Academic journal article International Review of Management and Business Research

The Relationship of Agency and Performance in Family Business: Small and Medium Enterprise in Yogyakarta

Academic journal article International Review of Management and Business Research

The Relationship of Agency and Performance in Family Business: Small and Medium Enterprise in Yogyakarta

Article excerpt


In general, family business is different with non-family business especially in its complexity and in its management. However, family business has similar goals with non-family business. Family business has higher complexity than non-family business. The complexity is more likely because family business has to accommodate three integrated system, which is family system (family first business), management system (management first business), and ownership system (ownership first business). Which system is the priority will depend on the vision of the company's owner.

Family first business system emphasize on the fact that the company was built for the family business. Family interest is the main concern, which is why the decision made that will affect the future of the company will depend on the family. The management first business emphasizes more on the business interest than the family interest. The performance of the working family member will be evaluated with those who are not from the family member. The leadership is hold by professional not from the family. The ownership first business system describe the existence of the business is not the main concern, but the return on capital will be the main concern. The company is built or bought which later on be transferred to the other owner as long as it is profitable for the family.

The family business that uses management first business will have conflict of interest among the owner and the management, which usually called agency problem. Jensen and Meckling (1976) describe that agency relationship as a contract between the owners (principal) with the management (agent). The criterion of this agency relationship is there is a distinction between the owner and the management. The agency problem can be minimize by implementing good corporate governance (CGC) or by having several controlling mechanism such as the policy to increase the use of debt, insider ownership, and dividend payout.

According to Jensen and Meckling (1976), Jensen (1986), Crutchley and Hansen (1989), Chen and Steiner (1999), and Morck and Yeung (2003), the increase in debt could decrease the agency problem between the management and the owner. The debt could reduce the excessive cash flow. However debt could also reduce the cash flow because the business has to pay interest and principal. When the cash flow decline, the free cash flow will also decline. This situation limits the desire of the management to use free cash flow to increase their income.

The advantage of increasing the insider ownership is to increase the interest fitness between the management and the owner. The insider ownership arises when the owner also act as the manager. Therefore, the greater the level of insider ownership that a business has the greater the fitness level and the level of controlling the management and the owner's interest (Jensen and Meckling (1976), Singh and Davidson (2003), and Maury (2006)). The management will have the decision based on the owner's interest if they have the proper incentives (Agrawal and Mandelker, 1987).

The increase of dividend payout ratio policy could decrease the agency problem among the management and the owner (Myers and Majluf (1984) and Borokhvich, Brunarski, Harman and Kehr (2005 )). The fund which is used to pay the dividend need to be replaced so that the petty cash will always be available. The connection between the three variables with reducing the agency problem is the controlling mechanism can be done to each variable individually and simultaneously. Kim and Lee (2003) and Maury (2006) describe that the decreasing agency problem could increase the business performance. Several empirical research by Morck, Shleifer, and Vishny (1988), McConnell and Serves (1990), Agrawal and Knoeber (1996), and Chen and Steiner (2000) uses Tobin's Q as the instrument to measure the business performance in term of agency problem. Based on the explanation above, this research uses empirical analysis to study on how to reduce the agency problem in small and medium family business (SMFB) in Yogyakarta, Indonesia. …

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