THE EFFECT OF DIFFUSION OF FOUNDING FAMILY INFLUENCE AND INSIDER HOLDING ON FIRM VALUE: THE MODERATING EFFECT OF PYRAMIDAL OWNERSHIP

THE EFFECT OF DIFFUSION OF FOUNDING FAMILY INFLUENCE AND INSIDER HOLDING ON FIRM VALUE: THE

MODERATING EFFECT OF PYRAMIDAL OWNERSHIP

Sanjay Goel *

Labovitz School of Business and Economics University of Minnesota Duluth

412 Library Drive Duluth MN 55812-3029, USA

Phone (1) 218-726-6574 FAX (1) 218-726-7578 E-mail: sgoel@d.umn.edu

Trond Randøy Agder University Bygg H, Serviceboks 422 N-4604 Kristiansand, NORWAY

Phone (47) 3814 1525 Fax (47) 3814 1027 E-mail: trond.randoy@hia.no

Virginia Blanco Universidad de Burgos

C/Parralillos s/n 09001 Burgos, SPAIN Phone (34) 947 259035

Fax (34) 947 258960 E-mail: vblanco@ubu.es

*Corresponding author

An earlier version of this paper was presented at 2007 Family Enterprise Research Conference, Monterrey, Mexico. Peter Jaskiewicz, Torsten Pieper, Ranjan Karri, Juan Bautista Delgado, Juan Manuel de la Fuente and Esther de Quevedo, provided valuable comments on an earlier version. They are of course not responsible for any errors that remain. Sanjay Goel and Virginia Blanco thank Blekinge Institute of Technology, Ronneby, Sweden, and Agder Maritime Research Foundation, Kristiansand, Norway, for research assistance and support during Autumn 2006, which made the collaboration among the authors possible.

THE EFFECT OF DIFFUSION OF FOUNDING FAMILY INFLUENCE AND INSIDER HOLDING ON FIRM VALUE: THE

MODERATING EFFECT OF PYRAMIDAL OWNERSHIP

ABSTRACT

Insights from agency theory and the theory of altruism are used to empirically examine the relationship between founder descendant board membership and the market value of publicly traded firms in Norway, Sweden, and Spain. We argue that both economic incentives and positive altruism drive the board room behavior of persons associated with inherited wealth. Consequently, founder descendant board membership may reduce agency costs in public firms by ensuring the continuity of the founder’s strategic vision. We also hypothesize a non-linear relationship between insider holding and firm value in firms with a descendant board member, arguing that both market discipline and altruistic behavior can be key competitive advantage for family- influenced firms. We also hypothesize an efficiency based argument for a positive influence of pyramid ownership structures on the performance of firms with descendant board membership. This suggests that pyramids favor the creation of firm value in second and later generation family firms. Evidence from 254 firms in the three non- Anglo-American countries largely supports the presented hypotheses.

Keywords: family firms; founder descendant board membership, corporate governance, insider ownership, pyramid ownership structure, Spain, Scandinavia

1. INTRODUCTION

A popular assertion about family firms is that by the third generation the firm is heading for decline (Ward, 1987). Recent studies also suggest that it is paramount to distinguish between founding influence (i.e. first-generation family influence) and descendant influence (i.e. influence of the family via second or later generations).

Several authors (Morck, Shleifer and Vishny, 1988; McConaughy, Walker, Henderson and Mishra, 1998; Anderson and Reeb, 2003; Adams, Almeida and Ferreira, 2005;

Fahlenbrach, 2006; Villalonga and Amit, 2006a and Barontini and Caprio; 2006) agree that family firms are better performers than are non-family firms when the founder remain active within the firm –in any of the positions he/she holds in the firm. However, the impact of descendant influence on firm value is controversial. Extant theory

provides argument that both favor and disfavors descendant influence in family firms.

For instance, agency theory suggests that managerial ownership is – as is the case of family ownership in public firms – aligns management interests to increase firm value (Jensen and Meckling, 1976). It has also been suggested that family involvement can also have a positive influence on firm value, due to extended time horizons, family ties (that allow for social control), quality of relations (based on trusts and altruism), and a desire to develop a long-term reputation (of firm and family), (James, 1999; Miller and Le Breton-Miller, 2005; Karra, Tracey and Phillips, 2006). However, in case of family ownership the managerial position is also susceptible to entrenchment and nepotism – as the owning family can recruit from a restricted labor pool for both board members and top managers (Burkart, Panunzi and Shleifer, 2003). The issue has not received unequivocal support either. For instance, McConaughy et al., (1998) and Sraer and Thesmar (2006) show that family firms with descendant CEO are better performance than non-family firms. Anderson and Reeb, (2003) and Barontini and Caprio (2006),

however, suggest that descendants serving as CEO have no effect on market

performance. And, Morck et al., (1988) and Villalonga and Amit, (2006a) find that firm value is destroyed when a descendant of the founding family serves as a CEO (see also Smith and Amoako-Ado, 1999; Pérez-González, 2006; Hillier and McColgan, 2005).

The scarce evidence over the influence of descendant family members on the board is also controversial. For instance, Barontini and Caprio (2006) show that family firms perform better than non-family ones when descendants sit on the board, whereas Villalonga and Amit (2006a) report that firm value is destroyed when a founder’s descendants serve as Chair. In this paper we focus on investigating this link, with specific focus on the use of pyramid ownership structures by family firms.

The purpose of this paper is to address the effect of descendant board influence on firm value. Furthermore, we analyze the influences that a descendant board member has on the relation between ownership structure and value creation. Additionally, we also analyze the potential impact that a specific control enhancing mechanism, pyramid ownership structure, has on the value of firms with descendant board membership. We theorize that a family descendant’s board membership has, on balance a positive effect on firm value. In addition, we hypothesize an inverted u relationship between insider ownership and performance in firms with descendant board membership influence.

Finally we suggest that there is a positive impact of pyramids on firm value within firms with descendant board membership.

Whereas the widely held public firm has historically been the focus of corporate governance research, the common organizational form among listed firms in most countries, is the closely held firm (La Porta et al., 1999; Shleifer and Vishny, 1997;

Faccio and Lang, 2002). We empirically test for a firm value effect of descendant board membership by using a sample of Swedish, Norwegian and Spanish publicly traded

companies. Firms from Anglo-American countries, whose laws originate in the

common-law tradition, tend to protect shareholders considerably more than continental European countries, whose legal rules originate in the civil-law (La Porta et al., 1998).

With weak protection of minority shareholders, concentrated ownership may be the only governance mechanism that limits expropriation by managers (Shleifer and Vishny, 1997). However, the lower level of minority shareholder protection allows large shareholders more discretion – and a greater potential for expropriation from minority shareholders – (Franks, Mayer and Rossi, 2004). This makes Scandinavia and Spain an especially useful empirical context when testing the potential negative and positive effects of one specific kind of closely held public firms, those with descendant family influence. Given the fact that a large share of public companies around the world are controlled by families, and sooner or later ownership control is inherited (Pérez- González, 2006), this issue is of great practical importance. Again this issue is

especially germane in Scandinavia and Spain, where there is a larger proportion of firms with pyramidal ownership structures, which allow an entity (family or non-family) to control conglomerates by holding a minority of shares. We also address this issue in this paper.

2. THEORETICAL BACKGROUND

Family influence offers the firm both advantages and disadvantages. One of the main arguments for the existence of the family firm advanced by earliest extant literature is the coincidence between control and management decisions (Jensen and Meckling, 1976; Dalton and Daily 1992), which supposedly reduces the agency costs of separation of ownership and control. Although this argument could be applied to any kind of closely held firms, the strong ties that unite family members give advantages in monitoring and disciplining agents (such as board members) inside the family firm

(Fama and Jensen, 1983; Mustakallio, Autio and Zahra, 2002). In addition owner- management alignment in family firms, makes these firms patient investors with a long time horizon (Kang, 2000; Sraer and Thesmar, 2006). The essence (or main objective) of the family business is to transfer the firm to the next generation (Litz, 1995;

Churchill and Hatten, 1987) with the intention to keep the private benefits that the family obtains from the control of the company (Demsetz and Lehn, 1985; Holz-Eakin, Joulfaian and Rosen, 1993). The desire to keep control across generations makes family members value not only the present rents but also the future rents that successor could obtain from the firm. So, when family members take decisions they consider a longer time horizon than a non-family member that discount the value of future rents.

In addition to the possible benefit of reduced agency costs due to incentive alignment, family firms may gain from employment relationships based on altruism and trust (Karra, Tracey and Phillips, 2006). Altruism refers to decisions that are made for selfless reasons to benefit others, rather than decisions made for selfish reasons typically assumed by classical economics literature (Lunati, 1997). Altruism within the family could lead to superior employment contracts by reducing the necessity of excessive monitoring and incentives-based pay, and by offering credible threat of sanctions from other family members (Chami and Fullenkamp, 2002; De Paola and Scoppa, 2001;

Randøy and Nielsen, 2002). Moreover, family members’ longer time horizon (relative to non-family members), including the long-term reputation of the family, makes them more likely to cooperate and make decisions that maximize firm value in the long run (Walsh and Seward, 1990; James, 1999; Anderson and Reeb, 2003).

However, extant theory also points out the disadvantages of family influence.

For instance, the interests of the family in a publicly traded firm with family influence are not necessarily the same as those of the minority shareholders (Allen and Panian,

1982). This is even more so in non-Anglo-American countries –where minority

shareholder protection is less developed. As a consequence, minority investors who do not share the controlling family’s interests could be affected by the family’s

expropriation of wealth (Anderson and Reeb, 2004). Other agency-related costs result from bias in favouring family interests over the economic interests (such as non-family shareholders), because of loyalty and a sense of filial duty toward the family (Schulze, Lubatkin, Dino and Buchholtz, 2001; Schulze, Lubatkin and Dino, 2003; Gomez-Mejia, Larraza-kintana and Makri, 2003), exposing these firms to managerial entrenchment (Gomez-Mejia, Nuñez-Nickel and Gutierrez, 2001; Thomsen and Pedersen, 2000).

Whereas the founding entrepreneur may possess the vision and managerial skills which led to the establishment of the firm in the first place, the same vision and skills may not be possessed by the descendant. Stewardship perspective on this issue also highlights the dark side of altruism that can actually encourage agency problems (Corbetta and Salvato, 2004; Eddleston and Kellermans, 2007) especially among descendants of the family firm founder.

However, it is critical to determine the precise position that a descendant occupies in the firm to determine the direction of effect (positive or negative) on firm value. By appointing a descendant as the CEO, the shareholders are deprived of access to market for managerial talent (Bukart et al., 2003; Becker, 1974; 1981; Schulze et al, 2001). This access is hampered partly because of a perception of the family firm’s natural inclination to favour candidates related to the family. This perception could reduce the quality of applicants for key managerial positions in the firm. A market- selected non-descendant CEO is likely to provide the firm with better managerial talent, as well as the flexibility to go back to the market if the talent does not deliver results.

On the other hand, board members usually provide an overall vision, hire key strategic managers, assess the strategy-setting process, audit the overall strategy of the firm, and monitor the firm’s management in executing that strategy. For this reason, we propose that a descendant director is likely to effect performance positively. Family board members are expected to create value for other shareholders through acting as effective monitors of family and non-family top executives; whereby their large undiversified equity position, historical presence in the firm, and role as a preserver of family reputation, provide strong incentives for descendant board members (Demsetz and Lehn, 1985). A descendant family director may be better able to preserve and continue the family’s overall vision and long-term goals than a non-family board member (Ward and Aronoff, 1994; Litz and Kleysen, 2001; Athanassiou, Crittenden, Kelly and Marquez, 2002). A descendant board member, being hierarchically at a higher level than the CEO, provides opportunities for close monitoring and long-term mentoring (as the family tends to be in the business for a long time). Overall, family representation on the board could play a moderating role in the agency conflict between large shareholders and minority ones.

3. HYPOTHESES

Board members (as agents) have a fiduciary responsibility to the firm’s owners (the principals), and in that role are de facto the final monitor of managerial behavior of the top management team, including the CEO. A prerequisite for an effective board member is incentive alignment with that of all shareholders. Alignment of board members’ incentives with those of the owners may occur via two means: altruism and economic incentives. Altruism involves a selfless adoption of owners’ objectives. It is self-reinforcing and also motivated by self-interest, since it allows individuals to achieve both others’ and their own selfish objectives simultaneously (Lunati, 1997).

When altruism is involved in incentive alignment, achieving the owners’ objectives is considered a reward in and of itself (Becker, 1974; 1981). This selfless service is akin to siblings helping each other, or parents performing duties for their children. Incentive alignment through economic incentive employs firms’ objectives as instruments to economic gains which board members are assumed to desire. However, incentive alignment through economic incentives is susceptible to the usual agency costs of writing a perfect contract.

While it can be argued that altruism in family relationships can lead to some kinds of agency problems - for instance, parents may favor their children to enhance their own welfare (Lubatkin, Schulze, Ling and Dino, 2005) - a descendant board member is also more likely to be driven by the vision and selfless zeal (with respect to the family business) inherent in the founding conditions of a family founded business.

The position of descendant board member offers a combination of economic incentives and altruistic attachment to a family firm (Steier, 2003). In other words, a descendant board member is more likely to represent the “brighter view” of altruism (or positive altruism), and preserve the continuity of family vision (Athanassiou et al., 2002, Ward and Aronoff, 1994; Litz and Kleysen, 2001). Non-family managers and board members suffer from a lack of altruism and therefore a finite time horizon problem. Because their tenure with the firm is finite, it could lead to decisions that improve performance during their tenure with the organization, but could be harmful in the long run. Altruism among family members leads to adoption of strategies that solves the problem of a board member’s finite time horizon. This occurs by linking an individual manager’s tenure (time horizon) with that of the family’s tenure with the firm, and to family’s reputation to the reputation of the firm (De Paola and Scoppa, 2001). Consequently, although family interest may not always align with minority shareholders, family representation

on the board potentially provides advantages to the overall board and the firm (Anderson and Reeb, 2004).

The discussion above suggests that positive altruism and economic incentives are relatively non-substitutable mechanisms for incentive alignment. Using economic incentives alone for a complex and multifaceted task could result in a multi-tasking problem. Using altruism alone could lead to shielding incompetence with or without intent. The relative non-substitution of altruism and economic incentives means that among the board members, descendant board members of closely held public family firms are likely to be more responsible and superior monitors of the firm than non- descendant Board members. Thus we propose the following:

Hypothesis 1: A descendant board member presence has a positive influence on firm value.

As we have argued above, in the closely held firm the classic agency conflict between owner and managers is minimized because large shareholders have strong incentives to monitor managers. However, in these firms the agency conflict appears between the large shareholders and the small ones because high ownership

concentration can lead to potential expropriation from minority shareholders (Villalonga and Amit, 2006a; Coff, 1999) who do not share the private benefits of control. The identity of large shareholders influences the relationship between ownership structure and performance because whereas ownership concentration determines the power and incentives of shareholders to enforce the firm’s goals, owner identity determines which are the firm’s objectives and goals (Thomsen and Pedersen, 2000; Pedersen and

Thomsen, 2003). The major concern of family owners is to remain influential within the firm (Casson, 1999; Chami, 1999), due to the non-pecuniary benefits that family obtain from maintaining corporate control (Demstez and Lehn, 1985). This family logic affects

to perpetuate the business for following generations can potentially reduce agency cost between controlling and minority shareholders. Indeed, factors such as the extended time horizon of family members, the implicit social contracts, and other elements of altruistic behavior could benefit firm value. On the other hand, by combining family and business interest across generations, this can constrain the firm’s access to executive skills and increase the conflict of interest between family’s and minority shareholders’

interests.

Empirically, Pedersen and Thomsen (2003) find that family ownership has no effect on firm performance. But, Anderson and Reeb (2003) find a non-linear

relationship between family ownership and performance and Maury (2006) also support a non-monotonic relationship between family control and firm performance. Our paper examines firms with descendant board members influences. In second and later

generations family firms, the separation of ownership from control will lead the power to enforce firm’s objectives and goals in those insider family managers who run the firm (Schulze et al., 2003). Extant literature on the influence of insiders (Morck et al., 1988;

McConnell and Servaes, 1990; Han and Suk, 1998; Short and Keasey, 1999; Pindado and de la Torre, 2004) show that the relationship between insiders` ownership and firm value is not linear -because both the convergence of interest and entrenchment effect.

We hypothesized that second and later generation family firms are likely to have also an inverted u curvilinear relationship between insider holding and firm value. Such that, family interests` coincide more with those of minority shareholders as insider ownership increase. Indeed, these family firms first benefit both from altruism and continuity of values across generations, as well as easy access to capital, transparency, and

monitoring by the market, and this among other reasons will increase firm value.

However, excessive insider ownership has a negative impact on firm value because very

high insider ownership is likely to deprive firm from taking advantage of a competitive market for corporate control that helps to curb the possible negative effects of family’s managerial entrenchment and nepotism.

Hypothesis 2: Insider holding and firm value have an inverted U curvilinear relationship when a descendant family member is a board member.

Large shareholders often have substantial power in excess of their cash-flow rights (La Porta et al., 1999; Claessens, Djankov and Lang, 2000 and Faccio and Lang, 2002). With separation of control-rights versus cash-flow rights the controlling

shareholder can potentially extract private benefits of control (Claessens et al., 2000).

Large shareholders can entrench themselves against pressure from the market for corporate control or monitoring by non-controlling shareholders (Shleifer and Vishny, 1997). Thus, entrenchment is the offsetting cost (to minority shareholders) of excessive control rights in closely held public corporations. In the family businesses context, Claessens, Djankov, Fan, and Lang, (2002), Villalonga and Amit (2006a) and Barontini and Caprio (2006) find that mechanisms to increase control-rights held by the family are penalized by the market in firm valuation. In other words, family control rights are not costless to the family. However, Villalonga and Amit (2006b) show that the different mechanisms to produce control rights generate different benefits and costs in the family firms.

The common devices to produce control rights are dual share classes with differential voting rights, ownership pyramids, cross-holdings and voting agreements.

Within these devices, European firms commonly use pyramid ownership structures, by which owners gain control rights in excess of ownership rights by means of several layers of control of public firms (Faccio and Lang, 2002). Pyramid firms facilitate entrenchment because there is no contestable market for corporate control – outside the

top of the pyramid. Even more, firms controlled by pyramid ownership structures are vulnerable to wealth transfer among pyramid corporations – at the expense of minority shareholders (Claessens et al., 2000; Lins, 2003; Morck and Yeung, 2004). Thus, one can expect to see reduced firm value in the presence of pyramid ownership structures (Malatesta and Walkling, 1988).

Hypothesis 3: Pyramid ownership structure affects firm value negatively.

"A pyramid is a structure in which an apex shareholder, usually a very wealthy family, controls a single company, which may or may not be listed. This company then holds control blocks in other listed companies " (Morck and Steier, 2005, p.4). One classic example is the Swedish Wallenberg family, that through the family controlled public firm Investor (by the Wallenberg family and the Wallenberg Foundations), has direct or indirect controlling ownership positions in a number of large firms such as Ericsson, Electrolux, ABB, SKF, Astra (for details see: Högfeldt 2005, p. 526).

Following our theoretical arguments on positive altruism, we argue that the potential negative effect of a pyramid structure on minority shareholders interests can disappear by the family’s active involvement coming from descendant board

membership. As descendant board member is likely to be partly driven by family altruism, any potential negative effect of an entrenchment descendant board member is likely to be muted compared to that of a non-descendant board member, who is not driven by altruism. Family bonds are produce powerful contexts and subtle incentives for active monitoring of descendant board members by other family members.

Furthermore, the main difference between the family and the non-family firms is the specific utility function of the firm’s decision makers (Fuente, Quevedo, Blanco and Delgado, 2005). One main interest of the family firm is the trans-generational succession of the firm. In this way, pyramids structures are a way to assure family

control and, whereby, to maximize the family utility. Pyramid structures could be used by family owners to diffuse family values and family capital (including reputation) at lower ownership threshold throughout the corporation. Because pyramid structures enable control of firms at lower ownership threshold, they could support corporations of larger size to benefit from the overall benefits of family influence. Indeed, previous literature has suggested that this mechanism could not be an indication of the desire to expropriate minority shareholders, but rather an indication of the resistance to the dilution of family control that come with family and firm growth (Villalonga and Amit, 2006a, 2006b) or a way to maximize the family firms` internal sources of financing sharing the benefits of the new firm with the minority shareholders of the original family firm (Almeida and Wolfezon, 2005). Such that, pyramids could have a beneficial effect on the value of second and later generation firms because helping to keep family control will also preserve the continuity of the specific sources of value that the family has established during the first generation. In particular, pyramids can be used as a capital-efficient mechanism by which family could transmit the specific competitive and survival advantages generated by the family influence across diverse businesses, while at the same time harnessing capital from broader capital market. Thus, via a pyramid, a family attempts to monetize the value of its “familiness” and lowers its overall cost of capital, while allowing non-family capital access to the positive value differential between family versus non-family management and control. Based on above we therefore suggest that:

Hypothesis 4: When a descendant family member is a board member pyramids are beneficial to firm value.

4. DATA AND METHODS

Our sample includes non-financial companies in three European countries (Sweden, Norway and Spain). The sample companies were publicly traded for at least two out of the three-year study period (1996-1999). We randomly selected 299 publicly traded firms from all countries. The initial sample of 299 companies was reduced to 254 firms useable firm observations (81 Swedish, 101 Norwegian and 72 Spanish), due to incomplete information (missing ownership or incomplete accounting data). The applied sample represents 719 firm-year observations. In order to verify the presence of one or more founder descendant on the board of directors, we compile information from different sources: (1) corporate websites, and web searches about company history and family relationships, (2) various news sources, (3) and telephone interviews to firms`

investor relations department. All other variables were accesses through secondary sources.

Our measure of firm value - our dependent variable – is the firm’s log

transformed q-value on December 31, 1996, 1997, and 1998. The q-value is measured as the ratio of market to book value of the firm’s equity. The natural log transformation was performed in order to reduce problems of heteroscedasticity. The appeal of this measure is that it reflects the current value of expected future performance (Perfect and Wiles, 1994; Chung and Pruitt, 1994; McFarland, 1988). The measure for Descendant Board Member is a binary variable that equals 1 if descendant(s) of the original founder(s) holds a position in the Board of Directors. Pyramid is a binary variable that equals 1 if a public corporation owns more than 25% of the firm, or if a public

corporation that is owned more than 50% by a non-public firm, owns the firm (Note:

Anglad et al., 2002 and Santana and Aguilar, 2004 provide a more extensive overview of corporate control mechanism in Sweden and Spain, respectively). To capture the potential non-linear relationship between insider ownership and firm value, we include

the level of insider ownership and the square of the level of insider ownership as independent variables.

CONTROL VARIABLES

Past research indicates that the Q-ratio is affected by firm size (Dalton, Daily, Johnson and Ellstrand, 1999), firm age (Mayer, 1997), and firm’s industry affiliation (Baysinger and Butler, 1985). Firm size relates to possible scale economy effects, and firm age relates to changes caused by firm life cycle changes (Smith, Mitchell and Summer, 1985). Firm size is measured by taking the logarithm of total revenues of each year, as the size alone was not normally distributed. Firm age is measured by the logarithm of the number of years between the observation year and the firm’s founding year. Based on well-established current literature we also control for the extent of the debt used and blockholder ownership as other forms of governance mechanisms (via monitoring). We also included a dummy variable to control for the possible differences between the Scandinavian and the Spanish context. In summary, we control for firm size, firm age, firm’s industry, debt ratio, blockholder ownership, and firm’s country affiliation.

We employ a two-way fixed effects model for our regression analysis in order to isolate any specific effect of our choice of countries, observation years and changes in country and year specific macro conditions on the dependent variable. The fixed effects are dummy variables for each year and country, as well as, country-year interactions were included. The method of pooling cross-sectional and time series data is susceptible to multicollinearity, heteroscedasticity and autocorrelation (Kmenta, 1997). To make sure that multicollinearity is not a problem in the regression models, we calculated the Variance Inflation Factors (VIF) for all variables in the models. The VIF statistics do not indicate any multicollinearity concerns. Furthermore, we control for serial

correlation and heterostedasticity using the Huber White Sandwich Estimator for variance.

5. RESULTS

Table 1 reports the means, standard deviations, and correlations among the variables. The multivariate results displayed in Table 2 show the main and interaction effects of our hypothesized variables on the dependent variable firm value (Q-ratio).

Hypothesis 1 predicted a positive relationship between the presence of a descendant on the board of directors and firm value. In the main effects model, having a descendant board member had a significant positive effect on firm value (p<0.05). In the full model, the effect remains positive but non significant (p=0.22). These results indicate that founding family descendant board membership leads to a higher firm value – for all shareholders.

The expected signs of coefficients on the variables insider ownership and insider ownership² were found. That is, the coefficient for insider ownership is significant and positive in the control model (p< 0.01), as well as, in the main and full effects model (p< 0.05). Furthermore, the coefficient for insider ownership² is significant and negative in both the main effects and full models (p<0.001). These results confirm the

hypothesized inverted u curvilinear relationship between insider ownership and firm value in companies with descendant board membership influence predicted in hypothesis 2. Finally, Hypothesis 3 predicted a loss in firm value due to pyramid ownership structure. This effect was true but not significant in the main effect model (p=0.24). However, the full model shows a marginally significant (p<0.10) negative effect from pyramid ownership. In hypothesis 4, we tested for the interaction of the descendant board member influence with the pyramid variable, and as predicted the effect was significant (albeit marginally) and positive (p<0.10).

6. DISCUSSION

This study is addresses the issue of benefits of family involvement empirically following insights from prior theoretical arguments and empirical work in this area (Schulze et al, 2001, 2003; Chrisman, Chua and Sharma, 2005; Eddleston and Kellermans; Corbetta and Salvato, 2004), in the presence of pyramidal ownership in non-anglo-saxon markets. We find that descendant influence by the means of a board membership has a significant and positive effect on firm value. The results from this sample suggest that the presence of a descendant in the board of directors might facilitate continuity of entrepreneurial vision and mission, and reducing the finite time horizon problem of non-family board members. Descendant board members potentially have a more active monitoring function. They add value to the firm by being driven both by economic incentives, as well as positive altruism toward other owners of the firm.

Earlier studies show an inverted u curvilinear relationship between family ownership and firm value (Anderson and Reeb, 2003; Maury, 2006). With succession, growing ownership dispersion will differentiate those family members who hold management positions inside the family businesses from those family members who only are owners. Therefore, we test that the inverted u curvilinear relationship holds between insider ownership and firm value in firms with descendant board members influence. Our results show that as insider ownership increases firm value increases, but when insider ownership becomes excessive the value of the firm starts decreasing. This is an interesting finding, because second and later generation family firms can balance the need for continuity of their values and vision, and attract outside capital, while increasing the value of the firm as long as insider’s ownership is not so high that damages the external market discipline.

Our findings confirm that excessive control rights, through pyramid ownership structure, provide incentives to controlling shareholder to extract private benefits from the expropriation of wealth from minority shareholders. However, we also found that pyramid benefits value creation within these companies with descendant board membership influence. This finding is consistent with earlier research in pyramidal ownership in family firms (Villalonga and Amit, 2006a, 2006b; Almeida and

Wolfenzon, 2005), which indicates that the presence of this mechanism has benefits in family firms because pyramids are not so much an indication of the ability to

expropriate minority shareholders as it is of a way to maintain the family’s control as the firms expands. We suggest that family businesses use the element of control that pyramids provide to maintain and preserve the genuine value creating opportunities that family influences confers. And, in addition, pyramids allow to extant the benefits of family influences into the pyramids corporations. Therefore, families can obtain benefits of control without expropriating these benefits from minority shareholders.

In summary, this study suggests that founding family influence on firm performance has the potential to last beyond the firm’s founders. We test these hypotheses in a sample of three European countries with lower level of external

investors´ protection than the Anglo-American countries. Our finding supports the idea that the family firms could be an efficient substitute for the weak legal protection of minority shareholders (Burkart, Panunzi and Shleifer, 2003; Martin de Holan and Sanz, 2006), as long as they incorporate some market discipline in their governance.

The main limitations of our study also suggest the future directions of this line of research. While this study explores differences in firm value and performance between firms with descendant board members and non-descendant board members, future studies may wish to explore differences within the descendant group. These

studies can model family firm-specific independent variables, such as social,

demographic and educational background of the board members, his or her age, size and composition of the founding family, number of family members involved in the firm, as well as the extent of their involvement. In addition, within-group studies of the strength of altruism-based relationships, and the degree of substitution they offer from agency costs could be other useful areas of research. Family business research has over the years developed several unique constructs that have no analogues outside family business, and hence within-group studies would be able to develop a richer theory in this area by incorporating these constructs.

We also suggest that implications of combining altruism and agency should be explored beyond the current study’s context of public family firms. In particular, the crisis of corporate governance in some public firms in the USA, despite high levels of incentive alignments through compensation and stock options, and professed greater transparency and regulatory controls, call for developing trust and confidence in

corporate leadership. We believe that processes that lead to development of altruism and trust outside family relationships are worth exploring (Eshel, Sansone, and Shaked, 1999), in order to develop more general prescriptions of value-added governance models for public corporations.

In summary, this paper extends our understanding of corporate governance of family firms, ownership structure and firm value, with implications for corporate leadership in these firms. With an appropriate board structure (Anderson and Reeb, 2004), the family influenced public firm may be able to combine the advantages of corporate governance based on altruism, providing multi-generational continuity, and access to efficient managerial labor and capital markets. Our results support the

proposed model of firm performance. Based on the main findings of this study, several useful areas of future research are outlined.

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TABLE I

PEARSON CORRELATION MATRIX

* p< .05 (two-tailed)

** p< .01 (two-tailed)

Variables ^{Mean S.D. (1) (2) (3) (4) (5) (6) (7) (8)}

1. Q-ratio (ln) ^{.704 .776}

2. Debt of total assets (%) ^{.527 .221 -.011}

3. Firm age (ln) ^{3.671 .987 -.161(**) .129(**)}

4. Firm size (ln) ^{10.042 2.049 -.077(*) .301(**) .384(**)}

5. Blockholder ownership (%) ^{45.993 21.699 -.113(**) .025 .001 .016}

6. Insider ownership (%) ^{27.234 28.104 -.103(**) .039 -.027 -.155(**) .296(**)}

7. Country ( ^{.720 .448 -.109(**) .365(**) .040 .032 -.132(**) .205(**)}

8. Pyramidal Ownership ^{.180 .387 -.071 -.178(**) -.007 .011 .251** .042 -.255(**)}

9. Descendant Board Member ^{.210 .407 .023 -.028 .040 -.018 .054 .180(**) .010} .010

TABLE II

THE EFFECT OF DESCENDANT BOARD MEMBER ON FIRM VALUE

Dependent variable:

Q-ratio (Ln transformed)

Predicted

sign Controls only

Controls and main effects

Controls, main and interaction effects

Controls

Debt of total assets (%) .531

(.172) **

.471 (.179) **

.479 (.179) **

Firm age (ln) -.056

(.031) ^†

-.057 (.031) ^†

-.057 (.031)*

Firm size (ln) -.041

(.015)**

-.034 (.016)*

-.037 (.015)*

Country (Spain=0; Scandinavia=1) -.785 (.110) ***

-.774 (.113) ***

-.753 (.115) ***

Blockholder ownership (%) -.002

(.011)

-.001 (.001)

-.000 (.001)

Main effects

Descendent Board Member + .125

(.059) *

-.127 (.117)

Insider ownership (%) + .007

(.003)*

.005 (.003)

Insider ownership²(%) - -.001

(.001)***

-.000 (.000)*

Pyramidal Ownership - -.104

(.069)

-.167 (.080) *

Interaction effects

Descendent Board Member x

Insider ownership (%) + .016

(.007)*

Descendent Board Member x

Insider ownership²(%) - -.000

(.001)*

Descendent Board Member x

Pyramidal Ownership + .329

(.164)*

Number of observations (Firm-years)

719 719 719

R-square .305 .325 .332

F-Statistics (Significance) 22.086*** 18.685*** 16.510***

Change F-Statistics

(model over model to the left) ^{4.839*** 2.662*}

Industry controls, year dummies and county x year interaction are not reported.

Beta values reported, and t-statistics in parentheses.

^† p< .10 (two-tailed)

* p< .05 (two-tailed)

** p< .01 (two-tailed)

*** p< .001 (two-tailed)