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This study examines the differences between founder-controlled firms and firms controlled by descendants or relatives of the founder. In general, we observe that founder-controlled firms grow faster and invest more in capital assets and research and development. However, descendant-controlled firms are more profitable. The results are consistent with a life-cycle view of the family firm in which the early years are characterized by rapid growth. The experience of the early years provides a basis for later, when the firm is more professionally run and can exploit its established position in the market.
To compare founder-controlled firms with descendant-controlled firms (which we define as those firms that are controlled by descendants or relatives of the founder), we examine the differences between the two groups. To provide a more informative context by which to evaluate their performance, we use a backdrop of non-family-controlled firms.
Studies of the impact of owner/managers on firm characteristics are often based on agency theory, which deals with the conflicts of interests between owners and workers. Agency theory hypothesizes that because of the incentives that shared ownership provides, the percentage of stock held by managers is positively related to firm value and performance.
However, the literature has paid relatively little attention to who the managerial shareholders are. For instance, general financial research has not usually distinguished between founders, relatives of the founders, and non-founding-family managers. Agency theory research on the effects of stock ownership follows the lead of Jensen and Meckling (1976), focusing primarily on managerial ownership as a determinant of corporate value. Though Demsetz and Lehn (1985) challenged the Jensen and Meckling view and presented evidence that managerial ownership depended on firm characteristics, their view was in the minority.
More recently, Jensen and Meckling's agency theory view has been challenged empirically. Even though early studies tried to present evidence to support their theory, the empirical evidence presented was not strong. Morck, Shleifer, and Vishny (1988) find a weak nonlinear relationship between board ownership and firm value as measured by Tobin's Q . Likewise, McConnell and Servaes (1990) find a curvilinear relationship between Tobin's Q and managerial ownership. Using managerial ownership as an explanatory variable, neither study was able to explain very much of the variation in firm values.
More recent studies suggest that managerial ownership is related to the characteristics of the firm, not the other way around. Cho (1998), using a three-stage least squares regression methodology, finds that firm characteristics explain managerial ownership levels, but managerial ownership levels do not explain firm characteristics.
McConaughy (1994) finds that although firm characteristics bear little relation to managerial ownership level, family control does. He suggests that, since family control is associated with high managerial ownership, studies of managerial ownership that do not control for family control may be misspecifled. In other words, the studies of Morck, Schleifer, and Vishny (1988) and McConnell and Servaes (1990), which show a relation between managerial ownership and performance, may be picking up a family control effect rather than an effect deriving solely from managerial ownership. Given that McConaughy (1994) finds that over 20% of the Business Week 1000 firms are family-controlled, it follows that not controlling for this factor omits important information common to many firms.
As we noted above, the impact of the control of founders and their descendants has received little empirical attention. Fama and Jensen (1983) suggest that family relationships between managers and owners can reduce agency costs because the multidimensional, long-term nature of the relationships allows improved monitoring of the decision agents:
...the restriction of residual claims to decision agents substitutes for costly control devices to limit the discretion of decision agents...The residual claims of these organizations... are also held by other agents whose special relations with decision agents allow agency problems to be controlled without separation of the management and control of decisions. For example, family members have many dimensions of exchange with one another over a long horizon and therefore have advantages in monitoring and disciplining related decision agents. (p. 306)
De Angelo and De Angelo (1985), using the same line of reasoning, write that family involvement serves to monitor and discipline managers:
The incentive for family monitoring is ultimately traceable to explicit and implicit contacts that tie family welfare to company profitability, through the quasi-rents relatives earn from …