Governing family enterprises and implications for performance - a financial perspective

Bachelor Thesis, 2008

53 Pages, Grade: 1,9


Table of Contents

1 Introduction
1.1 Problem Definition
1.2 Research Objectives
1.3 Course of Investigation

2 Setting the Family Business Framework
2.1 Definitions of Family Business
2.1.1 Qualitative and Quantitative Dimension
2.1.2 Family and Firm Dimension
2.2 Theories for Governing Family Enterprises

3 Setting the Performance Framework
3.1 Determining Performance according to Theory
3.1.1 Owner-Manager Conflict
3.1.2 Majority-Minority Conflict
3.2 Definition of Performance
3.3 Agency Conflicts in Family Enterprises

4 Setting the Financial Framework
4.1 Theories of Capital Structure, Investments and Finance
4.2 Investing Capital
4.3 Funding Capital
4.3.1 Empirical Evidence for Financing of Family Enterprises
4.3.2 Modern Financing Instruments and Family Enterprises
4.4 Managing Capital
4.4.1 Financial Management Techniques
4.4.2 Risk Management

5 Summary and Conclusion

List of Abbreviations

illustration not visible in this excerpt

List of Figures and Tables

Figure 1: Organigram of the F-PEC

Figure 2: Ownership, Region of Origin, and Focus of Study

Figure 3: Difference Long-Term and Short-Term Oriented Firm

Figure 4: The Family Enterprise Playing Field

1 Introduction

1.1 Problem Definition

Small and medium-sized enterprises (SMEs) represent the engine of Germany’s economy. Despite the fact that business magazines and newspapers appear to favor covering large international companies, public awareness of formerly in the background operating enterprises has risen within the last years. People are increasingly aware of the importance of smaller businesses. They notice that not only do smaller companies secure employment and wealth in their specific region of operation, but they also provide the overall economy with more employment than their multinational counterparts.

An important group of SMEs are the so-called family enterprises. A significant proportion of family enterprises have become global players themselves and have even excelled, in their particular field, to world market leaders. Besides Porsche and Villeroy & Boch, as two typical German examples of formerly small family enterprises which have developed continuously from regional to worldwide-operating businesses, many others could be named to illustrate this stunning development of family-owned businesses.

Paralleling the successful development of family businesses, researchers and practitioners alike have drawn their attention to the nature and particularity of family businesses.

In 2003, Anderson and Reeb investigated the relationship between founding-family ownership and firm performance. For the investigation, evidence from American companies of the S&P 500 was collected. They concluded that family firms perform “at least” as well as non-family firms (Anderson & Reeb, 2003, p. 1324).

Recently, a study published by HVB analyzed the performance of the 50 largest family-owned businesses in Germany since 1990. To fulfill the requirements of a family business, the family had to have at least a 25% share of the company and the founder was supposed to execute control from the board of directors or hold the position of chief executive officer (CEO). The findings of the study not only indicated that family enterprises perform at least as well as their counterparts but revealed an outperformance of the DAX by 9,5% (HVB Corporates & Markets Equity Research, 2004).

Among others, these empirical studies report a comparable or superior performance of family enterprises to non-family enterprises. Even though results were derived differently and the studies were conducted in distinct economic environments, it is necessary to address the issue of performance superiority of family enterprises.

Yet, researchers were not able to explain apparent competitive advantages of family enterprises in detail. What has been examined theoretically and empirically is the fact that Agency Theory provides an adequate framework for the assessment of performance. It has not been investigated, however, which fields of the family firm provide most evidence for advantages in the setting of Agency Theory.

Even though the nature of the research object has become clearer, researchers had many difficulties in finding common defining grounds for family businesses to begin with. As observed by Jaskiewicz, studies employ various definitions for family business which makes it increasingly difficult to build upon or compare each other’s work (Jaskiewicz, 2006, p. 13).

Both, Chua et al. and Jaskiewicz, make allusion to this obstacle for further research. Despite the inconsistencies in definitions, an array of studies investigating family businesses worldwide reports a positive theoretical and empirical relationship of family businesses and performance (Chua, Chrisman, & Sharma, 1999, p. 20).

Further problems arise in finding adequate means to measure performance advantages of family enterprises. In particular, family enterprises do not tend to disclose financial information and hence make it extremely hard if not impossible to assess performance. In fact, many private family enterprises are family enterprises especially because they do not want to disclose information and are hereby not subject to external regulation.

Another obstacle arises in the applicability of performance measurements. On the one hand, performance measurements can be accounting-based. On the other hand, if the family enterprise is public, capital market-oriented performance measurements can be applied. The results derived from both methods do not necessarily have to be identical. Accounting-oriented figures may be strongly influenced by accounting policies while capital-market oriented figures reflect the point of view of financial markets. Both results can therefore be regarded as different financial perspectives of a firm.

Moreover, Agency Theory is one of the fundamental theories for researching the nature of enterprises. It is thus recommendable to limit its use to few aspects of the firm, because otherwise the scope of the study would become unmanageable. However, as it bears significance for every aspect of the firm, studies risk to not account for significant cross-relationships between aspects of the firm.

After having pointed out difficulties in the research field of family enterprises, an adequate scope and objective for this study needs to be determined in the following chapter.

1.2 Research Objectives

As previously stated, many studies have reported a superior performance of family enterprises in comparison to their non-family counterparts. It was stated that Agency Theory represents an adequate framework for assessing differences in the governing systems of family and enterprise.

So far, Agency Theory has served to explain differences in firm performance by assessing the level of governing a firm. This study intends to analyze previous research findings and apply relevant findings to the financial perspective of the firm.

While other studies focus on additional perspectives of the firm, namely operational and strategic, it is the goal of this study to examine the financial perspective of the firm and investigate whether advantages of family enterprises exist in the financial field and can contribute to the explanation of the “family enterprise premium puzzle”[1].

This study seeks to find out whether activities in funding, investing and managing capital of a family enterprise may serve as an explanation for competitive advantages in the light of Agency Theory.

A useful definition for investigating the financial perspective of a family-enterprise should be derived from previously employed definitions. Subsequently, assumptions derived from Agency Theory should be used to examine financial strategies of family firms.

1.3 Course of Investigation

Variables influencing the nature of family businesses, family business performance, and financing and investing of family enterprises are manifold. Thus, structure and clarity represent paramount prerequisites for successfully investigating and reporting matters relating to family businesses. The following course of action of this study is to fulfill these requirements:

As previously mentioned, there has been much inconsistency in the body of literature concerning the definition of family businesses. This might be partially due to the fact that researchers investigated family-owned enterprises in parts of the world that face different economic circumstances. Whereas public companies of Anglo-Saxon countries reveal a much more disperse shareholder basis, public companies in Continental-Europe are viewed as more concentrated in terms of ownership. This example may have an effect on family enterprises and shows that an adequate review of family business definitions should incorporate studies from different countries. This review of definitions is undertaken in the first part of the second chapter.

After having shed light on the term family business, important theories of governing family businesses are identified and explained in the second part of the second chapter. These theories lay the foundation for chapter 3 in which the performance of family businesses plays the primary role. Theories from chapter 2 are employed and linked to theoretical aspects of performance. Having discussed firm performance from the theoretical point of view and formulated assumptions for empirical research, the second part of chapter 3 reviews and critically discusses findings from empirical research. Chapter 4 is to represent the main part of this study and introduces a different way of looking at family businesses.

Chapter 4 examines the financing, investing and managing capital perspective of family businesses by combining theoretical and empirical results as well as accounting oriented and capital-market based performance measurements. It evaluates in how far financial aspects of family businesses can contribute to the explanation of competitive advantages of family businesses. Before chapter 4 is introduced, assumptions based on the results of chapter 3 are made for the expected contribution of financial strategies to performance.

2 Setting the Family Business Framework

2.1 Definitions of Family Business

“Defining the family firm is the most obvious challenge facing family business researchers.” (Handler, 1989, p. 258)

Family business literature has been employing a multitude of definitions for family businesses in the past. Between 1989 and 1999, scientific studies applied more than 44 different definitions of family enterprises (Habbershon & Williams, 1999, p. 10).

As observed by Westhead, this leads to strongly diverging study findings and harms the comparability of studies. According to the author, the problem is that every time a type of company is mentioned as family business not one type of family business is described but a whole group of types (Westhead, Howorth, & Cowling, 2002, p. 263). The vast majority of family business literature in Europe and the United States lists family’s share of ownership and employment of family members in the management as basis for family business research. These two characteristics are used together as well as independently in studies. This fact contributes extensively to the difficulty of comparing research findings (Jaskiewicz, 2006, p. 15).

Jaskiewicz suggests that family businesses should be divided into subgroups which reflect characteristics such as type of family influence and its characteristic values. These variables may contribute to a clearer distinction among the different types of family businesses (Jaskiewicz, 2006, p. 13).

Most definitions of family enterprises, however, do not resolve the problem of variability. Operationalization of the family business characteristics is paramount to allow for empirical testing. Therefore, the need for measurable characteristics of family businesses is evident. Before reviewing quantitative measurements of family enterprises, light is shed on some proposals for qualitative variables.

2.1.1 Qualitative and Quantitative Dimension

The Resource-Based-View of the Firm (RBV) allows for a theoretical approach towards the measurement of family influence. As introduced by Habbersohn and Williams, “familiness” describes the ability of the family to improve the company’s setting of resources and skills.

Similarly, Arregle et al. name “social capital” as another qualitative factor which embraces unique characteristics of family businesses. Social capital expresses competitive advantage of family businesses and is founded on characteristics of the family system[2] (Arregle, Very, & Raytcheva, 2002).

Neubauer and Lank review the most frequently used criteria for family business in research literature. They find out that family’s share of ownership, employment of family members in the management and number of participating members of the family in the enterprise from different family generations constitute the three most widely used quantitative characteristics (Neubauer & Lank, 1998).

Daily and Dollinger similarly differentiate family enterprises from non-family enterprises by the prerequisite that two or more relatives of the owner of the company have to hold a management position (Daily & Dollinger, 1992). Gersick et al. view the variable of family ownership as the most significant in the definition of family enterprises (Gersick, Davis, Hampton, & Lansberg, 1997). According to Gersick et al., family ownership is more important than any other definition of family business.

Finding common grounds on the definition of family businesses is not only a mere question of finding appropriate variables but also of evaluating possible thresholds for values of these variables. While family ownership might very well be widely recognized as an important determinant for family businesses, an agreement on how high the threshold for family ownership is set has yet to be reached.

Many researchers apply constant percentages of ownership for their definition of ownership (Lansberg, 1983). Oetker argues that a constant proportion of ownership is not desirable for the definition of family businesses. He suggests that observed “Decisive influence” and comments made in the articles of incorporation have a much higher importance than a fixed value (Oetker, 1999, p. 14).

Gallo, Pont, or Klein and Blondel consider 10% of voting rights owned by the family as sufficiently large proportion of ownership as long as the following three shareholders do not own more together (Gallo & Pont, 1988; Klein & Blondel, 2002).

Astrachan and Kolenko state that the threshold has to be set at a level at which effective control over a company can be executed by a family while taking the operating environment into account. Astrachan and Konlenko therefore imply that the values may vary across countries and private or public family businesses (Astrachan & Kolenko, 1994, p. 255).

The survey of Redlefsen and Eiben concentrates on private family companies. Only 7,1% of the observed sample of family businesses is public. Despite the fact that public family businesses exhibit different characteristics than their private counterparts, differences tend to be relatively small in comparison to non-family businesses. Public family companies may not have a more dispersed structure of ownership than private ones (Redlefsen & Eiben, 2007).

Astrachan and Kolenko are not the only ones to account for regional differences in family business definitions (Astrachan & Kolenko, 1994). Georgen and Franks also discuss country-specific differences in thresholds. They reason that differences in definitions may occur because of varying shareholder basis. While capital-market-oriented countries such as Great Britain and the United States show a broad shareholder basis, European and Asian countries indicate concentrated structures of ownership (Franks & Mayer, 1997; Goergen, 1999).

Jaskiewicz illustrates the effect of a potential universal threshold for ownership by taking the 100 largest stock-quoted enterprises in Germany and the United States. He maintains that if a threshold value of 5% of ownership would be applied, 80% of German companies would fall into the category of family-owned businesses. On the contrary, a value of 25% of concentrated ownership in the United States would only include 10% of the largest listed companies (Jaskiewicz, 2006, p. 18).

The German Entrepreneurial Index (GEX) identifies all “owner-dominated” companies that are listed in the Prime Standard of the Frankfurt Stock Exchange. Identification makes use of an ownership threshold of 25% (Deutsche Börse AG 2008). The Index of Hauck&Aufhäuser Privatbankiers KGaA (HAFIxD) employs an indentical entry value for in the index participating companies. To be listed in the HAFIxD, it is moreover admissible that a shareholder possess only 20% of voting rights and has a strategic planning influence within the company (Börse München 2008).

According to Gallo and Sveen, a much higher share of family ownership is needed. They view 50% plus one vote as a good estimator of family-owned businesses. (Gallo & Sveen, 1991) Donckels and Fröhlich even go one step further by defining that in a family enterprise the family may not own less than 60% of company shares (Donckels & Fröhlich, 1991). Lyman even claims that 100% of all shares should be owned by the family (Lyman, 1991).

Jaskiewicz states that none of the thresholds can be viewed as either right or wrong. He claims that not only has the level of family influence to be determined when seeking universal definition of family business, but also the form of family influence (Jaskiewicz, 2006, p. 18).

In the F-PEC framework by Klein et al. frequently used variables for different forms of family influence have been incorporated. The framework summarizes qualitative as well as quantitative variables from existing research literature. The F-PEC, as shown in figure 1, structures family business variables into the three “subscales” of power, experience and culture (Klein, Astrachan, & Smyrnios, 2005, p. 321).

Figure 1: Organigram of the F-PEC

illustration not visible in this excerpt

Source: (Astrachan, Klein, & Smyrnios, 2002, p. 52)

Klein maintains that the dimensions experience and culture serve as a way to summarize employed variables for family business definition across different sources of research (Klein et al., 2005). The power subscale enlarges the notion of ownership by indirect ownership. In comparison to direct ownership, indirect ownership adjusts for country-specific, legal, and tax effects on ownership. It is further vital for the differentiation to separate between cash flow and voting rights.

Commonly, one share in a company represents one vote (Grossmann & Hart, 1988). Due to a recent common practice of issuing shares with specific participation structures, cash flow rights can be different to voting rights. For the calculation of direct ownership, it is substantial to accurately adjust for the issuance of preferred stock on the one hand and multiple-voting shares on the other hand. Differences in voting and cash flow rights can also be a result of complex holding structures. Cross-shareholding and pyramidal holding structure require careful examination of companies’ interdependencies. Jaskiewicz concludes that cash flow rights represent a lower boundary for family influence while voting rights mirror the upper limit for family influence.(Jaskiewicz, 2006, p. 33)

The framework thus accounts for cases in which ownership is complicated by complex holding structures or other tax-favorable company structures. When values of direct and indirect ownership are determined, family influence in the company bodies of management and board of directors is added and condensed to one power subscale value. Thus, a representative value, divisible into family-owned enterprises, family-led enterprises, and family-controlled enterprises can be derived (Klein et al., 2005, p. 338).

Despite the introduction of a universal framework, it is interesting to reflect upon the past differences of family business definitions. Jaskiewicz maintains that past differences in definitions mirror different geographical origins and in most cases the intention of researchers to concentrate on specific types of family businesses (Jaskiewicz, 2006, p. 16).

A number of studies have found that when defining family business on the grounds of family ownership, the level demanded depends on the governance system the company operates in. Likewise, geographic origin, either from the Anglo-Saxon or Continental-European sphere, plays a major role when looking at the threshold for family ownership. Results also indicate different characteristics when assessing suggested thresholds of capital market participants and family researchers. A further distinction between public and private companies is made. While private companies are considered to be a family enterprise with ownership of 50% and upwards in both, the Anglo-Saxon and the Continental-European business environment, the range of ownership for public companies spans from more than 10% in Continental-Europe to more than 30% in Anglo-Saxon countries as depicted in figure 2 (Astrachan & Kolenko, 1994; Gnan & Montemerlo, 2001; Klein & Blondel, 2002). Previous studies of Anderson and Reeb and Erhardt and Nowak have reported a range of greater than 1% to greater than 50% as a lower boundary for family ownership of public companies. One reason for the large gap between these ownership requirements can be found in the concentrated or dispersed ownership structures of the country of origin (Anderson & Reeb, 2003; Ehrhardt & Nowak, 2003).

Figure 2: Ownership, region of origin, and focus of study

illustration not visible in this excerpt

Source: (Jaskiewicz, 2006, p. 17)

As the objective of this study is to look at companies in a capital market environment, it is important to make use of a practical definition for family enterprises. Even though it was pointed out that quantitative definitions cannot consider all aspects of family enterprises, qualitative definitions are not accounted for in the course of this study. That the definition of family business via ownership proportion is of practical relevance can be concluded from the company entry requirements to family business indices such as the GEX or HAFIxD.

Consequently, as the study’s objective is to concentrate on the financial perspective, definition criteria are relaxed and family enterprises that have previously been identified as such are included in the study.

2.1.2 Family and Firm Dimension

System-theoretic literature describes family enterprise as intersection between the two systems family and enterprise (Whiteside & Brown, 1991, p. 384). Having summarized possible dimensions for the definition of family businesses, it is now advisable to take a closer look at the two systems that have an influence on how family businesses are governed. Introducing family and enterprise as separate systems will allow a smooth transition to the theories of governing family enterprises in the following chapter.

According to Thommen and Achleitner, an enterprise is an “[…] open, dynamic, complex, autonomous, market-driven, productive, and social system […]” (Thommen & Achleitner, 1998, p. 34). The term family can be understood in the anthropological sense of relationship which is described as “network of genetic and social bonds stemming from genetic parenthood” (Holy, 1996, p. 40).

According to Sahlins, families are based on long-term mutual relationships while enterprise systems rely upon short-term relationships in which money serves as a mean to equalize relationships. It is important to notice that in the family system achievement can be rewarded intrinsically or ideally whereas extrinsic or monetary is the predominant form of reward in the enterprise system. Relationships in family businesses are very personal and rules are informal. In the family system, evaluation of achievement plays a minor role and the member is mostly unconditionally loved and supported. Rules are often not pronounced clearly. A family’s rules can be described as informal expectations which aim at supporting other family members most in their development. Succession in a family system is determined by death of a member or divorce (Sahlins, 1972).

On the contrary, an enterprise concentrates on profit-maximization, efficiency, and growth. Relationships among members are rarely personal and rank behind the family relationships. An enterprise system consists of rules and regulations which a member must adhere to. Adherence is rewarded while violation of the rules is punished. Support of the system members depends on their achievement. If members act successfully, they are promoted. If the contrary proves to be true, the member can no longer participate in the system and is dismissed. Succession in an enterprise system is caused by retirement, promotion or dismissal (Dyer Jr., 1992, p. 147).

As this paper aims at explaining possible superior performance of family businesses as compared to their non-family counterparts, a further investigation of beneficial characteristics the family system may “lend” to the enterprise and therefore spur overall performance is necessary.


[1] derived from terms such as equity premium puzzle or capital structure puzzle

[2] characteristics of the family system are discussed in chapter 2.1.2

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Governing family enterprises and implications for performance - a financial perspective
European Business School - International University Schloß Reichartshausen Oestrich-Winkel
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Oliver Bruemmer (Author), 2008, Governing family enterprises and implications for performance - a financial perspective, Munich, GRIN Verlag,


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