Is trust better than control? A majority participation of a
private equity fund in a Dutch family firm
The impact on the management control system
by L.T.M. Stam1 20 October 2014 B. van der Kolk (MSc)
Supervisor
University of Groningen Faculty Economics and Business
MSc Business Administration
Specialization Organizational and Management Control
ABSTRACT
This paper explores in detail the impact of a majority private equity investment on the management control system of a Dutch family firm. In doing so, the answer to the question if there is a change from the more familiar stewardship approach of management control to the more formal and professionalized agency approach, which is in general followed by the private equity firms, is sought. By interviewing not only the employees and founders of the family firm, but also the managers of the private equity firm, an overall and objective picture of the change in the management control approach after the deal was created. The results seem to suggest that the former family firm still follows the entrepreneurial stewardship approach, but with some injections of elements of the agency theory (i.e. control oriented, control mechanisms) in order to make sure that this stewardship approach delivers results. This means that at the moment there is a combination of the two management theories and that the management control system of the family firm became more structured, formal and professionalized, but elements of the stewardship theory are sustained. Until now none of the theoretical agency-stewardship dilemmas occurred in the family firm. However, the results also showed that at the moment of the interviews, 1,5 year after the deal, the change of the management control system is still an ongoing process.
Key words
Family firm, private equity firm, management control, agency theory, stewardship theory, majority investment
Table of Contents
1. Introduction ... 3
2. Literature review... 5
2.1. Cooperation of the private equity firm and the family firm... 5
2.1.1. Management control... 5
2.1.2. The value added service of a private equity firm ... 6
2.2. Management control theories ... 7
2.2.1. Agency theory and stewardship theory ... 7
2.2.2. The agent-steward dilemmas... 8
3. Method and data... 11
3.1. Research design... 11
3.2. Case study ... 11
3.3. Case study background ... 13
3.3.1. Background of ABC Investment (ABCI)... 13
3.3.2. Background of RR Health (RRH) ... 13
3.3.3. Overview of the interviewees... 14
4. Findings ... 15
4.1. Results of the interviews with the founders of ABCI ... 15
4.1.1. Background ... 15
4.1.2. Changes in RRH after the deal with ABCI ... 15
4.1.3. Control... 17
4.1.4. Advice and support activities ... 17
4.1.5. Agency – Stewardship... 17
4.1.6. Summary ... 19
4.2. Results of the interviews with the founders of RRH... 19
4.2.1. Background ... 19
4.2.2. Changes in RRH after the deal with ABCI ... 20
4.2.3. Control... 21
4.2.4. Advice and support activities ... 21
4.2.5. Agency - Stewardship ... 22
4.2.6. Summary ... 23
4.3. Results of the interviews with the employees of RRH ... 24
4.3.1. Background results... 24
4.3.2. Changes ... 24
4.3.3. Control... 26
4.3.4. Advice and support activities ... 27
4.3.5. Agency - Stewardship ... 27
4.3.6. Summary ... 30
4.3.7. Remarks of the interviewees ... 32
5. Discussion... 34 6. Conclusions ... 38 6.1. Concluding summary ... 38 6.2. Recommendations ... 39 6.3. Limitations... 40 7. References ... 41 8. Appendices ... 43 8.1. Interviews ... 43
8.1.1. Specific interview questions for the founders of ABCI ... 43
8.1.2. Specific interview questions for the founders of RRH ... 43
8.1.3. Specific interview questions for the managers/employees of RRH... 43
1. Introduction
Family businesses are an important part of the economy and are acknowledged to form the majority in market-oriented economies (Hiebl & Kepler, 2012; Joyce, 2007). In this paper, family business is defined by “the involvement of family members in the ownership and management of the firm and the owning family’s desire for transgenerational control” (Chrisman, Chua, Pearson, & Barnett, 2012a; Chrisman, Chua, Steier, Wright, & McKee, 2012b). Before the 1990’s, there was no way to go for family owned businesses except intergenerational succession. However, family firms are nowadays able to sell their company to other parties (Gilbert, 1989). In the Netherlands 50% of the family firms are planning a transition of the business or parts of it within a period of 5 year (KPMG, 2012). The main reason for this high number is the ageing population in the Netherlands and amongst the possible buyers of the shares are private equity firms (PEFs).
In scientific research there is no clear definition for private equity, it is a phenomenon that developed in practice rather than theory (Hehn, 2011; Söding, Nobel, & Achleitner, 2012). In this paper the more functional definition of Söding et al. (2012) is used. The authors introduced the term “organized private equity” in their study and defined this term as “private equity funds that function as specialized intermediaries raising capital from a limited number of institutional and well-funded private investors and investing the pooled funds in selected portfolio companies”. Their goal is to add value by supplying financial and/or nonfinancial resources to the family firms and sell their shares for a higher price within a limited time period (Wulf, Stubner, Gietl, & Landau, 2010).
The management control function, which is part of the corporate governance, is used to influence the behaviour of the employees in favour of reaching the goals of the company (Corbey, 2010). The management control of PEFs can be best described and identified by the agency theory, which stresses controlling decision-makers through monitoring and giving incentives aligned with the goals of the organization (Ball, et al., 2008; Tappeiner, Howorth, Achleitner, & Schraml, 2012). On the other hand, the management control of family firms is associated with the stewardship theory, which stresses that decision-makers will act in the organizations’ best interest, even without strict control mechanisms (Corbetta & Salvato, 2004; Corbey, 2010; Tosi, Brownlee, Silva, & Katz, 2003). After the majority participation, the PEF may require more power and want to professionalize the management control by introducing a control function that is motivated by the agency theory. However, family firms are least inclined to relinquish command, according to the theory (Tappeiner et al., 2012)and this type of agency-based control can be counterproductive for the motivation of the stewards (Davis, Schoorman, & Donaldson, 1997). The interest of the two shareholders can diverge considerably and their relationships are prone to conflicts.
concluded that the positive effect is more pronounced when there is minority investment, because then the PEFs fulfil a more complementary role for the previous owners and managers instead of replacing them.
The transition period is a potential precarious time of change for the family firm and their stakeholders, because new shareholders will probably lead to new strategies, roles, routines and relationships within the family business (Steier & Miller, 2010). Achleitner et al., (2008a) concluded that the biggest consequences for the family firm are in the fields of corporate governance, controlling and reporting. Various studies identified the importance of family business peculiarities with respect to the corporate governance, which has resulted in different calls for studies of the change in management control after the family firm sold part of their shares to a third party (Dawson, 2011; Hiebl, Feldbauer-Durstmüller, & Duller, 2013; Parker & Praag, 2012; Sten, 2006; Teeffelen, 2012). Although research proved that the management control of a family firm experienced significant changes of a majority investment of a PEF, to my best knowledge, the impact on the management control system was never researched in detail before. This paper aims to fill this gap in literature.
This research is relevant for both academia and in practice. The findings in this research can shed light on the topic of majority private equity investments in family firms and show the impact that can be expected in the management control system. Furthermore, this research can also add a new perspective on the agency-stewardship discussion regarding the corporate governance of family firms and the change during a partly ownership transition. In practical view, the results of this research can help families and managers to better foresee the changes that they can expect when a PEF invests in a family company. Moreover, it can also help the PEFs to prepare better for a majority investment in a family firm and estimate which roles they can performin the family firm after the participation.
In order to gain knowledge this study examines a small and medium (SME)2 Dutch family firm that has taken an external majority equity investment from a PEF, with the aim of identifying the impact on their management control system after the participation, based on the stewardship- and agency theory. This paper addresses the following fundamental research question:
How does the majority investment from a private equity firm in a SME Dutch family business affect the management control of the family firm?
In order to answer the research question, a qualitative approach is chosen, primarily because the structures of private equity majority investments are complex and private equity funds and owner families tend to guard the confidentiality of their agreements, which makes available data of majority ownership of PEFs in family firms scarce. Furthermore, a qualitative study is the best way to capture the thoughts, experiences and relationships in the management control function.
Outline
The remainder of this paper is organized as follows: Chapter 2 will provide an introduction of the relevant concepts and an investigation of the literature available on this topic will be presented. The methodology and data can be found in chapter 3. The results of the interviews are presented in chapter 4. In chapter 5 the results are discussed. Finally there will be a summary of the results in chapter 6, accompanied by a conclusion, proposals for future research and a discussion of the paper’s limitations.
2 European Commission. (2003). EU recommendation 2003/361. Official Journal of the European Union. The
2. Literature review
In this section, the management control and supervision of the private equity firm on the portfolio company will be covered in more detail (2.1.1.). After that, the value added function of a private equity firm will be discussed (2.1.2.). Finally, the agency- and the stewardship theory are introduced and these theories are used to study the impact on the management control system of a family firm after a participation of a private equity firm (2.1.3.).
2.1. Cooperation of the private equity firm and the family firm 2.1.1. Management control
Management control is seen as a critical function in a company and a core function of the management (Merchant & van der Stede, 2007). In essence the management control function is about the goal of the organization and the behaviour of the employees (Corbey, 2010). Goal congruence is the most crucial term in management control. If the goals of the employees converge with the goals of the organization/owners then there is no management control problem. When goal congruence diminishes, there is growing management problem and the necessity to invest in a management control system increases (Corbey, 2010).
Merchant and van der Stede (2007) defined management control as all the systems and devices that are used to ensure that the employee’s behaviour and decisions are in line with the pre-set strategy and objectives of the company, and if necessary, that they are modified to the new situation. In a more general definition, which is related to the principal-agency theory, management control is explained as all activities of the principals (owners) that are necessary to let the agents (managers) act in the interests of the principals (Kleine, 1996). Moreover, there is a second management control situation, in which the top managers act as principals and other employees/managers as agents, which is especially important in transition from family control to non-family control (Chrisman et al., 2012b). Furthermore, Atkinson et al. (1997) stated that the management control system hasto create an informative environment in which managers can project and respond to the new directions of the firm, while it simultaneously has to be a stable and efficient system for the users and has to satisfy their needs.
Bruining, Bonnet, & Wright (2004) suggest that the ownership change provides a major opportunity to affect changes in the management control system. Moreover, Chrisman et al. (2012b) stated that the costs of financial losses that are caused by uncontrolled opportunism behaviour (that is often seen in family companies), is now replaced by the costs of control mechanisms that are used to prevent this kind of behaviour. Ball et al. (2008) researched to the managerial style in a family firm after a buyout. The authors stated that superior firm performance of former family firms after a buyout was positively associated with a management style that was a combination of the entrepreneurial and professional management style. It is even said that a change of family influence in the firm leads to a change in culture. Nevertheless, Ball et al. (2008) stated that a full-professionalised approach could be a risk for losing more intangible assets of a family firm such as commitment and loyalty, which may be important for the performance of the firm. The authors explained that an ownership change could be an important transitory phase in which it facilitates professionalization and the stewardship culture from the family firm can still be maintained (Ball et al., 2008).
that the portfolio company acts according to the strategy of the private equity firm, with the final goal of creating value. To reach their goals the PEFs want information-, control-, and ownership rights, to decrease the information asymmetry and have some control over the portfolio company. Nowadays, PEFs prefer a majority ownership or at least more control rights, so that they can respond more quickly on the ever changing circumstances and make important decisions during difficult economic periods. This is probably even more important in deals with family firms, because family members often have the characteristic that they are not only driven by economic goals but also by non-economic goals (Chrisman et al., 2004; Corbetta & Salvato, 2004). Family managers use less formalized finance and accounting systems and often take decisions on intuition, based on their deep firm and market specific knowledge (Sirmon & Hitt, 2003). Therefore, the private equity firm wants to recognize, decrease or even end the rationality deficits in the form of management failure in an early stadium (Weber & Schäfer, 1999). Often the family firm is professionalized after the buyout (Center for Management Buyout Research (CMBOR), 2008). This means that there are establishments of finance and accounting resources and this information is used to make on fact-basis decisions (Hiebl & Kepler, 2012). Furthermore, the appointment of a financial controller will increase the efficiency and effectiveness of the managers (Weber, 2004). This can be counterproductive for companies that have a management control system based on the stewardship theory, likemost family firms (Corbetta & Salvato, 2004; Corbey, 2010).
In this case study, one of the goals is to identify the impact of the private equity investment on the monitoring and control function in the family firm. The results can give the private equity firm an idea of how employees experience the changes and lead to lessfriction. 2.1.2. The value added service of a private equity firm
Private equity is also referred to as intelligent money, because it cannot only support the portfolio companies with financial resources, but some PEFS also support their portfolio companies with non-financial value-added services (Ruppen, 2001). These services are regularly organized and provided by a fund manager (Söding et al., 2012). The fundmanagers or advisors support their portfolio companies with their experience, expertise, ideas and business network on strategic, operational, financial and governance topics (Söding et al., 2012). In this way the PEFs actively engage in the family firm to add value and in this way increase the value of their portfolio firm (Sapienza, Manigart, & Vermeir, 1996).
For example, Berg and Gottschalg (2005) mentioned reducing agency costs, improving incentive alignment, improving monitoring/controlling and remove managerial inefficiencies as possible value creation levers, whileSöding et al. (2012) mentioned assisting the controlling shareholder in monitoring management, identifying and evaluating business opportunities, providing operational support and enhancing corporate governance as some of the value added levers. Wulf et al. (2010) stated that non-outperformingfamily firms have the most deficiencies in organizational structures and management systems. However, for many of the levers there is still a lack of empirical evidence and much of the empirical work that is available is limited in its power by small sample sizes (Berg & Gottschalg, 2005).
On top of that, Wulf et al. (2010) mentioned that internal barriers could lower the positive impact of the value-added services of the private equity firm. Argyris (1964) stated that agency related controlcould be potentially counterproductive by lowering the motivation of employees. However, the support from the employees in the family firm is also an important factor for the PEFs if they want to make changes in the portfolio company.
The results can give the private equity firm a better understanding what are the best by family accepted value-adding activities.
2.2. Management control theories
2.2.1. Agency theory and stewardship theory
The theoretical starting point and basis for the interviews in this research is the agency theory and the stewardship theory. In the management control literature agency- and stewardship theory are known as the best way to monitor the firm and to ensure that managers are acting in the firms best interest (Tosi et al., 2003). These two theories are based on different concepts of human behaviour (see table 1). However, both theories discuss the relationship between the (family) owners and the managers of the company and is therefore useful in family firm research (Hiebl & Kepler, 2012).
Agency Theory Stewardship theory
Model of man Self-actualizing man
Behaviour Collective serving
Psychological mechanisms
Economic man Self-serving
Motivation Lower order/economic needs
(physiological, security, economic),
Extrinsic
Higher order needs (growth, achievement,
self-actualization), Intrinsic
Social comparison Other managers Principal
Identification Low value commitment High value commitment
Power Institutional (legitimate,
coercive, reward) Personal (expert, referent) Situational mechanisms
Management philosophy Control oriented Involvement oriented
Risk orientation Control mechanisms Trust
Time frame Short term Long term
Objective Cost control Performance enhancement
Cultural differences Individualism,
High power distance
Collectivism, Low power distance
Table 1. Comparison of Agency theory and Stewardship theory. Source: Davis et al., (1997)
that are made to align the goals of the principals and agents are called agency costs. However, in family firms it is suggested that the agency costs and performance incentives are lower compared to non-family firms, due to a higher mutual trust and a lower need for goal alignments (Fama & Jensen, 1983; Hiebl & Kepler, 2012). This is especially the case in small and medium family firms in which the owners also work as (family) managers. It has been proved that the involvement of a family in a management team is a contingency factor for the design of a management control system, because it influences the characteristics of the corporate governance (Speckbacher & Wentges, 2012). For example, empirical evidence has proved that family firms use less formalized instruments for their management control, but there is no explanation why this is the case and what the family managers use as alternative control mechanisms (Speckbacher & Wentges, 2012). Nevertheless the agency theory can be useful for studying the relationship between non-family managers and the owners of the family firm (Chrisman et al., 2003). Family firms that have both family as well as outside shareholders, have unique agency costs, related to the family involvement (Slator, 2002). The family in a family firm can give a competitive advantage and give the firm strength. The competitive advantage created by the use of the stewardship theory is also described as the “secret sauce” of family firms (Davis et al., 2010). However, the family can also be a hindrance and a weakness for the firm (Eddleston & Kellermanns, 2007).
On the other hand, there is stewardship theory that is based on asociological and psychological approach to governance (Davis et al., 1997). Often family members do not recognize themselves in the negative concept of men of the agency theory (Corbey, 2010), therefore the stewardship theory is another approach to the principal-agent problem, which has the opposite characteristics of the agency theory (see table 1). In this theory it is assumed that managers act in the firms best interest and in line with the goals of the principals, even in the absence of controls (Chrisman et al., 2003). Corbetta and Salvato (2004) stated that it takes a relatively long time to see the effect of the stewardship determinants (e.g. altruism, relational contracts, and non-financial goals) on the family firm performance. Therefore, the authors stated that in the family firm literature, it is suggested that the involvement of the family has to be measured over a long-time horizon, because family firms have in general a long-term orientation.
Most family firm studies used the stewardship theory to analyse the behaviour of family members in the firm, assuming that the goals of the family firm and the family members align (Corbetta & Salvato, 2004). However, sometimes non-family managers can act according to the stewardship theory. For example, Vallejo (2009) concluded that nonfamily managers could act according to the stewardship theory in a family firm.
Which of the two alternative theories has the highest validity depends on the actual managerial behaviour and this is dependent on specific person- and situational related circumstances (Grundei, 2008). The choice between the agency- and stewardship theory for the managementcontrol in a firm is similar to the decision made in a prisoner’s dilemma, see table 2 (Davis et al., 1997).
2.2.2. The agent-steward dilemmas
In box 1, both parties choose the agency relationship and this will result in a true principal-agency relationship, in which both parties act to the expectation of the other party. The agent prefers his own goals above the one of the organization and also behaves in this way to the disadvantage of the organization. Management control is necessary to control the opportunistic behaviour of the manager. This relationship is designed to minimize the potential costs for both parties.
In box 4, both parties choose the stewardship relationship and this results in a true principal-steward relationship. In this case the manager acts as a steward, which works in the best interest of the organization because both parties have the same goal. This relationship is built on trust and high involvement of both parties and the principal supports this relationship by empowering control. The performance results in this group are high. Nevertheless, this only holds when both parties do not betray each other, which is a high risk in this relationship.
Principal’s choice
Agent Steward
Agent
Minimize potential costs Mutual agency relationship
1
Agent acts opportunistically Principal is angry Principal is betrayed 2 Manager’s choice Steward 3 Principal acts opportunistically Manager is frustrated Manager is betrayed 4 Maximize potential performance Mutual stewardship relationship
Table 2. Principal-Manager Choice model. Source: Davis et al.,(1997)
In box 2, a dilemma occurs because the principal chooses the stewardship relationship and the manager chooses the agency relationship. The agent (manager) will act opportunistically and the principal will feel betrayed and becomes angry. The agent will try to reach his own goals by using the resources of the organization and principal. It is like turning the hen house over to the fox (Davis et al., 1997).
First implication on the supervisor level, the agency based control system with extrinsic motivation mechanisms, can have a performative functioning on the steward in this relationship. This means that the management control system does not only control and motivate the manager, but it will also create a new kind of manager (Kolk van der, 2013). The performative perspective approach studies the control systems as it unfolds through practice. Due to the complex and changing environment and relationships in the control system, it is continuously “in the making”. In this case, the control structure is not an intermediary but it acts as a mediator. The management control system can change and even innovate the relationships in unpredictable ways (Vosselman, 2012). In the long run, it can be that the agent works to satisfy the goals set by the control mechanisms instead of working for the organizational goals. This can also be seen as goal displacement. The control system is usually implemented as sanctioning system instead for establishing trust and replace control by trust to reduce uncertainty (Grundei, 2008).
Second implication on the supervisor level, is based on the attributional approach (Grundei, 2008). After the implementation of an expensive control system, which the manager is part of, the manager always tries to keep it in place. In case of success of the company in an uncertain environment, it is not clear whether or not the employee acts in this way by himself or due to the control system, therefore the control system and the presence of the manager will be used to explain the success. It can be concluded that the supervisor prefers to invest in trust created due to the management control systems at the expense of the trust of the employees (crowding out of trust) (Grundei, 2008).
On the management level, the control mechanism undermines the pro-organizational behaviour of the steward and will have a negative effect on the manager’s motivation and can even lead to decreased feelings of self-worth, self-responsibility and self-control (Argyris, 1964). The extrinsic motivation, through performance incentives, increases and finally replaces the intrinsic motivation that stewards in family firms often have. However, the “new” extrinsic motivation is not as big as the “old” intrinsic motivation and therefore the control will lead to a decrease in the motivation of the employee. This is called the “crowding-out” effect. Related to this study, this means that stewards from the family firm will be less motivated after the participation of the private equity firm and the implementation of the associated performance incentives. Moreover, it is difficult to combine the agency and stewardship theory, because there is always a risk of a downward spiral of control and trust (Grundei, 2008).
Besides the theoretically possibly occurring dilemmas of the agency-stewardship relationship, the PEFs have an extra challenge in dealing with the employees of the family firm. The employees of family firms are characterised by their high involvement and in general have a stewardship relationship with the family (principal). It can therefore sometimes be expected that employees that have a long work relationship with the family may try to resist changes that are implemented by non-family owners, such as the PEFs (Burns & Scapens, 2000). Also the implementation of new governance mechanisms can take longer, due to the control that family with a minority possession still have in the business (Mosquera, 2012). Consequentially, the potential benefits of this new (in general more formal) management control systems can take some time due to the internal fraction and stagnation (CMBOR, 2008).
3. Method and data
The methodology section will elaborate on the research method that is used, aiming at answering the research question. At first, the research design section will explain the research type as well as the research outline (3.1.). Second, the use of a case study is explained (3.2.). The case situation that is used in this study will be introduced in section 3.3. with a detailed description of the situation of the private equity firm (3.3.1.) and portfolio firm (3.3.2.). 3.1. Research design
Central to this research is the impact of a majority private equity investment on the management control system of a family firm. The management control relationship between the private equity firm and the family firm (based on the agency-stewardship theory) and its possible dilemmas are debated through a review of existing literature in the preceding chapter. From this review, it can be concluded that the management control system and the possible changes depend on the situation characteristics of the family firm. Moreover, the management control strategy of the private equity firm plays an important role.
The theoretical foundation of the relationships between the private equity firm, the family firm and the management control systems provides estimates on which the rest of this study is based. Furthermore, the theory forms the basis of the interview questions, which are used to study the impact as experienced by different employees of the family firm. Through qualitative research of the experiences of managers in the family firm, as well as the experiences of the fund founders/managers of the private equity firm, the impact will be analysed. The employers and employees were interviewed on different management levels, to see if the impact differs per level and to compare the actual situation with the theoretical dilemmas on the first and second level.
The result of this study will be valuable for the private equity managers in understanding their impact on the management control function of the family and possible consequences thereof. Furthermore, it will be valuable for family business in understanding how they can prepare their business for a sale and what they can expect by selling a majority of their shares to a private equity firm.
3.2. Case study
The decision to choose a certain management theory and the relationships between the agent and steward have many facets and are complex, therefore studying the impact of the majority investment is done in the context of qualitative research in the form of a case study.
Yin (2009) stated that a case study is the preferred research method when the investigator has no or little control over the event, which is the case in the participation of a private equity firm in a family firm. In principle, every participation process differs, because it is influenced by many factors. Furthermore, by using a case study it was possible to retain the holistic and meaningful characteristics of the change in management control in the family firm.
construct validity of the case study, two sources of evidence are used. Interviews and provided documents are used as data for this research. Moreover, key interviewees will review the analysed results of the interviews to increase the construct validity.
Seeing as this study is an exploratory case study, it is not concerned with possibly wrongly concluded causalities and therefore the internal validity is of less concern. The analytic tactic of pattern matching is used to address internal validity (Yin, 2009). The generalizability of this single case study is low, because every family firm and private equity firm have specific characteristics that are of influence on the management control systems and the related relationships. Nevertheless, the results of this study can be useful for the PEFs and the family firms, to show the most important factors that impact the management control system and create a working method for the participation in family firms. By writing down every step during the research process, it is possible to reproduce this research and increase reliability.
For this case study it was possible to choose between cases from different PEFs in which a majority investment in a family firm was made. Therefore, there were initial interviews with two fund managers of different PEFs to get a better insight in their particular investments, their working methods and the ideas behind their actions. For this case study an investment of the private equity fund ABC Investment (ABCI)3 was chosen, because they made a majority investment in a family firm. More importantly, this family firm was a production company with a hierarchical structure and enough employees to participate in this study. In this particular case the family still worked in the business, but gave up their management function. Further details of the private equity firm ABCI and the family firm RR Health (RRH)3 are discussed in section 3.3. By interviewing not only the top management, but also employees of the different departments, it was possible to get a broader perspective of the impact of the participation of ABCI on the management control system of RRH. It gives a better view in what levels of the company the employees experienced an impact and what they thought of this change in the control system. To find the last pieces of the “impact” puzzle the fund managers were interviewed, to get a better understanding of what their intentions were and how they wanted the process to be perceived. Taking into account the results of the initial interview, new interview questions were prepared, which were primarily based on the agency- and stewardship theory.
By collecting the data, the triangulation method of Denzin (1970) was chosen. This method is useful for case study research because the method mix will mitigate the weaknesses of the (separate) methods and this will lead to stronger overall results (Hehn, 2011). There are four types of triangulation in doing evaluations: data triangulation, investigator triangulation, theory triangulation and methodological triangulation.
As discussed above, data is collected from different sources but are all aimed to corroborate the same phenomenon. Seeing as the evidence is used to explain the same phenomenon there is a convergence of the evidence. There is no investigator triangulation in this case study. Nevertheless, by letting the interviewees review their answers and conclusions an attempt was made to let the interviews be evaluated by an extra person. It is believed that there is a theory triangulation in this case study research, because the results can be explained by the agency theory or by the alternative stewardship theory. The methodological triangulation can be divided in two different methods, namely the within-method and the between-within-method (Denzin, 1970) and both within-methods are used in this case study. The within-method entails varieties of the same research method, which are used to investigate a research issue (Bryman, 2004). This method was used during the interview in order to determine whether the management control system is based on the agency- or
stewardship theory. The in between-method triangulation is present, because the interviews and other documents are used as data source for this case study.
The data of this case study is analysed by the pattern matching logic technique. In this case study, the patterns that are concluded from the interviews and the provided documents are compared to the patterns of the agency- and stewardship theory. The results are written in this case study report, which is written according to the linear-analytic structure (Yin, 2009). The entire process is described in detail so that the research can be reproduced.
3.3. Case study background
3.3.1. Background of ABC Investment (ABCI)
ABC investment is an independent Dutch private equity firm that was founded in 2010. This company is based in the west of the Netherlands and their philosophy is to invest in companies with a high profitable business model. They primarily make majority investments in companies with a market value between €10 and €50 million. It is remarkable that this private equity firm is open-ended and therefore the fund focuses on the long haul value creation. Another specific characteristic of this fund is that their philosophy is based on the circular economy (cradle-to-cradle principle). Circular economy is an economic system in which the reusability of products is maximized and the value destruction is minimized. Therefore, ABCI gives their portfolio companies the opportunity to integrate sustainable value into their strategy and business model, which has to distinguish them in the future, for an investment ABCI does not only look at the profitable, but also at the social and environmental perspective.
3.3.2. Background of RR Health (RRH)
RR Health is a company that develops solutions for the foot-related market and was founded in 2002. Their company is based in the east of the Netherlands and their products contribute to the prevention and treatment of foot-related discomforts to promote the mobility and quality of human life. This company is characterized by the fact that it has a wide range of products and services. The company is serving professional orthopaedic and podiatry companies in the medical industry and well-known brands in the (sports) shoe retail markets.
3.3.3. Overview of the interviewees.
In this paragraph there is an overview of the interviewees that participated in this study (see figure 1) and a short description of their function is given in table 3.
Figure 1: Overview of the interviewees. Source: Own data.
4. Findings
In this chapter the results of the interviews are presented, analysed and discussed. In order to properly arrange the results and to see the differences between the interviewees, the results are presented in three groups. First a summary of the interviews with the founders of ABCI and the initial interview will be presented (4.1.). Then there is a summary of the interviews with the founders of RRH (4.2.) and finally the results of the interviews with the RRH-employees (4.3.). The results are structured the same way as the interviews.
4.1. Results of the interviews with the founders of ABCI 4.1.1. Background
According to A. and B., the decision to participate in RRH was twofold. First, RRH has a product with potential in a growing and interesting market. Second, the male founder is on good terms with his employees, has a good vision and he seems open to changes.
A. and B. share the opinion that they always should take a majority share if they invest in a company. They think it is irresponsible to spend their investors’ money without having any managerial control, especially in this difficult economic period. As A said:
“It is our money, our risk. The minority shareholder just sold a part and received his money...He may think: pfff, I do not mind.”
They want the possibility to intervene if things are going wrong or not in the right direction. As B. said:
“So thatyou can take over the steering wheel yourself, if it is necessary.”
A. and B. said that RRH is acting according to their expectations. The managers of RRH are taking the right steps to professionalize RRH and also take their responsibility for this process. According to B. there is a difference between a family driven company and a private equity driven company and thus a transition is necessary. He believes that this transition in RRH will happen more quickly than the average transition from a family driven company to a private equity driven company, but never gives explicit reasons for this assumption.
4.1.2. Changes in RRH after the deal with ABCI
According to B. there were some changes that had an extreme impact on the company, because the top (management) of the company has been replaced and this will have an effect on the rest of the company. Moreover, RRH employed a new financial manager. Nevertheless, all these changes were planned according to the fund manager.
As he said:
“The key is to maintain the opportunism the founder had in the venture phase, and then add structure, focus, management control system and things like that, you end up with the holy grail.”
This would be the perfect situation, but he mentioned that these styles often clash in practise. Nevertheless, he thinks that this will work out in RRH.
ABCI has standard protocols for the first 100 days after the deal and used said protocols for RRH. Topics of these protocols are why-day, strategy, human capital, ESG, and marketing, which are all related to each other. With these protocols they create an overall strategic “house” and then every action, it does not matter in which area or by which person, has to benefit and be committed to the strategy. From this point ABCI and the managers translate this to annual action lists and prioritize these actions. Parallel to this strategic process, they want a monthly report as soon as possible, preferably from a financial manager that ABCI employed. Furthermore, they often add a supervisory board. As A. said:
“Something that we are really focusing on is that within one year, a year and half, we are independent from the founder, in terms of the company.”
Unfortunately, the protocols took longer than expected in RRH, because ABCI had to find a new financial manager and had to deal with things that they did not know beforehand.
ABCI experienced some resistance during the implementation of the new management control systems. Often the founders struggle with the new implementations, but according to A. and B. this was not the case in RRH, seeing as the founders realized it was better for the company and for themselves to take a step back. However, A. and B. said they experienced resistance from the employees of RRH. As B. said, the reason was:
“Employees preferred the cosy way of doing business that was done in the past, in which there was not a real blame culture. With blame, I do not mean “if you do not reach your goals you are a **** and you are fired”, but that you can talk and correct each other in a business-like way, business-like “This was your goal of this year and you did not reach that, why?””
The cosy way of doing business is good for the working atmosphere, but, as mentioned before, ABCI wants a more business-like environment and that process is going on at the moment. Even though they encountered little problems during the professionalizing of the company, when it came down to answering the question whether they chose the right course of action, A. said:
“Yes absolutely, I think that the company had to do this.”
Also B. confirmed this, with the following answer:
“Yes, I think we have done well, also with F. and the management team.”
Furthermore, besides the normal due diligences, nowadays ABCI also does a human resources(HR)due diligence. A. explains:
4.1.3. Control
The focus of ABCI in the management control system starts primarily in the area of monitoring and controlling (70% according to B.) and less focused on the advice and support activities. In the area of monitoring and controlling they have specific requirements and as A. said about the reporting:
“That is something that has to be there from day 1.(...) We do not make concessions anymore, it should be completed in the way we want.”
Related things that are the first needs of ABCI are a good functioning of the monitoring, controlling and governance. As B. said:
“If the monitoring and controlling system is not working properly, then you can never give good advice and support.”
A. confirmed this and said:
“Thus I think that the other aspect from the data that has been collected with monitoring and controlling, is to better compare and contrast the advice and support activities.”
A. and B. both still believe that there is an information asymmetry between ABCI and RRH. However, they believe that the management of RRH knows exactly what ABCI expects of the results and the ESG. Nevertheless, B. thinks that ABCI cannot know exactly what RRH is doing and how they are acting in the market. A. said that it can be dangerous when there is an asymmetry on the financial level and therefore it is important that from day one there is a report system according to the requirements of ABCI, without concessions. This was also a change for the employees of RRH, because more information was asked from them.
4.1.4. Advice and support activities As A. said during the initial interview:
“I think that the combination of family and private equity is often not a very happy combination.”
However, in the case of RRH, B. thinks that ABCI can play a complementary role for the founders. As mentioned before, the founder is a great visionary and has many ideas for new products, but this is also his weakness. According to A. and B., ABCI supports and complements RRH on a strategic and tactical level in the areas of HR, environmental social governance (ESG), circular business model and marketing. According to their experiences, these areas are often underexposed and in this way they can add something extra besides the financial support. Moreover, ABCI also tries to support RRH with their network.
4.1.5. Agency – Stewardship
the option, then both describe the management control system at RRH (at this moment) as a combination of the two theories. A. thinks that in addition to the agency theory they have the collective behaviour, trust and long term focus of the stewardship theory. Moreover, A. said:
“Yes, I think that the culture is still collectivism with low power distance and still a high involvement/identification of the employees, but this could become less in the long term because they are moving more towards the agency theory.”
A. also wants to keep this combination in the future. B. describes the management control system in the following way:
“If you are private equity owned there will always be a part cost control.(...) Also, I think that RRH, which is also a special company, is on the side of the stewardship theory.”
If it depends on B., RRH also uses the stewardship in the future, because he thinks that is the best way to achieve the targets. However, he said that when they do not reach their targets, the management control system will move more to the agency side.
Both managers of ABCI agree that there is a difference between the intention of ABCI and the perceptions of the employees of RRH. As A. said:
“Maybe the organization and managers think that we want to know things, while we want to create knowledge in het organization, which they can use to improve themselves.”
More importantly, the managers need the right information because they have to deal with more portfolio companies at the same time and they need this information to be of value to the RRH. This shows that the managers are more business-like and see RRH as an investment that has to be managed.
A. thinks that the goals of the employees as set by the management control system meet the goals of RRH as an organization. On the other hand, B. thinks that there are employees that work to satisfy the goals as set by the management control system of RRH instead of working for the goals of the organization. Nevertheless, he assumed that with the new performance management system, which is implemented by the HR manager of ABCI and the management, goals will converge and finally get together. A. and B. did not think that there are managers in RRH that implemented unnecessary management control systems to make themselves “more” important.
At the moment of the interviews there was no bonus system for the employees of RRH, but A. and B. are both positive about this aspect as long as the right bonus system is implemented. A. said that they are working on a bonus system for the top management of RRH in which the managing directors can participate in RRH. He also thinks it is good for the commitment to implement a bonus system for the employees of RRH, when the bonus is partly linked to the overall performance of RRH and partly linked to personal goals. As A. is cited:
4.1.6. Summary
A., as well as B., think that the majority deal of ABCI with RRH was positive for the development of RRH. Moreover, both managers agree that they are using the right approach, management control systems and can have enough influence on and within RRH. A. and B. have different opinions about the influence of ABCI on the management control system of RRH. A. said the following about the control system:
“I think that our influence on the system is big, because we pretty much demand the governance model, because that is how we want things done and because we are majority shareholder we can actually enforce it in the end.”
On the other hand, B. thinks that RRH is still RRH, only that the founder/managing director can now focus more on the things that he likes most and in this way can add more value to RRH. And as B. said:
“And to a certain extend professionalization/commercialization is implemented in the structure of the company. I think that is more or less what happened and I think that is a good thing.”
4.2. Results of the interviews with the founders of RRH 4.2.1. Background
According to C., the unique point of a real entrepreneur, is that he looks at the market, reads and listens a lot, and then thinks of a direction to go for with their business (in this case RRH). According to him, you need people in the top management that have the courage to act on a vision and then you need a bit of luck.
First, C. was sceptical about investors and at that moment gave the following reaction to his advisor:
“Investors are slick guys in slick suits and they only desire one thing, to earn a lot of money with someone else’s money as quickly as possible, because that is what they do. Pretty easy to be an entrepreneur.”
A remarkable statement from C. was that people cannot “buy” him. Or as he is cited:
“But what I want to say, I value all the people who have helped me and have struggled with me to get where we are now. I am not going to deny them by saying I received a lot of money and I am leaving.”
On the contrary, he said about the possibility of selling a majority to ABCI:
“And what a great advantage that could be, it is something that makes me happy I noticed, that we could possibly receive a reward for the first 10 years of entrepreneurship. We could put the money in our bank account and with this in our mind, we could build RRH 2.0.”
According to D., ABCI is acting to her expectations and she is very content with the PEF. C. thinks that the managers of ABCI can improve something. For example, he mentioned that ABCI could have paid more attention to E. and his private life, seeing as he moved his family from Greece to the Netherlands to work for RRH. He explains this lack of attention is due to pressure that ABCI experiences. As C. said:
“So I think that they (RRH), especially in this area (attention for employees/humanity), need to evaluate themselves more often. I think the biggest power that you can have in business is humanity.”
Nevertheless, if the managers of ABCI lose this humanity factor, it does not mean that ABCI is the wrong partner, according to C. For him it is more important that ABCI believes in the vision, stays focused on the end-goal, thinks in solutions and keeps believing in the employees, if RRH has 1, 2 or 3 difficult years, instead of ABCI playing the majority shareholders card by replacing employees with money-driven people and then think that they will earn more money. C. stated that this is not the right solution and will have a negative effect or as he said:
“If that happens then we will get into a fight.”
4.2.2. Changes in RRH after the deal with ABCI
C., as well as D., agrees that there were some major changes after the participation of ABCI. For example, D said:
“So where before C. and I had everything in our heads, that is now all put on paper. It is the same with the management reports, we knew exactly how everything was done, but now all the information must be shared.
Moreover, she stated that the new managing directors with their own management style resulted in a different management control system. According to C., fantastic changes were made and that these changes could not have been accomplished without the attendance of ABCI. For example, they took the financial department to the next level, something that was necessary for RRH 2.0. Also, C. said:
“(...) we both lacked a little bit of specialism and education. And that is one of the reasons we made this step. If you want something, then you must ensure that you add professionals and that is something that they (RRH) did.
However, C. also mentioned a negative point. He said that the new managing directors, who felt the pressure to meet their targets, were thinking about firing somebody. He stated that the managers did not try everything to let this person succeed first. According to C. this is the difference between him, the investors and managing directors now. One of his goals as entrepreneur was to make an effort and to let the people that he employed try to succeed in RRH. In the end, the person was not fired. C. said:
“I am someone who thinks “if I do not make it this year, then I will make it next year. And my final goal does not have to be reached this year, but is there (points his finger in front of him, meaning the future), that is different.””
C., as well as D., thinks positive about the course of action of ABCI for the implementation of changes in the management control system. According to C., ABCI only gets involved when necessary and otherwise they keep their distance. The founders have experienced no hindrances during the implementation of the new management control system. However, they are curious as to what the other RRH employees thought.
Moreover, the founders of RRH are positive about the changes that were implemented by ABCI in a gradual way, also because all the changes were discussed with the management/founders of RRH. Nevertheless, C. made the remark that he would have used a different approach and timing for the implementation of the ESG program. As he said:
“But sometimes I think, you (ABCI) ask something of the organization, while the focus has to be on something else and then you want to do it immediately, because it is important to you.”
He believes that another approach would have led to a higher quality of the ESG program, due to a higher dedication sentiment. It must be mentioned that during the interview C. does not know the exact name of the ESG program, he is just not interested in it. However, he understands that ABCI has to deal with more companies and just wants the program implemented.
4.2.3. Control
C., as well as D., experienced the most influence of ABCI in the area of monitoring and controlling, because a whole new management control system and especially a report system was created based on the requirements and a blue print of ABCI. With this report system, ABCI required more detailed information from RRH. For C. it is logical that ABCI requires more information and that this step was necessary. Moreover, he thinks that this change is fantastic and he learns from this process every day. As D. said:
“Yes, it helped us on our way, to what we are now working on, building RRH 2.0.”
According to D., the implementation of the management report is the next step in the professionalizing of RRH. The founders of RRH both concluded that the implemented management control systems are functional and realistic. In their opinion, there are no managers that are unnecessary and/or are superfluous.
According to C. and D. there is no information asymmetry between RRH and ABCI, due to the regular communication between the fund managers and the top management of RRH, and the implementation of the new report system. C. thinks it is important and necessary that the fund manager of ABCI visit RRH and talk with the different employees. In this way, the fund manager understands RRH’s position in the market and how the market develops.
4.2.4. Advice and support activities
A citation of C. is used to describe the managers of ABCI:
“High level of abstraction and conceptual thinking, great and that was really something I was looking for (...) they are a unique team.”
In addition, C. mentioned that the managers can objectify his vision and also give their opinion. According to D., RRH received valuable advice from the contacts of ABCI, especially with regard to the general management. The advice role of ABCI was primarily based on sparring and some human resources management, in the opinion of C. In the future C. wants to copy-paste the RRH-concept in 10 countries and then he thinks that ABCI will become an important sparring partner with an objective view from outside the market of RRH. As C. said:
“That is something that I found amazing, with the expertise that they have, that is something that I see as an enormous added value.”
Finally, C. stated that the initial excitement and enthusiasm of ABCI is gone, because they are probably busy with other ventures. Nevertheless, C. thinks that they help him when it is necessary, because he believes that switching quickly is one of their special skills.
4.2.5. Agency - Stewardship
C., as well as D., concluded that they managed RRH according to the stewardship theory before the deal with ABCI. C. thinks that the stewardship is the right theory at this moment, because that is where the company is coming from. Nevertheless, he stated:
“If you really want to make 2.0. a success, then you have to be somewhere between the two theories.”
The agency- and stewardship theory are two opposing theories and therefore very black and white. The interviewees were asked which combination of the characteristics of the two theories best described the management control system of RRH. C. stated that RRH is managed according to the stewardship theory, but that the goal of the management control system is now also based on cost control (agency theory). Because RRH is growing, C. stated that in the future they have to move to a more control oriented management system, because he thinks that control will become very important. D. also stated that stewardship theory is followed, but that cost control is now an important goal of the management control system. About the risk orientation, she made the following statement:
“Trust is good, but control is better.”
She said that in the areas of the management control system and the risk orientation of RRH, there is a combination of the two different theories. She mentioned that performance enhancement is very important, but that you also have to take into account the costs. Furthermore D. agrees with the statement that there could be a difference in the management style that is used by the top management and the perception of the employees.
the employees asked if the investors were satisfied with the results of last year. Then the two managing directors gave different answers. G. explained that the targets were not reached, but that this could be explained. Moreover, he said that the explanations were supported by data of the management control system and therefore it was no problem that the targets were not reached. E. answered that he understands the question and that if the investor is happy with the results then it is a welcome bonus, but that RRH is not working for the investor. C. agrees with the latter explanation and if even gave an elaborated one, as C. would say to A. and B. when they were sitting around the table:
“We like to use your expertise, we want to spar with you, but we do not do it for you.”
Furthermore, he understands that ABCI wants some control because they invested money, but he feels that ABCI is a participant of the journey of RRH. Moreover, C. stated that he and the employees of RRH still do their own thing and want to be assisted by ABCI. He said that ABCI can add something with their experiences and their expertise, but in the end he and the employees of RRH do not work for ABCI.
According to C., the different answers of the managing directors shows that G. has a different background, one in which the shareholders’ satisfaction was important. C. thinks that if ABCI wants to implement this kind of thinking, then the only solution is to fire all the old employees and to replace them with new ones that work according to the agency theory, but then C. will leave the company. This is supported by the following sentences that are cited from C.:
“If there is something that you should not do with me and I think also not with my employees, is that you say that because you own 51%, you now demand that I have to put my right arm in the air (you should not expect me to jump at your every command). If you act like this, then all your money goes down the drain, because then you will get the biggest war that ever existed. Literally, yes! That is not going to happen. At least, not as long as I am here, because then I will pack my bags and leave.”
At the moment of the interviews C. and D. said that there was no bonus system for the employees of RRH and both are positive about implementing such a system. Nevertheless, C. stated that the system must be based on the right measurements. He believes that bonus systems should be focusing on customer satisfaction and relation management.
4.2.6. Summary
C., as well as D., thinks that the sale of a majority share from RRH to ABCI was positive for the development of RRH. As C. said:
“Yes, this is what we needed. I would not have done what they have done now.”
Nevertheless, D. thinks that the same development had occurred with a minority position of ABCI.
Both founders experienced the influence of ABCI in general in a positive way, but C. specifically added the words; “up until now”. The founders had different opinions about the influence of ABCI on the management control system of RRH. As C. said:
However, D. said:
“I find it difficult to answer, because these are all things that we had thought of, too (...) I do not really know if it has changed because of their presence, but the change obviously happened faster.”
She also understands the importance of the management control system for ABCI, as she said:
“Of course you want to achieve everything as soon as possible, also to provide them with the right information.”
The founders gave two different answers to the question if ABCI used the right approach and control systems. According to C., what ABCI does makes sense and it is needed for RRH in order for ABCI and the bank to do business with each other. D. said that the employees of RRH built the whole management control system and ABCI only gave them advice and finally approved of it. She is happy with the open communication between the companies and thinks that they are on the right way. C. thinks that RRH can be used as an example for other portfolio companies.
4.3. Results of the interviews with the employees of RRH 4.3.1. Background results
The interviewees praised the transparency and communication of the founder, although they were informed about the deal with ABCI after it was completed. According to I., C. said that the two companies fit together. I. said about this:
“He (C.) will never through it away or think, I am done, I have my money and you can fend for yourselves. He will never do that and we have this confidence in him.”
Other interesting background information of the interviewees is summarized in table 2. 4.3.2. Changes
All the interviewees experienced changes since the deal of RRH with ABCI, except for interviewee J. According to H., some changes are taking place at the moment of the interview, but he thinks this is not all due to the effort of ABCI. As E. said:
“Intense, it has intensely changed, in particular the report and control mechanisms. Previously we did it on the basis of gut feeling and obviously there were some numbers from some of our systems, but those were primarily excel systems. The question now is whether this is because of interference of ABCI? We already had in mind to professionalize. I think that it happened many times faster, so in that sense, ABCI’s influence is surely present.”
