Governance of Family Firms

Abstract

We review what the financial economics literature has to say about the unique ways in which the following three classic agency problems manifest themselves in family firms: (a) shareholders versus managers, (b) controlling (family) shareholders versus noncontrolling shareholders, and (c) shareholders versus creditors. We also call attention to a fourth agency problem that is unique to family firms: the conflict of interest between family shareholders and the family at large, which can be thought of as the “superprincipal” in a multi-tier agency structure akin to those found in other concentrated ownership structures in which the controlling owner is the state, a bank, a corporation, or other institutions. We then discuss the solutions or corporate governance mechanisms that have been devised to address these problems and what research has taught us about these mechanisms' effectiveness at solving these four conflicts in family firms.

Agency Conflicts, Socioemotional Wealth, and the Debt Maturity Structure of Family Firms: A Critical Analysis

“…The agency conflicts that occur between different types of shareholders primarily refer to those between the controlling owners (agents) and non-controlling owners (principals), labelled as "Agency Problem II" (Villalonga & Amit, 2006), which in family businesses, is likely to overshadow "Agency Problem I" (Villalonga, Amit, Trujillo, & Guzmán, 2015) earlier examined here. However, the valuation premium associated with family firms, as shown by numerous studies (among others, Anderson & Reeb, 2003;Villalonga & Amit, 2006;Andres, 2008), demonstrates that the benefit of the reduction in "Agency Problem I" is greater than the higher costs related to "Agency Problem II".…”

“…This possibility derives from the divergence between voting rights and cash-flow rights, allowing family controlling shareholders to bear little of the wealth consequences of decisions they have made as controllers (Bebchuk, Kraakman, & Triantis, 2000). This divergence can be achieved through dual-class shares, pyramids and cross shareholdings (Villalonga et al, 2015), as well as disproportionate Board representation and voting agreements between the controlling family and non-family shareholders (Villalonga & Amit, 2009). Hence, large shareholders may avoid using their personal financial resources, in order to enhance wealth expropriation from minorities, and employ long-term debt to strengthen their own control.…”

“…Another important issue, as defined more recently by Villalonga et al (2015) "Agency Problem IV", refers to the conflicts of interest between family shareholders (agents) and family outsiders (superprincipal), that is, between the family shareholders and the family at large (non-shareholders, non-Board members and non-managers). Like any other agency conflict, this one arises from the divergence of goals of principal and agent.…”

Family Firms and Financial Analyst Activity

“…Concentrated ownership-more specifically, family ownership-is the prevailing form of ownership structure around the world (La Porta et al (1999)). Family firms are an important component of the world economy 1 and recent research in finance has analyzed different facets of their behavior (see Villalonga et al (2015) for a literature review). In this paper, I investigate a topic which has received little attention so far in the financial literature: the relationship between family ownership and financial analyst activity.…”

“…This might be done through the use of dual class shares or pyramidal structures to dissociate voting rights and cash-flow rights (Faccio and Lang (2002)), or through obtaining disproportionate board representation (Villalonga and Amit (2009)). This could lead to suboptimal corporate decisions which serve the main shareholder (to the detriment of minority shareholders) and aggravate the second type of agency conflict (Villalonga et al (2015)). This negative outcome as a result of ownership concentration is referred to as 'the entrenchment effect'.…”