How do family ownership, control and management affect firm value?

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Abstract

Using proxy data on all Fortune-500 firms during 1994–2000, we find that family ownership creates value only when the founder serves as CEO of the family firm or as Chairman with a hired CEO. Dual share classes, pyramids, and voting agreements reduce the founder's premium. When descendants serve as CEOs, firm value is destroyed. Our findings suggest that the classic owner-manager conflict in nonfamily firms is more costly than the conflict between family and nonfamily shareholders in founder-CEO firms. However, the conflict between family and nonfamily shareholders in descendant-CEO firms is more costly than the owner-manager conflict in nonfamily firms.

Introduction

Several recent studies show that family firms are at least as common among public corporations around the world as are widely held and other nonfamily firms (Shleifer and Vishny, 1986; La Porta et al., 1999; Claessens et al., 2000; Faccio and Lang, 2002; Anderson and Reeb, 2003).1 Whether family firms are more or less valuable than nonfamily firms remains an open question. Among large U.S. corporations, Holderness and Sheehan (1988) find that family firms have a lower Tobin's q than nonfamily firms, while Anderson and Reeb (2003) find the opposite. In other economies, the evidence is scarce but also mixed (Morck et al., 2000; Claessens et al., 2002; Cronqvist and Nilsson, 2003; Bertrand et al., 2004).

We attempt to reconcile the conflicting evidence by positing that, to understand whether and when family firms trade at a premium or discount relative to nonfamily firms, one must distinguish among three fundamental elements in the definition of family firms, namely, ownership, control, and management. The theory and evidence thus far raise questions about all three of these elements.

First, does family ownership per se create or destroy value? Berle and Means (1932) suggest that ownership concentration should have a positive effect on value because it alleviates the conflicts of interest between owners and managers. On the other hand, Demsetz (1983) argues that ownership concentration is the endogenous outcome of profit-maximizing decisions by current and potential shareholders, and thus it should have no effect on firm value. Demsetz and Lehn (1985), Himmelberg et al. (1999), and Demsetz and Villalonga (2001) provide evidence in support of Demsetz's arguments. Three recent studies focus more narrowly on the effect of ownership in the hands of families and other large shareholders: Claessens et al. (2002), Anderson and Reeb (2003), and Cronqvist and Nilsson (2003). Yet, because they do not separate family ownership from both family control and family management, the effect of ownership per se cannot be ascertained from these studies. While Claessens et al. (2002) and Cronqvist and Nilsson (2003) distinguish between family ownership of cash flow rights and ownership of voting rights, they do not separate these from the effect of family management. In contrast, Anderson and Reeb (2003) examine the effects of family ownership and management but do not distinguish ownership from control.

Second, does family control create or destroy value? Individual- and family controlled firms are the foremost example of the corporation modeled by Shleifer and Vishny (1986), one with a large shareholder and a fringe of small shareholders. In such a corporation, the classic owner-manager conflict described by Berle and Means (1932) or Jensen and Meckling (1976) (which we refer to as Agency Problem I) is mitigated due to the large shareholder's greater incentives to monitor the manager. However, a second type of conflict appears (Agency Problem II): The large shareholder may use its controlling position in the firm to extract private benefits at the expense of the small shareholders. If the large shareholder is an institution such as a bank, an investment fund, or a widely held corporation, the private benefits of control are diluted among several independent owners. As a result, the large shareholder's incentives for expropriating minority shareholders are small, but so are its incentives for monitoring the manager, and thus we revert to Agency Problem I. If, on the other hand, the large shareholder is an individual or a family, it has greater incentives for both expropriation and monitoring, which are thereby likely to lead Agency Problem II to overshadow Agency Problem I.

Which of these two agency problems is more detrimental to shareholder value? The evidence on this point is scant and inconclusive. Claessens et al. (2002) and Lins (2003) show that in East Asian economies, the excess of large shareholders’ voting rights over cash flow rights reduces the overall value of the firm, albeit not enough to offset the benefits of ownership concentration. Cronqvist and Nilsson (2003) find that in Sweden it is cash flow ownership, not excess voting rights, that has a negative impact on value. However, neither of these studies controls for the endogeneity of ownership and control, which earlier research shows is a major determinant of their effect on firm value (Demsetz and Villalonga, 2001).

Third, does family management create or destroy value? Because family management reduces and can even eliminate Agency Problem I, agency theory would predict a positive effect on the value of family management. Yet, this effect may be offset by the costs of family management if hired professionals are better managers than family founders or their heirs (Caselli and Gennaioli, 2002; Burkart et al., 2003). Consistent with the view that family management mitigates the classic agency problem, Morck et al. (1988), Palia and Ravid (2002), Adams et al. (2003), and Fahlenbrach (2004) find that founder-CEO firms trade at a premium relative to other firms. On the other hand, Smith and Amoako-Adu (1999) and Pérez-González (2001) find that the stock market reacts negatively to the appointment of family heirs as managers.

These findings raise several questions related to family management: Is there a positive family effect on firm value beyond that of founders? Does the positive effect of founders require that they occupy the CEO position in the firm, or do nonfounder CEOs with a founder as Chairman of the Board fare equally well, or perhaps even better? Is the effect of descendants neutral or negative? Does this effect vary across generations?

We use detailed data from the proxy filings of all Fortune 500 firms between 1994 and 2000 to examine these questions. Overall we find strong support for the differential effect of family ownership, control, and management on firm value. We show that whether family firms are more or less valuable than nonfamily firms depends on how these three elements enter the definition of a family firm. Family ownership creates value for all of the firm's shareholders only when the founder is still active in the firm either as CEO or as Chairman with a hired CEO. When family firms are run by descendant-CEOs, minority shareholders in those firms are worse off than they would be in nonfamily firms in which they would be exposed to the classic agency conflict with managers. This result holds even when the founder is present in the firm as Chairman. Founders create the most value when no control-enhancing mechanisms, such as multiple share classes with differential voting rights, pyramids, crossholdings, or voting agreements, facilitate the expropriation of nonfamily shareholders. Descendant-CEOs destroy value whether or not the family has established control-enhancing mechanisms.

We also find that the negative effect of descendant-CEOs is entirely attributable to second-generation family firms. The incremental contribution to q of third-generation firms is positive and significant, which points to a nonmonotonic effect of generation on firm value.

Our results are generally robust to the use of alternative specifications and econometric techniques, including multivariate regressions of q and industry-adjusted q on continuous and categorical measures of family ownership and control, fixed and random effects panel data models, and treatment effect models to control for endogeneity.

The paper is organized as follows. In Section 2 we describe our data. In Section 3 we present our main results, and we analyze their robustness in Section 4. In Section 5, we conclude.

Section snippets

Sample

Our sample comprises a panel of 52,787 shareholder-firm-year observations, representing 2,808 firm-years from 508 firms listed on the Fortune 500 during the period 1994–2000. Sample firms consist of firms that are in the Fortune 500 in any of these years, have Compustat data on sales, assets, and market value during that period, and whose primary industry is not financial services, utilities, or government. The primary industries of our sample firms span 53 different two-digit SIC codes and 41

Descriptive statistics

Table 2 provides descriptive statistics for our sample, broken down by family and nonfamily firms. Family firms represent 37% of our sample; 1,041 family firm-years from 193 different firms. The mean q of family firms is 0.23 higher than the q of nonfamily firms, and the difference is statistically significant at the 10% level using clustered standard errors. The difference is larger on an industry-adjusted basis: Family firms have a 0.40 higher q, which is significant at the 1% level. The data

Alternative econometric techniques

Table 9 analyzes the sensitivity of our main results to the use of alternative specifications and econometric techniques, including industry-adjusted q, fixed effects and random effects panel data models, and treatment effects models. We report only selected coefficients from more complete multivariate specifications that include the same statistical controls as Table 4. Column 1 reports coefficients of a family firm dummy using the same specification as the first column in Table 4. Columns 2–6

Conclusion

Although family firms play a vital role in the world economy, this sector has received relatively little attention, partly because of the difficulty in obtaining reliable data on these firms. We assemble a uniquely detailed panel data set on a sample of publicly traded U.S. firms that are in the Fortune 500 at least one year during the period 1994–2000. Using these data, we examine the impact of family ownership, control, and management on firm value. Our results highlight the differential

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    Both authors contributed equally to this paper. We would like to thank Carliss Baldwin, Lucian Bebchuk, Wilbur Chung, Harold Demsetz, Ben Esty, Mara Faccio, Raymond Fisman, Stuart Gilson, Robin Greenwood, Louis Kaplow, Josh Lerner, Ian MacMillan, Anita McGahan, Andrew Metrick, Todd Millay, Cynthia Montgomery, Mary O’Sullivan, Francisco Pérez-González, Urs Peyer, Thomas Piper, Michael Roberts, Stefano Rossi, Richard Ruback, Andrei Shleifer, Jordan Siegel, Howard Stevenson, Peter Tufano, Sidney Winter, Julie Wulf, Bernard Yeung, seminar participants at Boston University, Harvard Business School, the Harvard Law, Economics, and Organization seminar, MIT, UCLA, Wharton, Yale, the American Finance Association 2005 Annual Meeting, the BYU-University of Utah 2004 Winter Conference, the European Finance Association 2004 Annual Meeting, the National Bureau of Economic Research 2004 Summer Institute, the University of North Carolina – Duke Corporate Finance Conference, and the Harvard Economics Ph.D. students in the Corporate Finance class for their comments. We thank Jessica Grimes, Amee Kamdar, Blanca Moro and Mary Margaret Spence for their tireless contributions to the data collection effort. Raphael Amit is grateful for the financial support of the Robert B. Goergen Chair at the Wharton School and the Wharton Global Family Alliance. Belén Villalonga gratefully acknowledges the financial support of the Division of Research at the Harvard Business School. All errors are our own.

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