Academic journal article Entrepreneurship: Theory and Practice

Affiliate Directors and Perceived Risk Bearing in Publicly Traded, Family-Controlled Firms: The Case of Diversification

Academic journal article Entrepreneurship: Theory and Practice

Affiliate Directors and Perceived Risk Bearing in Publicly Traded, Family-Controlled Firms: The Case of Diversification

Article excerpt

The present study examines the influence exerted by affiliate directors in the diversification decisions of family-controlled, publicly traded firms. Using a relational view based on the development of social capital, we argue that affiliate directors play a different role in boards of family firms vis-a-vis nonfamily firms. Specifically, we develop a set of hypotheses proposing that affiliate directors stimulate family firms to pursue diversification strategies by sharing their knowledge and experience with family executives, and hence reducing the perceived risk that may be associated with growth strategies. Affiliates can play this advisory role without reducing the control of family owners, and this facilitates the firm's willingness to adopt growth-oriented strategies. Namely, affiliates who are business experts or support specialists would tend to encourage diversification. These effects are supported empirically.

Introduction

In the governance literature, social ties between the CEO and the board of directors are generally seen as a deterrent to board effectiveness. The lack of independence between top management and directors is thought to support passive involvement by the board, especially in the realm of strategic decision making. Boards that are "weighted down" by supporters of the CEO are thought to be largely passive and uninvolved in decision making (Herman, 1981; Mace, 1986; Wade, O'Reilly, & Chandratat, 1990). Many governance scholars argue that outside directors contribute greatly to this problem by being lax in their desire to monitor and to exert control over managers with whom they have close personal ties (Fredrickson, Hambrick, & Baumrin, 1988; Spencer, 1983; Walsh & Seward, 1990). We complement this view by suggesting that despite having social ties with top management, a specific set of outside directors can be particularly useful to strategic decision making in the context of family firms.

While most studies have treated outsiders as an indistinguishable group of non-executive directors, they can be further classified into two groups, affiliates and independents, based on their relationship to the focal firm. The most basic distinction between affiliate directors and independent directors rests upon the economic tie between the affiliate firm and the focal firm (Anderson & Reeb, 2004). Affiliate directors are linked to the focal firm through a business relationship forged between their employer and the focal firm. The economic link between the affiliate firm and the focal firm provides the basis for increased interaction and the potential for the development of social capital between the affiliate director and the top management team of the focal firm. In contrast, independent directors are employed by firms that do not maintain a business relationship with the focal firm. Thus, in comparison with affiliate directors, independent directors have less opportunity to develop social ties with the top management of the focal firm. In this study, we build on the idea of social capital created between affiliate directors and management of the focal firm to suggest that such ties can affect decision making by the latter.

Specifically, we argue that affiliate directors influence diversification decisions in publicly traded, family-controlled firms to a greater extent than affiliate directors of publicly traded, nonfamily-controlled firms. Family firms differ from nonfamily firms not only in terms of high ownership concentration in family hands and frequent family involvement in top management, but also in their need to preserve control (Gomez-Mejia, Makri, & Larraza-Kintana, 2007). And while affiliate directors may play an important role in any firm, in the case of family firms their influence is likely to be greater given the more permanent and personal relationship with firm's management, whose tenure tends to be much longer than in the case of nonfamily firms. …

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