Risk Aversion in Family Firms in the Context of Economic Theories and Models

Table of Content

1 INTRODUCTION

2 THEORETICAL FOUNDATIONS
2.1 Family Firms and Risk
2.2 Family Firm Behaviour

3 SYSTEMATIC LITERATURE REVIEW
3.1 Methodical Approach
3.2 Article Characteristics

4 FINDINGS
4.1 Theoretical Approach Towards the Risk Aversion in Family Firms
4.2 Factors Influencing the Risk Aversion in Family Firms
4.3 Effects of the Risk Aversion in Family Firms

5 CONCLUSION

BIBLIOGRAPHY

1 Introduction

In most countries, family firms form the backbone of the economy. Roughly 90 % of all firms in the world are in the hands of families¹ (usually the founder or his² descendants).³ Therefore, research in this field has intensified over the last decades. There is still much to be researched due to specificities of family firms in comparison to non-family firms.⁴

Although classic agency theory seems not applicable on most family firms due to the union of ownership and control, many scholars still see agency theory as the dominant approach for family firm governance.⁵ Other scholars disagree, as the focus of agency theory on the economic rationality of individuals falls short of the reality.⁶ Other theories like behavioural agency theory and stewardship theory complement the view of family firm governance. Recent research has, however, come up with even other approaches, for instance the control of the firm as the main reference point of family firms.⁷

Especially the topic of risk aversion is very interesting when talking about family firms. It could be assumed that family firms were more risk averse than non-family firms because of the accumulation of the families´ wealth in the firm. This was in line with agency theory. This assumption, while generally understandable, is highly questioned due to recent research. Risk aversion may be situational and depending on the circumstances of the family firm.

With respect to the points already mentioned, the main objective is to research the topic of risk aversion in family firms and to answer the question whether family firms are more risk averse than non-family firms. In order to do so, a distinction between different types of business risks faced by family firms is considered. Additionally, it is clarified, which factors affect the risk aversion in family firms. The potential effects of the risk aversion in family firms are treated as well.

However, there is one limitation. The paper is limited to the analysis of existing papers by a systematic literature review (SLR). Hence, no new findings in the proper sense should be expected. The study aims to gain insight about how much and what is known about the topic of risk aversion in family firms. Through collating the findings, a more complete and comprehensive overview of the topic is developed.

2 Theoretical Foundations

2.1 Family Firms and Risk

As mentioned above, the majority of firms in the world are family firms. But when talking about family firms, there is no common definition. In literature, no consensus could be reached until now.⁸ One approach is to define family firms by one or both of the two functions ownership and management.⁹ The involvement of one or more families or family members in the ownership or the management of a firm indicates the presence of a family firm, even though it is difficult to quantify thresholds for these involvements. Besides these two criteria, the family can exert influence through governance, culture and vision, which can also make a family firm. This makes it difficult to define family firms precisely. In every case, family firms behave and therefore act differently than their non-family counterparts.¹⁰

Family firms can be further distinguished by the degree of involvement of the owning family. For instance, in the case of an operating owner, the management is dominated by the owning family, whereby passive owners exert nearly no influence on the operative business of the firm.¹¹ For this study, the distinction between the different types of family firms is not relevant since the researched articles define family firms individually. The key issue is that family firms can be basically defined by a certain degree of family involvement in the ownership and/or management of a firm or by the exertion of influence, for instance through culture.

Often, family firms pursue (noneconomic) objectives that primarily serve the welfare of the family. Their actions are family-centred, which can reduce the economic performance of the firm in favour of gains of the family, for instance harmony, social capital and altruism.¹² This special behaviour is important when discussing the topic of risk aversion in detail.

As all firms, family firms are constantly exposed to risks. But as the definition of family firms, there is little consensus about the definition of risk among experts and in literature. Some definitions only treat the probability of bad events occurring (uncertainty), others also assess the consequences and still others consider both positive and negative potential results. This means that risks also include chances while exposing individuals or firms to negative outcomes, that are unwanted.¹³

For the course of this study, a distinction between different types of risks is necessary. Regarding business, two types of risks can be distinguished: performance hazard risk and venturing risk.¹⁴ Performance hazard risk presents the threat of underperformance due to bad decisions and impacts financial gains. It includes the possibility of failure and below-target performance. Venturing risk implies the search for new opportunities to ensure growth and improve performance.¹⁵ There is reason to suspect that the family firms´ attitude towards the two types of risks differs.¹⁶ This leads to the question whether and how risk aversion in family firms differs regarding the type of risk they face.

2.2 Family Firm Behaviour

To explain managerial behaviour in business, for instance risk aversion, the corporate governance¹⁷ research presents different theoretical approaches depending on the respective initial situation and the general assumptions about the human behaviour. Agency theory belongs to the most popular theories in corporate governance. It is part of the in the second half of the 20th century upcoming new institutional economics (NIE), which addresses the analysis of institutions. Institutions in this sense are rules, contracts and associated systems.¹⁸ In the NIE, the homo oeconomicus serves as model for individual human behaviour. He is characterised as rational, risk averse and self-interested, so he takes decisions by his own utility maximisation (mainly rent seeking). That also means that the satisfaction of his own needs is prior to the needs of others.¹⁹

Whenever there is a separation of ownership and control in a company, agency theory assumes conflicts of interest due to divergent interests of the owner (principal) and his manager (agent). Information asymmetries enable the agent to act opportunistically.²⁰ That means, he acts in his own interest, which is not necessarily the interest of the principal. These assumptions lead to several risks like adverse selection and moral hazard, which the principal is exposed to. These risks can be controlled by utilising corporate governance mechanisms like monitoring or incentive systems to align interests or reduce information asymmetries. A third possible solution is the use of trust, for instance due to good long-time experiences.²¹ The costs of The term corporate governance is not used consistently in literature. However, the system of corporate management and control as well as the respective parties are focused over the vast majority of broader definitions. Cf. Ulrich (2011), p. 56. the corporate governance mechanisms and the opportunity costs form the so-called agency costs, which are paid by the owners.²² Thus, a minimisation of agency costs leads ceteris paribus to a maximisation of shareholder value²³ and is therefore desirable from the owners´ perspective. Regarding the behaviour towards risk, agency theory indicates a rather high risk aversion. For managers, there is little incentive to be risk-seeking if they bear risks (for instance losing their job) but do not benefit (for instance profit participation).

Due to partially unrealistic assumptions, agency theory is criticised repeatedly and alternative theories are developed.²⁴ There has also been some effort to advance agency theory. One attempt represents behavioural agency theory, which tries to expand agency theory by behavioural psychology findings and the adjustment of some of the assumptions of agency theory.²⁵ Behavioural agency theory diverges from agency theory in mainly three aspects. First, agency theory focuses on efficiency by the utilisation of corporate governance mechanisms in a principal-agent relationship. Behavioural agency theory, however, covers both efficiency and effectiveness while concentrating on the relationship between performance and agency costs.

Second, agency theory implies agents to be rational, risk averse and rent seeking. But behavioural agency theory supposes agents not only to be rational and risk averse but also loss and uncertainty averse.²⁶ Behavioural agency theory furthermore assumes that a trade-off between extrinsic and intrinsic rewards exists while agency theory assumes that there is no intrinsic agent motivation. Third, a linear relationship between The shareholder value designates the value of a firm for its shareholders (market value of equity). Cf. Hegelich (2005), p. 239.

Considerations by behavioral psychology that suggest loss aversion to be the driving factor in the decision making (e.g. according to prospect theory; cf. Kahneman / Tversky (1979), p. 263ff.) are beyond the scope of this study. compensation and motivation is proposed according to agency theory. Behavioural agency theory, however, assumes a more complex pay-effort function, which is influenced by various factors, including nonpecuniary ones like the previously mentioned intrinsic rewards.²⁷ The adjusted assumptions about the behaviour of agents also affect the implications towards the risk aversion of family firms by adding more aspects. Apparently, risk aversion is not easily generalisable and influenced by various factors, including non-economic ones.

One alternative to agency theory represents stewardship theory. According to this theory, managers act as stewards of the owners of a company, operating in their best interests. Managers are therefore characterised as collectivistic, pro-organizational and trustworthy. As the motivation of managers is intrinsic, no corporate governance mechanisms are needed and no agency costs accrue.²⁸ The presence of stewardship relationships indicates rather lower levels of risk aversion because stewards act in the best interest of the owners without taking any unnecessary high risks.²⁹ Stewards are therefore rather risk neutral.

One might argue that this theory fits best for family firms. As the family´s goal should be the maximisation of long-term value without any divergence of interests between managers and owners, no conflicts of interest occur. Recent research has, however, cast doubt on this perspective.³⁰ Thus, stewardship theory is not in every case applicable on family firms. As interests of family and non-family stakeholders probably diverge in some cases, agency conflicts are possible in family firms as well. Even within families, quarrels can lead to disagreements. This will be further clarified during the analysis part.

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¹ Cf. Hiebl (2012), p. 49.

² For reasons of simplification, only the male form is used during this paper. Of course, women are always included.

³ Cf. La Porta / Lopez-De-Silanes / Shleifer (1999), p. 511.

⁴ Cf. Gedajlovic et al. (2012), S. 1030f.

⁵ Cf. Wasserman (2006), p. 970ff.

⁶ Cf. Ghoshal (2005), p. 81ff.

⁷ Cf. Gómez-Mejía et al. (2007), p. 106ff.

⁸ Cf. Geyer (2015), p. 9.

⁹ Cf. Klein (2004), p. 3.

¹⁰ Cf. Chrisman / Chua / Steier (2005), p. 237f.

¹¹ Cf. Steger / Amann (2008), p. 238.

¹² Cf. Memili / Chrisman / Chua (2011), p. 50.

¹³ Cf. Damodaran (2008), p. 9.

¹⁴ Cf. Gómez-Mejía et al. (2007), p. 107.

¹⁵ Cf. Huybrechts / Voordeckers / Lybaert (2012), p. 162.

¹⁶ Cf. Gómez-Mejía et al. (2007), p. 111.

¹⁷ Cf. Schwegler (2009), p. 13.

¹⁸ Cf. Schimank (2013), p. 103.

¹⁹ Cf. Jensen / Meckling (1976), p. 309 ff.

²⁰ Cf. Heyd / Beyer (2011), p. 34.

²¹ Cf. Welge / Eulerich (2014), p. 15.

²² Cf. Welge / Eulerich (2014), p. 24.

²³ Cf. Wiseman / Gomez-Mejia (1998), p. 133ff.

²⁴ Cf. Pepper / Gore (2015), p. 1061.

²⁵ Cf. Davis / Schoorman / Donaldson (1997), p. 20 ff.

²⁶ Cf. Davis / Schoorman / Donaldson (1997), p. 37ff.

²⁷ Cf. Le Breton-Miller / Miller / Lester (2011), p. 704.

²⁸ Cf. Le Breton-Miller / Miller / Lester (2011), p. 704.

²⁹ Cf. Le Breton-Miller / Miller / Lester (2011), p. 704.

³⁰ Cf. Le Breton-Miller / Miller / Lester (2011), p. 704.