OWNERSHIP STRUCTURE AND FIRM PERFORMANCE IN NON-LISTED FIRMS: EVIDENCE FROM SPAIN 1. Blanca Arosa 2. Txomin Iturralde.

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1 OWNERSHIP STRUCTURE AND FIRM PERFORMANCE IN NON-LISTED FIRMS: EVIDENCE FROM SPAIN 1 Blanca Arosa 2 Txomin Iturralde Amaia Maseda University of the Basque Country, UPV/EHU, Spain Abstract: This study provides new evidence regarding the way in which ownership concentration influences non-listed firm performance focusing on the conflict between majority and minority shareholders, and differentiating between the behavior of family and nonfamily firms, using data from 586 non-listed Spanish firms. In first-generation family firms our research shows that agency theory can be used to explain the role of ownership concentration in balancing conflicts between shareholder groups. A greater concentration of firm ownership in the first generation may bring the monitoring and expropriation hypotheses into play, whereas firms in which subsequent generations have joined may show a greater spread of ownership. In first generation family firms, the classic owner-manager conflict is mitigated due to the large shareholder s greater incentives to monitor the manager. However, a second type of conflict appears. The large shareholder may use its controlling position in the firm to extract private benefits at the expense of the small shareholders. 1 The authors thank Cátedra de Empresa Familiar de la UPV/EHU for financial support (DFB/BFA and European Social Fund). We also thank four anonymous referees and participants at the World Family Business Research Conference of IFERA, June 2009, Limassol (Cyprus) and the XIX Congreso Nacional, of ACEDE, September 2009, Toledo (Spain) for their helpful comments. All errors are our responsibility. 2 Correspondence to: Blanca Arosa, Departamento de Economía Financiera I, Avda. Lehendakari Agirre, 83, Universidad del País Vasco, E48015 Bilbao, Spain. Tel.; Fax: E- mail: blanca.arosa@ehu.es

2 The empirical evidence shows that for family firms, the relationship between ownership concentration and firm performance differs depending on which generation of the family manages the firms. In first-generation family firms the results show a positive relationship between ownership concentration and corporate performance at low level of control rights as a result of the monitoring hypothesis and a negative relationship of high level of ownership concentration as a consequence of the expropriation hypothesis. To reduce the expropriation effect, it could be considered opening family firms equity to other shareholders but maintain family control rights. Key words: Ownership, SMEs, non-listed firms, family firms, performance 2

3 1. Introduction The influence of ownership structures on firm performance has been researched extensively in the theoretical and empirical literature. The relevant literature suggests that ownership structure is one of the main corporate governance mechanisms influencing the scope of a firm s agency cost. Jensen and Meckling (1976) suggested that ownership concentration has a positive effect on performance because it alleviates the conflict of interest between owners and managers. The opposite view of the ownership structure directs attention towards the effects of the agency problem resulting from the combination of concentrated ownership and owner control (Fama and Jensen, 1983). This combination allows controlling shareholders to extract private benefits from the firm at the expense of minority shareholders (Demsetz, 1983; Shleifer and Vishny, 1997; Porta et al., 2000; Demsetz and Villalonga, 2001; Villalonga and Amit, 2006). A growing body of research on ownership structure has focused on the impact of ownership concentration on performance in family firms (McConaughy et al., 1998; Ang et al., 2000; Anderson and Reeb, 2003a; Habbershon et al., 2003; Chrisman et al., 2003; Cronqvist and Nilsson, 2003; Maury, 2006; Villalonga and Amit, 2006; Bennedsen et al., 2007; Miller et al., 2007; Eddleston et al., 2008). Nevertheless, the results of the studies have not been conclusive, and existing studies on the relationship between family ownership and firm performance mainly use data collected from large firms. Although scholars have reported that most family firms are small and mediumsized enterprises (SMEs), empirical studies that explicitly examine how family ownership influences the performance of SMEs are still necessary. This lack of studies is probably due to difficulties in collecting reliable and systematic data on SMEs. Given that SMEs play a dominant role in the economic development of industrialized regions and most family firms are SMEs (Poza 2007), a study that investigates the association between family and non-family ownership and SME performance is of academic 3

4 significance (Chu, 2009). In this regard, analyzing whether ownership structure acts as an control mechanism in non-listed SMEs is necessary to fill this gap in the current literature. The aim of this paper is to analyze the usefulness of ownership concentration as an internal control mechanism that prevent or reduce the potential conflict of interest that arise between different agents involved in non-listed SMEs and, in the case of family firms, also consider the generational effect. To test our hypothesis that ownership concentration moderates conflicts between opposing groups in the firm, we examined the relation between firm performance and ownership concentration in family and nonfamily firms. Our results indicate that there is no relationship between ownership concentration and performance regardless of whether firms are family or non-family owned. This paper has not been able to confirm the relationship between the ownership concentration and firm profitability in non-listed firms. These results are in line with previous studies of non-listed firms (Westhead and Howorth, 2006; Castillo and Wakefield, 2006). However, for family firms, our results suggest that the relationship between ownership concentration and firm performance differs depending on which generation of the family manages the firms. In first-generation family firms the results show a positive relationship between ownership concentration and corporate performance at low level of control rights as a result of the monitoring hypothesis and a negative relationship of high level of ownership concentration as a consequence of the expropriation hypothesis. Both the monitoring and the expropriation effects are confirmed. Our study contributes to the existing literature in several different ways. First, we analyze the relationship between ownership structure using the ownership concentration as an independent variable and firm performance in non-listed firms. Second, our findings provide a new perspective on the role that ownership concentration plays in 4

5 corporate governance as an internal control mechanism in family firms. We consider the role of this internal control mechanism in mitigating moral hazard conflicts between shareholder groups with diverging interests in family firms. Third, in first-generation family firms our research shows that agency theory can be used to explain the role of ownership concentration in balancing conflicts between shareholder groups. The remainder of the article is organized as follows. Section 2 contains a review of the literature regarding the ownership structure as a control mechanism and presents the hypothesis. Section 3 presents the data and the analysis procedure used to conduct the empirical study. Section 4 presents the main results and the discussion of the investigation. Section 5 introduces the principal conclusions, and the paper ends with a list of bibliographical references Theoretical Background Literature Review According to Jensen (2000), firms are affected by different mechanisms of corporate control, one of them being ownership structure. This internal control mechanism is significant in determining firms objectives, shareholder wealth and the level of discipline of managers. The literature on ownership structure has focused on three dimensions: the ownership concentration (Demsetz and Lehn, 1985; Shleifer and Vishny, 1986; McConnell and Servaes, 1990; Leech and Leahy, 1991; Morck et al., 2000; Westhead and Howorth, 2006; Castillo and Wakefield, 2006; Marttínez et al., 2007, Sraer and Thesmar, 2007; Sciascia and Mazzola, 2009), insider ownership (Stulz, 1988; Morck, et al., 1988; McConnell and Servaes, 1990; Faccio and Lasfar, 1999), and owner identity (Galve and Salas, 1992; Pedersen and Thomsen, 1997). The ownership concentration may result in a reduction in problems arising from the divergence of interests between 5

6 different agents, including an analysis of the prevailing hypothesis of monitoring compared to that of expropriation. In the context of companies with high ownership concentration, agency theory suggests that controlling shareholders often use their power to undertake activities intended to obtain private profit to the detriment of minority shareholders wealth (Shleifer and Vishny, 1997; La Porta et al., 1999, 2000; Francis et al., 2005; Miller et al., 2007). A greater concentration of voting rights can therefore lead to greater incentives for controlling shareholders to obtain private benefits. This trend may be exacerbated in the case of family firms because those benefits remain in the controlling family, whereas in non-family firms, they are distributed among a large number of shareholders (Villalonga and Amit, 2006). In this regard, some scholars have argued that controlling family shareholders can easily advocate for their own interests at the expense of those interests of minority shareholders by treating the company as a family employment service or a private bank, by limiting top management positions to family members or by making extraordinary dividend payouts (Shleifer and Vishny, 1997; Demsetz, 1983; Fama and Jensen, 1983). In these situations, agency costs take the form of dividends and extraordinary remunerations or of the entrenchment of the family management team. This entrenchment results in certain expropriatory practices of the controlling family shareholders wielding power over minority shareholders and ultimately reducing firm profitability (De Angelo and De Angelo, 2000; Morck et al., 2000; Gómez-Mejía et al., 2001; Fan and Wong, 2002; Francis et al., 2005; Santana et al., 2007). However, another group of authors suggested that the distinctive features of family firms have a positive effect on their corporate behavior. The family's interest in the long-term survival of the business as well as its concern for maintaining the reputation of the firm and the family, lead the family to avoid acting opportunistically with regard to the earnings obtained (Anderson and Reed, 2003a; Burkart et al., 2003; Wang, 2006). 6

7 Families have concerns and interests of their own, such as stability and capital preservation, which may not align with the interests of other firm investors. In general, the empirical evidence is not conclusive. Some empirical findings indicate that firms with concentrated ownership structure, such as founding families, show lower profitability than those firms with a dispersed ownership structure (Fama and Jensen, 1983; De Angelo and De Angelo, 2000; Gómez-Mejía et al., 2001). In contrast, empirical studies by Anderson and Reeb (2003a), Burkart et al. (2003), and Wang (2006) report that controlled family ownership positively influences firm performance Hypothesis Development Empirical studies that are specifically focused on examining the relationship between ownership-concentrated non-listed firms and performance are scarce. This scarcity is probably due to difficulty collecting data on SMEs and because there is no official database of family firms. In firms with high ownership concentration some studies focused on the conflict between large and small shareholders or controlling and minority shareholders (Shleifer and Vishny, 1997; La Porta et al., 1999, 2000; Francis et al., 2005; Miller et al., 2007). When large shareholders effectively control firms, their policies may result in the expropriation of minority shareholders. The conflicts of interest between large and small shareholders can be numerous, including controlling shareholders enriching themselves by not paying out dividends or other expropiatory practices. Fan et al., (1999) show that the concentration of control is negatively associated with market valuation. In this context, the first hypothesis proposes that an ownership concentration will be associated with a negative impact on performance. Accordingly, the following hypothesis is presented: H 1 : There is a negative relationship between ownership concentration and non-listed firm profitability. 7

8 Among non-listed firms, founding families represent a special type of shareholders. Family owners differ from other shareholders in two main aspects: the interest of the family in the long-term survival of the firm and the concern of the family for the reputation of the firm and the family itself. Anderson and Reeb (2003a), Villalonga and Amit (2006), Maury (2006), Barontini Caprio (2006) and Pindado et al. (2008) find a positive relationship between corporate performance and ownership concentration. The long-term goal of family firms suggests that these family firms desire longer-term investment projects than other shareholders. The wealth of the family is closely related to the value of the company, so families have strong incentives to monitor agents (Anderson and Reeb, 2003a) and create long-term loyalty in them (Weber et al., 2003). Moreover, due to the substantial and long-term presence of families in firms and their intention to preserve the family name, families have a greater interest in the company than others do. Furthermore, families are more likely to give up short-term benefits due to incentives to pass the business to future generations and protect the family s reputation (Wang, 2006). Also, this perspective generates a reputation for the family that involves creating long-term economic consequences for the company compared to non-family firms (Anderson et al., 2003). Strong control mechanisms can motivate family members to communicate more effectively with other shareholders and creditors, using higher quality financial reporting and, consequently, reducing the cost of debt (Anderson et al., 2003). These arguments suggest that the sustained presence of family owners in the firm may have positive economic consequences (Anderson et al, 2003; Wang, 2006). Thus, we expect family firms to be more profitable than non-family ones. H 2 : There is a larger positive relationship between family ownership concentration and firm profitability in non-listed family firms than in non-family ones. 8

9 Nevertheless, high ownership concentration can trigger other problems with corporate governance and other types of cost. If there are controlling shareholders, they are more likely to be able to use their power to undertake activities intended to obtain private profit to the detriment of minority shareholders wealth (La Porta et al., 1999; Villalonga and Amit, 2006). Furthermore, this trend can be exacerbated in the case of family-controlled firms, where the agency costs may take the form of dividends and extraordinary remunerations or the entrenchment of the family management team, showing certain expropriatory practices that ultimate reduce profitability (DeAngelo and De Angelo, 2000; Gómez-Mejía et al., 2001; Fan and Wong, 2002; Francis et al., 2005; Santana et al., 2007). There are two potential costs that can generate a negative effect on certain levels of ownership concentration (Pindado et al., 2008). On the one hand, there is the incentive of the owning family to carry out actions that increase its personal utility, resulting in poor firm performance (Anderson and Reeb, 2003a). Derived from this fact, one can assume that high levels of ownership concentration may be related to less efficient investment decisions, which can lead to a reduction in firm performance (Cronqvist and Nilsson, 2003). On the other hand, there are authors who suggest that a high family ownership concentration is related to the influence of the controlling family on its managers, which may, in turn, be related to a higher level of entrenchment of managers (Gomez-Mejia et al., 2003). In summary, family ownership may have both positive and negative effects on the functioning of the firm. Numerous empirical studies have found a nonlinear relationship between ownership concentration and firm performance in listed family firms (Thomsen and Pedersen, 2000; Anderson and Reeb, 2003a; Maury, 2006; Pindado et al., 2008). This relationship implies that when ownership is less concentrated, there is a positive effect on performance, as a result of the monitoring hypothesis. That is, all shareholders 9

10 devote their efforts to monitoring managers to maximize the value of the firm. However, as ownership becomes more concentrated, the relationship between the two variables becomes negative as a result of the expropriation hypothesis. When shareholder ownership is high enough, shareholders tend to expropriate wealth from minority shareholders and look for their own wealth. This observation led us to hypothesize that the relationship between family ownership and profitability is nonlinear in non-listed family SMEs. More specifically, we propose that the relationship is inverted U-shaped. First, we propose a positive relationship between ownership concentration and firm performance at low levels of the former as a result of the monitoring hypothesis and a negative relationship afterwards as a consequence of the expropriation hypothesis. H 3 : There will be an inverted-u-shaped relationship between family ownership concentration and firm profitability. According to Schulze et al. (2001), whereas the main source of agency problems is the separation between ownership and monitoring, such problems do not exist in firstgeneration family firms because the same person is responsible for making management and supervision decisions. Reductions in agency costs may be achieved by entirely eliminating the separation between owners and management. In such cases, the interests of principal and agent are aligned, and it is assured that the management will not expropriate the shareholders wealth (Miller and Le-Breton Miller, 2006). Because the family property is shared by an increasingly large number of family members, conflicts may start to arise when the interests of the family members are not aligned, and the agency relations between the various participants in the firm are conducted on the basis of economic and non-economic preferences (Chrisman et al, 2005; Sharma et al., 2007). Schulze et al. (2001) argued that family relationships tend to generate agency problems, mainly because control over firm resources enables 10

11 owner/managers to be generous to their descendents and other relatives. Parental altruism is a trait that positively links the controlling owner s welfare to that of other family members. Over time, however, the economic incentive to do what maximizes personal utility can blur the controlling owner s perception of what is best for the firm or family (Schulze et al., 2003). A greater concentration of firm ownership in the first generation may bring the monitoring and expropriation hypotheses into play, whereas firms in which subsequent generations have joined may show a greater spread of ownership. As a family firm enters second and later generations, the number of family members involved often grows, including founder s descendents and in-laws. Sometimes, there is harmony and the possibility of new talent coming into the business but as relatives proliferate, so too does the potential for conflict among those running the business, among the owners, and between the two groups (Miller and Le-Breton Miller, 2006). Schulze et al. (2003) argued that these conflicts are especially likely to occur when the distribution of ownership is balanced between competing blocks, as often occurs as later generations enter the business. Again, agency issues arise if those in control or running the business exploit other family or nonfamily owners, thereby serving as stewards not of the business, but of their own nuclear family. Such exploitation may be more common where rival ownership blocs among family factions have different interests and roles (e.g., extracting dividends vs. growing the business), and where there has been a turbulent family history (Miller et al., 2005). Another potential problem as the generations progress is the growing demand for dividends from a greater number of family members who no longer directly work for the business. In this sense, we expect an inverted-u-shaped relationship in family firms managed by subsequent generations. 11

12 H 4 : There is an inverted-u-shaped relationship between family ownership concentration and firm profitability in family firms managed by subsequent generations Empirical Research: Method, Data and Analysis 3.1. Population and sample We conducted this study on Spanish firms included in the SABI (Iberian Balance Sheet Analysis System) database for We imposed certain restrictions on this group of companies to reach a set that would be representative of the population. First, we eliminated companies affected by special situations such as insolvency, winding up, liquidation or zero activity. Second, restrictions concerning the legal form of companies were imposed; we focused on limited companies and private limited companies because they have a legal obligation to establish boards of directors. Third, we eliminated listed companies. Fourth, we studied only Spanish firms with more than 50 employees i.e., companies large enough to ensure the existence of a suitable management team and a controlling board to monitor firm performance. Finally, companies were required to have provided financial information in Based on these conditions, the sample under study was comprised of 3723 non-listed Spanish firms. There is no official database of family firms, and the level of difficulty of collecting data on SMEs is high also. In addition, the lack of an agreed definition of family firm leads to the use of restrictive samples (Daily and Dollinger, 1993; Schulze et al. 2001, 2003; Chua et al., 2003; Miller et al., 2007). Given these limitations, detailed analysis of the information in the databases and surveys are the only way to identify family and non-family non-listed firms. This study involves a combination of these two methods of identification. In this study, a family firm is a firm that meets two conditions: a) a large body of common stock held by the founder or family members, allowing them to exercise control over the firm, and also b) family members who participate actively in 12

13 monitoring the firm. Like La Porta et al. (1999), we established 20% as the minimum percentage of a firm s equity considered as a controlling interest. To ensure compliance with these two conditions, we conducted an exhaustive review of shareholding structures (percentage of common stock) and composition (name and surnames 3 of shareholders) and also examined the composition of the board of directors of each of the 3723 selected companies in the database. We accordingly classified a firm as a family firm if the main shareholder was a person or a family with a minimum of 20% of firm equity and there were family relationships between this shareholder and the directors based on the coincidence of their surnames. The composition of the management was also reviewed in search of family relationships between shareholders and managers. Based on the 3723 companies preselected, the original sample used in this study is a 2958 firm random sample. Of these firms, 586 responded the questionnaire correctly: 217 non-family firms (37%) and 369 family firms (63%) for which there were data on ownership structures, accounting variables and boards of directors. The 586 firms are a representative sample with a confidence level of 95% (Malhotra and Birks, 2007) Data Data were collected by means of telephone interviews, a method that ensures a high response rate, and financial reporting information was obtained from the SABI database. The questionnaire collects information on the variables required for study that could not be obtained from the SABI database and that would be captured more reliably through a survey. In particular, this included information regarding the ownership structure, the composition of the board of directors and company management. 3 The Spanish surname system, whereby women never take their husband s surnames and children take both surnames (father s and mother s surname) makes second-degree relationships (uncles, aunts, first cousins, and so on) easier to identify. 13

14 To guarantee the greatest possible number of replies, managers were made aware of the study in advance by means of a letter indicating the purpose and importance of the research. In cases where they were reluctant to reply or made excuses, a date and time were arranged in advance for the telephone interview. The final response rate was approximately 19.81%, and the interviewees were persons responsible for the management of the firms (financial managers in 56.48% of cases, chief executive officers in 31.06%, presidents in 1.54%, and others in 10.92%) Measurement of variables In this section, we present the variables used in the empirical analysis. Access to information is limited in the case of non-listed firms; as a result, the information used comes from two different sources: the SABI database, which collects financial information from the Spanish Official Register; and a survey used to obtain information about variables not in the SABI database Dependent variable Following Anderson and Reeb (2003a), Sciascia and Mazzola (2009), and Chu (2009), we use profitability as the dependent variable that examines the effect of non-listed ownership structure on firm performance. Profitability is measured by the accounting measure Return on Assets (ROA). ROA measures the ability of the assets of the company to generate profits and is considered a key factor when taking into account future firm investments (Masson, 2002). It is considered, therefore, an indicator of firm profitability. As suggested by Anderson and Reeb (2003a, 2003b), we have constructed ROA as Earnings before Interest and Taxes (EBIT) scaled by the book value of total assets, leaving aside the financial performance of the firm. EBIT is a traditional method of measurement that does not include capital costs and, instead, includes only the operating margin and operating profit. 14

15 Independent variables Family firm: We classified a firm as a family firm if the main shareholder was a person or a family with a minimum of 20% of firm equity and there were family relationships between main shareholder and directors based on the coincidence of surnames. Toward this end, following the methods of Anderson and Reeb (2003b) and Wang (2006), we created a dummy variable (FD) that takes the value 1 if the firm meets the criteria for being considered a family firm and a value of 0 otherwise. Generation managing the firm: The different characteristics attributed to family firms depending on the generation managing the firm make it necessary to classify family firms according to the generation managing it. Consistent with Miller et al. (2007) the GEN variable takes the value of 1 if the company is managed by the first generation and 0 otherwise. In this sense, we analyze whether the behavior of family firms varies depending on which generation manages the firm. Ownership Concentration: To measure the ownership structure as an internal control mechanism, we use the ownership concentration variable. Consistent with Pindado et al., (2008), we have created two variables to measure the ownership concentration: Family ownership concentration (FOC) for family firms and Ownership concentration (OC) for non-family ones. Each of these variables measures the percentage of ownership in the hands of the largest shareholder, which, in the case of family firms, is a family shareholder Control Variables Insider ownership: The INSOWN variable shows the percentage of ownership of the insider directors and the chief executive officer (Anderson and Reeb, 2003b; Villalonga and Amit, 2006). Composition of the board of directors: The OUTSIDERS variable is calculated as the percentage of external directors out of the total number of directors (Anderson and 15

16 Reeb, 2003a; Barontini and Caprio, 2006). The aim of this variable is to measure the monitoring capacity of the board of directors and to analyze its influence on the profitability of the firm. Firm size: The SIZE variable can also influence the relationship between ownership and firm performance (Anderson and Reeb, 2003a, Carter et al., 2003; Barontini and Caprio, 2006; Wang, 2006; Santalo and Diestre, 2006; Chu, 2009). To avoid the problems of extreme values, we construct it using the natural logarithm of total assets. Growth opportunities: According to Scherr and Hulburt (2001), the GROWTHOP variable has been calculated as Sales 0 /Sales -1,. In this case, the firms that grew more in the past will have the most growth opportunities in the future. Debt: The LEV variable is controlled because ownership structure may influence firm financial structure (Demsetz and Lehn, 1985). This variable has been measured as the ratio of total debt to total assets (Coles et al., 2005; Wang, 2006). Firm age: AGE is measured as the natural logarithm of the number of years since the establishment of the firm. Industry: SECT is measured using dummy variables following the Spanish industrial classification (CNAE) Summary statistics Table 1 presents descriptive statistics for the variables in the analysis. We shown mean values for family and non-family firms. The average ownership stake in family firms is nearly 50%; in non-family firms, it is around 74%. As different generations join the firm, that capital is diluted significantly, which may explain the difference that occurs between the two types of organizations: 42% of the family firms in the sample are part of the second generation and 19% are part of the third and successive ones. The Spanish non-listed firms generally have three significant partners who control around 90% of the 16

17 equity; this analysis lets us identify who has the control in the company and determine its level of representation in government bodies. TABLE. 1 Descriptive statistics of sample firms: Mean values for variable measures Family Firms Non-family Firms Number of observations Number of business segments Fraction of single-segment firms Ownership concentration (%) Insider ownership (%) ,10 Board of Director s composition (Outsiders %) Return on Assets (%) Growth opportunity (Sales 0 /Sales -1 ) Leverage (Total Debt / Total Assets) Firm s size (Total Assets) Firm s age (years) Source: Data of ownership structure, board of directors and management from the survey, and financial information from SABI. Family firms in the sample show significantly more diversification, with nearly 64% reporting only one line of business compared to 88.46% of non-family ones. Insider ownership levels are higher in family firms, mainly due to the CEO s percentage of ownership, which is on average 5% in nonfamily firms and 20% in family firms. Board of director composition, return on asserts, growth opportunities and leverage are not significantly different in family and non-family firms. Non-family firms are larger than family ones and, with regard to age, we note that family firms are on average 40 years old and non-family ones only 33, suggesting that the former are well established. TABLE. 2 - Correlation data Variables ROA 1 2 Ownership concentration Insider ownership *** 1 4 Outsiders *** 1 5 Growth opportunity

18 6 Leverage *** Firm s size ** ** 1 8 Firm s age *** and ** indicate significance at 1% and 5% levels, respectively. As shown in Table 2, the correlation coefficients are weak and do not violate the assumption of independence of the variables. To test for multicollinearity, the VIF was calculated for each independent variable. Myers (1990) suggests that a VIF value of 10 and above is cause for concern. The results indicate that all of the independent variables had VIF values of less than Results and discussion Table 3 presents the results of our linear regression evaluating the influence of ownership concentration on business performance for family and non-family firms. In first regression, we examined the influence of ownership concentration on firm performance. As noted in Table 3 (column I), the overall model is significant (F statistic = 1.95; p < 0.01). Our results show a nonsignificant relationship (β 1 = ) between ownership concentration and firm performance. Thus, firm value seems to be insensitive to this variable. The results were not expected, and hypothesis 1 was not supported. Instead, we divide the sample up into family firms and non-family ones. A positive coefficient is found between family ownership concentration and the profitability of firms (Table 3, column II), but the relationship is not significant. This lack of significance leads us to conclude that there is effectively no relationship between the variables of family ownership concentration and profitability, so we do not accept hypothesis 2. TABLE. 3- Relationship between ownership concentration and company firm profitability ROA I II III IV V VI Constant * * * * FOC

19 FOC*GEN ** FOC FOC 2 *GEN ** OC OC*FD OC OC 2 *FD INSOWN OUTSIDERS * * GROWTHOP ** *** *** *** *** ** LEV *** * *** ** *** ** SIZE AGE R ***,** and * indicate significance at 1%, 5% and 10% levels, respectively. Models I, III and V contain the entire sample. Models II, IV and VI refer only to family firms. If we compare the behavior of family and non-family firms, the results are not significant (Table 3, column III). In this case, neither 1, which reflects the relationship between ownership concentration and firm profitability in non-family firms, nor 2, which reflects the extent to which family firm status influences the relationship between ownership concentration and profitability, is significant. The presence of a majority shareholder in the company can result in agency problems between controlling and minority shareholders (Shleifer and Vishny, 1997). Following this argument, there are studies that have found a nonlinear relationship between ownership concentration and profitability (Gedajlovic and Shapiro, 1998; Thomsen and Pedersen, 2000; Miguel et al., 2004). Our study conducts further tests to examine the possibility of nonlinearity between firm performance and ownership concentration. So an inverted-u-shaped relationship is expected. 19

20 The results are shown in Table 3 (columns IV and V). For family firms (column IV), a positive coefficient is found for concentration of ownership and a negative coefficient for its square, but neither is significant. These results do not allow us to confirm whether there is a nonlinear or inverted-u-shaped relationship between concentration of ownership and profitability in the case of non-listed family firms. Therefore, we cannot accept hypothesis 3. If we consider the whole sample and compare the behavior of family and non-family firms, we can see similar results (column V). Both family and non-family firms show positive coefficients for ownership concentration and negative coefficients for its square, which may indicate the existence of a nonlinear relationship between ownership concentration and firm profitability. However, these coefficients are not significant in the case of the companies in the sample. No relationship is found between the ownership concentration and firm profitability. In addition, no evidence is obtained to support the monitoring and expropriation hypotheses for the companies analyzed. The arguments tested in relation to listed firms do not arise for non-listed ones. In this case, the level of ownership concentration does not appear to have any direct influence on the behavior of shareholders, which can be related to the non-listed status of the firm and its similar ownership structure. Table 3 (column VI) shows the results for ownership concentration and firm profitability taking into account the generation managing the family firm. The results show that there is no relationship between ownership concentration and profitability in family firms not managed by the first generation because 1 and 3 are not significant. However, in the first generation, family firms exhibit an inverted-ushaped relationship because the coefficients 2 and 4 are significantly positive and negative, respectively. Once a family has a sufficient ownership level for unchallenged 20

21 control, shareholders benefit more from expropriating minority shareholders than from maximizing company value. Firms managed by the first generation have more concentrated ownership structures. As new generations join a firm, the ownership structure becomes more dispersed, which may be the reason for the results. These generational effects seem to be critical to our understanding of the relationship between ownership concentration and performance. In first generation family firms, the classic owner-manager conflict is mitigated due to the large shareholder s greater incentives to monitor the manager. However, a second type of conflict appears. The large shareholder may use its controlling position in the firm to extract private benefits at the expense of the small shareholders. This increased ownership concentration may be the cause of the different behaviors observed. If the large shareholder is an individual or a family, it has greater incentives for both expropriation and monitoring, which are thereby likely to lead the problem between majority and minority shareholders to overshadow owner-manager conflict (Villalonga and Amit, 2006). Our findings show that, up to a certain degree of ownership concentration, the supervision hypothesis is predominant, providing that shareholders are focused on monitoring management. However, when ownership concentration is high, shareholders try to expropriate wealth from minority shareholders because of the great influence that a controlling family can exercise. Up to a 49% ownership concentration for first-generation family firms, the monitoring hypothesis prevails. After this cut-off point, the expropriation hypothesis prevails. 21

22 ROA Monitoring Expropiation FOC Figure 1. Relation between ownership concentration and firm profitability McConnaughy et al. (1998), Anderson and Reeb (2003a, 2003b), Adams et al. (2003), Villalonga and Amit (2006) and Barontini and Caprio (2006) found a positive effect on profitability in firms where the founder is the chief executive officer. However, our findings show a nonlinear relationship; thus, beginning with a certain level of ownership concentration, the positive effect does not exist and the expropriation hypothesis prevails. 5.- Conclusions The aim of this study is to analyze the usefulness of ownership concentration as an internal control mechanism that prevent or reduce the potential conflict of interest that arise between different agents involved in non-listed SMEs and, in the case of family firms, also to consider the generational effect. To test our hypothesis that ownership concentration moderates conflicts between opposing groups in the firm, we examined the relation between firm performance and ownership concentration in family and nonfamily firms. Moreover, unlike most previous studies, our study did not focus on large listed companies, but instead, adopted a sample that includes mainly SMEs, none of which is listed. In an ownership concentration context, we used a sample of 586 nonlisted Spanish firms, of which 217 are non-family firms and 369 are family firms. The main results of this research suggest that the ownership concentration does not have a direct influence on the behavior of shareholders, which can be related to the non-listed status of firms. Thus, this paper has not been able to confirm the relationship between 22

23 ownership concentration and firm performance for non-listed firms. The results indicate that the arguments validated for listed firms do not apply to non-listed ones. However, for family firms, our results suggest that the relationship between ownership concentration and firm performance differs depending on which generation manages the firms. In first-generation family firms the results show a positive relationship between ownership concentration and corporate performance at low level of control rights as a result of the monitoring hypothesis and a negative relationship of high level of ownership concentration as a consequence of the expropriation hypothesis. Both the monitoring and the expropriation effects are confirmed. This study contributes to the existing literature in several different ways. First, we analyze the relationship between ownership structure using the ownership concentration as an independent variable and firm performance in comparing family and non-family firms. Second, our findings provide a new perspective on the role that ownership concentration plays in corporate governance as an internal control mechanism in family firms. We consider the role of this internal control mechanism in mitigating moral hazard conflicts between shareholder groups with diverging interests in family firms. Third, for first-generation family firms, our research shows that agency theory can be used to explain the role of ownership concentration in balancing conflicts between shareholder groups. Fourth, previous family firm studies (Anderson and Reeb, 2003a, 2003b) have focused on relatively large publicly traded family firms (S&P 500). The shortage of studies on non-listed firms is probably due to the difficulty of collecting data on SMEs as well as a lack of an official database of family firms. Nevertheless, this study has focused on non-listed family and non-family SMEs and has chosen a combination of two methods of identification of non-listed SMEs: the detailed analysis of the information in databases and the survey. 23

24 Several implications arise from our findings. These results suggest that family ownership is related to higher firm performance depending on the role the family plays in the firm. If the family is a large shareholder with a board of directors or executive representation, family firm behavior differs from other concentrated ownership structures and seems to face different agency problems. In our analysis, in 94% of family firms, the chief executive is a member of the family, and the boards of directors are composed mainly of relatives, so their incentives to expropriate wealth from minority shareholders are larger when they extend beyond their ownership rights. It is much easier for family shareholders to coordinate their actions and use their voting rights to maximize their own wealth. To reduce the expropriation effect, it could be considered opening family firms equity to other shareholders but maintain family control rights, which would secure the advantages of concentrated ownership. These results can be explained in several ways. On one hand, La Porta et al. (1998) showed that Spanish firms have a higher percentage of ownership concentration in comparison with U.S., U.K., Japanese and German firms. In addition, the presence of controlling shareholders with interests different from those of minority owners would make it easier to expropriate the latter s wealth; on the other hand, the structure of the boards of directors in Spain implies that board members manage the company and also supervise its activity, so one might question their role in monitoring management and controlling for expropriation. It must also be considered that the rules governing the treatment of minority shareholders in a weaker investor protection system such as in Spain could explain the likelihood of expropriation. This research has some limitations. First, it was very difficult to obtain a database of non-listed firms and even more difficult to obtain one for family firms. This lack of data 24

25 has kept us from distinguishing between lone founder and other family firms. Second, our data are cross-sectional and they refer to 2006; therefore, we cannot make clear inferences regarding causality. Only a panel data sample will allow researchers to test and support our findings. Third, data were collected exclusively in Spain, therefore limiting the possibility of generalizing our findings. Several recommendations for future research can be formulated. First, researchers should analyze the usefulness of ownership concentration as an internal control mechanism distinguishing, like Miller et al (2007), between lone founder and true family firms. Second, a research design based on longitudinal data would be more suitable for this kind of study because it would increase the reliability of findings related to causality directionality. Third, a similar study could be conducted in countries other than Spain to increase the validity of our results. We conclude that the relationship between ownership concentration and firm performance differs depending on which generation of the family manages the firms. In first-generation family firms the results show a positive relationship between ownership concentration and corporate performance at low level of control rights as a result of the monitoring hypothesis and a negative relationship of high level of ownership concentration as a consequence of the expropriation hypothesis. These results show that agency theory can be used to explain the role of ownership concentration in balancing conflicts between shareholder groups Key references Adams, R.B., Almeida, H. & Ferreira, D., (2003). Founder-CEOs and Firm Performance. Working paper, New York University. Anderson, C. R., & Reeb, M. D. (2003). Founding-Family Ownership and Firm Performance: Evidence from the S&P500. The Journal of Finance, vol. LVIII, no. 3,

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