Academic journal article Journal of Small Business Management

The Influence of Large Stake Family Control on Performance: Is It Agency or Entrenchment?

Academic journal article Journal of Small Business Management

The Influence of Large Stake Family Control on Performance: Is It Agency or Entrenchment?

Article excerpt

Agency theory posits that the greater degree of control by those with decision-making authority, the greater the overall organizational performance. Conversely, entrenchment theory implies that at extremely high levels of inside control by those with decision authority, organizational performance decreases. Using a nationwide sample of 2,631 privately held and publically traded family businesses, we examined if the relationship of percent family ownership is an agency or entrenchment relationship and found the latter. Specifically, there was a statistically significant negative relationship between percent of family control and sales growth as well as a strong inverse relationship between percent of family controlling the top management team and all measures of financial performance.

Introduction

The relationship between ownership and firm performance was a topic of great interest in the late 1980s and 1990s as a result of the increased level of merger/acquisition activity and the number of employee buyouts (Oswald and Jahera 1991; Verespri 1987). Today, in the aftermath of Enron and WorldCom, and in the shadows of Sarbanes Oxley, American businesses have been challenged to assume greater corporate accountability and fiscal responsibility and are under increased scrutiny for their operational decisions (McConnell and Banks 2003).

A generally accepted belief, albeit with little empirical support, has asserted that family-controlled businesses (1) differ considerably from professionally managed companies (McConaughy, Matthews, and Fialko 2001). America was built on family-owned businesses and today, family ownership remains the predominant form of business in the United States. An estimated 40 percent of the Fortune 500 companies are family-owned or controlled (Gersick et al. 1997), and slightly half of the U.S. private sector workforce originated as a family business (Headd 2000). Consequently, with so much of America's landscape built on family businesses, it seems prudent to study the effect of family control on firm performance.

Two different perspectives have been advanced to explain the relationship of family control on firm performance. One line of thinking, agency theory, a financed-based theory (Jensen and Meek-ling 1976), argues that the greater the degree of ownership or financial attachment by those with decision-making authority, the greater the overall organizational performance. This would suggest that, in accordance with Fama and Jensen (1983), family businesses with a greater percentage of family control would perform better financially than counterpart firms with a lesser degree of family control because the cost of monitoring a family-controlled business is considerably less.

A conceptually opposing view, grounded in the finance and strategy literature, entrenchment theory, suggests that high levels of stock ownership, defined by researchers as levels of ownership above 7.5 percent (Wright et al. 1996; McConnell and Servaes 1990; Morck, Shleifer, and Vishney 1988), leads to executive decisions that are "inconsistent with growth-oriented risk taking" (Wright et al. 1996, p. 441) This view supports Schulze et al. (2001) assertion that strong family control results in additional entrenchment, providing family members with secure employment and privileges that may distract from firm profitability.

Empirical studies on family-controlled businesses have not provided the needed evidence to resolve this theoretical debate. Entrenchment theory has been applied to insider ownership and firm performance in large publicly traded companies, but has seldom been used to explain that same relationship in the context of family businesses (Hu and Kumar 2004; Ugurlu 2000; Wright et al. 1996). On the other hand, agency theory has generated inconsistent result in studies when applied to family-controlled businesses (Lee 2004; Yam-meesri and Lodh 2004; Anderson and Reeb 2003; McConaughy, Matthews, and Fialko 2001). …

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