Family Involvement in Family Businesses influencing Business Continuity

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Family Involvement in Family Businesses

influencing Business Continuity

A literature study to the influence of families in family businesses on the

financial firm performance, and the development of a decision-tree model

Groningen

August 25, 2009

Master Thesis

University of Groningen

Faculty of Economics and Business

Master of Science in Business Administration

Specialization Organizational & Management Control

Author: Lisette Buisman

Student number: s1384058

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Abstract

This thesis discusses family involvement through ownership, board of directors and board of supervisors in family businesses, influencing the long-term business continuity. By setting-up a decision-tree model family involvement is linked to firm performance. Board independency and the generation in charge of the board of directors seems to have the largest influence on firm performance. Next, the more a company ages, the more a company is professionalized by including independent directors. They limit agency conflicts which are prevalent from third generations. They also protect the family business from entrenchment, which often occurs in firms with concentrated ownership. In general the literature and analysis show that FBs are better performers than non-FBs. FBs have lower debt-to-equity rates, and higher profitability and growth rates.

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Preface

My attention to this subject was attracted by reading recently an article in which the performance of family businesses was discussed. It seems to be dependent of the extent of family involvement in ownership and the board of directors. Having the right division of family involvement within the company results in higher performance than non-FBs. Less explicit literature and empirical evidence could be found regarding this topic. Just one theoretical model exists measuring the family involvement in family businesses. This model is central in this thesis and I converted it to a decision-tree model which investigates the relations between family involvement, through ownership and the board, and the business continuity on the long-term. Next it was interesting for me to show the complex structure of the family business, consisting of an owners, business, and family subsystem. The emotional ties make a family business unique. This structure is of main importance to achieve superior performance. I think more research is needed regarding family businesses since it is the prevalent business form in the world.

I want to thank my supervisor, drs. J. Westra-de Jong, for her support and assisting me with my master thesis. You learned me always to think backwards. During the first months this was hard for me because this resulted in only reading articles and testing if my analysis is achievable. However, this really supported me in finishing my master thesis, because I was able to write my thesis in 2,5 months. I am sure that this advice of thinking backwards will support me in my future job. Next I also want to thank you for our long social talks, I really enjoyed.

Without the support of my family and friends finishing this master thesis would not have been possible. Moreover I want to thank Georg Suurmeijer for proofreading my thesis and his continuous support.

Finally I want to dedicate my thesis to my parents Peter and Margriet Buisman. They supported me throughout my whole study in Groningen.

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Abbreviations & Definitions

B.V. private limited company (Dutch translation: Besloten Vennootschap)

EU European Union

F-PEC Family influence – Power, Experience, Culture scale of Astrachan, Klein and Smyrnios (2002). A model which measures family influence in family businesses according the power, experience and culture dimension

FB family business

GNP gross national product

N.V. public limited company (Dutch translation: Naamloze Vennootschap) ROA return on assets

SB supervisory board

SQ sub question

U.K. United Kingdom U.S. United States

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1 Introduction

1.1 Introduction of the theme

The last 25 years the world around family businesses (FBs) is extensively explored. More information is collected and knowledge is created about the distinctive characteristics of FBs and the problems they face to maintain business continuity. FBs are the most dominant form of business structure worldwide (La Porta, Lopez-de-Silanes, & Shleifer, 1999). It ranges from more than 50% in the European Union (EU) to between 65% and 90% in Latin America and over 95% in the United States. Besides, they employ many millions of people, and play a significant role in the global economy, generating between 35% and 65% of the gross national product (GNP) of the EU member states (PricewaterhouseCoopers, 2007).

FBs have different characteristics compared to non-family owned businesses (non-FBs). They are more flexible in work, time and money and have a long term vision. Weaknesses are the rigidity and the fact that they face more difficulties when attracting capital from third parties (Flören & Jansen, 2006). The power of a family business is also derived at the interaction between the business-, owner-, and family system. This structure makes a FB distinctive from a non-FB because the directors, managers and employees work in a family bond (Flören & Jansen, 2006). These overlapping systems make it difficult to run a FB as best as possible. Several studies found that FBs outperformed non-FBs (Anderson & Reeb, 2003; McConaughy, Matthews, & Fialko, 2001), but it is also opposed that FBs are relatively poor performers due to (agency) conflicts that arise as a family attempts to manage a firm (Faccio, Lang, & Young, 2001).

Continuing the firm as a family business is often a dream of the founder, but passing the FB on to the next generation is tough. Indeed many fail to make the leap: only one-third of FBs worldwide are successfully transferred into the second generation and just 10% continue into the third generation (Neubauer & Lank, 1998; Birley, 1986). With support of good functioning governance mechanisms – like an independent board of directors – such failures could be avoided (Bammens, Voordeckers, & Van Gils, 2008). Several studies suggest that there is a positive correlation between good corporate governance and financial performance, of which the composition of the

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board (including externals) is one of the most important factors in this comparison (PricewaterhouseCoopers, 2007).

Family involvement could have a significant effect on firm performance. Astrachan, Klein & Smyrnios (2002) developed the F-PEC scale of family influence. With this model family involvement in a firm can be measured along three dimensions: power, experience and culture. The F-PEC scale is central in this thesis, which emphasizes the power and experience dimension. Power consists of ownership, the board of management and the governance board. Experience refers to the experience gained with succession. All dimensions could play a significant role in generational transitions.

The central question of this thesis is whether family involvement through power and experience influences the family business continuity on the long-term. What relationships could be identified? And which distinctive characteristics of FBs are of decisive influence for the long-term success? The aim of this thesis is to collect information and create knowledge about the above mentioned topics, and to deduce a decision-tree model from the F-PEC related to firm performance. Hopefully this thesis can clarify the relations between family involvement and financial firm performance, and which characteristics contribute to the long-term success of FBs.

1.2 Thesis outline

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2 Research Design

This section contains the formulation of the problem statement and the used research methodology. The chapter finishes by presenting the research model.

2.1 Problem statement

The problem statement describes the aim of the research. It consists of three elements: the research objective, the research question, and the preconditions (De Leeuw, 2005, p. 85).

2.1.1 Research objective

From the problem introduction the following research objective can be derived: “Providing Dutch family businesses insights in the association of family involvement in ownership and the boards, and its effects on business continuity”.

2.1.2 Research questions

The research question can be deduced of the research objective and is the main question in this thesis. The research question of this thesis is: What relationships could be identified between family involvement – through ownership and the boards – and the long-term business continuity?

Sub questions:

The research question can be split up in three sub questions (SQ). These need to be answered in order to answer the research question and give a thorough conclusion.

SQ1 How could the family business be defined, and what are the distinctive characteristics of a family business?

Objective of this SQ is to discus the family business definition, and to explain the unique characteristics of the FB. Definitional clarity of the FB supports to the literature review.

SQ2 Which theories can be found in the literature, related to the decisions of the decision-tree model, about the linkages between family involvement and firm performance?

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dimensions of family involvement are deduced of the F-PEC scale (see appendix A) and form the base of the decision-tree model, and literature study.

SQ3 What are the outcomes of adopting the decision-tree model in practice?

In chapter 5 (findings practical research) the decision-tree model of chapter 4 will be tested in practice. The outcomes of the analysis will be linked to the theory found in the literature review.

2.1.3 Preconditions

The research has to be carried out under several specific preconditions:

 The subject of this thesis must be related to theories of the master Organizational and Management Control.

 Accomplishing this master thesis is worth 20 European Credits.  This research is carried out from March 2009 until August 2009.

2.2 Research methodology

This paragraph defines the used research methods, and the belonging data- and sample collection method for this thesis.

2.2.1 Method of research

Before starting the main research, an explorative study is used to explore the world around family businesses in order to set up a clear formal study (Cooper & Schindler, 2003). In the formal study (this thesis) different methodologies are applied: a qualitative method (literature research) and a quantitative method (empirical research). It can also be described as a descriptive study when analyzing the relationship between family involvement and business continuity, and a causal study when explaining those relationships (p. 146).

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serves as a guideline to set up the decision-tree model.Although the F-PEC scale measures on a continuous scale, in this survey it is applied as a categorical scale.

In the empirical study quantitative data is derived of annual reports. The ratio analysis could be described as a longitudinal survey, because firm performance ratios are analyzed on different times (De Leeuw, 2005). The outcomes are discussed in SQ3. Testing the decision-tree in practice provides a more detailed and deeper view of the studied domain.

2.2.2 Data collection and sample collection

In this research merely secondary data is used. Information for the literature study (SQ1 and SQ2) is collected from academic papers, journals and books. Sources which are consulted are the library of the University of Groningen, Business Source Premier, Web of Science, PurpleSearch and other academic sources. Also general search engines on the internet are used to collect additional information and important research findings. Furthermore, surveys of FBNed (union of family businesses Netherlands) and BDO CampsObers Accountants & Advisors contribute to this thesis.

Regarding the empirical research, secondary data about financials is gathered from annual reports from Bureau van Dijk’s Amadeus. Also additional information is collected from the websites of the examined companies, or from daily news paper articles.

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2.2.3 Research model

The research model in figure 2.1 shows roughly the principal themes used in the research process. It is deduced of the F-PEC scale (see appendix A).

Figure 2.1 Research model

Family influence by power refers to dominance exercised through financing the business, and through controlling and/or leading the business through management and/or governance (supervisory board) participation by the family (Klein, Astrachan, & Smyrnios, 2005). The power dimension is leading in this thesis. Experience refers to experience that the family brings into the FB and is translated in the generation in charge of ownership and the boards (Astrachan, Klein, & Smyrnios, 2002). The culture dimension refers to the commitment in the overlap of family and business values (Astrachan et al., 2002). Because this dimension is rather subjective, differs per family business, and is difficult to measure, we excluded the culture dimension from this study.

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3 Family Business Definition

This chapter deals with the first sub question: How could the family business be defined, and what are the distinctive characteristics of a family business?

3.1 Family businesses

There is still no widely accepted definition of a family business. Family involvement makes a FB distinctive (Miller & Rice, 1967), but it is more than ownership and management (Handler, 1989). FB scientists lack consensus on which criteria are most important in identifying FBs. The criteria used to define FBs include: percentage of ownership, power over strategic direction, voting control, active management by family members, involvement of multiple generations, and others (Handler, 1989).

Chua, Chrisman & Sharma (1999) reviewed over 250 papers in the FB literature and found 3 differences: (1) family-owned and family managed, (2) family-owned but not family managed, (3) family managed but not family-owned. They did not find a clear definition. They state that the definition should mark the uniqueness of a FB. Not family involvement makes a business unique, but the specific structure of ownership, governance, management and succession makes that a FB behaves in different manner than a non-FB. This structure influences the way strategies, goals and structures are formulated, designed and implemented in the business. Resulting from their study they defined a new definition: “The family business is a business governed and/or managed with the intention to shape and pursue the vision of business held by a dominant coalition controlled by members of the same family or a small number of families in a manner that is potentially sustainable across generations of the family or families” (Chua, Chrisman, & Sharma, 1999), p.25.

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Figure 3.1 Concentric circles of the family business (Shanker & Astrachan, 1996)

Each definition can affect the size of the FB universe, so a broader definition includes more FBs. According to Flören (2002a) the amount of FBs in the Netherlands contain 83% in the broadest ring, 55% in the middle one, and 22% in the narrow ring.

Based on the above mentioned theory the F-PEC scale (see appendix A) is developed (Astrachan et al., 2002). In chapter 4 this model is converted to a decision-tree which examines the association between family involvement and firm performance.

In order to conduct good research definitional clarity is important. The Dutch scientist Flören did much research in the field of FBs and defined a clear, observable and measurable definition. He deduced it of the middle ring of the model of Shanker & Astrachan (1996). He replaced the criteria ‘>1 mgt position’ to the middle ring. In the Netherlands, this definition is broadly accepted by the Chamber of Commerce, FBNed, University of Nyenrode, and others. Furthermore, this definition (see table 3.1) will be used in this research.

Little direct involvement

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Table 3.1 Definition family business (Flören, 2002b)

Using this definition means that 55% of the businesses in the Netherlands are FBs. In 2005 the Netherlands counted 330.100 companies of which are 183.100 FBs (Thomassen, Duitman, Geerlings, Jansen, & Flören, 2007). Employability in FBs range between 42% and 50%, and they generate between 45% and 54% of the GNP (Flören, 2002b).

3.2 Complexity of a family business

Miller and Rice (1967) describe FBs as two overlapping systems: the family and the business. Each of these subsystems has its own norms, goals, priorities, value structure and organizational structure (Gersick, Davis, McCollom Hampton, & Lansberg, 1997). The family system is based on emotions: harmonization and unity are the driving forces. The business system is based on attaining better performance and exploiting changes. The interaction or mutual overlap between these subsystems makes a FB distinctive from a non-FB (Flören & Wijers, 1996). Tagiuri and Davis (1982) identified the importance of a third subsystem: ownership. This resulted in the three-circle model and is shown in figure 3.2. Each individual can be placed in one of the seven segments. 1. Just family 2. Just owner 3. Just management/employees 4. Family – management/employee 5. Family – owner 6. Owner – management/employee

7. Family – owner – management/employee

Figure 3.2 Three-circle model of family business (Tagiuri & Davis, 1982) A company is a family business when it fits at least 2 of the 3 criteria:

1. more than 50% of the shares are held by one family;

2. one family has decisive influence on the business strategy or succession decisions; 3. a majority or at least 2 board members are from one family.

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This model is widely accepted, because it is theoretically sophisticated and immediately applicable (Gersick et al., 1997). It portrays the FB as containing three independent but overlapping subsystems: family, business, and owners. This structure makes a FB unique, because no other type of business has this structural form (Murray & McCracken, 2005). This unique structure results in better firm performance than non-FBs since overlapping roles limit (agency) cost (Anderson & Reeb, 2003; Anderson, Reeb, & Mansi, 2003; Eisenhardt, 1989; Jensen & Meckling, 1976; Oswald, Muse, & Rutherford, 2009; Fama & Jensen, 1983). The three-circle model is a practical tool for understanding the sources of role dilemmas, interpersonal conflicts and boundaries in the family firm. These issues could have direct influence on financing decision(Flören, 2002b).

When an individual moves to another segment within the three-circle model (i.e. from ‘just family’ to ‘family–owner’) this results in evolutions in every subsystem. Since the time-development aspect misses in the circle model, Gersick et al. (1997) developed the three-dimensional developmental model. It shows in figure 3.3 how every subsystem could evolve. It should be remarked that the sequence of these evolution phases is not chained.

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The ownership axis in a FB can develop according different evolution phases (Ward, 1991). The controlling owner is often the founder and/or has full ownership. This could be succeeded by the children which is the sibling partnership (brothers and sisters). Involving more family members of different generations of different parents results in a cousin consortium (Gersick et al., 1997). The business axis relates to the life cycle and is deduced of other growth models (Greiner, 1972). A FB moves from the start-up phase to the expansion/formalization phase when the FB is settled on the market, has a stabilized method of working, or is expanding activities together with increasing organizational complexity. As growth is stabilized or stagnating the maturity phase is reached. Achieving this stage means that they have to move to other business stages, because the maturity phase results in stagnating firm performance (Gersick et al., 1997).

The family axis starts at the young business family in which the controlling owner establishes the business. When generations get older children are slowly involved (and employed) in the FB (entering the business stage). When the older generations are 40-50 years and the children 20-30 years, they are fully involved in the company. Than two generations are working together (stage 3) and governance aspects are becoming more important, such as implementing effective communication channels and succession planning (International Finance Corporation, 2008). As the oldest generation retires, succession takes place (passing the baton stage). It is possible that in a cousin consortium all stages of the family axis are involved, because it concerns different households. This makes the structure of a FB more complex (Gersick et al., 1997).

3.3 Bivalent attributes of a family business

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4 Literature Review

4.1 Decision-tree model

Figure 4.1 Decision-tree model family involvement – business continuity (firm performance) family involvement % family ownership (shares) ≤50% no relationship because of definition FB >50% direct ownership indirect ownership % family in board of directors (management/ control)

≤50% which generation active (multiple

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Figure 4.1 presents the decision-tree in which family involvement is the driving force. The base of this decision-tree is deduced of the F-PEC scale (see appendix A). The power dimension – represented by ownership, board of directors and board of supervisors – is leading in the decision-tree model. The experience dimension is integrated in the last decisions regarding which generation(s) is/are active on the boards.

The objective is to link the different outcomes of the decisions to the long-term financial performance of the FB. Firm performance is measured by sales growth, profitability and capital structure. This chapter tries to answer SQ2: Which theories can be found in the literature, related to the decisions of the decision-tree model, about the linkages between family involvement and firm performance?

4.2 Ownership

Ownership assesses the percentage of family members that share ownership in a business (Astrachan et al., 2002). As stated before (see table 3.1) a firm could be defined as a family business when one family holds more than 50% of the shares.

Many firms in the world have a family as controlling shareholder (La Porta et al., 1999). It is found that 52,7% of the largest listed European firms had a family as ultimate owner (Claessens & Tzioumis, 2006). This ultimate ownership (family has >50% shares) can be divided in direct and indirect ownership. Direct ownership means that the family controls the firm by directly holding its shares (registered on personal name). Indirect ownership refers to a company which is held by other entities (e.g., trusts, companies, holding companies) that, in turn, the family shareholder controls (Astrachan et al., 2002).

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Worldwide about 69% of the FBs separate ownership and control (Fama & Jensen, 1983). In the Netherlands this counts for 50% and is executed by certificating shares in a foundation administration office or by personal holdings (Hamel, 2005). This indirect ownership could mean that only on paper ownership and control are separated so the family is not personal liable. Only 29% of the ultimate owners of Dutch private limited companies (B.V.) certificate shares.

Concentrated ownership

The literature is divided which percentage of ownership influences the firm performance positively (e.g. (Villalonga & Amit, 2006; Claessens, Djankov, Fan, & Lang, 2002). It is presumed that FBs with a larger percentage of family ownership would have better financial performance and higher growth (Steijvers, Voordeckers, & Vandemaele, 2007; Fama & Jensen, 1983). Stronger ownership concentration mitigates the conflict of interest between owners (principal) and managers (agent) because a larger owner has greater incentives to monitor the management (Steijvers et al., 2007; Jensen & Meckling, 1976). Next to it, the FB is unique because of the contractual structure of overlapping family- and business ties (see figure 3.2), and the desire of the family to keep firm control across generations. This efficient relationship reduces agency costs (Blanco-Mazagatos, Quevedo-Puente, & Castrillo, 2007). Their long-term vision, great levels of firm specific knowledge and large family involvement contribute to the reduction of role conflicts, resulting in higher firm-performance than non-FBs (Van der Eijk et al., 2006; Jiraporn & DaDalt, 2009). About 80% of all Dutch FBs have a maximum of two stockholders (Flören, 2002a).

FBs concentrate ownership because this gives them control of the boards, they have less financial publication obligations to other shareholders, and have decisive influence on financial (long-term) decisions and strategy planning (Flören, 2002b). In the Netherlands 90% of all FBs have one family owning >50% of the shares/certificates (Flören, 2002a).

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2009). Examples of entrenchment issues are extraordinary dividend payouts, rejecting high risky profitable projects, secure employment for (incapable) family members and the choice of non-pecuniary benefits (taking away resources from projects that could otherwise be profitable) (Demsetz, 1983). These dealings can distract from the firm profitability. Besides when control rights of the largest shareholder exceed its cash-flow ownership, firm value falls (Claessens et al., 2002). Also growth is limited by choosing 'safe' projects (with a lower rate of return) instead of risky projects, because the family is risk averse (Schulze, Lubatkin, Dino, & Buchholtz, 2001). Families view their business as an asset to be passed along several generations rather than a means of funding current consumption. This could explain their risk aversion, which results in more conservative financing than non-FBs (McConaughy et al., 2001). Because family ownership is strongly related to control rights, they are reluctant to use external financing (i.e. for growth expansion). FBs (>50%) tend to have lower debt-to equity ratio's than non-FBs (McConaughy, Walker, Henderson, & Mishra, 1998; Hagelin, Holmén, & Pramborg, 2006; Mishra & McConaughy, 1999; Anderson et al., 2003). This is consistent with the pecking-order theory, which states that firms prefer internal equity over external financing sources, and external debt over external common stock (Myers, 1984). They usually reinvest their funds. Next to the involving costs of external financing, it means the dilution of control of family members and obligations regarding publishing financials (Mallin, 2007; La Porta et al., 1999). Conservative financing is associated with higher percentages of ownership concentration (Wright, Ferris, Sarin, & Awasthi, 1996; Van der Eijk et al., 2006). This does not mean that a FB will not survive generational transfers, but their growth could stabilize or stagnate when no additional capital is used for expanding activities.

Dispersed ownership

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Ownership stage Dominant shareholder issues

Stage 1: Controlling owner  leadership transition  succession

 estate planning

Stage 2: Sibling partnership  maintaining teamwork and harmony  sustaining family ownership

 succession

Stage 3: Cousin consortium  allocation of corporate capital: dividends debt, and profit levels

 shareholder liquidity  family conflict resolution  family participation and role  family vision and mission  family linkage with the business

Table 4.1 Key family governance issues faced by evolving FBs (Ward, 1991)

More shareholder dispersion (especially when indirect ownership) could result in higher information asymmetries, monitoring costs, and agency conflicts between the different persons involved. Also moral hazard and adverse selection could be a consequence. This could lead to lower firm performance, unless professional structures are implemented (Eisenhardt, 1989; Jensen & Meckling, 1976; Mallin, 2007). Just 9% of the Dutch FBs have more than three stockholders (Flören, 2002a).

Because ownership is strongly linked to voting rights, firm performance seems to be more dependent on the percentage of controlling family shareholders in the boards than on the percentage of ownership (McConaughy et al., 1998; Yin-Hua & Woidtke, 2005).

4.3 Board of directors

4.3.1 Board composition

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board can be composed in several ways: (1) only family members, (2) only outsiders (non-family members), (3) or a mixture of family members and outsiders. It is found that the last option is positively correlated to financial firm performance (PricewaterhouseCoopers, 2007).

Outside directors can be classified into affiliates (people with existing or potential business ties to the firm), or independents whose only tie to the firm is their directorship (Weisbach, 1988; Dalton, Johnson, Daily, & Ellestrand, 2009). Both are placed on the board to provide objective advice, industry-specific expertise, or are generally acting as advocates for viability and corporate health. Independent directors are more objective and more effective monitors of the family than affiliates. They limit family opportunism and moral hazard conflicts, minimize entrenchment, and protect the rights of all shareholders through which firm value could be created (Dalton et al., 2009; Shleifer & Vishny, 1997).

The decisive criteria for choosing between family members and outsiders should be the expertise and experience of the candidate, and not the family ties (Huse, 2005). Especially when a FB ages and grows it is important to have an active board of directors balanced with outsiders who can provide valuable advice (Ward & Handy, 1988; Flören & Jansen, 2006; Anderson & Reeb, 2004). Nevertheless, family members should be represented on the board, because independent directors miss firm-specific knowledge about insiders and the family, which could result in bad strategic decisions. Too little or no family representation could result in resistance (i.e. political activities) of insiders, and possibly reduces managerial monitoring. This hinders the board's effectiveness which could limit the firm continuity (Westphal, 1998; Finkelstein & Hambrick, 1996). Some family involvement on the board results in higher sales growth, profitability and market value/book value rates, because of less monitoring costs and the risk aversion of the family (McConaughy et al., 2001; Fama & Jensen, 1983; Barontini & Caprio, 2006).

Percentage family board representation

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When the ratio of family board representation to independent director representation exceeds 50% (1 family director to 2 independent directors), firm performance (measured by ROA and Tobin's q) deteriorates (Anderson & Reeb, 2004). Other studies confirm that high family involvement in the board subtracts firm value and impacts growth negatively (Ng, 2005; Silva & Majluf, 2008). In this case boards dominated by family members and affiliates are associated with strong, negative entrenchment effects, resulting in poor governance systems, and lower firm value or ROA (Yin-Hua & Woidtke, 2005; Hillier, 2009; Wright et al., 1996; Maury, 2006). The study of Oswald et al. (2009) found a strong inverse relationship between high family involvement on the board and firm performance, further supporting the entrenchment theory. When (family) ownership and control is separated by having a more independent board, entrenchment effects could be mitigated (Claessens et al., 2002; La Porta et al., 1999).

Also high family involvement in control leads to more (conservative) financing with (all) equity. At this control level, the potential for family opportunism increases, which imposes a capital constraint that inhibits firm growth (Carney, 2005). Including independents results in less conservative financing and more leverage, because they are less risk averse (McConaughy et al., 2001; Mishra & McConaughy, 1999). This could stimulate growth. When outsiders hold the CEO position the costs of debt financing are lower than when the CEO position is held by family members (Anderson et al., 2003).

Schulze (2001) found that outsiders have a positive effect on firm performance, but also found that their independence is not decisive. Independents have only a positive effect on firm performance (measured by sales growth) when it is coupled with complementary governance mechanisms – such as a supervisory board. Family differences and role conflicts can offset the benefits of reduced monitoring when no professional independent managers are involved (Kets de Vries, 1993; Morris, 1989). So board independence could be a safeguard to reduce the agency effect when the FB grows and ages (Oswald et al., 2009).

4.3.2 Experience

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succession adds significant valuable business experience to the family and the firm, and that the contribution of value is greatest in the transfer from the first to the second generation (Astrachan et al., 2002; Davis & Harveston, 2001; Birley, 1986). This amassed value of experience is shown in figure 4.2.

Figure 4.2 Experience of succession curve (Astrachan et al., 2002)

Succession is a key problem for FBs, since it has a central importance for the business continuity (Flören, 2002b; Brenes, Madrigal, & Molina-Navarro, 2006). Only one-third of FBs worldwide are successfully transferred into the second generation and just 10% continue into the third one (Neubauer & Lank, 1998; Birley, 1986). In the Netherlands at least 100.000 FBs will face succession in this decade (Flören, 2002a). Their survival and growth depend greatly upon how wisely succession is planned. In the Netherlands, just 29% of all FBs have prepared a complete succession plan (Flören, 2002a). It is necessary in cases of unexpected decease, being disabled, and divorce, by which controlling-owners are extremely vulnerable (Flören, 2002a; Brenes et al., 2006; Flören & Jansen, 2006; Flören & Jansen, 2006). Unsuccessful succession might result in job losses, economic hardship or even bankruptcy. Also many ownership and control transfers have resulted in role conflicts, which destroyed these companies (Danco, 1995).

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firm performance (Tobin’s q) (Bartholomeusz & Tanewski, 2006; Morck & Yeung, 2003). It also supports the FB in moving to the next generation and next growth/evolution phase (see figure 3.3: three-dimensional developmental model of a FB) (Flören & Jansen, 2006; Bammens et al., 2008).

Which generation is active on the board of directors?

Most studies make a distinction between founder- or descendant-controlled FBs, of which the last one is not split up in different generation numbers. Both groups run their company different, but both share firm-specific knowledge and run their firm more efficiently than firms without family ties (McConaughy et al., 1998).

Early generations concentrate ownership

Early generations are associated with higher firm performance, because of their more concentrated ownership. There are less people involved into the business, which limits monitoring costs and role conflicts (McConaughy et al., 1998; Fama & Jensen, 1983; Steijvers et al., 2007). During the first generation often no independent directors are presented on the board. When the second generation is in charge of the board of directors, they run the FB more efficiently. They are in a position to consolidate the advantages passed on to them by the founders (first generation) and can utilize a market advantage to create superior sales growth and high margins (Fama & Jensen, 1983; McConaughy et al., 1998).

However, agency costs increase as more people (possibly of two generations) get involved. They should compensate these costs by the enlargement of the firm’s financial structure in order to compete in the same resource structure conditions as non-FBs (Blanco-Mazagatos et al., 2007). This counts for every generation when more people get involved (Bammens et al., 2008). Also each succession transfer has a negative effect on operating profit (ROA) (Bennedsen, Nielsen, Perez-Gonzáles, & Wolfenzon, 2007).

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are more risk averse. Siblings are also more likely to detract from firm performance, because they have a CEO position through family ties rather than job qualifications (Anderson et al., 2003; Hillier, 2009). It is found that firm performance (ROA, firm value) is highest in FBs where the founder is still active as CEO (Andres, 2008). The literature is divided how successful descendant-CEOs are (Barontini & Caprio, 2006; Villalonga & Amit, 2006; Anderson & Reeb, 2003).

From third generations: dispersion and professionalization

From third generations ownership and family ties are getting more dispersed (and complex) and agency costs become more intense because of altruism problems (Blanco-Mazagatos et al., 2007). The formal authority of family influence may decline and it is harder to maintain cohesiveness between family members, which could affect firm performance negatively. Hence, the level of task conflicts is prevalent from third generations and occurs in the siblings partnership or cousin consortium (Neubauer & Lank, 1998). This mainly happens in FBs where parents (founders) are not alive anymore (Chrisman, Chua, & Steier, 2005). As a consequence, the need of professional independent directors becomes extremely important to retain business sustainability (Hamel, 2005; Chittoor & Das, 2007). They can play a vital role as arbitrator/advisor in the FB. From third generations this role is more important than the experience they add to the business (see figure 4.2).

When ownership more disperses (i.e. cousin consortium), boards are more likely to risk the use of debt to fund growth when entrenchment (i.e. cutting dividends) is limited and agency problems are better controlled (Gersick et al., 1997; Schulze et al., 2003; Anderson et al., 2003). Also succession by an outside CEO rather than a descendant-CEO is associated with higher firm value, higher operating performance (ROA), higher succession performance, and lower cost of debt financing (Morck, Shleifer, & Vishny, 1988; Barontini & Caprio, 2006; Anderson et al., 2003; Bennedsen et al., 2007; Chittoor & Das, 2007; Hillier & McColgan, 2004).

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4.4 Board of supervisors

Family involvement through the board of supervisors (governance board) can be measured as the percentage of board seats held by the family and the percentage of family representatives (Astrachan et al., 2002). The board of supervisors represents the interests of the stockholders (Gersick et al., 1997).

The legal system of a country has influence on the type of board. Most western countries, like the U.S. and U.K., have a one-tier board. On the other hand, i.e. Germany and the Netherlands, have a two-tier board in which a member of one board (supervisory board or board of management) is, by law, not permitted to have a dual role on both board levels (Mallin, 2007). In the Netherlands it is obligatory by law to implement a supervisory board (SB) when the FB is a public limited company (N.V.) or has a structure regime.

The structure regime requires large companies to appoint a SB. The legal status of the company is irrelevant in determining the application of the regime. A ‘large company’ is defined as one when it meets the following criteria (Holland Van Gijzen, 2004): (1) having equity capital of at least EUR 16m.; (2) being required by law to have a Workings Council (whether at the parent company or a subsidiary); (3) employing at least 100 people within the Netherlands (whether at the parent company or a subsidiary).

About 62% of the 5.000 largest Dutch FBs (more than 100 employees) use commissioners (Flören, 2002a). Supervisors have relevant business experience and knowledge. They supervise the executive directors and the CEO, but also provide advice and approval regarding strategy, large investments, acquisitions, the annual report, the composition of the management, and support succession planning (Hamel & Thomassen, 2003). The SB is appointed by the stockholders (general meeting of shareholders), and the working council has the right to recommend potential supervisors. The stockholders have the right to dismiss the SB (Holland Van Gijzen, 2004).

Percentage family board representation

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supervisors (Flören, 2002a). Though the ideal commissioners from outside the family are experienced, are independent outsiders, and have no conflicts or interests in the business/family. With their expert knowledge on specific issues they can add significant knowledge in order to run the FB as best as possible (Gersick et al., 1997).

It is found that performance of FBs is distinguishable from non-FBs when the family is actively represented in the executive or supervisory board. They are not distinguishable when they are just large shareholders without board representation (Andres, 2008). Too much representation leads to entrenchment decisions. So, again some family involvement in the supervisory board is needed to distinguish from firm performance of non-FBs.

Which generation is active on the board of supervisors?

Implementing a board of supervisors is associated with generations who already faced (several) successions (Neubauer & Lank, 1998). It depends mainly on the evolution phases of the ownership- and business axis (see figure 3.3) (Gersick et al., 1997). It often starts in an informal way: one or two commissioners (often friends) provide professional advice (i.e. regarding finances and strategy), but have no further (legal) rights. FBs try to avoid the legal obligation, because the supervisory board has the right to appoint and lay off the board of management, and they must be consulted for approvals regarding long-term decisions (Hamel & Thomassen, 2003).

From 3rd generation

It is assumed that the need of non-family members in the supervisory board becomes prevalent when at least the third generation (siblings partnership or cousin consortium) is met and the FB is in the formalization/expansion phase (Neubauer & Lank, 1998; Gersick et al., 1997). Than the level of task conflict is the highest and professional advice and arbitration of outsiders are needed (Bammens et al., 2008). Professionalization by the use of a SB supports to the long-term survival of the FB (PricewaterhouseCoopers, 2007). CEO-duality by externals has a negative effect, but in the Netherlands this is prevented by the two-tier structure (Bammens et al., 2008).

Family institutions as substitute of the board of supervisors

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building consensus, which could result in less agency conflicts and entrenchment (Gersick et al., 1997; Hamel, 2005). Family institutions range from informal to highly formal bodies and evolve over time in parallel with the three-dimensional developmental model (Neubauer & Lank, 1998; Gersick et al., 1997). An overview of family institutions is given in appendix D.

4.5 Conclusion

Depending on the definition of a family business, in this thesis it is assumed that a firm is a FB when one family has >50% direct or indirect ownership. Direct ownership is associated with small FBs. Indirect ownership is prevalent, which separates ownership and control by i.e. a pyramidal structure. This could also influence the ownership structure of the subject company, because it often allows the owners to have control rights in excess of their cash flow rights. The literature is divided about the percentage of family involvement in ownership (concentration/dispersion) influencing the business performance. Concentration reduces agency costs but does also strengths entrenchment. It also results in conservative financing, because the family is risk-averse. However, ownership is strongly linked to control (rights) and it seems to be more dependent on the percentage of family members on the boards.

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5 Findings Practical Research

5.1 Company selection & graphics firm performance

This chapter deals with the last sub question: What are the outcomes of adopting the decision-tree model in practice? For the analysis three large Dutch family businesses were selected with different percentages of family-ownership. They operate in an industry (retail sector – food and beverages) with low inherent risk, which contributes to a more solid comparable analysis of the financial performance of the companies. The outcomes of the analysis will be linked to the theory found in the literature review.

Selected companies

Jumbo Group Holding B.V. (Jumbo) – is founded in 1921 (previously named as Van Eerd Group Holding B.V). Nowadays Jumbo is one of the fastest growing Dutch retailers in the Netherlands (Amadeus, 2009). Jumbo is a 100% family-owned company with a reputation for value and customer satisfaction, winning the Best Supermarket Award in the Netherlands in 2006.

Heineken Holding N.V. (Heineken) – is founded in 1864. Presently they are one of the world’s largest brewing groups. The Heineken family has through several entities ultimate ownership of Heineken N.V., in which operational activities take place.

Royal Ahold N.V. (Ahold) – is founded in 1887. Prime subsidiary of Royal Ahold N.V. is Albert Heijn. Ahold also expanded to the U.S. In 2003 the book-keeping scandal in the US resulted in economic downturn. During generations family shares were sold to outsiders, which resulted in 0% family-ownership and control in 1993.

Business continuity

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consolidated statements and can be found in appendix F. It should be remarked that the results of Jumbo contain a time period of 7 months in 2001. This is due to the foundation of Jumbo Group Holding B.V. in 2001 on May 31st. Below figure 5.1, 5.2 and 5.3 show respectively the profitability, capital structure and growth of the sample companies.

Figure 5.1 Profitability (by return on total assets)

Figure 5.2 Capital structure (by debt-to-equity ratio)

-5 0 5 10 15 20 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 re tu rn o n t o tal assets (i n % ) year

Profitability

Jumbo Groep Holding B.V. Heineken Holding N.V. Koninklijke Ahold N.V.

0 2 4 6 8 10 12 14 16 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 d e b t-to -e q u ity rat io year

Capital structure

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Figure 5.3 Growth (by growth rate revenues)

5.2 Ownership

The selected companies have different percentages of family ownership. All have separated ownership and control (indirect ownership) by a pyramidal structure: the family achieves control of the subject company according to a chain of ownership relations of other intermediary firms (Astrachan et al., 2002). Direct ownership is recognized in the company in the top of the pyramid. Appendix E shows the holding structures of the firms.

Jumbo changed in 2001 the organizational structure by adding an public limited company (Jumbo Group Holding B.V.) in the top of the pyramidal structure. From this period Jumbo experiences significant growth in the amount of supermarkets. An additional level in the pyramid supports to the spread of risk. According to the decision-tree model (see figure 4.1) they have >50% of the shares, and indirect ownership by having a holding structure of 3 levels. Ownership is concentrated among 4 family stockholders: 1 person of the 2nd generation has a 25% interest; 3 persons of the 3rd generation have each an equal interest of 25% (Baltesen, 2007).

The Heineken family has set-up a more complex holding structure (complete overview in appendix E). Heineken Holding N.V. has a 50,005% interest in the issued share capital of Heineken N.V. The holding is ultimately controlled by the Heineken family through several intermediary firms. According to the decision-tree the family has a 50,001% interest, and indirect ownership by having a pyramidal structure of at least 4 levels. Family ownership is concentrated

-50 -40 -30 -20 -10 0 10 20 30 40 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 gr o wt h r ate r e ve n u e s (i n % ) year

Growth

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N.V. (respectively 41,22% and 49,995%) are widely dispersed. Every Heineken N.V. share held by Heineken Holding N.V. is matched by one share issued by Heineken Holding – both having identical net asset values, and dividend payables. After the decease of Freddy Heineken in 2002, his daughter inherited his interests and became ultimate shareholder of Heineken (Heineken International, 2009).

Ahold is a FB by origin, but according to the decision-tree they are not a FB since they have ≤50% family-ownership. As of 1993 family ownership is about 0%. Ownership of Ahold is widely dispersed, and has no ultimate shareholder (Redactie economie, 1993).

The literature states that FBs with a larger percentage of family ownership would have better financial performance and higher growth, because of lower agency costs (Steijvers et al., 2007; Fama & Jensen, 1983). These costs are limited because of the overlapping family- and business ties (Blanco-Mazagatos et al., 2007). In consensus with the results it is found that Jumbo (100%) has the highest profitability and growth, followed by Heineken (50,005%) and Ahold (0%: non-FB). Ownership concentration improves firm performance, but could also cause entrenchment which results in declining profits (Oswald et al., 2009). However, no data is found supporting this theory. This is probably due to the fact that the studied companies professionalized their firm because many people are involved of the owner-, family-, and business system. No professionalization results in higher monitoring costs, information asymmetries and agency conflicts (Mallin, 2007). Because Jumbo is the smallest company of the sample group, relatively less people are involved, resulting in lower agency costs and the highest performance. Again, since ownership is strongly associated with board control, the financial performance will be further discussed in the next paragraph.

5.3 Board of directors

Family involvement through the board of directors can be measured as the percentage of board seats held by the family and those named by the family (Astrachan et al., 2002).

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Heineken’s composition of the board of directors remained the same in the period 2002 – 2008. It consists of 4 persons, of which Mrs. Carvalho-Heineken (delegated member since 2002) has ultimate ownership. She is of the 4th generation. Another member could be described as an affiliate since he is former chairman of Heineken N.V. Besides, the other two directors are members of the board since 1972 and 1994. It is reasonable that these persons are also affiliates. This totals a family board representation of at least 50%.

Ahold: in 1989 family-CEO Albert Heijn is succeeded for the first time by a non-family member. No information could be found that the family is still active on the board of directors. So family board representation is 0%.

The results show that Ahold, as non-FB, has relatively the lowest firm performance measured by ROA and growth. Jumbo, as 100% family-owned company, has the highest rates which is supported by Anderson & Reeb (2003) who state that FBs are better performers than non-FBs because of the family ties. Next, in 2003 Ahold was involved into a book-keeping fraud which influenced firm performance extremely negative.

Scientists argue that some family involvement on the board results in higher sales growth and profitability (Barontini & Caprio, 2006). When family representation exceeds 50% their involvement could have negative influence on growth and firm value, due to entrenchment effects and more conservative financing with (all-) equity (Hillier, 2009; McConaughy et al., 2001; Silva & Majluf, 2008). Our results show that Jumbo, with its highest rate of family board representation, has the highest ROA and growth. While Jumbo and Heineken both have >50% family (and affiliate) board representation, no supporting data of negative firm performance can be deduced of the graphics. However, throughout time Jumbo experienced declining board representation together with rising profits and growth. This implies that some family involvement improves the business continuity. If board composition stays the same (Heineken) this results in stable growth.

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when the family has equal interests in share capital (Anderson et al., 2003). This make them risk averse in choosing safe projects. From 2005 Jumbo’s debt-to-equity rate slowly increases which could indicate that they are less risk averse, because entrenchment is limited and agency conflicts are better controlled (Schulze et al., 2003; Oswald et al., 2009). This could also be explained by the explosive growth of the number of expanding supermarkets.

It is remarkable that Heineken has the highest debt-to-equity ratio. This could be due to the fact that they have spread their risk throughout the pyramidal structure. The objective of the foundation of Heineken Holding N.V. is to supervise or manage the boards of the Heineken group, and to provide services for Heineken N.V. Their role is to safeguard its continuity, stability and independence, and to invent conditions for controlled, steady growth of Heineken. That is why the family wants to remain ultimate shareholder (Van der Eijk et al., 2006). Their aim to create stability and continuity could explain Heineken’s stable use of debt, resulting in steady growth. Their fast growth in 2008 could be explained by increasing selling prices, other product mixes and some divestments. However, in general, all companies are really close to each other regarding the debt rate.

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5.4 Board of supervisors

Family involvement through the board of supervisors (governance board) can be measured as the percentage of board seats held by the family and the percentage of family representatives (Astrachan et al., 2002). All the sample companies have a supervisory board standing at the top of the holding. This is in accordance with the literature which states that from 3rd generations a formal board of supervisors is necessary (Neubauer & Lank, 1998). However, it is also obligatory by law.

Jumbo has a supervisory board situated in the holding group. It consists of 4 members who are probably affiliates of the family Van Eerd. This is assumed because the composition of the SB stayed the same from 2003 – 2008. However, no supporting data could be found. At Heineken the SB is situated in Heineken N.V. and not into the holding company. The SB consists of 8 members, of which 3 members are not independent. This is because they are also director in the holding company. Board representation never exceeded 50% in the studied period. In 2008 it was 37,5% (Amadeus, 2009). The SB of Ahold consists of 8 members, and no relations with the family or affiliates could be found. So board representation is 0%.

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5.5 Conclusion

In general from the results could be concluded that FBs are better performers than non-FBs. The higher ownership is concentrated within the family the higher the profitability and growth. Also in accordance with the literature FBs with larger percentages of ownership have lower debt-to-equity ratio’s because they are reluctant to use external financing, resulting in dilution of their control.

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6 Conclusion

Family businesses (FB) are predominant in the world and are complex entities because of their unique structure. This can be explained from the overlapping systems in a FB: owners, business, and family. The family system is an emotional system and makes a FB distinctive from non-FBs (p.15). Families are largely involved, have a long-term vision, are financial independent because of the use of little to no debt, and have fast decision- making by overlapping roles. However, family involvement could result in rigidity, less professionalization, or entrenchment effects (appendix C). Still many studies concluded that FB are better performers than non-FBs, which is supported by our practical study.

This thesis tried to answer the main research question: What relationships could be identified between family involvement – through ownership and the boards – and the long-term business continuity? Family involvement was deduced of the F-PEC scale and was central in this thesis by formulating these dimensions in a decision-tree model. The decision-tree model linked family involvement to business continuity on the long-term. The culture dimension was excluded from this study because of its subjectivity.

Power through ownership, the board of directors and board of supervisors does have influence on the business continuity. It is found by literature and the analysis that aged FBs separate ownership and control by setting-up holding structures (p.21 / appendix E). This indirect ownership allows them to spread their risk and being not personal liable. Their ownership rights are strongly linked to control (rights), which means that family involvement on the board of directors is of main influence on the firm performance. When ownership is concentrated and thus control is concentrated, this could result in less agency conflicts (since overlapping roles) and more entrenchment (p.21). Holding large stakes could indicate that the family wants to keep control and that they are reluctant to use external financing, for i.e. expanding growth activities, since this dilutes their control. This risk averse behaviour results in conservative financing. The analysis showed that concentrated ownership does generate lower debt-to-equity rates (p.22), but it is also found that they have higher profits and growth than dispersed ownership firms or non-FBs (p.36).

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Board independency becomes more important in the formalization/expansion evolution phase and from third generations (siblings partnership or cousin consortium) where role/task conflicts are at a high level (p.28). This is often a result of ownership dispersion. Independents have industry-specific expertise, are objective and can act as arbitrator to limit role conflicts and family expropriations. Literature states that some family involvement on the board of directors results in higher sales growth, firm value and profitability because of less monitoring costs and the risk aversion of the family (p.24). The risk aversion protects the company from too risky investments and the use of too much debt by independents. When family representation exceeds 50% performance should deteriorate because of entrenchment (p.25). Anyway, this is not supported by our empirical study (p.37). Probably this could be explained by the experience dimension (p.38). The studied firms are aged and professionalized their firm by involving independents. Still family remains control and is strict supervised by independents having a role in daily management, supervisory board, or audit committee. Besides our sample companies were obligatory to publicize their financials which make them probably reluctant to entrenchment.

One sample company diluted their ownership and control completely. They had a cousin consortium and too many family members were involved with different interests. This resulted in agency conflicts on a high level – harming the firm performance. As non-FB in our survey they were the worst performer (p.38).

Regarding family involvement on the supervisory board less literature and empirical evidence could be found. It is argued that some family involvement improves firm performance and that a supervisory board becomes important when the company is in the formalization/expansion phase and/or in the siblings partnership/cousin consortium (p.30). All sample companies had an experienced supervisory board.

Limitations & future research

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The association of ownership and board of directors should be more deepened. This interrelated topic is of main influence on the business continuity since indirect ownership allows FBs to have excess voting control on the board. Next, our analysis does not support the literature about which percentage of family representation on the board of directors influences firm performance most positively. A study with a larger sample could reinvestigate what percentage is of decisive influence to the long-term success.

The experience dimension, the generation in charge, seems also to be of main influence on the business continuity. The more a company ages, the more professionalization. An important limitation of this topic is that literature deals mostly with the distinction between founder- or descendant-controlled FBs, respectively the first and second generation. Less evidence could be found from third, fourth or fifth generations. Clarifying why and how aged FBs are able to survive different generations could support young FBs to survive on the long-term.

At last, little to no literature and empirical evidence about family involvement in supervisory boards regarding firm performance could be found. We did not exclude this dimension from this study as it is a sub element of the power dimension.

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Family Involvement in Family Businesses influencing Business Continuity