Riassunti Family Business

Introduction to family companies

It’s important to study family business (FB) because the greatest business is FB and the majority of the workers will work in one of them. First of all, there is a problem of longevity since a FB has a long-term outlook (at least 40 years) while only 30% of the second generation will run the business. There is this long-term view because the father wants to give it to his successor.

Family business definition

There are 2 types of definition, each one is useful at different moments:

• Theoretical definition which responds to the question, what does it mean to be a family business?
• Operational definition which is useful to analytically identify, using some measurable characteristics of the FB.

Theoretical definition

Chua, Chrisman, Sharma: A FB is a business which is governed by a family or a small number of families which try to find a competitive advantage to be sustainable across generations of the family (e.g., deforestation, I will not cut all the trees now or my son will not have something to cut tomorrow).

Theoretical and operational: System theory perspective, overlapping circles model

2 Circles: To define a FB, we can say that it is an entity which unifies 2 social systems: Family and the Economic side (the business). This overlapping doesn’t have to be complete; some parts of the family could be out of the business and vice versa. If there is, for example, the predominance of the business, there will be less communication, loyalty, and so on; vice versa, with the predominance of the family, there will be difficulties in decision-making, strategic options, and so on. The key is to find the right balance.

3 Circles: Here the social system business is divided into 2 parts, so the model is composed of: Family, Ownership (who owns the company), and Management (who manages the company). There could be in a firm different importance to different things: Family-first approach (long-term oriented but possible conflict); Ownership-first approach (Short-term thinking, loss of vision), Management-first approach (economic-goals, no commitment to family). The problem of this theory is that it is too simplistic (for example, there is no consideration of the influence of others), so the main problems are stereotyping, inadequate analysis of interpersonal dynamics, and low analysis of the whole system.

Operational criteria to identify a FB

Look for something which is measurable, for example, ownership (how many owners are of the family), then management, directorship, and so on. An important operational indicator is the self-identification (auto-identify as a FB) or the intra-family succession (think about the children's future in the company). All of these criteria are good, but each of them should be used in a specific situation to be the most adapted one.

Useful definition

In order to understand which one is a FB and which one is not, we should try to maximize the general differences between FB and non-FB and minimize the differences among FB. Generally, Family Involvement Measure (Family ownership & Family management) is not very effective at distinguishing between FB and non-FB; but is better to use Family Essence measure (self-identification and intra-family succession).

Discrete vs continuous

Everything is not black or white, it could be gray (continuous, not discrete) because, for example, I can own only a percentage of the firm, not all of it. There could also be discrete events like succession and disruption changes (birth and death of members).

The developmental model

This model is the most important temporal framework for FB and looks at how different parameters evolve over time. There are no more circles but axes which are: Family, Ownership, and Business Development over time. It’s important to consider also the transitory phase which is composed of: Accumulation phase, the trigger, the disengagement, the alternative exploration, the choice, and the commitment.

Type of theory

There are 2 types: theories that follow a Descriptive approach (describe what happened) and theories that follow a Prescriptive approach (predict what will happen), and this could help us in making the right choice.

Conceptual model

We mix one of the following theories (which are organizational theories) with the family system theories (Circles model) in order to obtain the Theories of Family firm.

• Agency theory: This theory says that any time that we differentiate Manager (the Agent, who manages the company) and Owner (Principal, who owns the assets), we have a coordination problem due to a conflict of interest. The Principal invests and there is a risk-bearing (be ready to lose the money) while the Agent, since they are not his money, could even make a bad choice. On top of it, to look as a good manager, he could behave opportunistically; for example, if there are needed a high number of sales, he could make crazy discounts so the sales will increase but the profit will decrease due to the discount (and the owner pays for it). A solution could be the stock option, which makes the Manager act as an Owner by giving him part of the company. In FB, we don’t have so much of this phenomenon because there isn’t a distinction between agent and owner since they could be the same person or linked by a family bond. Something that could happen is also the tunneling problem, which happens when there is a family F which has the majority (not all) of company A and fully owns company B. If A buys with an overpriced price from B, family F will earn, but the other owners of A will lose money.
• Resource-based view: Here we start from the resource that the firm has which gives us a competitive advantage (Inimitable, Rare, Valuable, Non-substitutable). The resource that a FB could exploit are also financial resources, human capital, external social capital (relationship outside the firm), internal social capital (trust).
• Behavioral theory of the firm (BTOF): Here we look at the FB from the perspective of risk, which involves family financial wealth and socio-emotional wealth. For example, if there are financial problems, the family is more prone to act with risky behavior.
• Stakeholder theory: Stakeholders influence the future of the company also in emotional relations; for example, the company gives more priority to who is more important, makes more urgency, and has the legitimacy to ask.
• Theory of planned behavior (TPB): This theory analyzes what drives a certain plan of decision, for example, visibility enhances planning (being successful makes my successor want to take over the business).

Governance

From now, we know that if Manager and Owner are distinguished, we encounter an Agency problem due to the fact that there is a conflict of interest; the interests of the two are not the same. Some solutions could be: Incentive-based performance contract (bonus); Monitoring (but it is not easy to link the performance of the company with the single employee performance); Enforcement mechanism (like managerial labor market).

New definition of firm

(Riadattata da me): Private corporation where there is a nexus for contracting relationships and the existence of divisible residual claims over which manager don’t have the power.

Theory of the firm

Jensen and Meckling created a book called Theory of the Firm which starts from the merging of 3 points: Property rights theory, Financial theory, and Agency theory.

• Property Rights Theory: It helps us understand the impact that the ownership has on investment; for example, if I own a house, I’ll take care of the garden, if the house is rented maybe not. But also, for example, if I own a company, I’m tempted to take some value out from the company to take it only for myself.
• Financial Theory: Manages the value of the equity share looking at the future.
• Agency Theory: We discussed it before.

Governance

Governance refers to the system of structures, rights, and obligations by which companies are directed and controlled. Governance establishes what are the contracts, the power, the incentives, the freedom, the duties, and the things that you cannot do in a firm. There are 3 forms of governance:

• Managerial Governance: Used by public utility companies which, in order to control the manager, use policies and formal planning procedures;
• Alliance Governance: The capital of a firm is supplied by external shareholders, more contractual relations;
• Family Governance: Unification of ownership and management (control). There is:
  • Parsimony: Since we are linked by family bonds, we don’t waste the money;
  • Personalism: The same family owns and manages (concentrated ownership);
  • Particularism: We make decisions based on our criteria.

So FB doesn’t have so much governance also because they are not strictly controlled by bureaucratic constraints, but there are other difficulties like bias in making decisions since the family members are involved.

Stewardship theory

The reason why governance is not needed in FB is that while in other businesses there are Agency problems, in FB the members follow the stewardship theory which states that we act as a group all together looking for the same collective interest; Agents instead act only for their private interest. So we should try not to assign a job but to involve people in it. In addition, in FB there are family bonds.

Traditional governance mechanism

Internal:

• Board of directors (consiglio di amministrazione): Not used a lot in medium-small FB but makes the owner control the manager and they are linked.
• Concentrated ownership: The same family owns and manages; the problem could be entrenchment (radicamento) and expropriation (try to move others out).
• Performance-based pay: Bonus, not used in FB.

External:

• Managerial labor market: It is difficult that a manager who is part of the family will be fired.
• Threat of takeover: Usually, not all the shares of FB are on the market, so others cannot take over.

Agency cost on FB

In a different way, even FB has agency costs and they are:

• Favoritism / Adverse selection
• Harmony
• Class ceiling
• Consumption of perquisites
• Insider trading