How Family Firms Solve Intra-Family Agency Problems Using Interlocking Directorates: An Extension

Article excerpt

This commentary makes two contributions to a better understanding of interlocking directorates in family firms. First, we compare agency costs in family and nonfamily firms. Second, we present additional propositions on how interlocking directorates address agency issues in family firms.

**********

Using the concept of community-level social capital, Lester and Cannella (2006) discuss how interlocking directorates can address intra-family agency problems as well as some of the characteristics of the interlocking directorates that family firms are likely to employ. To put their paper in context, we use the accounting of agency costs in family and nonfamily firms as presented by Chrisman, Chua, and Litz (2004). We then extend Lester and Cannella's contributions by presenting additional propositions on how interlocking directorates address agency issues in family firms.

The Agency Context

Agency costs consist of the combination of costs incurred by a firm in terms of lower performance through its unwillingness or inability to effectively deal with agency problems, and of costs incurred through the incentives and monitoring activities used to deal with information asymmetries and align the interests or actions of an agent with the interests of a principal (Jensen & Meckling, 1976). Chrisman, Chua, and Sharma (2005) observed that the agency literature covers agency problems that arise between owners and managers, owners and lenders, and majority and minority owners. Schulze, Lubatkin, Dino, and Buchholtz (2001) have added intra-family agency costs to this list. They propose that intra-family agency costs may be caused by asymmetric altruism, and may exist even in the absence of asymmetric information. For example, some agency problems of family firms may be a consequence of an inability or unwillingness to enforce contracts on family members rather than incomplete contracting (Bernheim & Stark, 1988).

Based on the possibility of agency problems between the parties mentioned above, the research question that has begun to receive attention is whether the agency cost of the family form of organization is higher, lower, or equal to those of organizing as a nonfamily firm. As displayed in the following inequality (Chrisman et al., 2004, p. 339), the hypothesis in vogue is that the agency costs are not equal.

(1) ALT + [OM.sub.F] + [OL.sub.F] + [DM.sub.F] [not equal to] [OM.sub.NF] + [OL.sub.NF] + [DM.sub.NF]

where the subscript F stands for family firms, NF for nonfamily firms, and:

ALT = Intra-family agency costs arising from asymmetric altruism and other family interactions.

OM = Agency costs arising from separation of ownership and management.

OL = Agency costs arising from information asymmetries and conflicts of interests between owners and lenders.

DM = Agency costs arising from information asymmetries and conflicts of interests between dominant and minority shareholders.

Observing that recent large sample studies of publicly traded firms (e.g., Anderson & Reeb, 2003) suggest that family firms have higher economic performance than nonfamily firms, Lester and Cannella (2006) asked how this could be, when family firms must incur the costs of dealing with the additional intra-family problems. Since this would result only if the following inequality holds, Lester and Cannella surmised that successful family firms must have developed strategies, structures, or processes to deal with intra-family agency costs efficiently. (1)

(2) ALT < ([OM.sub.NF] + [OL.sub.NF] + [DM.sub.NF]) - ([OM.sub.F] + [OL.sub.F] + [DM.sub.F])

Actually, if the agency costs of nonfamily firms--with respect to the owner-manager, owner-lender, and majority-minority shareholder relationships--are much higher than those of family firms, i.e., the right-hand side of the inequality in equation 1 is as large as some researchers believe (e. …