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A Governance Perspective on Family Business Successions

Soo LeeDepartment of Management

College of Business & Public Administration

Faculty Seminar23 March 2007

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Why the Study is Important• Privately-held, family businesses are the dominant

form of economic organization (GDP, employment)Underrepresented in the study of organizations &

managementSuccession ensures business continuity

• No separation of principal-agent in family businesses Is agency theory generalizable to family businesses?

• Add to research on firm performance-CEO turnover link from a family business perspective

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Purpose of Study

• To examine if boards play a role in governing the firm performance-succession link since there is no separation of principal-agent in family businesses

• To explore how board-related disciplinary mechanisms work in family businesses

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Definitions

• Family Business:– Family (individuals related by blood, adoption

or marriage) owns a controlling interest with at least one family member employed in the top management team.

• Succession:– Process in which managerial control of the

business is transferred to another person (outside of retirement, illness or death).

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Agency Theory: Control/Governance Role of the Board

• In large, public firms, agency costs arise from separation of principal-agent relationship, info asymmetry & dispersion of ownership (Jensen & Meckling, 1976)

• Control/governance role of the board (Fama & Jensen, 1983) :– Safeguard principals’ interests by monitoring & ratifying

managerial actions to reduce agency costs– Reward/penalize management to maximize shareholder wealth

§ In family businesses, there is no separation of principal-agent, no info asymmetry with significant ownership concentrationNo agency costs in family businesses?No control/governance role of the board in family businesses?

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Agency Costs in Family Businesses

• Agency problems, leading to low firm performance, are caused by:– Self-control problem e.g. ‘doing what I want rather than

what I should’ (Thaler & Shefrin, 1981)

– Altruism e.g. welfarism (Schulze et al., 2001; 2002; 2003a; 2003b;

Lubatkin et al., 2005)

– Lack of external control mechanisms e.g. no threat of takeover or no competitive labor market

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Role of the Board in Family Businesses

• Protect the value of the business, not shareholder wealthTo ensure business continuity

• Discipline the principal when resources are misappropriated (firm viewed as a distinct entity)Involuntary turnover e.g. succession

§ Effectiveness of the board is affected by its level of independence from the principal

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Board Independence is related to:

• Board Composition– Board size

– Types of directors

– Separation of Chair-CEO

• Board Structure– Committees

• Board Process– Frequency & formality of meetings

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Hypotheses Firm Performance (standard agency theory argument)

– Inability to sustain positive firm performance leads to turnover (Fredrickson et al., 1988).

H1: Low firm performance will be positively associated with a succession.

– Boards serve as a disciplinary mechanism to reduce agency costs pertaining to value misappropriation but only effective if they can resist principal domination.

H2: The level of board independence will moderate a succession in low firm performance.

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Empirical Model

SuccessionFirm

Performance

BoardIndependence

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Sample• 400 private-limited companies were randomly selected from a

Small Business Directory database in Singapore– have a board of directors– > 5 years in operation– < 500 employees

• Survey items from extant literature & interviews with family business owners.

• Survey was pretested with 5 family businesses for face validity.

• Questionnaire was mailed to companies, who responded by fax or mail.

• Follow-up with 2nd round mailing, 3rd round fax and 4th round telephone calls to appeal for participation over 5 weeks.

• 81 companies responded (20.25% response rate).• 70 usable questionnaires as 9 questionnaires had extensive

missing data & 2 were not family businesses.

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• Firm Performance– Sustained firm performance measured by 3-year

average % change in revenue growth• Succession

– Dummy variable measured if founder/CEO of family business was replaced.

• Board Independence– Board Composition (Zahra & Pearce, 1989)

• Board size• Family ratio (family members who are directors)• Insider ratio (non-family employees who are directors)• CEO-appointed board members• Duality

Variable Definitions

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Variable Definitions (cont’d)

– Board Process (Barnhard et al., 1994)

• 7-item scale measured board structure & process (=.94)– Board sets up committees to establish compensation & monitor

audits– Board meets regularly– Board gives CEO ideas/advice to manage the business– Board is active in seeking information to make decisions– Board provides CEO with business opportunities– Board holds CEO accountable for decisions– Board limits CEO’s approval on capital expenditures above a

certain amount

• Control Variables– Family ownership– Human capital (years as CEO, years in industry)

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Statistical Method

• Logistic Regression • Partial Least Squares (PLS)

– Non-parametric technique, to deal with small sample & data limitations as it does not require assumptions of normal distributions & non-multicollinearity.

– Bootstrapping function, in which a large number of sub-samples are created using random selection & replacement of original data, generates stable coefficients.

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Preliminary Analyses

• Crosstabs

• Descriptive statistics

• T-tests between firms with No-Succession & Succession

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Crosstabs

No Succession

(43)

Succession

(27)

Zero-Negative 3-year Average Performance

23 20

Positive 3-year Average Performance

20 7

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Mean, Standard Deviation & Intercorrelations  mean s.d. 1 2 3 4 5 6 7

1.Succession .39 .49              

2.Performance 4.61 20.46 -.27*            

3.Board Size 3.96 .89 .24* .05          

4.Family Ratio

.72 .23 .16 -.06 .08        

5.Insider Ratio

.12 .16 .21 -.01 .28* -.46**      

6.CEO-appt .69 .35 .04 .09 .11 .33** .04    

7.Duality .67 .47 -.76** .09 -.17 -.04 -.25* -.12  

8.Process 4.11 1.57 .04 -.03 .25* -.36** .11 .01 .03

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t-tests

  No Succession(mean), n=43

Succession(mean) n=27

p-value(2-tailed)

Performance 9.01 -2.41 .02

Board Size 3.79 4.22 .04

Family Ratio .69 .77 n.s.

Insider Ratio .10 .17 n.s.

CEO-appt .68 .71 n.s.

Duality .95 .22 .00

Process 4.07 4.19 n.s.

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Hierarchical Logistic Regression on Succession

  β s.e. p-value

Block 1 (controls)      

Family Ownership -.02 .02 n.s.

Years as CEO -.04 .04 n.s.

Years in Industry .01 .03 n.s.

R2 .04   n.s.

Block 2      

Performance -.04 .02 .03

R2 .12   .01

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PLS on Succession

BoardIndependence

Firm Performance

x Board Independence

Succession

FirmPerformance

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PLS on Succession (Positive Performing Firms, n=27)

BoardSize

FamilyRatio

InsiderRatio

CEO-appointedmembers

Duality

BoardProcess

Succession

-.85 (t=4.65)

R2=86%

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PLS on Succession(Zero-Negative Performing Firms, n=43)

BoardSize

FamilyRatio

InsiderRatio

CEO-appointedmembers

Duality

BoardProcess

Succession

-.26 (t=1.96)

.37 (t=2.14)

-.64 (t=4.63)

R2=60%

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Summary of Results

• H1: supported (firm performance)

• H2: partial support (boards matter more in poorly performing firms)

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Discussion• Antecedents to Succession

– Agency explanation: poor performance• Role of Board: governance or discipline occur in decision control

to enhance value appropriation – Poorly Performing Firms:

• Family board members (protect family assets tied to the economic welfare of the firm)

• Separation of Chair-CEO (reduce CEO entrenchment)• Non-CEO-appointed board (reduce CEO entrenchment)

– Positive Performing Firms: • Separation of Chair-CEO (reduce entrenchment)

Agency theory is generalizable to family businesses through governance control of the board even without separation of principal-agent relationships

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Limitations & Areas for Future Research

• Limitations:

– Survey

– Small sample size

• Future Research

– Examine antecedents to family firm performance:

service role of board in value creation by facilitating CEO decision management

• Resource dependence explanation – board interlocks

• Social capital explanation – prestigious external members

• Human capital explanation – members with high levels of KSAs

• Design longitudinal study to test a recursive causal model in future