FOUNDING FAMILY OWNERSHIP AND FIRM PERFORMANCE

Transcription

1 FOUNDING FAMILY OWNERSHIP AND FIRM PERFORMANCE December 6, 2001 Ronald C. Anderson a and David M. Reeb b a Kogod School of Business American University 4400 Massachusetts Ave, NW Washington, DC randers@american.edu and b Corresponding Author: Kogod School of Business American University 4400 Massachusetts Ave, NW Washington, DC (202) reeb@american.edu Rough Draft Version 1 Both Professor Anderson and Professor Reeb would like to acknowledge support they received as Kogod Endowed Faculty Fellows, as well as additional support from American University.

2 Founding Family Ownership and Firm Performance ABSTRACT We investigate the relation between founding-family ownership and firm performance in large, publicly traded U.S. firms. We find that family ownership is both prevalent and substantial; families are present in one-third of the S&P 500 firms and account for over 18% of outstanding equity. Contrary to our expectations, we find that family firms are more profitable and more valuable than non-family firms. We also document that the relation between founding-family holdings and firm performance is nonlinear; performance first increases as the level of family ownership increases but then decreases with increasing family ownership. Additional analysis reveals that when a family member serves as the firm s CEO, firm performance is better than if an outsider is CEO. Overall, our results are inconsistent with the hypothesis that minority shareholders are adversely affected by continued founding family ownership and instead they suggest that family ownership represents an efficient organizational structure. 1

3 As the Hewletts, Packards and Fords are demonstrating, founding families often retain a surprising amount of influence on quoted companies. The Economist, November 17, 2001 Founding-family ownership and control in public firms is commonly perceived as a less efficient, or at the very least, a less profitable ownership structure. Fama and Jensen (1985) argue that combining ownership and control allows concentrated shareholders to exchange profits for private rents. Demestz (1983) suggests that such owners may choose non-pecuniary consumption and thereby draw scarce resources away from profitable projects. More generally, firms with large, undiversified owners such as founding families may forgo maximum profits because they are unable to separate their financial preferences with those of outside owners. Families also often limit executive management positions to family members suggesting a restricted labor pool from which to source qualified and capable talent; potentially leading to competitive disadvantages relative to nonfamily firms. 1 Overall, anecdotal accounts and prior literature generally suggests that separating ownership from control, as is implicit in most U.S. corporations, is an organizational form that leads to superior firm performance (Fama (1980), Fama and Jensen (1983)). The notion that large, concentrated shareholders are inherently less efficient is not a universal view. Berle and Means (1932), and Jensen and Meckling (1976) suggest that combining ownership and control may be advantageous. Specifically, the family s historical presence, largeundiversified equity position, and control of management and director posts place them in an extraordinary position to influence and monitor the firm (Shleifer and Vishny, 1997). Faccio et al (2001) suggest that family owners often have de facto control of the firm. Beyond monitoring and control advantages, James (1999) posits that families have longer investment horizons, leading to greater investment efficiency. If families have advantages in disciplining and monitoring managers, 2

4 extended investment horizons, and provide specialized knowledge, the question of whether founding-family presence hinders or facilitates firm performance becomes an empirical issue. We explore the relation between founding-family ownership and firm performance. Using accounting and market measures of firm performance, we conduct a time-series cross-sectional comparison of family and non-family firms. Our analysis also investigates the incremental impact on firm performance, if any, of placing a family member in the CEO position. Finally, we examine the impact of other large equity blockholders on firm performance in the presence of family ownership. Using the Standard & Poor s 500 firms from 1992 through 1999, we observe that founding families are a prevalent and important class of investors in most industry groups. Family firms constitute over 32% of the S&P 500 Industrials and, on average, families own nearly 18% of their firms outstanding equity. Contrary to the notion that family ownership is detrimental, we find stronger firm performance in family firms than non-family firms. Controlling for industry and firm characteristics, our analysis suggests that firms with continued founding-family presence exhibit significantly better accounting and market performance than non-family firms. We also present evidence that the relation between founding-family holdings and firm performance is nonmonotonic; performance first increases as family ownership increases but then decreases with increasing family ownership. At very high family-ownership levels, we find that firm performance is marginally worse versus non-family firms. Our investigation also indicates differential performance based on CEO status. Specifically, we find that family CEOs, founders or founder-descendants, exhibit a positive relation to accounting profitability measures. Market performance however appears to be better only in the presence of founder CEOs; founder descendants serving as CEO have no effect on market 1We find that family members serve as CEO in about 43% of the family firms in the S&P

5 performance. Our results for family ownership and family CEOs are statistically and economically significant and are robust to concerns of non-spherical disturbances, outliers, multi-collinearity, endogeneity, and alternative measures of the key variables. The remainder of this paper is organized as follows. Section I reviews the literature and presents our hypotheses. Sections II and III discuss the data, research design, and presents the empirical results of our large-sample comparisons of family and non-family firms. Section IV provides robustness tests and section V concludes the paper. I. Founding Family Ownership and Firm Performance Demsetz and Lehn (1985) note that U.S. public corporations typically feature a separation of ownership and control where professional managers rather than fragmented shareholders control important business decisions. Yet, Shleifer and Vishny (1986) document that large shareholders are common and in particular, note that founding families continue to hold equity stakes and board seats in nearly 33% of the Fortune 500 firms. These founding families represent a unique class of investors in that they hold poorly diversified portfolios, are long-term investors (multiple generations), and often control senior management positions. 2 As such, families are in an uncommon position to exert influence and control over the firm, potentially leading to performance differences with non-family firms. A. The Costs of Family Ownership With substantial ownership of cash flow rights, founding families have the incentives and power to take actions that benefit themselves at the expense of firm performance. For instance, Fama and Jensen (1985) posit that large undiversifed shareholders employ different investment 4

6 decision rules than atomistic shareholders. Diversified shareholders are presumed to evaluate investment decisions using market value rules that maximizes the value of firm s residual cash flow. Large concentrated shareholders however, may no longer receive maximum utility from enhancing firm value but rather garner greater benefits from pursuing objectives such as firm growth, technological innovation, or firm survival. Further, because firm survival is potentially of great importance to families, Shliefer and Vishny (1997) and Maug (1998) indicate that family owners are likely to seek avenues that minimize firm risk. Families for example may have strong incentives to undertake low risk investments, seek non-value enhancing corporate diversification, or use capital forms that reduce the probability of firm default. Barclay and Holderness (1989) note that large ownership stakes also reduces the probability of bidding by other agents, thereby reducing the value of the firm. Furthermore, the family s role in selecting managers and directors potentially creates further impediments for third parties in capturing control of the firm, suggesting greater managerial entrenchment and lower firm values relative to non-family firms. In fact, Shliefer and Vishny (1997) suggest that one of the greatest costs that large shareholders can impose is by remaining active in management even if they are no longer competent or qualified to run the firm. Families are also in a unique position to expropriate wealth directly from the firm through excessive compensation, related-party transactions, or special dividends. For instance, a recent recapitalization plan at Ford Motor increased the family s voting power without providing compensation to the firm s other shareholders; leading to widespread criticism that the board s plan benefited the family at the expense of other claimants. 2We find that families that appear in both Forbes Wealthiest Americans Survey and the S&P 500 have over 69% of their wealth invested in their firms. 5

7 In general, Demsetz (1983), and Demsetz and Lehn (1985) suggest that large shareholders such as founding families will ensure that management either through themselves or through professional managers serves family interests. 3 While families may pursue actions that maximize their personal utility, many of these same actions potentially lead to sub-optimal policies resulting in poor firm performance relative to non-family firms. 4 B. The Benefits of Family Ownership Although prior literature suggests that family ownership leads to poor firm performance (e.g. Faccio, et al., 2001), others posit that family influence is beneficial. Demsetz and Lehn (1985) argue that concentrated investors have substantial economic incentives to diminish agency conflicts and maximize firm value. Specifically, because the family s wealth is so closely linked to firm welfare, families may have strong incentives to monitor managers and minimize the free-rider problem inherent with small, atomistic shareholders. Grossman and Hart (1980) and Shleifer and Vishny (1997) support this notion by showing how firms with large incumbent shareholders could be more valuable than firms with small, diversified shareholders because of the large owner s incentive to monitor and discipline control agents. Founding families also often maintain a long-term presence in their firms. The DuPont family for instance has held a substantial equity stake (at least 15%) for over 200 years in the firm bearing their name. As such, families potentially have longer horizons than other shareholders, suggesting a willingness to invest in long-term projects relative to shorter managerial horizons. James (1999) supports this notion by showing in a two-period model that family ownership provides 3Demsetz and Lehn (1985) describe particular instances (e.g. Disney ) where families have derived nonpecuniary benefits by influencing firm policies in ways that were not profit maximizing but provided for their own utility. 4Bebchuck (1994) observes that concentrated owners negatively affect the value of the firm when they misapply their control position. 6

8 incentives to invest according to the market rule (i.e. positive NPV projects). Specifically, his model suggests that family firms invest more efficiently than non-family firms because the family intends to pass the firm onto succeeding generations. Following Becker (1974, 1981), Casson (1999) and Chami (1999) also concur with James by positing that founding families view their firms as an asset to pass on to their descendants rather than wealth to consume during their lifetimes. Firm survival is thus an important concern for families suggesting they are potentially long-term value maximization advocates. Founding families also face reputation concerns arising from the family s sustained presence in the firm and its effect on third parties. 5 The long-term nature of founding family ownership suggests that external bodies, such as suppliers or providers of capital, are more likely to deal with the same governing bodies and practices for longer periods in family firms than in non-family firms. Thus, the family s reputation is more likely to create longer-lasting economic consequences for the firm relative to non-family firms where managers and directors turnover on a relatively continual basis. In summary, large investors have substantial economic incentives to maximize firm performance and the influence and power to cause it to happen. If founding families provide competitive advantages to the firm, we expect to observe better firm performance in family firms versus non-family firms. C. Control of Management Positions by the Founding Family A common characteristic of family firms is that a family members often serve as the firm s CEO or fill other top management positions (e.g. Wm. C. Ford at Ford Motor). Family CEOs raise 5Fama (1980), Holmstrom (1982), and Gibbons and Murphy (1992) show that career concerns are important elements of managers total incentives. 7

9 two particular concerns. First, families can more readily align the firm s interests with those of the family, suggesting that the effects of family ownership on firm performance are potentially magnified in the presence of a family CEO. Demsetz and Lehn (1985) argue that families are more likely to supply top managers when they can better meet their consumption goals through the firm rather than through their wealth. Second, family members potentially place one of their own members in the CEO position at the cost of excluding more capable and talented outside, professional managers. For example, Wang Laboratories, once a highly profitable and viable business while under the control of the firm s founder, suffered severely under the founder s son. Prior research on small private firms suggests that founder s exhibiting a bias towards other family members entering the business, results in suboptimal investments and lower profitability (Singell and Thornton, 1997). Gomez-Mejia, et al. (2001) extend this argument and suggest that family CEOs are potentially less accountable to shareholders and directors than outside, professional managers. Schulze, et al. (1999) note that placing family members as CEO can lead to resentment on the part of senior non-family executives because tenure, merit, and talent are not necessarily requisite skills for top management positions. 6 Although restricting executive talent to a labor pool of family members can be problematic, a family CEO can bring special skills and attributes to the firm that outside managers do not possess. Morck, Shleifer, and Vishny (1988) suggest that founder CEOs as entrepreneurs, bring innovative and value-enhancing expertise to the firm. Moreover, Davis et al (1997) argue that family members act as stewards and, as such, identify strongly with the firm and view firm performance as an extension of their own well-being. Anderson, Mansi, and Reeb (2001) suggest that the family s 6Johnson et al (1985) and Morck, Shleifer, and Vishny (1988) suggest that founder CEOs are associated with strong performance early in their careers, poorer performance in later years, and that family member CEOs aremore entrenched in their positions. 8

10 sustained presence in the firm also creates powerful reputation effects that provide incentives for family managers to improve firm performance. D. Research Focus Our central question is the relation between family ownership and firm performance. The differing financial preferences of family and minority shareholders, the potential for non-pecuniary benefits for family members, and the restricted tradability of their claims suggest that family ownership represents a less efficient organizational form. Yet, arguments of extended horizons, family loyalty, and concerns over reputation suggest families hold strong incentives to ensure firm profitability. Ultimately, the family s influence on firm performance is an empirical issue that we investigate in this study. We address three basic issues. First, are family firms less profitable or less valuable than non-family firms? Second, if founding family ownership influences performance, is the performance/ownership relation linear over all ranges of family holdings? Third, does the level of family involvement or family members acting as CEO negatively impact firm performance? Our investigation provides a comprehensive analysis of these questions, using firm-level data on large publicly traded US firms. II. Sampling and Data Collection A. The Sample For our investigation of family influence on firm performance, we use the Standard & Poors 500 firms as of December 31 st, 1992 as our sample. 7 Consistent with Friend and Lang (1988), we exclude banks and public utilities from the sample. Our primary reasons for eliminating these firms 7We place no constraints on our firms other than they are members of the 1992 S&P 500. At the beginning of sample (January 1993), we have 403 firms. At the end of the sample period (December, 1999), we have 329 firms or a 19% drop out rate. 9

11 is due to the difficulty in calculating Tobin s Q for banks and because government regulation may effect the way that families retain their ties with the firm. We collect data on board structure, CEO characteristics, independent blockholdings, family attributes, and firm characteristics from 1992 through 1999 on 403 non-utility/non-banking firms yielding 2,723 firm-years or observations. From table 1, our analysis suggests that family firms are present in 72% of the SIC codes in the S&P 500, indicating that families operate in a board array of industries. We note however, that family firms appear to be the prevalent organizational forms in lumber and wood products (24), printing and publishing (27), rubber and miscellaneous plastic materials (30), electric, gas and sanitary services (49), food stores (54), apparel and accessory stores (56), eating and drinking places (58), miscellaneous retail (59), and business services (73). 8 This suggests the importance of controlling for industry affiliation in our empirical analysis. B. Ownership Structure Family Ownership In our data collection efforts, one of our primary concerns is the determination of family firms. Prior research provides little guidance on how to ascertain family firms. As such, we use the fractional equity ownership of the founding family and/or the presence of family members on the board of directors to identify family firms. For some of our younger firms, this determination is straightforward since the proxy statement denotes the founder, his/her immediate family members, and their holdings. However, several generations after the founder, the family expands to include distant relatives such as second or third cousins whose last names may no longer be the same. We 8This examination is based on industries with 5 or more firms and where family firms are at least 50% of the firms in the industry. 10

12 resolve descendant issues by examining corporate histories for each firm in our sample. Histories are from Gale Business Resources, Hoovers, and from individual companies. While the fractional holdings of family members provides a measure of control similar to other ownership studies, it may understate (overstate) the influence that family members exert on the firm. For instance, the Ablon family is viewed as controlling the Ogden Corporation as if they were the majority owners but they hold roughly 2% of the outstanding shares, while at Nordstrom s the family has retained 24% of the shares in order to maintain control. To address this uncertainity, we create a dummy variable that equals 1 when founding families hold shares in the firm or when founding family members are present on the board of directors. It is our belief that we have captured all family firms and their equity holdings. Yet, to the extent that we may have excluded firms with a family designation or their shareholdings, this should bias our results towards zero and make family influence more difficult to detect in our analysis. 9 C. Governance Characteristics Prior research suggests that corporate governance mechanisms influence firm performance. We therefore include various measures of governance in our analysis. We use annual corporate proxy statements to collect data on the size and composition of the board of directors. Composition is established using a director classification scheme similar to the categorization in Brickley, Coles, and Terry (1994). Directors currently employed by the firm or retired and their 9Our estimates of the fractional holdings of families are possibly biased downwards due to reporting requirements. For instance, two great grandchildren of Schlumberger Limited s founder serve on the current board of directors. From 1992 to 1997, the aggregate ownership reported in the proxy statement of these two directors is 1.3%. However, in 1998, their aggregate holdings increase to 5% because their mother passes away and they inherit an additional 25 million shares that were not previously reported in the proxy statement. The Securities Exchange Act of 1934 only requires that officers and directors, and 5% owners report their holdings. Thus, several family members could hold 4.9% of the firm, not serve as an officer or director, and we would not capture this as family ownership. This suggests the use of a binary indicator variable to denote family firms. 11

13 immediate families are identified as insiders. Outside directors are identified as members whose only affiliation with the firm is their directorship. Affiliated or gray directors are those board members with existing or potential business ties to the firm. We collect board information for every other year of our sample period; 1993, 1995, 1997, and We also incorporate a CEO compensation measure into the analysis because of the relation between executive pay and firm performance. Our measure, pay mix, is defined as equity based pay (new options) divided by the sum of equity based pay, salary and annual bonus. Compensation data comes from S&P s CompuExec. Other large shareholders such as mutual or pension funds may also play a significant role in monitoring and disciplining managers. As such, the family s voice and control in the firm may be substantially smaller in the presence of outside blockholders. From corporate proxy statements, we identify all blockholders with at least a 5% equity stake in the firm. Blockholders are defined as affiliated or unaffiliated where an unaffiliated blockholder is defined as an entity with no relation with the firm other than their equity holdings. We develop a ratio to proxy for the family s influence in the firm relative to outside blockholdings; family holdings divided by outside blockholdings. D. Performance Measures Tobin s Q and return on assets (ROA) are our primary performance measures. We follow Perfect and Wiles (1994) and Yermack (1996), and estimate Tobin s Q (Q) as the market value of total assets divided by the replacement cost of assets. We estimate the replacement cost of assets using Yermack s (1996) algorithm. Return on assets (ROA) is computed in two ways. In one approach, we use net income scaled by the book value of total assets. In the second approach, we use earnings before interest, tax, depreciation and amortization (EBITDA) divided by the book value of total assets. 12

14 E. Control Variables We introduce several control variables into our regression analysis to control for industry, and firm characteristics. Casson (2001) suggests that the characteristics of family firms could be different from non-family firms (e.g. smaller). Firm-specific control variables are calculated with data drawn from the Compustat Industrial Files. Firm size is the natural log of the book value of total assets. Growth opportunities are proxied by ratio of research and development expenses to total sales. Firm risk is the standard deviation of monthly stock returns for the prior 60 months. We control for debt in the capital structure by dividing long-term debt by total assets. III. Summary Statistics Table II presents descriptive statistics for our sample of firms. The table provides means for the entire (pooled) sample, family firms, and non-family firms. The last column of the table provides t-statistics for difference in means tests between family and non-family firms. Family firms represent 32.5% (882 observations) of our sample. We adjust the t-statistics for serial correlation because the variables are unlikely to be independent from year-to-year. Rows 3, 4, and 5 provide information on the frequency of family CEOs. We find that among family firms that 45.7% of the CEOs are family members and 54.3% are outsiders, that is, hired-hands. Of the 45.7% family CEOs, we note 14.9% are founders and 30.80% are founder descendants. Row 9 shows that family firms, on average, are 37.1% smaller than nonfamily firms but still of substantial size with mean total assets of $9.314billion. Family firms also appear to use slightly less debt; their long-term debt ratio is 18.1% versus 19.0% for non-family firms. Rows 11 through 15 present accounting and market performance for our firms. With respect to accounting performance, we find little difference in the univariate analysis between family and nonfamily firms with the exception of ROA (using net income as the numerator). ROA 13

15 indicates that family firms are stronger performers than non-family firms. Market performance, Tobin s Q, also suggests that market participants place a significantly greater value on family firms (1.582) versus nonfamily firms (1.332), t=6.76. Corporate governance characteristics are shown in rows 16, 17, and 18 indicating systematic differences between family and non-family firms. Outside directors for instance, hold less than a majority of board seats in family firms (43.7%) whereas the boards of non-family firms have a substantial majority of independent directors (60.7%). In addition, we also note that CEOs in family firms earn nearly 7% less of their total pay in equity-based forms compared to CEOs in non-family firms. If families seek to entrench themselves and extract private rents from the firm, the lack of strong external monitors and discipline agents potentially permits them to pursue this path. Because of observable firm and industry characteristics that potentially affect firm performance, we examine the individual control mechanisms in the following section using multivariate analysis. IV. Family Ownership and Firm Performance Our main interest is the relation between founding family ownership and firm performance. The analysis also incorporates variables that identify CEOs as firm founders or descendants of the firm s founder. We use a two-way fixed effects model for our regression analysis: the fixed effects are dummy variables for each year of the sample and dummy variables for each 2-digit SIC code. The regression equation we employ for our multivariate analysis takes the form: Firm Performance = δ 0 + δ 1 (Family Firm) + δ 2 (CEO Founder) + δ 3 (CEO Descendant of Founder) + δ 4 (Control Variables) + δ 1-54 (2 Digit SIC Code) + δ (Year Dummy Variables) + ε (1) where; Firm Performance = ROA based on EBITDA and net income, and Tobin s Q. 14

16 Family Firm = binary variable that equals 1 when the founding family is present in the firm and 0 otherwise. CEO Founder = 1.0 if the CEO is founder of the firm and zero otherwise. CEO Descendant of Founder = 1.0 if the CEO is a descendant of the firm s founder and zero otherwise. Control Variables = natural log of total assets, research and development expenses divided by total sales, long-term debt divided by total assets, stock return volatility, equity holdings of officers and directors less family holdings, fraction of independent directors, fraction of equity based pay. 2-Digit SIC Code = 1.0 for each different 2-digit SIC code in our sample. Year Dummy Variables = 1.0 for each year of our sample period. Our data spans from 1992 through 1999 and covers 403 firms. Because our observations are unlikely to be independent from year-to-year, we control for serial correlation using the Huber/White/sandwich estimator for variance. Table 3 presents results using accounting performance measures. In columns 1 and 2, we use return on assets (ROA) calculated with earnings before interest, tax, depreciation, and amortization (EBITDA). Columns 3 and 4 show ROA using net income as the numerator. Columns 2, and 4 include binary variables to denote founder CEOs and founder-descendant CEOs. Contrary to our primary hypothesis, we find no evidence that firm performance is inferior in family firms versus non-family firms. The family-firm binary coefficients in the regressions in table 3 suggest that ROA (columns 1 and 3) is better in family firms compared to non-family firms. However, the t-statistics indicate that the significance levels are only marginal at the 15% level 10. The inclusion of family-ceo variables suggests that the improved performance differentials we observe in family firms is primary driven by having founder and founder descendants serving as the firm s CEO. The firm s ROA is better by 3.7% and 1.1%, respectively, when the firm s founder or a descendant of the founder serves as CEO. 10We also repeat the analysis using return on equity (ROE) as the performance measure. Consistent with the ROA results we find no evidence that the family firms perform worse than non-family firms. 15

17 Table 4 examines market, rather than accounting, performance for family and non-family firms. Using the same regression specification and using an approximation of Tobin s Q for the dependent variable, we find evidence that the market places greater value on family firms than nonfamily firms. Tobin s Q for family firms is 11.6% larger compared to non-family firms. 11 After including the family-ceo variables, we still find that family firms have superior market valuations versus non-family firms. The prior analysis with accounting measures suggests that both founder CEOs and founder-descendant CEOs are associated with better firm performance. With Tobin s Q however, we find that the market only places greater valuations on founder CEOs; the coefficient on founder-descendant CEOs is insignificant. V. Non- Linearities between Firm Performance and Founding Family Ownership The results from the prior section suggest that founding-family presence exhibits a positive association with accounting and market performance. In this section, we examine the possibility of non-linearities between firm performance and family ownership. Previous research suggests that the relation between equity ownership structure and firm performance may be non-linear if the incentive structure of the equity claimant changes as holdings increase (e.g. Morck, Shliefer, and Vishny. 1988). We modify our regression specification by including family ownership and the square of family ownership, as continuous variables. 12 The results are in table 5 with columns 1 and 2 using accounting measures, while column 3 uses market performance or Tobin s Q. The results indicate that the relationship between firm performance and founding family ownership is non-linear. Beginning with ROA using EBITDA (net income), column 1 (2) suggests 11We calculate this as the coefficient estimate of family firms (0.164) divided by the average Tobin s Q for the sample (1.415). 12Himmelberg, Hubbard, and Palia (1999) and McConnell and Servaes (1990) also use ownership and square of ownership to capture non-linearities. In their models however, they examine managerial holdings rather than family ownership. 16

18 firm performance increases with increasing family ownership up to 30.9% (33.1%) of outstanding equity held by the family. After reaching a maximum performance level at 30.9% family ownership, we find additional equity holdings by the family are associated with declining firm performance. Using Tobin s Q (column 3) we find a similar relation with an inflection point or maximum performance at 33.2% family ownership 13. Overall, our analysis suggests that the relation between founding family holdings is not uniform over the entire range of family ownership; firm performance first increases as family ownership increases but then decreases with increasing family ownership. VI. On the Endogeneity of Family Ownership and Firm Performance As in most empirical work, our analysis suffers from a potential endogeneity problem. For our purpose, the issue is whether family ownership improves performance or strong performance prompts families to maintain their holdings. Families, because of their large equity stakes and frequent control of senior managerial positions, arguably have information advantages over the firm s other shareholders. As such, families can more readily ascertain the firm s future prospects suggesting they retain ties to only those businesses with favorable outlooks. While founding families may have superior information, the argument for greater performance causing family holdings is troublesome for two reasons. First, families have held their stakes on average for 75.9 years, suggesting exceptional foresight by the family in predicting performance. Second, it implies that families, as investors, have special insights (beyond those held by other large shareholders such as institutional investors) in ascertaining future firm performance. However, to the extent that family ownership is potentially a function of superior firm performance, 13Including family CEO variables, we also find a statistically significant, curvilinear relation between family holdings and Tobin s Q (inflection point is at 34.0%). 17

19 we follow Himmelberg, Hubbard, and Palia (1999) and use instrumental variable regressions to estimate the relation between family ownership and firm performance. Demsetz and Lehn (1985) suggest that ownership is a function of firm size and risk. Accordingly, we model family ownership using the natural log of total assets, the square of the natural log of total assets, and monthly stock return volatility as our instruments. Table 6 presents instrumental variable, two-stage least squares (IV-2SLS) estimates using the Himmelberg et al regression equation. We follow their model using the same variables, for our sample, to provide consistency and comparison to prior empirical work. Columns 1 and 2 use accounting measures of performance and column 3 uses our market performance metric. Overall, our estimates from the IV-2SLS regressions are consistent with our prior OLS results, suggesting that family firms are superior performers relative to non-family firms. The coefficients on the family firm variable are significant and positive using accounting or market performance measures. VII. Robustness of Model Specifications An assumption of our analysis is that the specifications and proxies adequately capture the appropriate attributes. We find that our results are also robust to various alternative specifications. First, we use an alternative approach to investigate non-linearities in family ownership and firm performance. Specifically, we explore a piece-wise linear regression model with breakpoints estimate using switching point regressions. We explore both two-piece and three-piece models and estimate the breakpoints by choosing the models that minimizes the unexplained variance of the regression. We find evidence supporting both two and three piece models. Regardless of the specification chosen, we find that families firms perform at least as well as non-family firms. Specifically, we find that performance is first increasing and then decreasing family ownership. 18

20 To test the sensitivity of our results in the presence of outliers and influential observations, we eliminate observations that the R-Student and the DFFITS statistics indicates as influential. These tests examine a sample to determine if any observations have a dramatic effect on the fitted least-squares funciton. The results are similar to those reported in the tables and do not change substantively when truncated for outliers at the largest one, three, or five percent levels for each tail of the distribution for the model variables. Further, because firm-year observations may intensify the outlier bias, we repeated the analysis using pooled regressions which also leads to similar results. VIII. Summary and Conclusion Our large-sample, cross-sectional analysis indicates that family firms perform at least as well non-family firms. Using profitability based measures of firm performance (ROA) we find that family firms are significantly more profitable than non-family firms. This result is surprisingly robust to the measurement of ROA and is inconsistent with the hypothesis that family ownership is inherently less efficient. Further testing suggests this greater profitability in family firms, relative to non-family, stems from those firms in which a family member serves as the CEO. One interpretation is that the family understands the business and that involved family members view themselves as the stewards of the firm. Using market based measures of firm performance provides additional evidence that family firms are at least as valuable as non-family firms. Specifically, we document that family firms have higher Tobin s Q values than non-family firms in both the univariate and multivariate testing. These results are both statistically and economically significant, with family firms enjoying about an 11.6% greater Tobin s Q, relative to non-family firms 14. Focusing on the impact of family members as 14This is computed by dividing the coefficient estimate for the binary family firm indicator variable by the average Q value in the sample. 19

21 CEO, indicates that founder CEO s are associated with the greatest value gains, but that even in families with hired hands or descendent family members as CEO, the firm is still more valuable. The analysis also shows that the relation between family ownership in large public firms and firm performance is not uniform across all levels of family ownership. Specifically, we find that performance is first increasing and then decreasing in ownership (using both accounting and market based measures). This suggests that large family holdings potentially lead to wealth expropriation from minority shareholders or that families are better able to entrench themselves at the expense of other claimants. Taken as a whole, our evidence implies that family firms perform as well as, if not better than non-family firms. Yet, Faccio, et al. (2001) suggest that family ownership in East Asia leads to severe conflicts with other claimants and hampers firm performance. Perhaps differences in the rules governing the treatment of minority shareholders, the greater disclosure of firm data in the US, the prevalence of cross-shareholding networks outside the US, or the influence of other influential claimants explains these differing inferences about family ownership and control in the US and Asia. At a minimum, however, our results imply that continued founding family ownership, in and of itself is not necessarily a less efficient organizational structure. Instead, it may be that the ability of outsiders to monitor firm activity is an important attribute in minimizing family manipulations. 20

22 References Becker, G., 1974, A Theory of Social Interactions, Journal of Political Economy, Nov./Dec., Becker, G., 1981, A Treatise on the Family, 2 nd Edition, Cambridge, MA, Harvard University Press. Beim, D., 1992, Estimating bond liquidity. Working Paper, Columbia University. Berle, A. and G. Means, 1932, The Modern Corporation and Private Property. New York, Mac Millon. Casson, M., 1999, The Economics of the Family Firm, Scandinavian Economic History Review 47, Chami, R., 1999, What s different about family business?, Working Paper, University of Notre Dame and the International Monetary Fund. Demsetz, H., and K. Lehn, 1985, The structure of corporate ownership: Causes and Consequences, Journal of Political Economy 93, Duffie, G., 1998, The Relationship between Treasury Yields and Corporate Bond Yield Spreads, Journal of Finance, 103, Elton, E. and M. Gruber, 1995, Modern Portfolio Theory and Investment Analysis, New York, John Wiley & Sons. Fama, E., M. Miller, 1972, The Theory of Finance, Hinsdale, IL, Dryden Press Filatotchev, I., T. Mickiewicz, 2001, Ownership Concentration, Private Benefits of Control, and Debt Financing, working paper, University of London and University College London Gersick, K., J. Davis, M. Hampton and I. Lansberg, 1997, Generation to generation: Life cycles of the family business, Boston: Harvard Business School Press. Gibbons, R., and K. Murphy, 1992, Optimal incentive contracts in the presence of career concerns: Theory and evidence, Journal of Political Economy 100, Gomez-Mejia,L. M. Nunez-Nickel, and I. Gutierrez, 2001, The role of family ties in agency contracts, Academy of Management Journal 44, Green, R., and B. Odegaard, 1997, Are there tax effects in the relative pricing of U.S. government bonds, Journal of Finance 52, Himmelberg, C., R. Hubbard, and D. Palia, 1999, Understanding the determinants of managerial ownership, Journal of Financial Economics, 53: Holmstrom, B., and R. Costa, 1986, Managerial incentives and capital management, Quarterly Journal of Economics 101,

23 Jensen M. and W. Meckling, 1976, Theory of the firm: Managerial behavior, agency costs and ownership structure, Journal of Financial Economics 3, Johnson, B., R. Magee, N. Nagarajan, and H. Newman, 1985, An analysis of the stock price reaction to sudden executive deaths: Implications for the management labor market, Journal of Accounting and Economics 7, Jewel, J. and M. Livingston, 1998, Split ratings, bond yields, and underwriter spreads, Journal of Financial Research 21, McConnell, J. and H. Servaes, 1990, Additional evidence on equity ownership structure, and firm performance, Journal of Financial Economics, 27, Morck, R., A. Shleifer, and R. Vishney, 1988, Management ownership and market valuation: An empirical analysis, Journal of Financial Economics 20, Myers, S., 1977, Determinants of corporate borrowing, Journal of Financial Economics 5, Mueller, H. and R. Inderst, 2001, Ownership concentration, monitoring, and the agency cost of debt, Working Paper, University of Mannheim. Nelson C. and A. Siegel, 1987, Parsimonious Modeling of Yield Curves, Journal of Business 6, Neter, J., M. Kutner, C. Nachtsheim, and W. Wasserman, 1996, Applied Linear Regression Models. Irwin-McGraw Hill Publishing. Reeb, D., S. Mansi, and J. Allee, 2001, Firm internationalization and the cost of debt financing: Evidence from non-provisional publicly traded debt, Journal of Financial and Quantitative Analysis 36, Shleifer, A. and R. Vishny, 1997, A Survey of Corporate Governance, Journal of Finance 52, Tufano, P., 1996, Who manages risk? An empirical examination of risk management practices in the gold mining industry, Journal of Finance 51, White, H., 1980, A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity, Econometrica 48,

24 Table 1 Number and Percent of Family and Non-family Firms by 2 Digits SIC Code Number and percent of firms by two-digit standard industry classification code. Non-family refers to those firms without family ownership or family presence on the board of directors. SIC Industry Description Non-Family Firms Family Firms Percent Family Firms in Industry 10 Metal, mining Oil and gas extraction General building contractors Heavy construction, except buildings Food and kindred products Tobacco Products Textile mill products Apparel and other textile products Lumber and wood products Furniture and fixtures Paper and allied products Printing and publishing Chemical and allied products Petroleum and coal products Rubber and misc. plastic products Leather and leather products Stone, clay, & glass products Primary metal industries Fabricated metal products Industrial machinery and equipment Electronic and other electrical equip Transportation equipment Instruments and related products Miscellaneous manufacturing prods Railroad Transportation Trucking and warehousing Transportation by air Communications Electric, gas & sanitary services Wholesale trade - durable goods Wholesale trade - nondurable goods Building materials and gardening General merchandise stores Food stores Auto dealers and service stations Apparel and accessory stores Furniture and home finishings Eating and drinking places Miscellaneous retail Non-depository institutions Security and commodity brokers Insurance carriers Insurance agents, brokers, services Hotels and other lodging places Personal services Business services Auto repair, services and parking Motion pictures Amusement and recreation services Health services Engineering and management serv

25 Table 2 Summary Statistics This table provides summary statistics for the data employed in our analysis. The data set is comprised of 2,723 firm-year observations from for S&P 500 firms. Pooled Family Firms Non- Family Firms t-statistic 1 Observations 2, ,833 2 Family Ownership (%) * 3 Founder CEOs (%) * 4 Descendant CEOs (%) * 5 Outside CEOs (%) * 6 R & D/Sales (%) LT Debt/Total Assets (%) ** 8 Return Volatility Ln (Total Assets) ($000,000) 12,987 9,314 14, * 10 Firm Age (Years) * 11 Return on Assets (EBITDA) (%) Return on Assets (Net Income) (%) * 13 Return on Equity (EBITDA) (%) Return on Equity (Net Income) (%) Tobin s Q * 16 Officer and Directors Ownership (less family) (%) Outside Directors (%) * 18 Outside Blockholdings (%) * 19 CEO Equity Based Pay (%) * *, ** Significant at the 1% and 5% level, respectively. 24

26 Table 3. Accounting Measures of Performance and Founding Family Ownership This table gives the estimated coefficients from regressing return on assets (ROA) on a binary indicator of family ownership and various control variables. The specification is: ROA = δ 0 + δ 1 (Family Firm) + δ 2 (CEO Founder) + δ 3 (CEO Descendant of Founder) + δ 4 (Control Variables) + δ 1-54 (2 Digit SIC Code) + δ (Year Dummy Variables) + ε where ROA is based on EBITDA and net income, Family Firm is binary variable that equals 1 when the founding family is present in the firm and 0 otherwise, CEO Founder is equal to 1.0 if the CEO is founder of the firm and zero otherwise, CEO Descendant of Founder is equal 1.0 if the CEO is a descendant of the firm s founder and zero otherwise, Control Variables (natural log of total assets, research and development expenses divided by total sales, long-term debt divided by total assets, stock return volatility, equity holdings of officers and directors less family holdings, fraction of independent directors, fraction of equity based pay), 2-Digit SIC Code equal to 1.0 for each different 2-digit SIC code, and Year Dummy Variables that equal 1.0 for each year of our sample period. Variable Return on Assets Return on Assets (Using EBITDA) (Using Net Income) (1) (2) (3) (4) Intercept * (4.10) * (4.06) * (7.32) * (6.80) Family Firm (1.55) (0.44) (1.78) (0.59) CEO Founder ** (2.15) * (2.71) CEO Descendant ** (2.18) ** (2.04) Officer and Directors Ownership (less family) (0.29) (0.65) (0.93) (1.21) Outside Directors (1.48) (1.22) (0.31) (0.21) CEO Equity Based Pay (1.06) (1.44) (1.49) ** (2.01) R & D/Sales * (3.09) * (2.74) (1.58) (1.33) LT Debt/Total Assets (0.97) (1.04) * (9.37) * (9.60) Return Volatility * * * * (4.47) Ln (Total Assets) (0.68) (4.98) (0.73) (4.45) (1.76) (4.65) (1.62) Adjusted R Square *, ** Significant at the 1% and 5% level, respectively. The t-values, given in parenthesis below each estimate, are corrected for heteroskedasticity. 25

27 Table 4. Market Measures of Performance and Founding Family Ownership This table gives the estimated coefficients from regressing Tobin s Q on a binary indicator of family ownership and various control variables. The specification is: Tobin s Q = δ 0 + δ 1 (Family Firm) + δ 2 (CEO Founder) + δ 3 (CEO Descendant of Founder) + δ 4 (Control Variables) + δ 1-54 (2 Digit SIC Code) + δ (Year Dummy Variables) + ε where Tobin s Q is as the market value of total assets divided by the replacement cost of assets, Family Firm is binary variable that equals 1 when the founding family is present in the firm and 0 otherwise, CEO Founder is equal to 1.0 if the CEO is founder of the firm and zero otherwise, CEO Descendant of Founder is equal 1.0 if the CEO is a descendant of the firm s founder and zero otherwise, Control Variables (natural log of total assets, research and development expenses divided by total sales, long-term debt divided by total assets, stock return volatility, equity holdings of officers and directors less family holdings, fraction of independent directors, fraction of equity based pay), 2-Digit SIC Code equal to 1.0 for each different 2-digit SIC code, and Year Dummy Variables that equal 1.0 for each year of our sample period. Dependent Variable = Tobin s Q (1) (2) Intercept * (7.51) * (7.64) Family Firm ** (2.19) (1.78) CEO Founder ** (2.08) CEO Descendant (0.37) Officer and Directors Ownership (less family) (0.93) (0.99) Outside Directors (0.11) (0.13) CEO Equity Based Pay * (2.71) * (2.98) R & D/Sales * (5.14) * (4.74) LT Debt/Total Assets * (4.67) * (4.78) Return Volatility * (5.41) * (5.67) Ln (Total Assets) ** (2.12) ** (2.34) Adjusted R Square *, ** Significant at the 1% and 5% level, respectively. The t-values, given in parenthesis below each estimate, are corrected for heteroskedasticity. 26