Family Ownership and Firm Performance: Analytical Essay

Identity of ownership has always been a main topic to study in Finance. Many researchers studied the effect of ownership concentration and the identity of the largest shareholders on many factors, such as Capital structure, growth opportunities, and firm performance. (Jiang & Peng, 2010; Anderson & Reeb, 2003; San Martin & Duran, 2015; Javid & Iqbal, 2008; Thomsen & Pedersen, 1997; Diana Bonfim, 2015; Villalonga & Amit, 2004; Pindado & De la Torre, 2011; Ozler & Taymaz, 2004.). Family firm is a type of ownership that needs to be examined closely. Family firms are defined as firms that family continues to have an ownership or board seats in it (Anderson and Reeb, 2003). A “family-owned and -controlled large firm” is defined as “having a family and/or its identifiable members as the largest owner(s)” (Jiang and Peng, 2010). San Martin and Duran (2015) Identified Family firms when the family has 40% or more ownership of the company. Family refers to either the founder’s family or a family that becomes the largest shareholder in the firm through the acquisition of shares (Villalonga & Amit, 2004). Family ownership is defined as percentage of shares held by family members, whose surname is same as the founder or his family by blood or marriage (Javid & Iqbal, 2008).

The relationship between family ownership and control with performance is a puzzle. Many researchers conducted different studies to examine the relationship which had different results; positive, negative, or irrelevant (Jiang & Peng, 2010; Anderson & Reeb, 2003; San Martin & Duran, 2015; Javid & Iqbal, 2008; Thomsen & Pedersen, 1997; Villalonga & Amit, 2004; Zattoni et al., 2012). The inconsistent findings may perhaps be a result of the fact that family ownership poses potential costs and benefits at the same time. One of the potential cost of Family ownership is that families have the incentives and power to take actions that benefit themselves at the expense of firm performance, and they might replace talented, more professional and capable managers by placing family members in CEO position. (Anderson and Reeb, 2003).

In addition, the agency theory proposed by Fama and Jensen argued that the ownership of families might lead to poor performance in large firms, unlike the small firms that reduces the principal-agent conflicts and leads to better performance. (Jiang and Peng, 2010). If the CEO is a family member his/her position isn’t threatened, so they do not have to maximize efforts to keep their jobs. The main agency problem is risks resulted of controlling shareholders on the expense of minority shareholders. The controlling shareholder makes the decisions but all shareholders bear the cost. (Javid & Iqbal,2008).

On the other hand, family ownership may have some benefits. Families tend to minimize the agency conflicts that might rise by closely monitoring the managers which will lead to better performance, so the ownership is viewed as corporate governance mechanism. The information asymmetry problem in agency relationships may also be reduced if the CEO is a family member due to the close ties with the owners. Family CEOs have sufficient incentives to place family’s wealth ahead of personal interests, thus may perform better than firms with professional CEOs. (Jiang and Peng, 2010).

Also, through social relationships with managers and employees, family CEOs may create a competitive advantage by helping to obtain intangible resources such as loyalty, trust, and social interactions, in addition to gaining access to unique resources. (Jiang and Peng, 2010). It is also shown that families firms have long horizon due to the fact that they intend to view the firm as an asset that they pass to other generations, so they are willing to invest in long-term efficient investments to assure long-term value maximization and therefore long-term survival. (Anderson and Reeb, 2003).

In addition, third parties such as suppliers or creditors are more willing to deal with same governing bodies for longer horizons when comparing with nonfamily ownership. Families with good reputation will lead to long lasting economic consequences with third parties, such as having lower cost of debt financing (Anderson and Reeb, 2003). Also, Distinctive firm-level resources and capabilities is a unique result of involvement and interaction between the family and business (Zattoni et al., 2012).

The purpose of this paper is to shed a light on the impact of family ownership on firm performance using the context of Jordan. This study will utilize a sub-set of firms listed on the Amman Stock Exchange (ASE), namely Industrial firms, over a horizon of 10 years (from 2007 to 2017). This thesis will identify the identity of family firms by tracking the ultimate owner for each firm through time. Then a model will be developed to asses the performance by linking the debt, size, liquidity, tangibility, and growth generated in the family firms. Recognizing the importance of family ownership allows the owners, investors, shareholders, and other stakeholders to make the best choices that affect the profitability as a measure of the performance. The thesis will also highlight whether the debt will work as a governance tool to help in reducing the agency problems in family firms in Jordan and therefore enhance the performance.

There is a growing interest to study the effect of family ownership and firm performance, to examine if the family ownership can overcome the internal conflicts that might appear.

This study examines the effect of family ownership on the firm’s performance, by comparing the performance measured by ROA, and Tobin’s Q for both family and nonfamily firms. It will also focuses on the effect of other variables on mediating the relationship between ownership and performance namely the use of debt, and the controlling variables categorized by size, liquidity, tangibility, and growth.

This thesis tries to highlight the effect of family ownership and performance due to the different arguments mentioned by researchers. (Morck& Yeung, 2010) argued that high ownership concentration may lead to agency problems explained by the agency theory. The aim of the corporate governance is controlling and reducing the internal contradiction in capitalism so people’s savings in firms will be governed by highly trustworthy people, these firms need restrictions to create a governance of the internal conflicts that might rise because the inefficiency and irrationality of decisions will hampers economic growth and value maximization.

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Family ownership concentration in the firm may create a conflict between a family perspective and its responsibility to other shareholders characterized by principal- principal problem that causes a reduction in the firm performance. (San Martin and Duran, 2015).

(Jensen, 1986) argues that free cash flow is one of the main causes of agency problems, as the managers intend to invest the free cash in negative NPV projects if they spend it for their own benefits. This argument might be our main cause to study the mediating effect of the debt to see if it allocates the resources away from non-profitable investments.

On the other hand, many benefits might rise from the family ownership such as the argument of (Anderson and Reeb, 2003), where the long horizon of family firms as a result of their intention to pass it to other generations will lead to long-term efficient investments to assure value maximization and long-term survival. The unique capabilities of the firm are a result interaction between the family and business (Zattoni et al., 2012). The concentrated ownership is viewed as corporate governance mechanism, where the agency problem might be reduced if the CEO is a family member with incentives to place the firm’s value upon of personal interests. (Jiang and Peng, 2010).

The problem of the study lies in finding the impact of the family ownership on firms’ performance in Jordan. Due to the heterogeneity of results found by other authors, this thesis will investigate if the family ownership concentration will overcome the agency problems and therefore enhance the performance, so the negative views held against family ownership will be reduced. The family ownership is an important topic to study; the firms controlled by families are the most common form of businesses in the world. Family-owned firms covers over 80 percent of all firms in the U.S. (Anderson and Reeb, 2003).

Anderson and Reeb (2003) studied the relationship between family ownership and firm performance in S&P 500’s firms excluding banks and public utilities, leading to 403 firms through the period 1992 to 1999, they found that family firms perform better than nonfamily firms regardless the age of the firm (young or old), this relationship is nonlinear relationship suggesting that when family ownership increases the performance increases until a point where the increase in the family ownership will lead to decrease in performance. They also studied the status of CEOs on the performance and found that CEOs who are family members have a positive effect on accounting performance measures.

Jiang and Peng (2010) examined the relationship between family ownership and performance in 744 publicly listed large family firms in 8 Asian countries. On aggregate level the results were irrelevant but showed different results on country level. Two main mechanisms were used for measuring family ownership and control; family CEO and pyramid structure, the dependent variable, firm performance, is measured by the cumulative stock return in 1996. The authors intend to study the principal-principal conflicts to explain the relationship, which are the conflicts that might rise between controlling and minority shareholders, they also explain the different results in different countries through legal and regulatory protection and governance to minority shareholders.

San Martin and Duran (2015) investigated the relationship between ownership structure and performance in public firms in Mexico for 142 firms listed on Mexican stock exchange during the periods of 2005- 2011, considering corporate governance measured by both debt and the structure of board of directors as institutional factors, financial firms and nonprofit organizations were excluded from the sample due to difficulties in calculating Tobin’s Q, and any firm with missing information in their financial statements were eliminated from the study, the final sample consisted of 75 firms. The results confirm a positive relationships between family ownership and performance calculated by Tobin’s Q, showing how participation of inside shareholders in board of directors and low level of debt lead to better performance. It was found that in family firms the effect of debt on performance is negative, while nonfamily firms showed that the effect of debt on performance is positive.

Villalonga & Amit (2004) conducted their study based on proxy data for the firms that are in the Fortune-500 for at least one year during the period 1994-2000. The result of their study of the relationship between family ownership, management, and control on firm value is that family ownership creates value only if the founder serves as CEO of the firm or a Chairman with a hired CEO. They contributed to the literature by classifying the definition of family firms into nine definitions that range from least restricted (Family has any shares) into the most restricted definition (Family is the largest voteholder, that at least has 20% of the votes, and has family officers and directors, and is in second or later generation) and showed how results were different across these definitions.

Zattoni et al. (2012) examined 421 Norwegian nonpublic small and medium-sized firms to study the relationship between family involvement and firm performance measured by ROA, by studying the mediating role of board tasks and processes. They found that family involvement has a positive impact on some of board processes such as effort norms and use of knowledge and skills, while it has a negative impact on cognitive conflicts, this leads to a positive influence on board tasks performance. The board control tasks have no significant influence on financial performance, while the board strategy task has a positive influence on the firm financial performance. On average we can say that family involvement has a small positive effect in firm financial performance.

Also Javid & Iqbal (2008) viewed the ownership structure and its implications on corporate governance and firm’s value measured by ROA and Tobin’s Q. The ownership is defined by cash flow rights. The sample consisted of 60 non-financial firms listed in Pakistan, Karachi Stock Exchange for the period 2003 to 2008. They found that in Pakistan firms there is significant ownership concentration, which is defined as the percentage of shares owned by the largest five shareholders in the firm, they explained the results by poor legal environment, where there is a small legal protection, so the ownership concentration become an instrument to resolve the agency conflicts. The identity of large shareholders determines the firm performance. Family ownership have a positive impact on firm performance, as they bring better governance practices to the firm, and therefore reduce the agency conflicts. Another reason for the positive relationship is that families have longer investment horizons which leads to more efficient investments.

The results introduced by Thomsen and Pedersen (1997) in their study of 435 largest non-financial companies in 12 of European countries for the period 1991-1996, to understand the impact of ownership structure on economic performance, found that family ownership have low market to book values and ROA, and high sales growth, it also have high debt to equity ratio comparing with financial institution ownership which have a better access to stock market. The ownership here is defined as the identity and concentration of the largest owner, where performance is measured by ROA, Tobin’s q, sales growth, and control variables used were capital structure, and nation and industry effect.