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«BI Norwegian School of Management Hand-in date: 01.09.2011 Thesis supervisor: Øyvind Bøhren Program: Master of Science in Business and Economics ...»

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Do family firms grow differently than

non-family firms?

GRA 1900 Thesis

BI Norwegian School of Management

Hand-in date: 01.09.2011

Thesis supervisor: Øyvind Bøhren

Program: Master of Science in Business and Economics

Torbjørn Magnussen and Martin Bie Sundelius

This thesis is a part of the MSc programme at BI Norwegian School of

Management. The school takes no responsibility for the methods used,

results found and conclusions drawn.


This thesis seeks to explain family firm growth in a corporate governance context, and provide statistics on how family firms grow in Norway. We set up a simple panel data model based on contemporary knowledge, and find that family ownership has something to say on growth. We find that unlisted family firms show lesser growth than non-family firms. Even after we consider for financial stress and other known factors influencing growth, the effect still persist.

Acknowledgment We would like to thank our supervisor Øyvind Bøhren for his guidance and feedback along the way.

Contents 1 Introduction............................. 5 2 Literature review.......................... 5

2.1 Family firms............................. 6

2.2 Growth............................... 7

2.3 Agency theories........................... 8 Agency Problem 1 (A1).................. 8 Agency Problem 2 (A2).................. 8 Agency Problem 3 (A3).................. 9

2.4 Diversification loss......................... 9

2.5 Short-termism........................... 10

2.6 Control variables.......................... 10 Industry........................... 10 Firm size.......................... 10 Age............................. 11 Financial constraints.................... 11 Financial performance................... 11 Separation

–  –  –

1 Introduction The recent financial crisis has shown us how important growth is, and that the consequence of weak growth can be social unrest and political instability.

In this context we know that the economy in our part of the world is very dominated by family ownership (Morck, Wolfenzon, and Yeung, 2005). Since these families might have different attitude towards investment projects, it will be very interesting to see if this corporate governance issue of aligned interest will result in different growth rates. Because there is a difference and corporate governance will matter for the economy. Also, in the real economy, family owners would clearly benefit on both the cost and on controlling their firms by their own, rather than hiring professional managers. Although aligned interest of ownership and management is beneficial for the owner, it might not be beneficial for overall economical growth, because the family firms might have conflicting incentives and preferences. We will contribute with using a huge and very detailed Norwegian dataset, and exploratively investigate whether a theoretical corporate governance framework could explain some of the different growth rates that exist between family and non-family firms. Our

research question is:

In what way does family ownership influence the growth of a com- pany?

Specifically, we are analyzing in what direction does family ownership contribute to the growth of the firm. Our research question signals that we believe that there are certain influencing factors arising from a family ownership.

The research question should be read in the context of the growing corporate governance literature, particularly the stream related to family ownership. Indirectly, we also examine if families invest differently, although we are unable to provide much empirical insight to the same. This thesis questions whether family ownership creates a better growth-conditions than those created by a non-family firm.

This paper is structured as follows: It starts with a review of existing literature, theory and empiric followed by our research and finally our methodology is presented.

2 Literature review

The corporate governance literature on family control is divided into what can be coined the competitive advantage and the private benefits of control (Villalonga and Amit, 2010). The first category of papers seeks to explain that there is a competitive advantage with family control, i.e., the structure 2 Literature review 6 of ownership and control is optimal and provide better alignment of interests among the most important stakeholders in the firm. The second category explains why family ownership is beneficial for the family only, while it is nonbeneficial for minority owners. Fortunately, some of the literature is supported by quantitative empirical investigations, and we will refer to some of these results during the course of this paper. It is important to mention that it is only recently that corporate governance from a quantitative financial perspective has gained momentum in terms of published articles. We review literature with the objective of giving a theoretical foundation for our model, based on theories on firm growth, financial theories and theoretical propositions taken from the corporate governance area.

2.1 Family firms Agency problems and growth are two subjects that have considerable attention, particularly on the aggregate (macro) level. The subject is studied from a range of perspectives, and much of the research have been qualitative, for instance in strategy and organizational disciplines. Still, an increasing amount of literature is being conducted in a quantitative manner due to the increasing availability of data. Little research has been done on the relationship between family ownership and growth in unlisted companies. The aim of this thesis is to investigate how family ownership affects the growth rate of family firms.

An outcome of our research will be increased clarity on how family firms grow, and how this growth differs from non-family private firms.

Generally, non-listed firms owned by large families dominate the economy Morck, Wolfenzon, and Yeung (2005). Furthermore, a significant part of the corporate governance literature concerning family firms has been conducted on listed firms. One explanation is the scarce availability of reliable data material and the fact that most research is done on the Anglo-Saxon countries that are known to have a large part of their companies listed.

The literature does not provide us with a clear definition of a family firm.

Several empirical studies use different thresholds on ownership concentration as a proxy for control of the firm. There has been several different thresholds levels which creates a dummy variable in the corporate governance literature.

The most common threshold is the 20% threshold. In contrast, the literature uses ownership concentration and low thresholds, often in the 10-20% region on listed firms. The low threshold is often explained by small owners not attending board meetings and in that way a large investor could control a firm with a smaller fraction of ownership.

Investing in unlisted family businesses is something that the most successful and wealthy investors do. For instance, Warren Buffet, the third richest man 2 Literature review 7 in the world looks for family businesses when he is searching for new firms in Europe1. He has successfully pursued a strategy of acquiring family firms and let the family still be in-charge of the firms (in which many have been unlisted beforehand). Since the one of the worlds best investors find special value in family firms, it it interesting to get more insight into the mechanics and incentives of family firms.

Summarizing, family firms are special because they are governed differently and have a different investment behavior. Understanding family firms can be valuable for an investor. Next subsection will mention some growth insights and how they are related to family firms.

2.2 Growth Coad and Holzll (2010) find that growth rate are hard to predict, and that it is better modeled as a random process, because there is very little persistence in the growth rate. Growth levels are not clustered in certain sectors, nor are the high growth firms young or small. Another insight they provide us with is that growth distribution is heavily tailed, in which the tail provides the growth of the economy, and where the average firms create very moderate growth levels.

Also, many managers are very concerned about growing their firms. Growth is associated with more prestige for some managers. Still, for some families, growth might be a result of more risk-taking.

Few studies of family firms have been done with growth as a dependent variable. On the contrary, performance is often the object of measure for empirical studies. Still, growth is indirectly used in studies as a control variable. Lately empirics have shown that listed family firms increased their sales on an average by 2% more than that of non-family listed firms from 2006-2009 (Villalonga and Amit, 2010). Another study with 1000 listed French firms in the period from 1994-2000 revealed a sales growth rate of 16% for family firms that were run by the founders, and 7% for both descendant managed and widely held non-family firms (Sraer and Thesmar, 2007). Thus they argued that family firms significantly outperformed comparable non-family firms. Their definition of a family firm required one family to own a voting block of at least 20%.

Firms benefit with economies of scale, for example, by serving larger markets and minimizing fixed cost as a part of the total cost picture. Growing firms attract more qualified employees due to better expected career opportunities, and the growth is often more sustainable than performance on profitability (Coad, 2009). Growth is a critical factor in the investors’ process of valuing firms (Koller, Goedhart, Wessels, Copeland, McKinsey, and Company, 2005).

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIz3cvRYvHW0 Retrieved 08/26/11 2 Literature review 8 To achieve growth a firm needs to have the capital to invest and the growth opportunities. To detect the growth opportunities the firm needs the knowledge to detect them. They also need the power to act upon them before they disappear.

Hamelin (2009) studied the firm growth of French non-listed SMEs. We categorize this as a study on the micro level since the sample consisted of accounting statements from many individual firms. Her result was that family firms grow slower than non-family firms. Hence we adopt the following


HA1 : Family firms grow slower than non-family firms.

To sum up, growth is hard to predict. Furthermore, unlisted firms have different growth percentages than those that are listed firms. Still, growth is important for the firm, investors and the economy. In addition, SME family firm grows slower than non-family firms in France. We adapt Hamelin (2009) as our base case and follow her methodology in our model.

2.3 Agency theories Agency Problem 1 (A1) In one of the most cited articles about corporate governance Jensen and Meckling (1976) incorporated agency theories into a financial setting. They identified and modeled agency conflicts between owner (principal) and management (agent), which they labeled A1. The theory argues that there is less reason to monitor this conflict in an owner managed firm than it is in a family firm because of the aligned interests with respect to growth opportunities and risk preferences.

Agency Problem 2 (A2) A2 is between the majority owner who controls the firm, and the minority owners, who might be exploited. Specifically for family firms, there have been a series of debates on exploitation of private benefits of control (Grossman and Hart, 1980).Here, the incumbent owning management exploit the minority shareholders through extracting benefits. The cost can be allocated either from the management to the shareholders, or from large shareholders to minority shareholders. It is appropriate to restrict the problem to exploitation of minority shareholders (A2), because the managementshareholders problem (A1) is not relevant for a family firm by definition. In a series of seminal articles, Porta, Lopez-De-Silanes, and Shleifer (1999) found evidence of pyramid structures, and a split of controlling and owning shareholder classes, both with the suspected intention of taking advantage of the private benefits. This is a cost for both the minority shareholders, and the society, which might result in a growth that is not optimal compared with the firm’s growth potential.

2 Literature review 9 Unlisted firms generally have higher ownership concentration. A1 is less likely to be a severe problem for the total population of unlisted firms. On the other hand, A2 is a significant problem because dominant owners want to exploit the minority owners.

Agency Problem 3 (A3) A3 is the possible conflict between shareholders and creditors. Because the family firm have less incentive for transparency, we expect A3 to be higher. As a consequence banks will be more reluctant to give loans, causing financial constraints and hence underinvestment. A3 might also reduce the willingness to take risky project and thus give a lower growth rate. On the other hand Myers (1977) has shown that with leverage being too high the firm underinvests because of to much debt. Less capital makes the firm prioritize between positive NPV projects. Family firms are reserved from issuing stocks because they do not want to dilute their ownership. This could make the family firms more capital constrained than other private firms. The argument that firms with a high debt are more eager to grow is working in a different direction than the capital constraint argument. Family firms are more willing to lever up because of the high benefit of increasing the sales.

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