Agency Relationships in Family Firms: Theory and Evidence

Abstract

Does owner management necessarily eliminate the agency costs of ownership? Drawing on agency literature and on the economic theory of the household, we argue that private ownership and owner management expose privately held, owner-managed firms to agency threats ignored by Jensen’s and Meckling’s (1976) agency model. Private ownership and owner management not only reduce the effectiveness of external control mechanisms, they also expose firms to a “self-control” problem created by incentives that cause owners to take actions which “harm themselves as well as those around them” (Jensen 1994, p. 43). Thus, shareholders have incentive to invest resources in curbing both managerial and owner opportunism. We extend this thesis to the domain of the family firm. After developing hypotheses which describe how family dynamics and, specifically, altruism, exacerbate agency problems experienced by these privately held, owner-managed firms, we use data obtained from a large-scale survey of family businesses to field test our hypotheses and find evidence which suggests support for our proposed theory. Finally, we discuss the implications of our theory for research on family and other types of privately held, owner-managed firms.

The Benefits of Family Ownership, Control and Management on Financial Performance of Firms

“…Although there is a recent trend towards the micro-foundation of family firms (Carney 2005;Chrisman, Chua & Litz, 2004;Chua, Chrisman & Bergiel, 2009;Schulze, Lubatkin, Dino & Buchholtz, 2001;Schulze, Lubatkin, Dino, 2003a, b) our study cannot contribute to the discussion of how and why special forms of family agency create, maintain or destroy efficient monitoring behavior in family firms. While our research design has to treat this as a black box other researchers might use the essential component of family control as a lever to open this box.…”

“…In noncomplex businesses it can be beneficial for firm competitiveness to combine ownership, control and management within the same agents; a belief that is convergent with the strategic management view of family business (Chrisman, Chua & Sharma, 2005). At the same time more complex (larger) family businesses who omit to separate control and management suffer from their restricted human capital pool and are likely to underperform (Schulze, Lubatkin, Dino & Buchholtz, 2001). Moreover, recent studies (e.g.…”

“…What is the essence of 'essence'? This question is the basis of a relative recent research stream investigating family specific micro-foundation of agency and altruism at the interface of agency theory, strategic management and the resource based view (Carney 2005;Chrisman, Chua & Litz, 2004;Chua, Chrisman & Bergiel, 2009;Schulze, Lubatkin, Dino & Buchholtz, 2001;Schulze, Lubatkin, Dino, 2003a, b). Regarding the second question one could easily fall prey to the logical fallacy that empirical family business research has exactly done that.…”

“…Moreover this combined system reduces the pool of possible decision agents, as they must be willing to bear risk, have good decision skills and must be wealthy enough to invest. In the case of owner run family businesses these problems are amplified as the pool of possible decision agents is additionally restricted to family members which may not have sufficient human capital and these agents must not only consider their own risk but also altruistic risk for the family which aggravates the risk aversion problem (Schulze, Lubatkin, Dino & Buchholtz, 2001). …”

Short-Term Borrowing for Long-Term Projects: Are Family Businesses More Susceptible to 'Irrational' Financing Choices?

“…As the knowledge needed to manage and control a business is more specific in large, complex enterprises, it generally becomes increasingly efficient, with increasing business size, to separate ownership and management, and to delegate control (Fama/Jensen 1983, p. 11). Schulze et al (2001) provide a comprehensive discussion of agency problems in family businesses. Responding critically to the arguments in favour of lower agency costs of family businesses, they argue that in reality, family enterprises are no strangers to costly agency problems.…”