In this chapter, we will deal with the level of involvement in family firms. At the end of this section we will provide the reader with measures from a dataset of Mexico’s largest firms in 2015 as listed in Expansion 500. This data was complemented with several hand-collected measures and it describes:
- A)Type of firm (state-owned, domestic or multinational subsidiary)
- B)Level of family involvement (ownership, boards, and management)
- C)ROE (average measure) for 2015 to 2017
Family Firms
Family enterprises are the most prevalent form of business organizations. They represent 90 percent of worldwide firms and employ 60 percent of the global workforce (Gedajlovic et al. 2012; Neckebrouck, Schulze, and Zellweger 2018). They are unique because the governance of these firms is largely determined by the governance of the family behind the family firm. The most important voice in governance is not that of an individual but, rather, of a group of people who are interrelated by blood or marriage. Thus, power allocation within the family, its governance institutions, the interaction among family members and stakeholders, and family characteristics such as size and age are all likely to influence firm outcomes (Bennedsen, Pérez-González, and Wolfenzon 2010).
In family firms, the overlap between emotional and cognitive–practical issues is such that family members notably influence major decisions and strategies of these enterprises and vice versa. A family firm is governed and managed with an intention to shape the vision of the business held by dominant family coalitions in a way that is potentially sustainable across generations. The uniqueness of a family firm comes from how its ownership, governance, management, and succession influence the firms’ goals, strategies, and structures and the way in which they are implemented. The family component has a special influence within family firms because the quality of family interactions outside the firm shapes firm outcomes (Chua, Chrisman, and Sharma 1999). The components of involvement most often used for family business research are: ownership, management, and governance.
Academics from various disciplines have been drawn to family business studies in order to understand the determinants and consequences of family involvement in business. How such involvement influences the formation and evolution of family enterprises over time has been a guiding principle; differences and similarities of goals, values, resources, strategies, and performance that distinguish family enterprises from their counterparts have been explored since the early 1950s. The first family business center was established in 1962 in Cleveland, Ohio.
Socioemotional wealth (Gomez-Mejia et al. 2007) can be considered a unifying theoretical lens with which to explore family businesses since it addresses core issues that make family businesses unique.
Research on how family firm decisions affect stakeholders was unimportant within family business scholars. The assumption of profit maximization as the main goal of the firm and shareholders as relevant actors was challenged. Some firms pursue objectives beyond profits acting as a mediating hierarchy that effectively balances stakeholder interests. In the specific case of family firms, they are motivated by nonfinancial aspects, and family owners are committed to preserving their socioemotional wealth (Gomez-Mejia et al. 2011). Family heads are usually driven to protect and enhance their socioemotional endowments. The concept of socioemotional wealth refers to emotional endowments that family owners establish with a given firm and influence their decision-making processes.
Research on the performance of family firms shows that large: i) founder-led firms outperform and ii) CEO family-led firms underperform their nonfamily counterparts (Miller et al. 2007; Bennedsen et al. 2007).
It has been argued that family CEOs do not maximize firm value but rather consume managerial perks and attempt to entrench in their role at the expense of shareholders. But, having a founder CEO probably has intangible nonmonetary benefits since founders tend to work harder than most outsider CEOs (Palia, Ravid, and Wang 2008). This argument has been extended to heirs since family CEOs can become benevolently entrenched through higher levels of effort, social recognition as business leaders, and their tacit knowledge on firm operations (González Ferrero et al. 2010). The nonmonetary benefits families enjoy when one of them is CEO do not necessarily lead to a bad outcome for other shareholders (Burkart, Panunzi, and Shleifer 2003).
Succession is probably the most evident assessment of a firm’s governance institutions. It is a powerful force that seems to preserve an instinctual drive. Evidence shows that the selectivity of the college attended by a family CEO can have a significant effect on firm performance; the gap is at least 15 percent of firm value (Pérez-González 2006). Further evidence shows that CEOs selected on primogeniture rules exhibit lower levels of managerial practices and productivity than other firms (Mehrotra et al. 2013). Outsider CEOs perform better than family CEOs (Bloom and Van Reenen 2007). Additional evidence also shows that 37 percent of family firms report conflicts resulting from performance of family members in top management roles (Bennedsen et al. 2007).
Warren Buffet was quoted as saying that “family members in management should be the exception and not the rule. It is like choosing an Olympic team based on the primogeniture of the gold medals from previous Olympic events.” Indeed, the family in management problem is exacerbated by talented executives avoiding family firms because of limited opportunities of advancement and lack of objective performance measures (Bloom and Van Reenen 2007; Pérez-González 2006). Chang and Shim (2015) find evidence that firms that transition from family to professional CEOs outperform their family CEO counterparts. This performance improvement is more pronounced when a) families maintain high ownership control and outgoing family CEO does not stay in the firm, b) the transition is from nonfounder to professional CEOs, and c) professional CEOs graduated from elite universities.
Ownership concentration provides not only incentives for monitoring management but also opportunities for self-serving behaviors, especially if legal protection of investors is weak. Dominant owners in these environments could increase firm value by appointing a majority outsider board with strong qualifications and committees in order to assure investors that the majority owners will refrain from diverting firm resources. Family control on a firm has shown to be inefficient in rapidly evolving industries where future investments are hard to predict (Burkart, Gromb, and Panunzi 1997). This type of control discourages other stakeholder investments and this is probably why family control is rare in research and development industries (Villalonga and Amit 2008).
Outside the United States and especially in countries with low levels of legal protection for investors, ownership structures often include large controlling shareholders (i.e., families). These block holders usually exercise control by appropriating voting rights that do not coincide with their cash flow rights. This can be done using pyramidal structures and cross-shareholdings. Once a family has sufficient ownership for unchallenged control, it can extract resources for personal benefit including excessive compensation or dividends. Families will even retain a poor performing CEO if private benefits are obtained through control (Anderson and Reeb 2003b). A common problem in this type of environments is tunneling, which benefits controlling shareholders by transferring assets at nonmarket prices (Johnson et al. 2000). According to La Porta, López-de-Silanes, and Shleifer (1998), ownership concentration of the largest three shareholders in Mexico stands at 64 percent (vs. 20 percent in the United States and 40 percent in their sampled countries). Voting rights concentration is 74 percent.
Family in Boards
Boards of family firms can be used to monitor management and can also work to resolve conflicts among family members. They can also be a forum where disagreements with top managers and other insiders are solved.
Sraer and Thesmar (2007) show that family firms often have long-term relationships with their employees and offer contracts with implicit long-term job security. By doing this they are able to attract highly qualified staff and increase productivity. These authors also find that in family firms the impact of industry cycles is softened and families strive to honor the implicit parts of labor contracts serving as mediators in family conflicts. Li and Srinivasan (2011) further show that boards dominated by founding family members offer generous compensation packages to CEOs but they are more likely to replace them for poor performance. Because these founding board members have firm-specific knowledge, this allows them to attract more diligent CEOs. Family directors can better assess if the CEO is acting on the shareholders’ best interests and they have longer term investment horizons (Gomez-Mejia, Nunez-Nickel, and Gutierrez 2001). Families that exercise control through a board influence performance and reputation positively and, if the board includes the founder, they outperform other firms (Andres 2008; González et al. 2012; Wang 2006). Finally, there is also evidence showing that family boards can be very sensitive to performance even when the CEO is part of the family (Gonzalez et al. 2015).
Let us now turn to the importance of board outsiders. We mentioned that they could serve as mediators in conflicts between family members and top managers, but few outsiders have a real say in governing a family business. Debt holder monitoring is rare due to family firm’s tendency for financial conservatism. Thus, the composition of a family firm board is an essential element to determine their governance quality (Bammens, Voordeckers, and Van Gils 2011).
While family control has mixed results on performance (Filatotchev, Lien and Piesse 2005) and family firms are usually reluctant to appoint independent directors, research has shown that family firms with more independent members perform better than their nonfamily counterparts. Independent members seem to mitigate opportunistic behavior by dominant shareholders (Anderson and Reeb 2004). Independent board members also: i) reduce behavioral tendencies of family leaders to favor the family over the firm (Goel et al. 2013) and ii) enhance group effort and motivation (Bettinelli 2011). Thus, we can say that most evidence points to independent directors as a mechanism that enhances board monitoring capability.
In Table 5.1 we can find average ROE for 2015 to 2018 in descending order and the degree of family involvement in ownership, management, and boards for the largest Mexican firms (Expansión magazine 2015). It is worth noting that:
Table 5.1 Largest firms by ROE: 2015 to 2018
- A)70 percent are domestic firms, 20 percent are multinational subsidiaries, and only 7 percent are state-owned entities
- B)Top 2 performing firms are state owned (Pronósticos and Fovissste)
- C)50 percent of the top performers are financial firms
- D)40 percent of bottom performers are state owned
- E)The highest performing group in terms of ROE are multinational subsidiaries (18 percent) followed by state-owned entities (13 percent) and domestic firms (9 percent)
- F)For domestic firms we find that:
- •Ownership concentration for the first shareholder (family) is 52 percent
- •Average percentage of first family in TMT is 10 percent
- •Average percentage of first family in board is 26 percent