldt-University Berlin, in particular the Data Service Center who provided very helpful support with the financial databases. Throughout the entire dissertation, I had various discussions with other researchers working on similar topics. I would like to thank Markus Ampenberger, Oliver Klöckner, and Dr. Eva Nathusius for their inspiring discussions. I am also thankful to Andreas Thams who made me familiar with the Bayesian approach of thinking about statistics. He is also a coauthor of a paper that is included in this dissertation (Chapter 6). Finally, I owe great thanks to Philipp Sandner, with whom I cooperated on various side projects during the time of my dissertation. The work with him has been a great experience and rewarding in many ways. With our joint papers, we had a steep learning curve, from which my dissertation benefited strongly. I also thank him for giving very valuable and constructive feedback on later versions of my dissertation. I am also grateful to my colleagues Oliver Alexy, Florian Jell, Simone Käs, Stefanie Pangerl, Manuel Sojer, Dr. Marcus Wagner, Johannes Wechsler, and Evelin Winands for a very supportive team environment. Particular thanks go to Oliver Alexy and Dr. Marcus Wagner who engaged in many constructive discussions about the details of my dissertation. Above all, I wish to thank my parents and my brother for their continued support (my father has read and commented the entire dissertation). I am also indebted to my girlfriend and future wife Maria Cristina for her love and patience. This book is dedicated to you.

Jörn Hendrich Block

Table of contents Foreword .......................................................................................................................V Preface ....................................................................................................................... VII Table of contents......................................................................................................... IX List of figures .......................................................................................................... XIII List of tables ...............................................................................................................XV List of abbreviations...............................................................................................XVII Zusammenfassung .....................................................................................................XX 1

Introduction........................................................................................................... 1

1.1 Motivation ...................................................................................................................................... 1 1.1.1 Example of the Freudenberg Group ................................................................................................ 3 1.1.2 Discussion in the media ................................................................................................................ 4 1.2

Research goals ................................................................................................................................ 6

1.3

Structure of the dissertation.............................................................................................................. 6

2

Family firms .......................................................................................................... 9

2.1 Definition of a family firm ................................................................................................................ 9 2.1.1 Background information ............................................................................................................... 9 2.1.2 Definitions used in this thesis ...................................................................................................... 15 2.2

Family influence ............................................................................................................................ 19

2.3 Theories about family firms ............................................................................................................ 21 2.3.1 Agency theory .......................................................................................................................... 21 2.3.2 Stewardship theory .................................................................................................................... 36

3

Long-term orientation of firms ......................................................................... 42

3.1 Key terms ..................................................................................................................................... 42 3.1.1 Intertemporal choice .................................................................................................................. 42 3.1.2 Short-termism, myopia, and long-term orientation ........................................................................... 43 3.2

Dimensions of long-term orientation ................................................................................................ 44

X

Table of contents

3.3 Long-term orientation in family firms: a discussion ........................................................................... 46 3.3.1 Management practices................................................................................................................ 46 3.3.2 Managerial opportunism ............................................................................................................. 47 3.3.3 Executive compensation ............................................................................................................. 48 3.3.4 Information asymmetry and signaling ........................................................................................... 49 3.3.5 Impatient capital, stock market myopia.......................................................................................... 50 3.3.6 Further explanations from family business theory ............................................................................ 51 3.3.7 Summary of the discussion ......................................................................................................... 53 3.4

Research questions ........................................................................................................................ 54

4

Data and method................................................................................................. 58

4.1

Construction of the dataset ............................................................................................................. 58

4.2 Descriptive analysis of the dataset ................................................................................................... 60 4.2.1 Types of family firms and dimensions of family influence ................................................................ 60 4.2.2 Characteristics of firms .............................................................................................................. 62 4.2.3 Governance and CEO characteristics ............................................................................................ 64 4.2.4 Industry classification ................................................................................................................ 66 4.3 Method: Bayesian analysis.............................................................................................................. 68 4.3.1 Introduction to Bayesian analysis ................................................................................................. 68 4.3.2 Differences between Bayesian and classical analysis ........................................................................ 69 4.3.3 Motivation to use Bayesian methods ............................................................................................. 72 4.3.4 Description of the Bayesian model estimated .................................................................................. 74

5

Performance of family firms.............................................................................. 76

5.1

Literature review........................................................................................................................... 76

5.2 Family firms versus non-family firms .............................................................................................. 77 5.2.1 Univariate analysis .................................................................................................................... 78 5.2.2 Multivariate analysis.................................................................................................................. 81 5.3

Impact of family management and family ownership ......................................................................... 89

5.4

Summary and conclusions .............................................................................................................. 92

6

Family firms and R&D spending ...................................................................... 94

6.1 Introduction ................................................................................................................................. 94 6.1.1 R&D spending, innovation, and long-term orientation ...................................................................... 94 6.1.2 What does R&D spending measure? ............................................................................................. 96 6.1.3 Studies using R&D expenditures as a proxy to measure long-term orientation....................................... 97 6.2 Theory and hypotheses ................................................................................................................... 98 6.2.1 Impact of family ownership on R&D spending ............................................................................... 98 6.2.2 Impact of family management on R&D spending .......................................................................... 100 6.2.3 Impact of family firm age on R&D spending ................................................................................ 102 6.3 Data ........................................................................................................................................... 103 6.3.1 Sample .................................................................................................................................. 103 6.3.2 Measures ............................................................................................................................... 106

Table of contents

XI

6.4 Results ....................................................................................................................................... 107 6.4.1 Univariate analysis .................................................................................................................. 107 6.4.2 Multivariate analysis................................................................................................................ 109 6.5 Discussion................................................................................................................................... 126 6.5.1 Implications for theory ............................................................................................................. 126 6.5.2 Implications for practice ........................................................................................................... 130 6.6

Summary and conclusions ............................................................................................................ 131

7

Family firms and employment downsizing .................................................... 133

7.1

Introduction ............................................................................................................................... 133

7.2

Family firms and their employees: a literature review ...................................................................... 135

7.3 Theory and hypotheses ................................................................................................................. 136 7.3.1 Family management and its influence on downsizing ..................................................................... 136 7.3.2 Family ownership and its influence on downsizing ........................................................................ 138 7.4 Data ........................................................................................................................................... 139 7.4.1 Sample .................................................................................................................................. 139 7.4.2 Measures ............................................................................................................................... 139 7.5 Results ....................................................................................................................................... 140 7.5.1 Univariate analysis .................................................................................................................. 140 7.5.2 Multivariate analysis................................................................................................................ 144 7.6 Discussion................................................................................................................................... 150 7.6.1 Implications for theory ............................................................................................................. 150 7.6.2 Implications for practice ........................................................................................................... 151 7.7

Summary and conclusions ............................................................................................................ 152

8

Family firms and executive pay....................................................................... 154

8.1

Introduction ............................................................................................................................... 154

8.2

Related literature ........................................................................................................................ 156

8.3 Data ........................................................................................................................................... 157 8.3.1 Sample .................................................................................................................................. 157 8.3.2 Measures ............................................................................................................................... 158 8.3.3 Regression models .................................................................................................................. 158 8.4 Results ....................................................................................................................................... 159 8.4.1 Descriptive statistics and univariate analysis................................................................................. 159 8.4.2 Multivariate analysis – full sample ............................................................................................. 164 8.4.3 Multivariate analysis – only non-family CEOs .............................................................................. 171 8.5 Discussion................................................................................................................................... 172 8.5.1 Implications for theory ............................................................................................................. 172 8.5.2 Implications for practice ........................................................................................................... 173 8.6

Summary and conclusions ............................................................................................................ 174

XII

Table of contents

9

Executive pay in family firms: a principal-agent model............................... 176

9.1

Introduction ............................................................................................................................... 176

9.2 Literature review......................................................................................................................... 178 9.2.1 Non-family executives in family firms ........................................................................................ 178 9.2.2 Executive pay in family firms .................................................................................................... 179 9.2.3 Principal-agent models on executive pay ..................................................................................... 180 9.2.4 Principal-agent models on managerial myopia .............................................................................. 181 9.3

The model................................................................................................................................... 181

9.4 Analysis...................................................................................................................................... 186 9.4.1 General compensation rules ...................................................................................................... 187 9.4.2 Compensation of a non-family executive ..................................................................................... 190 9.4.3 Family versus non-family executives .......................................................................................... 191 9.5 Discussion................................................................................................................................... 193 9.5.1 Implications for theory: avenues for further empirical research ........................................................ 193 9.5.2 Implications for practice: some guidelines for family business owners ............................................... 195 9.6

Summary and conclusions ............................................................................................................ 196

10 Summary, implications, and outlook .............................................................. 197 10.1 Summary.................................................................................................................................... 197 10.2 Limitations ................................................................................................................................. 200 10.3 Implications ................................................................................................................................ 200 10.3.1 Theoretical implications ........................................................................................................... 200 10.3.2 Practical implications............................................................................................................... 204 10.4 Directions for further research ...................................................................................................... 206

Bibliography.............................................................................................................. 209 Appendix ................................................................................................................... 237 List of firms in the dataset ..................................................................................................................... 237 List of variables .................................................................................................................................... 238 MatlabTM code for Bayesian random-effects model ................................................................................... 247 Correlation table .................................................................................................................................. 250

List of figures 2-1

Trade-off between firm value and private benefits for an owner-manager

2-2

Owner-manager sells a fraction of her equity

25

2-3

Rational expectations of the equity market

26

2-4

Agency costs of equity

27

2-5

Role of monitoring activities

28

2-6

Family business group organized in a pyramidal structure

35

4-1

Number of family firm observations in the sample

60

5-1

Bayesian regression of the firm’s market-to-book value

5-2

Effect of family firm characteristics on the firm’s market-to-book value (Bayesian analysis)

6-1

Family versus non-family firms – Bayesian RE regression of R&D/assets

6-2

Effect of family management and family ownership on R&D/assets (Bayesian model)

117

6-3

Effect of different degrees of family ownership on R&D/assets

118

6-4

Interaction effect

119

6-5

Impact of firm age on R&D/assets in family and non-family firms

121

6-6

Family versus non-family firms – Bayesian RE regressions on R&D/sales

122

6-7

Effect of family management and family ownership on R&D/sales (Bayesian model)

123

7-1

Histogram of workforce decrease by family ownership

145

8-1

Box plot of total pay

160

8-2

Median CEO pay over time

161

8-3

Histograms regarding the structure of executive pay

162

9-1

Sequence of events

185

9-2

Sensitivity analysis

189

A-1

TM

Matlab

code

24

86, 87 91 112, 113

247-249

List of tables 2-1

Family firm definitions used in the literature

11

2-2

Family firm definitions used in this thesis

18

2-3

Dimensions of family influence used in this thesis

21

2-4

Differences between agency and stewardship theory

38

3-1

Concept of long-term orientation in this thesis

44

3-2

Arguments regarding long-term orientation of family firms

54

4-1

Changes between the different firm categories

61

4-2

Channels through which the family influences the business

62

4-3

Firm characteristics by family firm definition

63

4-4

Governance and CEO characteristics by family firm definition

65

4-5

Family and non-family observations by industry

67

4-6

Differences between classical and Bayesian analysis

72

5-1

Arguments regarding superior performance of family firms

77

5-2a Financial performance in family and non-family firms (group of non-family firms remains fixed)

79

5-2b Financial performance in family and non-family firms (group of non-family firms changes with the family firm definitions used)

80

5-3

Random-effects GLS regressions of return on assets

83

5-4

Random-effects GLS regressions of the firm’s market-to-book value

85

5-5

Effect of family firm characteristics on the firm’s market-to-book value

6-1

Family and non-family firm observations by R&D-intensive industry

6-2

Characteristics of (R&D-intensive) family and non-family firms

108

6-3

Family versus non-family firms – classical RE regressions of R&D/assets

110

90 105

6-4

Family versus non-family firms – Bayesian RE regressions of R&D/assets

111

6-5

Effect of family firm characteristics on R&D/assets (classical RE model)

115

6-6

Effect of family firm characteristics on R&D/assets (Bayesian RE model)

116

6-7

Effect of family firm age on R&D/assets (Bayesian RE model)

120

XVI

List of tables

List of tables (continued) 6-8

Effect of being a family firm on R&D/assets (alternative family firm definitions included in one model)

125

7-1

Summary statistics and correlations

142

7-2

Univariate analysis

143

7-3

Random-effects logit regressions of workforce decreased (>0.1%, >5%, >6%, >8%, and >10%)

146

7-4

Heckman model

149

8-1

Level and structure of executive pay

161

8-2

Structure of executive pay – family versus non-family firms

163

8-3

Regressions of total pay (in $000s)

166

8-4

Median regressions of the structure of executive pay – full sample

167

8-5

Median regressions of the share of base salary (in %) – family versus non-family firms

168

8-6

Median regressions of the share of annual bonus (in %) – family versus nonfamily firms

169

8-7

Median regressions of the share of stock option pay (in %) – family versus nonfamily firms

170

8-8

Median regressions of the structure of executive pay – only non-family CEOs

171

9-1

Notation used in the model

186

9-2

Numerical example comparing a family and a non-family executive

A-1

List of firms in the dataset

238-242

A-2

List of variables used in the empirical analyses

243-246

A-3

Correlation table

193

250

List of abbreviations AG

Aktiengesellschaft

ASQ

Administrative Science Quarterly

Avg.

Average

BLUE

Best linear unbiased estimator

Bn

Billion

Bzw.

Beziehungsweise

CARA

Constant absolute risk aversion

CD

Compact disc

CEO

Chief executive officer

CFO

Chief financial officer

COO

Chief operating officer

Corp.

Corporation

Co.

Company

CSR

Corporate social responsibility

DVD

Digital versatile disc

DEF 14A

Definitive proxy statement 14A

DFG

Deutsche Forschungsgemeinschaft

DM

Deutsche Mark

Dr.

Doktor

EBITDA

Earnings before interest, taxes, depreciation, and amortization

Ed./eds.

Editor/ editors

Et al.

Et alii (and others)

Etc.

Et cetera (and so on)

E.g.

Exempli gratia (for example)

FBN

Family Business Network

FEDC

Financial and Economic Data Center

FGF

Förderkreis-Gründungsforschung e.V.

F-PEC

Family – Power, Experience, and Control

F&E

Forschung und Entwicklung

GAAP

Generally accepted accounting principles

GLS

Generalized least squares

XVIII

List of abbreviations

List of abbreviations (continued) IFERA

International Family Enterprise Research Academy

IFERA

International Family Enterprise Research Academy

Inc.

Incorporated

I.e.

Id est (that is)

ISO 9002

International Organization for Standardization 9002

LR-test

Likelihood-ration test

Max.

Maximum

MCMC

Markov chain monte carlo techniques

Min.

Minimum

MTB

Market-to-book value

Mn

Million

M&A

Mergers & acquisitions

NASDAQ

National Association of Securities Dealers Automated Quotation System

No.

Number

NYSE

New York Stock Exchange

N/a

Not available

Obs.

Observations

OLS

Ordinary least squares

P./ pp.

Page/ pages

PPE

Property, plant, and equipment

Prob. (ß), P(ß)

Probability of ß

RE

Random-effects

ROA

Return on assets

ROE

Return on equity

ROI

Return on investment

SE

Standard error

SEC

Securities and Exchange Commission

SFB

Sonderforschungsbereich

SIC

Standard Industrial Classification

STATA

Stata is a general-purpose statistical software package

Std. dev.

Standard deviation

S&P 500

Standard & Poors 500 stock market index

S&P 1500

Standard & Poors 1500 stock market index

List of abbreviations

XIX

List of abbreviations (continued) S&P Global 1200

Standard & Poors Global 1200 stock market index

UK

United Kingdom

US

United States

VIF

Variance inflation factor

Vs.

Versus

VW

Volkswagen

Yrs

Years

WHU

Wissenschaftliche Hochschule für Unternehmensführung

Z.B.

Zum Beispiel

Zusammenfassung Eine große Anzahl von Unternehmen weltweit befindet sich in Familienbesitz. In Deutschland z.B. sind mehr als 60% aller Unternehmen mit einem Umsatz von mehr als 1 Million Euro der Gruppe der Familienunternehmen zuzurechnen. Eine wachsende Zahl von Untersuchungen vergleicht Familien- und Nichtfamilienunternehmen bezüglich ihres finanziellen Erfolges. Eine langfristiger ausgerichtete Unternehmensstrategie wird in diesem Zusammenhang als ein Wettbewerbsvorteil von Familienunternehmen im Vergleich zu Nichtfamilienunternehmen angesehen. Es existieren bereits einige qualitative Arbeiten insbesondere über US-amerikanische Familienunternehmen zu diesem Thema. Evidenz im Rahmen großzahlig-quantitativer Untersuchungen gibt es bisher jedoch nicht. Diese Dissertation leistet einen Beitrag zur Schließung dieser Lücke und untersucht mit Hilfe von großzahligen Paneldaten aus den USA, ob und unter welchen Bedingungen Familienunternehmen langfristiger handeln als Nichtfamilienunternehmen. Langfristigkeit ist ein multidimensionales Konzept und zeigt sich in vielen Aspekten der Unternehmensstrategie. Diese Arbeit fokussiert auf Aspekte der Langfristigkeit im Bereich des Innovationsmanagements, des Personalmanagements sowie der Bezahlung von Führungskräften. Es wird empirisch untersucht, ob Familienunternehmen mehr Ressourcen in F&E investieren, seltener (in großem Maßstab) Personal abbauen und ihre Führungskräfte weniger stark anhand kurzfristiger Erfolgsindikatoren bezahlen. Die empirische Untersuchung findet Evidenz für die Vermutung, dass Familienunternehmen eine langfristiger ausgerichtete Unternehmensstrategie verfolgen als vergleichbare Nichtfamilienunternehmen. Die Ergebnisse unterscheiden sich jedoch sehr stark nach der verwendeten Familienunternehmensdefinition. Je enger die Gruppe der Familienunternehmen definiert ist, desto eher lässt sich Evidenz für eine langfristiger ausgerichtete Unternehmensstrategie finden. Unternehmen, in denen die Familie einen hohen Eigentumsanteil hält (mehr als 30%), investieren mehr Ressourcen in F&E als andere vergleichbare Unternehmen. Diese Unternehmen bezahlen ihre Manager auch seltener in Form von Aktienoptionen. Bei Verwendung einer weiter gefassten Familienunternehmensdefinition, lassen sich diese Zusammenhänge jedoch nicht finden. Die Ergebnisse der Untersuchung zeigen auch, dass sich die beiden Familienunternehmensdimensionen Familienmanagement und Familieneigentum in ihrer Wirkung auf die Langfristigkeit der Unternehmensstrategie deutlich unterscheiden. Familieneigentum hat einen positiven Einfluss auf die Höhe der F&E-Ausgaben und verringert die Wahrscheinlichkeit großzahligen Personalabbaus. Des Weiteren sinkt der Anteil von Aktienoptionen in der Managervergütung. Familienmanagement hingegen hat keinen (oder nur ei-

Zusammenfassung

XXI

nen geringen) Einfluss auf die Höhe der F&E-Ausgaben, das Durchführen von Personalabbauprogrammen und der Struktur der Managervergütung. Interessanterweise zeigt sich auch, dass das Alter eines Familienunternehmens einen Einfluss auf die Langfristigkeit der Unternehmensstrategie hat. Ältere Familienunternehmen investieren im Durchschnitt weniger Ressourcen in F&E als junge Familienunternehmen. Dieser Zusammenhang konnte in der Gruppe der Nichtfamilienunternehmen nicht gefunden werden. Die Arbeit schließt mit einem theoretischen Kapitel. Mit Hilfe eines formalen PrinzipalAgenten-Modells wird untersucht, wie ein Manager eines Familienunternehmens, der nicht zum Kreis der Familieneigentümer zählt, entlohnt werden sollte. Es wird dabei unterstellt, dass die Familie das Unternehmen langfristig entwickeln möchte und dass der Fremdmanager seinen Wert auf dem Markt für Führungskräfte steigern will. Das Modell erlaubt eine Reihe von normativen Aussagen zur Gestaltung von Vergütungsverträgen in einer solchen Situation. Das optimale Niveau an kurzfristigen Erfolgsanreizen verringert sich in dem Ausmaß, in dem der Fremdmanager Erfolgssignale an den Markt für Führungskräfte senden möchte. Des Weiteren hängt das optimale Niveau an Anreizen für kurzfristigen Erfolg von der Risikoeinstellung des Managers, der Beobachtbarkeit seiner Anstrengungen für kurzfristigen Erfolg und seiner Reaktion auf Anreize im Allgemeinen ab. Die Ergebnisse der empirischen Untersuchung und des theoretischen Modells sind relevant für die Theorie und Praxis. Aus Sicht der Theorie liegt der Wert der Arbeit darin, dass die vielfach unterstellte Annahme einer stärkeren Langfristigkeit von Familienunternehmen gegenüber Nichtfamilienunternehmen mit empirischen Daten überprüft wird. Es zeigt sich, dass die Aussage „Familienunternehmen handeln langfristiger“ nicht für alle Familienunternehmen gleichermaßen zutrifft und Fallunterscheidungen nötig sind. Die Ergebnisse dieser Arbeit stellen das Wissen zu dieser grundlegenden Annahme somit auf eine solidere Basis. Die Arbeit trägt zur Management- und Ökonomieliteratur gleichermaßen bei. Aus Sicht der Praxis ist diese Arbeit hilfreich für Eigentümer von Familienunternehmen und ihren Vertretern gegenüber der Politik. Die Ergebnisse der Arbeit zeigen, dass Familienunternehmen, sofern eng definiert, in der Tat eine langfristiger ausgerichtete Unternehmensstrategie verfolgen und somit für das Wohl einer Region von besonderer Bedeutung sein können. Familienunternehmen können die Ergebnisse der Arbeit in ihrer Darstellung gegenüber anderen wichtigen Stakeholdergruppen (z.B. Mitarbeiter, Kunden oder Zulieferer) verwenden. Diese wiederum gewinnen ein umfassenderes Bild über die unternehmerischen Ziele von Familienunternehmen. Zu guter Letzt können Familienunternehmenseigentümer die Ergebnisse des theoretischen Modells zur Bezahlung von Fremdmanagern verwenden, um ihre bestehenden Vergütungsverträge ggf. anzupassen bzw. kritisch zu hinterfragen.

1 Introduction 1.1

Motivation Many firms around the world, both small and large, are family firms. For example, more than

60% of all German firms with a revenue greater than one million Euro belong to the group of family firms (Klein, 2000). In the US, 20% of Fortune 500 firms have a family as the largest holder of voting rights (Villalonga and Amit, 2006).1 Family firms and their role in the economy have been widely debated in the academic literature. In his seminal works The Visible Hand: The Managerial Revolution in American Business2 and Scale and Scope: The Dynamics of Industrial Capitalism3, the renowned business historian Alfred DuPont Chandler argues that large firms run by a cadre of salaried managers are managed better and care more about their long-term competitive advantage as compared to ‘personal enterprises,’ which he refers to as “firms managed by individuals or by a small number of associates, often members, of founder’s families, assisted by only a few salaried managers” (Chandler, 1990, p. 235). Chandler attributes Britain’s industrial decline relative to the US and Germany before World War II to the strong persistence of family firms in that country.4 He further argues that the shift toward salaried managers running large enterprises is responsible for the growth and strength of US industries in the early years of modern capitalism (1850-1920). Referring to British family firms, Chandler states that their “goal […] appears to have been to provide a steady flow of cash flow to owners – owners who were also managers” (1990, p. 390). Short-term income was preferred to long-term growth, dividend payments were high and retained earnings were low. By contrast, “in American managerial firms the basic goals appear to have been longterm profit and growth” (Chandler, 1990, p. 390). He argues that salaried managers are more capable of dealing with ‘dividend-hungry owners’ than managers who are also members of the owner-

1

2 3 4

For further evidence regarding the importance of family firms, see the following studies: US (Shankar and Astrachan, 1996; Shleifer and Vishny, 1986), Western Europe (Andres, 2008; Becht and Roell, 1999; Faccio and Lang, 2002; Franks and Mayer, 2001; IfM Bonn, 2007), Asia (Claessens et al., 2000, 2002), and 27 industrialized countries (La Porta et al., 1999). See Chandler (1977). The book received the Pulitzer Prize in 1978. See Chandler (1990). This argument has been criticized by business historians for overstating the number of family firms in Britain while understating the number of family firms in the US. For criticism from various perspectives, see, e.g., Alford (1994), Church et al. (1990), or Church (1993).

2

1 Introduction

ship family. The latter are more vulnerable to pressure from family members uninvolved in the business, and thus favor high dividends. Michael Porter, author of the seminal work The Competitive Advantage of Nations5, takes a different point of view. He argues that the US system of allocating investment capital is failing (Porter, 1992). US firms invest too little, in particular into the assets and capabilities required for competitiveness, including R&D, employee training, and supplier relations. This underinvestment places US firms at a competitive disadvantage relative to German or Japanese firms. He argues that the main reason for this development in the short-term relationship between US firms and external capital providers is as follows. About 60% of total equity is owned by institutional investors (e.g., mutual funds or pension funds), which have highly diversified portfolios with only small stakes in each firm. The average holding time of shares is only 1.9 years.6 Investors focus on financial goals over the near term. They base their investment choices on limited information oriented towards predicting short-term stock price movements, focusing on easily measurable figures, such as current earnings. Ultimately, the funds supplied by the institutional investors move rapidly between firms. In contrast, this is not the situation in Japan or Germany. Porter argues that firms in these two countries have ‘dedicated owners’ who act as principals rather than as agents. These owners “hold significant stakes, rather than small fragmented positions […] and seek long-term appreciation of their shares, which they hold in perpetuity” (Porter 1992, p. 70). Although Porter did not explicitly refer to family owners as a group, family owners resemble in many aspects Porter’s group of ‘dedicated owners.’7 In particular, family owners possess the desire to pass the firm on to the next generation, leading them to think long-term (Casson, 1999; Guzzo and Abbot, 1990; James, 1999; Tagiuri and Davis, 1992). For these and other reasons explained below, scholars in the fields of business history (e.g., Berghoff, 2006; Casson, 1999), economics or finance (e.g., Anderson and Reeb, 2003; Bertrand and Schoar, 2006; Böttcher and Linnemann, 2008; James, 1999), and management (e.g., Le BretonMiller and Miller, 2006; Miller and Le Breton-Miller, 2005; Simon et al., 2005; Zellweger, 2007) have followed Porter’s view that family firms are more oriented towards the long-term than nonfamily firms.8 However, apart from some qualitative research, no large-scale empirical study has analyzed this basic assumption. This dissertation aims to close this gap, analyzing to what degree 5 6 7

8

See Porter (1998). The numbers are taken from Porter (1992) and refer to the year 1990. Other important blockholders in Germany have been banks and insurance companies. In Japan, suppliers and customers own large stakes in each other in order to cement their business relationship. See Section 3.3.

1 Introduction

3

and under which conditions family firms are oriented towards the long-term. I used the S&P 500 firms as of July 31st, 2003 and collected detailed information about each firm’s ownership and management structures for the years 1992-2003, allowing me to identify family and non-family firms. The resulting dataset was then used to analyze the long-term orientation of family firms along several dimensions. Before describing the research goals and objectives in detail, the topic is motivated using an example of a family firm oriented towards the long-term, as well as through media statements regarding the long-term orientation of family firms. 1.1.1

Example of the Freudenberg Group The Freudenberg Group is an interesting example of a family firm oriented towards the long-

term. The example is a clear illustration of the link between family ownership and long-term orientation. On their corporate website, the firm portrays itself as a “family company offering its customers technically challenging product solutions and services.”9 The website also adds that “as a family company, we are guided by our long-term orientation, financial solidity and the excellence of our people in 53 countries around the globe.”10 The Freudenberg Group is a diversified company with a broad spectrum of products, including seals and nonwovens, household products, lubricants, and IT services. The firm was founded in 1849 by Carl Johann Freudenberg and his partner Heinrich Christian Heintze in the Müllheim valley near Weinheim, Germany.11 Today, the firm is a conglomerate consisting of more than 400 individual business groups. It has more than 34,000 employees and reports sales of more than € 5.3 million. Still, in most of its characteristics, the firm resembles a family firm. The parent company that controls the conglomerate is governed by a board of partners which “consists of between seven and a maximum of 13 members […], the majority of which must be members of the Freudenberg family or the spouse of a member of the Freudenberg family.”12 Dr. Wolfram Freudenberg, a member of the founding family, acts as chairman of the board. The firm is not listed on the stock market and is owned by more than 300 individual family shareholders. I am interested in the measures taken by the family members involved with the firm to achieve long-term orientation.

9

See http://www.freudenberg.com (accessed January 18th, 2009).

10

http://www.freudenberg.com/ecomaXL/index.php?site=FCN_EN_portrait (accessed January 18th, 2009).

11 12

Weinheim is a town in the northwest of Baden-Würtemberg, Germany. See http://www.freudenberg.com/ecomaXL/index.php?site=FCO_EN_board_of_partners (acces-sed January 18th, 2009).

4

1 Introduction In an interview with the economic magazine Brand Eins13, Dr. Wolfram Freudenberg, the

chairman of the group, explained the relationship between the family and the firm as follows. Concerning priorities, he pointed to “a golden rule: the firm is first priority, followed by the family, and then the individual.”14 This can be seen in the firm’s dividend policy. The partnership agreement between the members of the family specifies that dividends are capped at 20% of earnings. Regarding the sale of ownership shares, the partnership agreement states that shares can only be sold to other family members. In-laws have to sell their ownership rights if a family member’s marriage ends in divorce. The agreement is valid until the year 2030. Regarding the role of non-family managers, Dr. Wolfram Freudenberg states that “competence is the only thing that counts – regardless of where it comes from.” The CEO of the Freudenberg Group, just like the CEOs of the various business groups, is not a member of the Freudenberg family. Freudenberg states that “the firm has been growing so fast […] there were not enough talents in the family. We needed knowledge from outside.” No family member has the automatic right or privilege to a career in the firm, since family members have to fulfill the same requirements as non-family candidates. Regarding corporate governance, Freudenberg argues that “in its internal relationships, the firm is not different from any publicly listed company. […] Yet, in its external relationships, the firm works like a private company.” That is, the firm does not have to follow any ‘management fashion’ that emerges. For example, the firm has a strongly diversified business portfolio, which is against the recent trend of focusing on the core business alone. All strategic decisions are taken by the board of partners, in which the family has the majority of votes. The family speaks with one voice and aims to avoid family conflicts, which is not easy with more than 300 individual family owners. To this end, the family involves all members through regular meetings and tries to keep them informed of the firm’s developments. The goal is to establish an emotional link to the firm.15 1.1.2 Discussion in the media In recent years, the media has become interested in the group of family firms (e.g., Business Week, 2003; Handelsblatt, 2007a, 2007b; Manager Magazin, 2008a, 2008b; Stuttgarter Zeitung, 2008).16 In this discussion, the issue of the long-term orientation of family firms has played a

13 14 15 16

This interview led to an article, see Sywottek (2008). This statement, as well as those that follow, were translated from German by the author of this thesis. For a deeper discussion of the firm’s unique culture and cohesion, see Pieper (2007). Since I am more acquainted with the German-speaking press, I refer to examples from the German-speaking area. The leading German-language business newspaper, Handelsblatt, devotes a weekly section to the issue of family firms. It has also launched a hall of fame of successful German family entrepreneurs. Also, The Süd-

1 Introduction

5

prominent role (e.g., Handelsblatt, 2007a, 2007b). There are three major ongoing debates in this literature. The first is linked to the stock market performance of owner-dominated firms. The development of style indices representing the performance of owner-dominated, publicly-quoted firms such as the German entrepreneurial index (GEX®)17 or the Swiss Entrepreneurial Index has led to a discussion of whether the particular characteristics of owner-dominated firms lead to stronger stock market performance.18 In this context, a stronger long-term orientation is considered one of several advantages of owner-dominated firms. The second debate concerns ‘hidden champions’ and their importance for the German economy (e.g., Handelsblatt, 2008). Hidden champions are lesserknown companies that have succeeded quietly, and most of them are family-owned (Simon, 2007, 2009). Apart from being relatively unknown and family-owned, hidden champions are often market leaders in their specialized markets. Hermann Simon, the main promoter of the concept, argues that hidden champions are more oriented towards the long-term than other firms. To this end, he cites Karsten Ottenberg, CEO of Giesecke & Devrient19: “We are not thinking about the firm’s development in the next quarter, but about sustainability in terms of generations”20 (Simon 2007, p. 82). Finally, there has been an active debate on the benefits of private equity investments.21 Some family firms and their owners have undertaken investments that appear similar to private equity strategies. However, the public debate does not view them as private equity investment funds. Often, family firms are viewed as the ‘good guys,’ whereas private equity funds such as KKR22 or Permira23 are viewed as the ‘bad guys’24 (Manager Magazin, 2008b). In the public’s view, private equity investors are focused on the short-term and do not care about long-term prospects of the firms in which

deutsche Zeitung, another important daily newspaper, has a family firm rubric on its website. See http://www.sueddeutsche.de/wirtschaft/456/301453/uebersicht (accessed February 1st, 2009). 17

18 19

20 21 22 23 24

The (GEX®) has been developed by the Center for Entrepreneurial and Financial Studies (CEFS) at Technische Universität München together with the Deutsche Börse AG, a stock market exchange. See Achleitner et al. (2005a, 2005b) for the five selection criteria of the GEX® and their theoretical foundation. See Achleitner and Ampenberger (2006) for a comparison of the Swiss and German entrepreneurial indices. Note that the GEX® excludes firms that have been listed on the stock market for more than 10 years, which is why the GEX® is not representative of the entire population of family firms. For a non-academic book on this issue, see Sander (2008). Giesecke & Devrient is a family-owned technology group that produces banknotes, among other products. See http://www.gi-de.com (accessed January 20th, 2009). This statement is translated from German. For a collection of papers dealing with this issue, see World Economic Forum (2008). See http://www.kkr.com (accessed January, 19th, 2009). See http://www.permira.com/en/index.html (accessed January 19th, 2009). They were even referred to as ‘locusts’, only interested in quick returns on their investments.

6

1 Introduction

they invest. Contrary to that, family firms and their owners are viewed as investors that have a strong interest in developing portfolio firms.25

1.2

Research goals The long-term orientation of family firms has both theoretical and practical relevance. Regard-

ing theory, this dissertation aims to contribute to the general management literature on the issue of long-term orientation, to the finance literature on the performance of family firms, and to the family business literature. Further, as the level of R&D spending and the structure of executive compensation are used to measure long-term orientation, I also aim to contribute to the innovation literature on the determinants of R&D spending and to the finance literature on the determinants of executive compensation. From a practical perspective, these results may be relevant for family firms, family business owners, and stakeholders that deal with family firms (e.g., employees, customers and suppliers). A firm’s long-term orientation is a concept with several dimensions and involves many aspects, such as brand building, innovation, and human resource management (see Section 3.2). In order to reflect this multidimensionality, this dissertation studies the long-term orientation of family firms in several ways. I analyze whether family firms spend more on R&D (an indicator of longterm orientation) and whether they are less likely to engage in large-scale employment downsizing (an indicator of corporate myopia). Furthermore, this study investigates to what degree executive pay is linked to short-term measures of performance. Finally, using a principal-agent model, I aim to understand how a non-family manager in a family firm should be compensated given that the ownership family pursues long-term goals. The specific research questions are formulated in Section 3.4. The next section describes the structure of this dissertation.

1.3

Structure of the dissertation This dissertation comprises ten chapters. The following chapter deals with the theoretical

foundations of family firms. Chapter 3 discusses the concept of long-term orientation and presents the specific research questions to be analyzed. Chapter 4 introduces the data and the methods used. Chapter 5 compares the financial performance of family and non-family firms. Chapter 6 aims to understand whether family firms spend more on R&D than other firms. Chapter 7 analyzes whether family firms are less likely to engage in short-term job cuts. Chapter 8 compares the structure of 25

Note that this hypothesis is not proven. There is little empirical research on this issue. For papers that deal with this issue, see Achleitner et al. (2006, 2008a, 2008b, 2008c).

1 Introduction

7

executive pay in family and non-family firms, with a particular focus on incentive pay. Chapter 9 uses a formal principal-agent model to derive the optimal compensation contract of a non-family executive employed by a family firm. Finally, Chapter 10 summarizes the key findings and discusses the main theoretical and practical implications. More specifically, Chapter 2 reviews the extant literature on the definition of a family firm and discusses the particularities of the US corporate governance system. I introduce the specific family firm definitions used in the empirical chapters of this dissertation. Next, the concept of family influence is presented as an alternative to the dichotomous view of family vs. non-family firms, and the specific measures used in this dissertation are described. This chapter closes with a review of agency and stewardship theory, the two most widely used theories in the field of family business research. Chapter 3 discusses a firm’s long-term orientation, the main concept underlying the research questions of this dissertation. Key terms are defined, such as intertemporal choice, myopia, and sustainability, and are distinguished from the concept of long-term orientation. Next, I present my own understanding of a firm oriented towards the long-term and give concrete examples of longterm orientation in various settings, such as brand building or innovation. In a next step, I review the extensive literature on the causes of corporate myopia and relate this literature to the discussion of long-term orientation in family firms. This chapter closes with the specific research questions to be analyzed. Chapter 4 describes the construction of the dataset used in the empirical chapters. Next, the dataset is analyzed in a descriptive way. I rely on univariate statistics to compare family and nonfamily firms according to firm, CEO, industry, and governance characteristics. Then, I provide an introduction to Bayesian methods, which I use in addition to classical statistical methods. Chapter 5 analyzes the financial performance of family and non-family firms. The chapter starts with a literature review of studies on the performance of family firms. Following this review, I present my own results using the data described in Chapter 4. I perform univariate and multivariate analysis in order to determine whether family firms outperform non-family firms and to learn about the impacts of both family management and family ownership on financial performance. I use both classical and Bayesian methods. Chapter 6 focuses on the innovation dimension of long-term orientation and analyzes whether family firms spend more on R&D than non-family firms. The chapter starts with an example that illustrates the link between long-term orientation and R&D spending. After that, I summarize extant work using the level of R&D spending as a proxy for long-term orientation. I refer to family business theory and the literature on long-term orientation to derive hypotheses about the

8

1 Introduction

impacts of family management, family ownership, and family firm age on the level of R&D spending. The empirical investigation starts with a description of the sample and the measures used. The hypotheses are analyzed using univariate and multivariate analyses as well as Bayesian and classical statistical techniques. Finally, I discuss the theoretical and practical implications of these results. Chapter 7 focuses on the relationship between family firms and their employees, another dimension of long-term orientation. More specifically, I analyze whether family firms are less likely to engage in deep job cuts. After some introductory examples regarding the link between corporate myopia and deep job cuts, I summarize what is known about the roles of employees in family firms. I derive theoretical hypotheses on the impacts of family management and family ownership on the likelihood of deep job cuts. The empirical investigation starts with a description of the sample and the measures used. Next, I test the hypotheses with univariate and multivariate analyses. The chapter ends with a discussion of the theoretical and practical implications. Chapter 8 deals with the structure of executive pay in family and non-family firms. After a short introduction, a summary of the related literature, and a description of the data, I present the results of univariate and multivariate analyses. I focus on stock option pay in particular, which has been criticized for its adverse effects on long-term thinking. The final section highlights the theoretical and practical implications of these results. Chapter 9 does not make use of data. Instead, I use a formal principal-agent model to derive the optimal compensation contract of a non-family manager working in a family firm. The chapter is normative, and it is linked to the main research question through the implications for how longterm-oriented family owners should reward short-term-oriented non-family executives. After an introduction to this management problem, I present a review of the literature. The review summarizes research about (1) the role of non-family executives in family firms, (2) the size and structure of executive pay in family firms, (3) principal-agent models on executive pay, and (4) principalagent models explaining managerial myopia. Based on this review, I construct a model to derive the optimal compensation contract. In a next step, I analyze the model and the optimal compensation contract and formulate compensation guidelines resulting from the model. Finally, Chapter 10 concludes with a summary of the main results and contributions of this work. From the key findings, I derive recommendations for family firms, family business owners, and stakeholders that deal with family firms. Furthermore, I discuss the implications of the key findings for management research and present the future research questions resulting from this dissertation.

2 Family firms The goal of this thesis is to analyze the performance and long-term orientation of family firms. Yet, before I can proceed with the empirical analysis of this topic in Chapters 5 to 8, some basic knowledge about family firms is required. This chapter summarizes what is known about family firms, focusing on research regarding the definition of a family firm (Section 2.1), the concept of family influence (Section 2.2) and theories that are used to explain the behavior and performance of family firms (Section 2.3).

2.1 2.1.1

Definition of a family firm Background information The definition of a family firm is a complex issue. The academic literature so far has not

found a satisfactory definition of the family firm (Astrachan et al., 2002; Handler, 1989; Klein et al., 2005). Habbershon and Williams (1999) note that at least 44 different definitions of family firms were used in the literature between 1989 and 1999. Flören (2002) provides an overview of more than 50 definitions; Miller et al. (2007) give an overview of 28 definitions used in the literature until now. Why is it so complicated to define a family firm? As an illustration consider the following three examples that show the broad spectrum of what can be regarded as a family firm. The first example concerns a founder-dominated firm. EBay Inc.26, an American Internet company that manages amongst others an online auction website, was founded in 1995 by Pierre Omidyar. As the founder is still active in the business in the year 2003, it is considered a (founderowned) family firm by Anderson and Reeb (2003) and Villalonga and Amit (2006).27 The second example is about a firm which was founded by the state and is now in the process of being acquired by a family firm. The Volkswagen group (VW), currently Europe’s largest car manufacturer, was founded in 1937 by the German state.28 Adolf Hitler, chancellor (and dictator) of Germany at that time, asked Ferdinand Porsche to design a car that is suitable for the working man. The result was a 26 27

28

See www.ebay.com (accessed September 12th, 2008). Miller et al. (2008) critisize this approach and argue that a founder-owned firm is conceptually different from a family-owned firm. It is argued that founder-owned firms do not suffer from nepotism and inter-generational squabbles and should thus perform better than family-owned firms. See http://www.volkswagen.com (accessed September 12th, 2008).

10

2 Family firms

car later known as “VW Käfer”. Until today, the German state owns a large fraction of shares of the Volkwagen Group and aims to control the firm.29 However, in October 2005, the ancestors of Ferdinand Porsche and owners of the Porsche Group30, a premium car manufacturer, acquired a large equity stake in the firm and attempted a takeover. Ferdinand Piech, the grandson of Ferdinand Porsche and an influential owner of the Porsche group, heads the supervisory board of Volkswagen.31 Finally, as a third example, consider the case of the Bauer AG. The firm was founded by Sebastian Bauer in the year 1790 and is currently owned and managed by the 7th family generation.32 The firm has never been owned or managed by individuals who are not members of the founding family. The three cases show the broad spectrum of what has been considered as a family firm in the literature. The cases have in common that the founder or the ancestors of the founder own a large share of equity. Yet, they differ in the role of the family towards management: The Volkswagen and the Porsche Group are managed by non-family managers33, whereas the Bauer AG is managed by a member of the owning family. Table 2-1 below summarizes the main definitions that have been used in the literature. It is surprising that only few studies use a definition that distinguishes between founder-owned and family-owned firms.

29

30 31 32

33

The federal state Niedersachsen (Lower Saxony) passed the so-called ‘Volkswagen Law’, under which no shareholder of VW can exercise more than 20% of the firm’s voting rights, regardless of their share of voting stock. Note that the European Court of Justice has indicated that the law is against EU rules. See http://www.porsche.com/usa/aboutporsche (accessed February 4th, 2009). Ferdinand Piech is also a former CEO of Volkswagen. See www.bauer.de (accessed September 12th, 2008). The firm went public on July 4th, 2006. The Bauer family still owns more than 50% of stock. Thomas Bauer, a member of the founding family, is CEO of the firm. Both Wendelin Wiedeking (currently CEO of the Porsche Group) and Martin Winterkorn (currently CEO of the Volkswagen Group) are not members of the Porsche or the Piech family.

2 Family firms

11

Table 2-1: Family firm definitions used in the literature

Definition

Study

Region

Stock market listed/nonlisted firms

Family controls > 20% of shares and is the largest shareholder by a factor of 2

La Porta et al. (1999)

World

Listed

Ownership of founding family > 5% or member of founding family is on board

Anderson and Reeb (2003) BusinessWeek (2003)

US

Listed

Top executive is family member or descendant of founder

McConaughy (1994)

US

Listed

Family is the largest voteholder

Villalonga and Amit (2006)

US

Listed

Family holds some ownership, has more than one management position, and is at least in the 2nd generation

Shanker and Astrachan (1996)

US

Both

Family controls > 50% of the votes

Gallo and Sveen (1991)

Spain

Non-listed

Judgment of the person answering the ques- Gallo et al. (2004) tionnaire

Spain

Both

Family controls > 20% of the votes

Faccio and Lang (2002)

Western Europe

Listed

Family controls > 10% of equity

Blondel et al. (2002)

France

Listed

Family controls > 50% of equity

Ehrhardt and Nowak (2003a)

Germany

Listed

% of family ownership + % of family members in supervisory board + % of family members in management > 100 (if family owns at least some shares)

Klein (2000) Achleitner et al. (2007)

Germany

Both

2 individuals (or their family members) hold IfM Bonn (2007) at least 50% of voting shares and are repre- Stiftung Familienuntersented in the management of the firm nehmen (2007)

Germany

Both

For-profit enterprise with family kinships among owners34

Germany

Both

Gabler Wirtschaftslexikon (1992, p. 1099)

The large variety of definitions for family firms causes some problems. Comparisons between studies become difficult, if not impossible. For example, a large number of studies have analyzed whether family firms perform better financially than non-family firms. In their frequently cited paper, Anderson and Reeb (2003) concluded that family firms perform better, or at least not worse, than non-family firms – a conclusion that conflicts with the findings from other studies (e.g., Bennedsen et al., 2007; Holderness and Sheehan, 1988; Perez-Gonzales, 2006). Later, Villalonga and Amit (2006) show that Anderson and Reeb’s results are not robust to alternative definitions of family firms. In a similar study, Miller et al. (2007) show that only family firms

34

The statement is translated from German by the author.

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2 Family firms

with a lone founder outperform non-family firms.35 This illustrates that, since there is no widelyaccepted, transparent, and easy-to-use definition of the term ‘family firm’, there is a risk of making statements that do not apply to all family firms but only to a small subsample. Furthermore, it is difficult to conduct a quantitative meta-analysis in the spirit of Hunter and Schmidt (2004), which combines the results of several studies that address related research hypotheses. The only way to circumvent this problem is to use several definitions when analyzing the data and determine whether the same conclusions are reached. Another problem with multiple definitions is that it is difficult to test theories. A number of theories predict differences between family and non-family firms36, but it is difficult to test these theories without a clear definition or a commonly-agreed upon set of distinguishing characteristics for family firms. Again, to avoid this problem, it is necessary to compare the results of an empirical analysis using several family firm definitions and to accept only those results that do not change when an alternative definition is used. Another solution is to develop more fine-grained theories that distinguish between different types of family firms, e.g., family-managed versus non-familymanaged, first-generation versus multiple-generation, or small versus large. In this case, the object of investigation would not be a dichotomy between family and non-family firms; rather, particular subgroups of family firms would be compared to other subgroups of family firms or to the entire population of firms. To some degree, this problem parallels those found in early entrepreneurship research, which at first drew similarly stark distinctions between entrepreneurs and non-entrepreneurs (e.g., Carland et al., 2006). Later, it was understood that different types of entrepreneurs exist, e.g., necessity versus opportunity entrepreneurs (e.g., Reynolds et al., 2002)37 or high-tech versus non-high-tech entrepreneurs (e.g., Song et al., 2008).38 A similarly fine-grained approach would benefit research on family firms in two ways: First, the results would become more robust, and replication and metaanalyses would become possible. Second, there would be an opportunity to make contributions in the more general context of management theory, instead of simply testing theories that try to explain the differences between family and non-family firms.

35 36 37 38

Lone-founder firms are firms in which no relatives of a founder are involved. See Section 2.3. See also Block and Wagner (2007), Block and Sandner (2008) or Block and Köllinger (2008). For a similar comment, see Wiklund (2006).

2 Family firms

13

According to the overview in Table 2-1 above, the main features that define a family firm are: 

Ownership. How many shares or how much equity does the family own? Is the family the largest shareholder?



Control. How much equity does the family control? Does the family control the majority of the votes? Is there a powerful supervisory or advisory board39 controlling the firm?



Management. What is the influence of the family on the management of the firm? Does the CEO or the chairman come from the family? What percentage of top management is composed of family members?



Family generation. Is the firm a single-generation or a multiple-generation family firm? How many generations are simultaneously involved as owners or managers of the firm?

The exact definition of a family firm should depend upon the precise research context and research questions. The main reasons for making a distinction are: 

Size of the firm. The size of the firm determines how large the family’s holdings need to be in order to be classified as a family firm. In terms of veto power, 10% ownership in a large firm is different from 10% ownership in a start-up or a medium-sized firm. The reason is the low voting rate of shareholders in large firms, which effectively may give a 20% ownership stake a much-amplified voting power of 50% and more.40



Listed versus non-listed firm. A firm which is not listed on the stock market does not need to follow the laws and rules of financial market regulatory authorities such as the US Securities and Exchange Commission (SEC) and does not need to follow listing rules of stock exchanges such as the NYSE or the NASDAQ.41 This exemption affects issues such as insider trading, accounting standards, and the level of reporting requirements. Generally, most of these regulations help to strengthen the position of investors with a minority

39

40

41

Advisory boards (in German: Beirat) play an important role in the governance of e.g. German family firms. Often, they have not only an advisory but also a controlling function. For a summary of the literature on advisory boards, see Henseler, 2006; for an empirical study about the role of advisory boards in German family firms, see May et al. (2002). For example, the voting rate in the 2008 annual shareholders meeting of the Siemens AG was 48.5% (Allianz AG: 40.2%). See http://w1.siemens.com/investor/pool/en/investor_relations/events/annual_shareholders_meeting/2008/voting_res ults.pdf or http://www.allianz.com/en/alianz_group/investor_relations/general_meetings/presence_und_voting_results/agm0 8_presence.pdf (both were accessed January 27th, 2009). See Claessens and Tzioumis (2006) for a comparison of listed and non-listed firms.

14

2 Family firms

stake; correspondingly, a 10% ownership stake in a listed firm gives more power than a 10% ownership stake in a non-listed firm. Thus, most researchers agree that the ownership stake to make a firm a family firm should be lower in a listed than in a non-listed firm (Jaskiewicz, 2006). A similar argument can be made about the management aspects of the family firm definition. Ceteris paribus, the position and influence of management in a nonlisted firm is stronger than in a listed firm. The management does not need to explain its management decisions to the capital market. Correspondingly, for a non-listed firm to be classified as a family firm, members of the family should either be members of the firm’s top management team or balance this lack of power by other means such as a high ownership stake or control through a powerful supervisory board. 

Ownership structure. A 10% equity stake in a firm with a widely-dispersed ownership gives more power than a 10% equity stake in a firm with concentrated ownership. Furthermore, it makes sense to differentiate between the type of investors owning the firm, e.g., active versus passive investors, or institutional42 versus non-institutional investors. Power dynamics differ depending on whether or not the family’s ownership stake is equaled by the stake held by an active investor, such as a private equity firm.



Corporate governance system. The family firm definition depends also on the firm’s system of corporate governance. As Section 2.1.2 below discusses, corporate governance differs dramatically between nations. The definition of a family firm should differ depending on whether a one-tier or a two-tier board system prevails. In a two-tier board system, the family often uses a strong supervisory board to exert control, whereas a one-tier board system places great importance on the percentage of family members on the board of directors or the important committees (e.g., executive or audit committee).43



The field of study. The research question and the purpose of the study may also affect the family firm definition that is used. If the research focuses on listed firms, as is often the case in studies in the field of finance, then the family firms within the sample will also be restricted to listed firms. Accordingly, the family firm definition should include low ownership thresholds, in line with the preceding arguments about listed versus non-listed firms.

42

43

Institutional investors pool large sums of money and invest those sums in firms. They include banks, insurance companies, retirement or pension funds, hedge funds, and mutual funds. In this thesis, the terms ‘institutional investor’ and ‘financial investor’ are used as synonyms. For a discussion of one-tier and two-tier board systems, see Maassen and Van den Bosch (1999). For a more general survey of corporate governance systems, see Shleifer and Vishny (1997) or Weimer and Pape (1999).

2 Family firms

15

Although the family itself is an integral part of any family firm definition, the term ‘family’ is rarely defined (Astrachan et al., 2002). Marriage, child-adoption, and divorce make this a nontrivial issue. In addition, the definition of a family may differ across cultures and time. For example, the concept of family may mean something different in Western societies than it does in Asian or Latin-American societies. The concept of family may also differ across disciplines. An economist studying fertility and ‘the demand for children’ or the division of labor in households may use a different concept of family than a psychologist concerned with family therapy, or a sociologist who wants to learn about the role of family ties in social behavior. Making matters even more difficult, research into family firms is interdisciplinary and involves economists, sociologists, management scholars, and social psychologists.44 Similar to the previous situations, the only fully inclusive method is to use several definitions of family and to compare the results. 2.1.2

Definitions used in this thesis This thesis analyzes the performance and long-term orientation of large US family and non-

family firms. Since my sample consists exclusively of US firms, the family firm definitions used should be adapted to the US context. Hence, before describing the exact definitions used, I first summarize some relevant and important characteristics of the US system of corporate governance. Of particular importance are the specifics of board structure, the position and power of the CEO, the status of investors, and the way corporate control is exerted.45 Board structure. US firms typically have a one-tier board system.46 The board of directors is responsible for both management and control of the firm. Typically, the CEO also holds the position of chairman of the board. In countries with a two-tier board structure, such as Germany or the Netherlands, this dual role would be impossible. There is a formal division of power between the management and the supervisory board. The chairman heads the supervisory board but not the management board, and cannot simultaneously be the CEO. In the one-tier board system, an important distinction is drawn between inside directors (current employees of the firm such as the CEO), affiliated outside directors (directors with substantial business relations with the firm such as a consultant or an investment banker), and independent outside directors (directors who are neither insiders nor affiliated outsiders such as a retired executive from an non-affiliated firm). The average US 44

45

46

For a discussion of the interdisciplinary nature of the field of family business research, see Habbershon and Williams (1999) or Wortman (1994). For a more detailed description of the particularities of the US and other systems of corporate governance, I refer to La Porta et al. (2000), Mayer (1997), or Roe (1993). Tirole (2006, pp. 29-35) provides an introduction to the one-tier board system. See also Maassen and Van den Bosch (1999).

16

2 Family firms

firm has a nine-person board, of which 40% are inside directors (including the CEO), 20% are affiliated outside directors, and 40% are independent directors (Denis and Sarin, 1999). What does this imply for a US family firm definition? Clearly, it makes little sense to include membership in a supervisory or an advisory board as a criterion in the definition. Instead, what matters is the presence of family members or affiliated individuals in the board of directors and the relevant committees. It is also of crucial importance whether a member of the family is CEO or chairman, or both. Investor protection. Legal protection for investors forms an integral part of any system of corporate governance. Through regulations and laws, investors obtain certain rights or powers that protect them from insider expropriation. These rights or powers are very broad, encompassing rules for disclosure or accounting rules, dividend rights, voting rights, the right to participate in shareholder’s meetings, and the right to sue the management of the firm. These rules may come from various legal sources such as company, security, bankruptcy, takeover, or competition laws. Accounting standards and stock exchange regulations may also play an important role. La Porta et al. (1988, 2000) discuss the key rules of investor protection and document their prevalence in 49 countries around the world. They show that the prevalence of such protection differs strongly across countries and their respective legal systems. Strong differences exist between countries relying on a common law system (e.g., the US, UK, Canada, and Australia) and countries relying on a civil law system (e.g., Germany and France).47 Generally, investor protection seems to be stronger in common law countries than in civil law countries. For example, common law countries are more likely to have oppressed-minority mechanisms in place than civil law countries (94% vs. 29%48). How does the strength of investor protection affect the definition of family firm? When investor protection is strong, the family needs less voting power to control the firm than when investor protection is weak. Another argument is that, with strong investor protection, the family’s reputation is not needed as a signaling device to attract outside investors; the entrepreneur or her family is not forced to hold large ownership shares (La Porta et al., 2000). With weak investor protection, the situation is different: Outside investors may demand a commitment of the family towards the firm and force the family to hold large ownership shares. Both arguments suggest that the definition of family firm for the US should require a relatively low ownership stake.

47

48

Common law systems emphasize judiciary independence, respect for precedents, and limited codification of laws. The law is developed mainly through decision of courts (case law), rather than through legislative statutes. Civil law systems, in contrast, stress codification and are more centralized (Tirole, 2006, p. 54). This percentage refers to countries with a French civil law system. 52% of countries with a German civil law system have oppressed-minority mechanisms (La Porta et al., 2000).

2 Family firms

17

Position of the CEO. In the US, the position of the CEO is strong. The CEO often has direct control over the composition of the board. Although directors should be voted into office by shareholders and have a fiduciary duty to protect shareholder’s interests, the actual nominating process may differ in practice. As an example consider the case of Ross Johnson, the former CEO of RJR Nabisco who is widely considered to be the pre-eminent example of executive greed.49 Ross Johnson hand picked most of RJR Nabisco’s directors. In an empirical study, Shivdasani and Yermack (1999) show that when the CEO serves on the nominating committee or no nominating committee exists, firms appoint fewer independent outside directors and more directors with conflicts of interest.50 They also find that stock price reactions to independent outsider nominations are lower when the CEO is involved in the nominating process. Consistent with this finding, Anderson and Reeb (2004) show that those family firms in which family influence is balanced by independent directors have a higher market-to-book value than family firms with relatively few independent directors. Hence, in a US context, whether the CEO is a family member or not is important, and this should be reflected in the family firm definition. When the CEO belongs to the family, the family can exert a strong influence on the firm, even with a low ownership share. A similar argument can be made about the position of chairman of the board of directors. Insider- versus outsider-controlled system. The corporate governance literature differentiates between insider-controlled and outsider-controlled corporate governance systems (Franks and Mayer, 1994; Hackethal et al., 2005). The US corporate governance system is an example of an outsider-controlled system; the German corporate governance system is an example of an insidercontrolled system. In an insider-controlled system, control is exerted through internal mechanisms and institutions such as the supervisory board. Seats on the supervisory board are held by key stakeholder groups, including bankers, employee or union representatives, and blockholders.51 An insider control system functions on the basis of internal information; little information is made public. In an outsider-controlled system, control is exerted by a public takeover market (the market for corporate control).52 A company with poor performance either disappears or is taken over by an-

49

50 51

52

See the book Barbarians at the Gate: The fall of RJR Nabisco by Bryan Burrough and John Helyar (Burrough and Helyar, 2003). The book also appeared as a television movie. For further anecdotal evidence on this issue, refer to Mace (1971) or Lorsch and MacIver (1989). For more information about German supervisory boards, see Kaplan (1994) or Tirole (2006, p. 29). For the role of bankers in German supervisory boards, see Dittmann et al. (2009); for the role of unions in supervisory boards and codetermination, see Gorton and Schmid (2004). For more on the idea of a market for corporate control, see Holmström and Kaplan (2001) or Tirole (2006, pp. 43-51).

18

2 Family firms

other firm. Bankers and employee representatives do not engage in corporate control and are not members of controlling institutions. How is the definition of a family firm affected by the difference between insider-controlled and outsider-controlled systems of corporate governance? In an insider-controlled system, internal institutions such as the supervisory board are very important. To exercise control, the family as a shareholder needs to be represented in these institutions. In contrast, in an outsider-controlled system, the family can rely on public information and the market for corporate control to pursue its interests. Being a member of internal institutions is less important. To summarize, a family firm definition adapted to the US context should include the following criteria: a low family ownership threshold (e.g., 5% or 10%), whether or not a family member is CEO or chairman, and the percentage of family members on the board. Due to the one-tier board structure and the fact that the US corporate governance system is an outsider-controlled system, it makes little sense to include family presence in a supervisory board as a criterion (such as this is necessary in a European context). In this thesis, five family firm definitions are used, as summarized in Table 2-2. Table 2-2: Family firm definitions used in this thesis

broad

narrow

#

Definitions

Variable name

1

Combined stock ownership of the family > 5% or member of the family is either CEO or chairman

Family firm1

2

Family owns more stock than all institutional investors together do (minimum of 5%) or member of the family is either CEO or chairman

Family firm2

3

Combined stock ownership of the family > 5% and member of the family is either CEO or chairman

Family firm3

4

Family owns more stock than all institutional investors together do (minimum of 5%) and member of the family is either CEO or chairman

Family firm4

5a

Family owns more stock than all institutional investors together do (minimum of 5%) and member of the family is either CEO or chairman and the firm is younger than 51 years

Family firm5a

5b

Family owns more stock than all institutional investors together do (minimum of 5%) and member of the family is either CEO or chairman and the firm is older or equal than 51 years

Family firm5b

The family firm definitions present a wide spectrum. The definition family firm1 is a broad definition and considers a large number of firms to be family firms. To be classified as a family firm, the combined stock ownership of the family needs to be above 5% or a member of the family needs to be either CEO or chairman. The definition is similar to the definition used by Anderson

2 Family firms

19

and Reeb (2003) and BusinessWeek (2003). The definition family firm5a is at the other end of the spectrum. To be classified as a family firm, (1) the family should own at least 5% of the stock, (2) the combined ownership share of the family should be higher than the combined ownership share of institutional investors, (3) a member of the family should be either CEO or chairman, and (4) the firm should not exist for more than 50 years.53 As already described in Section 2.1.1, the concept of ‘family’ is part of any family firm definition. I define the family in a broad way and include the founders, the spouses of the founders, the descendents of the founders, and the spouses of the descendents of the founders, as well as adopted children. This differs from narrower family definitions, e.g., lone-founder firms are regarded as family firms. An actual or intended transfer of ownership is not included as a criterion in the definition, which is in line with the definition of IfM Bonn (2007) or Stiftung Familienunternehmen (2007).54 Furthermore, it is not required that the founder or the descendent of the founder is married or engaged in a relationship, i.e., that she has already started a family. To reveal the differences between young and old family firms, I created definitions 5a and 5b. Definition 5a refers to family firms younger than 50 years, whereas definition 5b refers to family firms older than 50 years. Despite the broad spectrum of family firm definitions used in this thesis, some shortcomings remain. Chief among these shortcomings is the fact that the presence of the family in the board of directors is only measured for the CEO and the chairman, because data on other members of the board of directors were not available. Another important concern involves the distinction between voting and non-voting stock. Due to data restrictions, I can only make a statement about the ownership share of the family (i.e., the share of common stock), but not the actual voting power. DeAngelo and DeAngelo (1985) and Villalonga and Amit (2008) show that family firms often use dual classes of stock to increase their voting power; this is another reason to use a low ownership threshold in a US family firm definition. The data collection efforts and the steps to apply the family firm definitions are described in Section 4.1.

2.2

Family influence Measures of family influence are an alternative way to overcome the family firm definition di-

lemma. Family business researchers generally agree that family involvement is what makes family 53

54

Note that Anderson and Reeb (2003) also used 50 years as a criterion to differ between young and old family firms. In this context, Villalonga and Amit (2008) differ between founder-controlled and family-controlled firms. For a discussion about generational transfer as a criterion in the family firm definition, see Miller et al. (2007) and Ward (1987).

20

2 Family firms

firms different from other firms (Chua et al., 1999). Most researchers interpret this involvement as either ownership or management (Handler, 1989). Recently, with the ‘familiness’ construct and the F-PEC scale of family influence55, more elaborate concepts of family involvement have been advanced in the literature. This section discusses these concepts and introduces the measures of family influence used in this thesis. Habbershon and Williams (1999) and Habbershon et al. (2003) use the resource-based view (Barney, 1991; Wernerfelt, 1984) and link the interactions between family, business, and individuals with the resources of the firm. They describe the bundle of resources resulting from family influence as ‘familiness’. Their basic idea is that familiness is a unique resource a “particular firm has because of the systems interaction between the family, its individual members, and the business” (Habbershon and Williams, 1999, p. 11). This resource is not reflected by other firm resources such as physical or human capital. They propose that scholars should analyze the competitive implications resulting from ‘familiness’, rather than assessing whether or not family firms have a competitive advantage. This approach offers two advantages: First, a (dichotomous) family firm definition is not needed; the family firm definition dilemma (Klein et al., 2005) is circumvented. Second, by using a continuous variable, it becomes possible to investigate the entire continuum of family firms. The collapse of an interval variable such as level of family ownership into a dichotomous variable (family versus non-family firm) can lead to a loss of important information. Astrachan et al. (2002) and Klein et al. (2005) follow this idea and propose a scale that assesses the extent and quality of family influence. They argue that there are three important dimensions of family influence: Power, Experience, and Culture (F-PEC). Each dimension is determined on a different scale. The power subscale is measured by the proportion of shares held by the family, the percentage of family members in top management, and the percentage of family members on the board. The experience subscale relates to the experience the family provides to the business, and is measured by how many generations have been in charge of management and ownership (the more generations, the more experience). The culture subscale is the overlap of family and business values. The more the values overlap, the stronger the family influence on the business. The culture subscale is measured by the family business commitment questionnaire (Carlock and Ward, 2001). In this thesis, family influence is determined in many ways. Most of these measures refer to the power subscale of the F-PEC. The experience subscale, which deals with the family generation in control, is proxied by the age of the firm. The culture subscale is not included. The reason is that the firms in my sample are among the world’s largest firms, which makes it difficult to obtain ques-

55

PEC refers to Power, Experience, and Culture.

2 Family firms

21

tionnaire data. Moreover, using the culture subscale as a measure of family influence might be problematic, since long-term orientation, the main subject of analysis in this thesis, is part of the culture of an organization (Denison and Mishra, 1995; Denison et al., 2004; Kotter and Heskett, 1992; Marginson and McAulay, 2008). The concrete measures used in this thesis are summarized in Table 2-3 below. Table 2-3: Dimensions of family influence used in this thesis Dimension

Description

Management CEO is member of the family. Chairman of the board of directors is member of the family. CEO or chairman are members of the family. CEO and chairman are members of the family. Ownership Percentage of common stock owned by the family Family owns more stock than financial investors. Family owns more than 5% (20%, 30%) of common stock. Experience Age of the family firm

The data collection efforts, and the concrete steps to collect the family firm measurements, are described in Section 4.1.

2.3

Theories about family firms In this section, I describe the agency and the stewardship theory, which are the two most

widely used theoretical frameworks in research on family businesses. 2.3.1

Agency theory Agency theory is used in this thesis in two ways. First, it is used in the empirical sections to

motivate hypotheses about differences between family and non-family firms or within the group of family firms (see Chapters 5 to 8). Second, agency theory is used to calculate the optimal compensation contract of a non-family manager working in a family firm (see Chapter 9). This section proceeds as follows. After a short introduction to agency theory, four different types of agency costs relevant in the context of family firms are described: (1) agency costs from the separation of ownership and management, (2) agency costs from altruism, (3) agency costs from conflicts between owners and lenders, and (4) agency costs from conflicts between dominant and minority shareholders. The section concludes with a comparison of agency costs in family and non-family firms.

22

2 Family firms

Introduction Generally, agency theory is concerned with resolving problems that arise in agency relationships.56 An agency relationship is described as a situation in which one party (the principal) delegates work to another party (the agent). This principal-agent relationship exists between employers and employees, lawyers and clients, or buyers and suppliers. Agency theory attempts to solve two problems. The first one is the agency problem that arises when the goals of the principal and the agent diverge, and it is difficult for the principal to verify the agent’s actions. The second one is the problem of risk sharing which arises when the principal and the agent have different attitudes towards risk. Agency theory has developed along two lines: a positivist stream and a principal-agent stream (Jensen, 1983). Both streams share a common unit of analysis (the contract between the principal and the agent) and common assumptions about people, organizations, and information (bounded rationality, self-interest, etc.). The two streams, however, differ in their mathematical rigor and their dependent variables. The principal-agent focuses on quantitative economic models, whereas the positivist stream is more descriptive. Another difference is that the principal-agent stream is concerned with the general theory of the principal-agent relationship, whereas the positivist stream focuses almost exclusively on the relationship between the CEO and the owner(s) of a firm. This thesis uses the principal-agent stream, in particular the model from Holmstrom and Milgrom (1991)57, to derive the optimal compensation contract of a non-family manager working in a family firm. As there is little connection to the empirical sections, I summarize the relevant literature needed to develop the model in the model section itself (Chapter 9). The review in this section focuses exclusively on the positivist stream. The positivist literature has focused on agency problems that arise between owners and managers of large firms (Berle and Means, 1932). Most studies in this field deal with governance mechanisms needed to solve the agency problem. Jensen and Meckling (1976) discuss how equity ownership by managers aligns the interests of managers and owners. Fama (1980) discusses how efficient capital and labor markets can control the self-serving behavior of management. Fama and Jensen (1983) refer to the board of directors (in particular the non-inside directors) as an information gathering institution that owners of large firms can use to monitor the management.

56

57

For a detailed review of agency theory and its link to organization and management research, see Eisenhardt (1989). The model describes the optimal incentive structure in a multi-task environment.

2 Family firms

23

The next section describes in detail the model by Jensen and Meckling (1976), a good starting point to motivate differences between family and non-family firms. Most publications in the family business field refer to this model as a starting-point from which more specific models are derived. Agency costs from the separation of ownership and management58 Consider an owner-manager59 who faces a decision between maximizing firm value, V, and consuming private benefits, F (such as office space or a corporate jet) (Figure 2-1). The firm value is at an optimum when its marginal benefits from consumption of private benefits are equal to its marginal costs, point V*. If the consumption level increases beyond this optimum, the firm value is reduced, line V*F.60 V* may not be the best solution for the manager. The manager’s taste for firm value and private benefits is represented by her utility function, giving indifference curves such as U1. The owner-manager’s objective is to maximize her utility (described by U1) subject to a budget constraint with a slope of -1 (described by line V*F). Her optimal level of private benefit consumption and the resultant firm value are determined by the point where the budget constraint is tangential to the indifference curve, point A. In this case, the level of consumption of private benefits will be F1, and the resulting firm value will be V1.

58

59

60

This section is partially based on Block and Jaskiewicz (2007). The paper was awarded the 2nd place at WHU’s Best Paper Award on Family Enterprises (2007). An owner-manager owns 100% of the equity of the firm she manages. The firm value is part of her personal wealth. If the owner-manager consumes more private benefits than what is optimal from a firm’s perspective, costs arise. Jensen and Meckling (1976) define F as the cost of providing these extra-benefits.

24

2 Family firms

Figure 2-1: Trade-off between firm value and private benefits for an owner-manager

V*

owner-manager‘s tastes for wealth and private benefits A

V1

firm value

U1

owner-manager‘s budget constraint

slope = -1

F1

F

market value of the stream of manager‘s expenditures on private benefits

2 Family firms

25

Assume now that the owner-manager sells a fraction 1- of her equity at the valuation V1 of the firm, i.e. with the implicit assumption that she will stick to F1 (Figure 2-2). If the equity market believes the owner-manager to consume the same level of private benefits as she did when she was sole owner, the ownership stake of 1- is worth (1-)V1. This partial sale however leads to a new situation for the manager. She no longer bears the full cost of her decision to consume private benefits. The budget constraint rotates outward61, ceteris paribus, resulting in a new optimum level of consumption, F2 (point B). Figure 2-2: Owner-manager sells a fraction of her equity

V*

U1 A

V1

U2

B

firm value

V2

slope = -

slope = -1

F1

F2

F

market value of the stream of manager‘s expenditures on private benefits

61

The slope of the budget constraint is now -.

26

2 Family firms

However, if the equity market is characterized by rational expectations, this scenario is unlikely to hold (Figure 2-3). The market anticipates the manager’s new situation, in particular her new level of consumption of private benefits, and pay her only (1-)V3 for a fraction 1- of her equity (point C). The value of the firm has dropped from V1 to V3.62 Figure 2-3: Rational expectations of the equity market

V* V1

U1 A

B

V2 firm value

U2

C

V3

U3

slope = -

slope = -1

F1

F2, 3

F

market value of the stream of manager‘s expenditures on private benefits

62

Note that for the equity market the budget constraint with slope=-1 applies.

2 Family firms

27

Yet, this situation is suboptimal from the manager’s perspective. By reducing her consumption of private benefits, she could sell her 1- share of equity for a higher price, and thereby reach a higher level of utility (Figure 2-4). F4 is the only level of consumption where both the equity market and the manager are satisfied. Graphically, this corresponds to the situation where the manager’s indifference curve is tangent to her budget constraint with slope -, but also lies on line V*F (point D). Line V*F corresponds to the budget constraint that applies to the equity market.

agency costs of equity

Figure 2-4: Agency costs of equity

V* V1 V2 V4

D

B

U4 C

V3 firm value

U3

slope = - slope = - slope = -1

F1

F4

F2, 3

F

market value of the stream of manager‘s expenditures on private benefits

The value of the firm is now V4, and the agency costs of equity are described by V1-V4. The decline in firm value is caused entirely by the executive’s behavior.

28

2 Family firms

Next, Jensen and Meckling (1976) point out the role of monitoring (e.g., through an auditing firm or a supervisory board) or bonding activities (e.g., incentive compensation) to influence the executive’s behavior. These actions are aimed at reducing the agency costs of equity. Figure 2-5 shows the situation when a monitoring mechanism is installed.

agency costs of equity

Figure 2-5: Role of monitoring activities

V1

G

V5 V4

F E

monitoring costs slope = -

firm value

D

slope = -1

F1

F5 F4

F

market value of the stream of manager‘s expenditures on private benefits

The curve DEG depicts a budget constraint given the possibility of monitoring activities. The points on curve DEG describe the firm value for varying levels of monitoring and at a given level of , namely V=V*-F(M,)-M. The shape of the curve is inverse U-shaped because it is assumed that monitoring activities (M) reduce the level of private benefits (F) at a decreasing rate, i.e., F/M0. At point D, no monitoring activities are undertaken (the result from Figure 2-4), whereas at point E the optimum level of monitoring expenditures is reached, as determined by V/M=0 and ²V/²M 5% or a member of the family is CEO or chairman.” Family firm3 is defined as “family stock ownership > 5% and a member of the family is CEO or chairman.”

118

Note that the family firm definitions are not mutually exclusive. See also Figure 4-1.

4 Data and method

61

Table 4-1: Changes between the different firm categories Non-family firm Non-family firm Family firm1 Family firm2 Family firm3 Family firm4

30/60 25/50 0/0 0/0

Family firm1

Family firm2

Family firm3

Family firm4

30/60

25/50 15/23

0/0 68/35 68/29

0/0 73/50 73/48 25/36

15/23 68/35 73/50

68/29 73/48

25/36

Example how to read the table: There are 30 changes from the category non-family firm (x-axis) to the category family firm1 (y-axis) and 60 changes the other way round. The number of observations that was considered was N=4,856.

Table 4-1 above shows how often a firm changes its category. A non-family firm becomes a family firm (family firm1) in 30 cases (0.6% of all observations), whereas a family firm (family firm1) becomes a non-family firm in 60 cases (1.2% of all observations). Table 4-2 below presents the channels through which the family influences the business. The group of family firms is defined using the broadest definition (family firm1). The following results regarding firm management stand out: In 83% of the 1,746 observations, a member of the founding family is chairman of the board of directors, while a member of the founding family is CEO in 69% of all cases. Family influence on the firm’s management is high. This is different when the ownership dimension is considered. The mean percentage of common stock owned by the family is 12.6%. Yet, the variation is large: The median is 5.8%, and the standard deviation is 17.3%. Overall, the family’s ownership shares seem to be low, particularly when compared to family firms in Continental Europe or Asia (Andres, 2008; Becht and Roell, 1999; Claessens et al., 2000; La Porta et al., 1999).119 In only 17% of the cases, the family owns more than 30% of common stock, and in only 4% of the cases does the family own more than 40% of common stock. In 40% of the cases, the family owns more stock than financial investors do. These numbers fit well given the particularities of the US system of corporate governance. Due to strong investor protection and a widely dispersed ownership structure of US publicly listed firms in general, the family does not need to own large portions of equity to further its interests.120

119

120

In Europe, the median size of the largest voting block of listed industrial companies ranges from 9.9% (UK) to 55% (Italy) (Becht and Roell, 1999). In Hong-Kong, about 67% of all listed firms have a family shareholder with voting rights of more than 20% (Indonesia: 69%, Thailand: 56%, Japan: 13%) (Claessens et al., 2000). See also Section 2.1.2.

62

4 Data and method

Table 4-2: Channels through which the family influences the business Dimensions of family influence Management CEO is member of the family Chairman of the board of directors is member of the family CEO or chairman is member of the family CEO and chairman are members of the family Ownership Percentage of common stock owned by the family Family owns more than 5% of common stock Family owns more than 20% of common stock Family owns more than 30% of common stock Family owns more than 50% of common stock Family owns more stock than financial investors

69% 83% 85% 62% Mean: 12.6% Median: 5.8% Std. dev.: 17.3% 56% 25% 17% 4% 40%

Experience Age of the family firm

Mean: 49.5 yrs Median: 35 yrs Std. dev.: 39.9 yrs

Notes: The definition family firm1 is used to define the group of family firms. N=1,746

4.2.2

Characteristics of firms Table 4-3 displays characteristics of the firms in the sample grouped by family and non-family

firm observations using the five family firm definitions listed in Table 2-2. Striking differences emerge121: Family firms are smaller than non-family firms, as can be seen from the firm’s assets (median 3.5 bn $ vs. 9.4) and sales (median 2.9 bn $ vs. 5.9) as well as the number of employees (median 13,030 vs. 22,090). In addition to that, family firms are younger than non-family firms. Non-family firms have a median age of 89 yrs, whereas the median age of family firms is less than 40 yrs. An interesting result stands out with regard to cash flow: Due to their smaller size, family firms report a lower cash flow than non-family firms. Yet, when correcting for firm size, it turns out that family firms have more internal finances available than non-family firms. Median cash flow in percent of assets is about 9% in the group of non-family firms, and with family firms this number is between 10.8% (family firm3) and 11.6% (family firm5a). Finally, note that the differences between family and non-family firms seem to be larger than the differences within the group of family firms. For example, consider the small difference in median assets between the group of family firms defined by a broad definition (e.g., family firm1) and the group of family firms defined by a narrow 121

Again, the definition family firm1 is used to define the group of family firms.

4 Data and method

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definition (e.g., family firm3). The last two columns allow a differentiation between young and old family firms (family firm5a vs. family firm5b). Young family firms have less employees than old family firms (median 12,700 vs. 14,800, p