Academic journal article Entrepreneurship: Theory and Practice

Family Control and the Rent-Seeking Society

Academic journal article Entrepreneurship: Theory and Practice

Family Control and the Rent-Seeking Society

Article excerpt

A high level of trust within a small elite, like a low level of trust in society at large, may be a serious impediment to economic development. This is because such concentrated high trust among the elite promotes political rent seeking, known to retard growth. We propose that entrusting the governance of a country's great corporations to a few wealthy families promotes this undesirable distribution of trust. Preliminary empirical evidence and arguments grounded in game theory support this view.

Introduction

Big businesses in the United States and many other developed economies are run by professional managers for dispersed shareholders. Despite well-known agency problems in such firms, these economies sustain high levels of economic and social development. (1) In contrast, La Porta et al. (1999) show that most large firms elsewhere are organized into vast corporate groups controlled by a few extremely wealthy families, with dispersed ownership the rarest of curiosities. These differences in ownership structure are important to economic prosperity.

Many economists now concur with Krueger (1974) that official corruption is a critical barrier to growth. Murphy et al. (1991) argue that official corruption diverts resources and talent away from real investments into political rent seeking: lobbying politicians, influencing judges, and currying favor with bureaucrats. (2) Lucrative returns from political rent-seeking investments "crowd out" real investment in physical assets, research, and the like, which pay only normal returns. Murphy et al. (1993) argue that this diversion is often large enough to starve real investments, especially in innovation, of capital. Since Schumpeter (1934), Solow (1957), and Romer (1986) are widely accepted as correct in arguing that innovation is critical to growth, Krueger (1974), Murphy et al. (1991, 1993), and others argue that this diversion seriously impedes growth.

Fukuyama (1995a,b), La Porta et al. (1997b), and others hold that an absence of trust prevents large, professionally managed businesses from developing, and that this impedes growth for two reasons. First, not trusting outsiders causes family firms to avoid hiring professional managers and to shun growth that requires external capital. Second, not trusting insiders causes public investors to be wary of buying stocks. Without disputing these, we propose yet another reason. A high level of trust between members of a small elite magnifies the returns to political rent seeking by this elite. We present empirical evidence consistent with this thesis, and argue that it follows naturally from viewing political rent seeking as a cooperative game among members of the elite and a non-cooperative game between the elite and the rest of society.

Of course our results are statistical averages. Every very large family-controlled firm or group of firms is probably not primarily engaged in political rent seeking. Some entrenched oligarchic mercantile families might be enlightened and benevolent. Moreover, professional management leads to a well-known set of agency problems that can also impede growth. Further work is needed to clarify how these tradeoffs between the problems of entrenched family oligarchic control and those of professional management differ in different circumstances.

Family Control over Large Firms and Economy Performance

Table 1 shows the fraction of the top 20 publicly traded firms, ranked by market capitalization in each country, that are controlled by families in December 1995, as reported by La Porta et al. (1999). As a robustness check, control is defined in two ways: first as a 20% voting block, and then as a 10 % voting block. A majority block is not normally required for control because most small shareholders do not vote.

Family control is least important in the United Kingdom, where no family controls more than 20 % of any of the top 20 public firms. …

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