Founding Family Control and Capital Structure: The Risk of Loss of Control and the Aversion to Debt

Abstract

This paper tests the hypothesis that Founding Family Controlled Firms (FFCFs) are more averseto control risk than similarnon-FFCFs and therefore avoiddebt. Higherlevelsof debt Increase the likelihood of bankruptcy and the level of control risk. We showthat FFCFsuse less debt; their choice of debt Is more sensitive to conditions associated with control risk; and that leverage Is not significantly related to managerial ownership In non-FFCFs, Indicating that founding family control, not managerial ownership, matters In determining leverage.Founding family controlled firms (FFCFs) seem to eschew debt. The Arthur AndersonlMassMutual American Family Business Survey '97 notes that "Family Businesses tend to avoid debt." It notes that 34.3% report no debt other than trade payables and another 34.2% have debt to equity levels of 1% to 25%. McConaughy (1994) finds that large, public FFCFs use significantly less debt than do non-FFCFs. Agrawal and Nagarajan (1990) note that firms with no long-term debt are more likely to be family controlled. Two-thirds of the firms examined by De Angelo and De Angelo (1985) that raise capital by issuing non-voting common stock (a way to raise capital without debt that maintains control) are family controlled.This study tests the hypothesis that FFCFs use less debt because founding family CEOs are more averse to control risk, the risk of losing control. Control risk increases with leverage because of the higher probability of bankruptcy that is associated with higher leverage. We examine a subset of public family-controlled firms in which the founding family plays a strong and direct role: firms whose CEO is the founder or related to the founder. Looking at these firms, therefore, should lead to a better understanding of distinctive financial characteristics of founder (enterpreneur) owned and operated firms, especially in the context of their control incentives and risks. Finally, we show that ignoring the founding family control factor in the analysis of firms' leverage policies omits an important factor common to many firms and may lead to an incomplete or incorrect understanding of financing decisions in cross-sectional studies of firms.Founding family CEOs have great personal wealth and undiversified human capital tied to the firm. If the unique status of founding family CEOs provides them returns to their family human capital, such as quasi-rents and scope for actions not generally available to non-founding family CEOs, then founding family CEOs have more to lose Summer, 1999

Capital Structure Dynamics: Near vs. Off Target Firms in Sri Lanka

“…This study finds across all leverage measures, the coefficient of family ownership factor is only significant in total debt ratio in near target firms and short-term debt ratio in off target firms. This is supported by the findings by Mishra and McConaughy (1999), that family owned firms use less debt and thus have low propensity to target debt adjustment. Percentage of directors' compensation variable confirms the significant relationship with adjustment speed, except under model 2 for near target firms, but the sign of the coefficients implies mixed results.…”

Effects of Family Ownership, Debt and Board Composition on Mexican Firms Performance

“…Family businesses are commonly hesitant to use debt as indebtedness reinforces financial risk [53], which relates in a positive way with bankruptcy risks and loss of firm control [54][55][56]. The dispersion of ownership in family firms has been proven to lead to less use of debt [57].…”

Exploring alternative strategic management paradigms in high-growth ethnic and non-ethnic family firms

“…There is a growing interest in this topic both within mainstream management and entrepreneurship journals (Sharma and Manikutty, 2005;Chrisman, Chua and Sharma, 2005). Although various empirical studies of family firms have explored issues relating to capitalisation, growth, and reliance on networks (Tsang, 2002;Gomez-Mejia, Nunez-Nickel, and Gutierrez, 2001;Mishra and McConaughy, 1999), there is a dearth of empirical studies exploring the strategic decision making processes of family firms (Kelly, Athanassiou, and Crittenden, 2000). This lacuna extends to research that investigates strategy-making in ethnic family firms.…”