Family Firm Governance and Financial Policy Choices in Newly Public Firms

• DOI: http://doi.org/10.1111/corg.12113
• Date: 01 September 2015
• Author: Bharat A. Jain,Yingying Shao
• Published date: 01 September 2015

Family Firm Governance and Financial Policy

Choices in Newly Public Firms

Bharat A. Jain and Yingying Shao*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Using agency theoryand socioemotional wealth perspective as the theoretical framework, we eval-

uate the extent to which f‌inancing choices subsequent to going public and their economic consequences differ for family f‌irms

relative to non-family f‌irms.

Research Findings/Insights: Our resultssuggest that family f‌irms maintainhigher post-IPO leverage and longerdebt maturity

structurerelative to non-family f‌irms.Further, family f‌irms raiseless external capital subsequentto going public relative to non-

family f‌irms.The reluctance of family f‌irms to raise post-IPOcapital, however,results in higher investmentsensitivity to internal

cash f‌lows and consequently ineff‌icient investment. In addition, family f‌irm f‌inancing choices differentially inf‌luence various

facets of post-IPO performance.

Theoretical/Academic Implications: This study suggests that agency conf‌licts among f‌irm stakeholders as well as

socioemotionalwealth considerationsare important determinantsof family f‌irm f‌inancing behavior subsequentto going public.

Further, ownership structure is an important determinant of the extent IPO f‌irms capitalize on the opportunity to raise capital

subsequent to going public to f‌inance investments.

Practitioner/Policy Implications: Our results offer insights to entrepreneurs, managers, venture capitalists, and other capital

market participants with regard to the link between f‌irm ownership structure and the economic benef‌its of going public

Keywords: Corporate Governance, Family Firm Governance, Debt Maturity Structure, External Capital, Investment

Sensitivity

INTRODUCTION

Acentral motive for f‌irms to undertake initial public offer-

ings (IPOs) is to gain greater access to external capital

markets in order to f‌inanceanincreaseinf‌irm investments

(Brau & Fawcett, 2006). Research indicates that an IPO has

the potential to fundamentally transform the f‌inancial struc-

ture of the f‌irm aswell as lower its cost of capital. Forinstance,

Schenone (2010) f‌inds that IPO f‌irms are able to increase

borrowing and lower interest rates relative to pre-IPO levels,

largely as a result of increased transparency from going pub-

lic, weakening the monopoly power of relationship banks.

Similarly, an IPO enhances the ability of f‌irms to issue equity

subsequent to going public and/or rebalance their capital

structure (Hertzel, Huson, & Parrino, 2012; Pagano, Panetta,

& Zingales, 1998). Despite the considerable f‌inancing benef‌its

of going public,research suggests that almosthalf of IPO issu-

ing f‌irms do not raise capital in the 2–5-year post-IPO period

(Helwege & Liang, 1996; Hertzel et al., 2012). Further, IPO

f‌irm investments are largely driven by internal cash f‌lows

suggesting that f‌inancial constraints limit their ability to pur-

sue prof‌itable investment opportunities (Chaddad & Reuer,

2009). The reluctance of IPO f‌irms to capitalize on the oppor-

tunity to raise capital subsequent to going public is puzzling

and highlights the need to gain an understanding of factors

that inf‌luencethe post-IPO f‌inancing behaviorof issuing f‌irms

as well as the economic consequences of their f‌inancing deci-

sions. The focusof this study is to evaluate the impactof alter-

native ownership structures (family versus non-family) on

post-IPO f‌inancing behavior and its economic effects.

Research indicates that f‌irm f‌inancing behavior and their

wealth effects are largely driven by agency conf‌licts, f‌irm

information environment, and governance quality. For in-

stance, research suggests thatthe potential for agency conf‌licts

among f‌irm stakeholders inf‌luences capital structure deci-

sions (Barclay, Morellec, & Smith, 2006; Harris & Raviv, 1990;

Hart & Moore, 1995; Jensen, 1986; Morellec, 2004; Morellec,

Nikolov, & Schürhoff, 2012; Stulz,1990). Similarly, researchin-

dicates that f‌irm information environment and governance

quality inf‌luence the supply and cost of various securities

and consequently f‌irm f‌inancing choices (Berrone, Cruz, &

Gomez-Mejia, 2012; Frank & Goyal, 2003; Jung, Kim, & Stulz,

*Address for correspondence: Yingying Shao, Professor of Finance, TowsonUniversity,

Towson, MD 21252, USA. Phone: 410-704-3839; Fax: 410-704-3454; E-mail:

yshao@towson.edu

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12113

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Corporate Governance: An International Review, 2015, 23(5): 452–468

1996; Myers & Majlu f, 1984; Shleifer & Vishny, 1997). How-

ever, the extent agency conf‌licts, governance quality, and in-

formation asymmetry shape f‌irm f‌inancing behavior is likely

to depend on f‌irm ownership structure. For instance, large,

unaff‌iliated stockholders are well positioned to mitigate the

adverse effects of weak governance and agency conf‌licts

relative to diffused ownership f‌irms (Anderson, Mansi, &

Reeb, 2003; Jensen & Meckling, 1976; Shleifer & Vishny, 1986,

1997). As such, the f‌inancing behavior of f‌irms with large

concentrated shareholders are likely to fundamentally differ

from those with more diffused ownership structures.

Among varioustypes of large shareholders,family f‌irms are

one of the mostwidely prevalent and economically signif‌icant

organizationalforms that often combine ownership with con-

trol and active participation in the governance of the f‌irm

(Anderson & Reeb, 2003; Bennedsen, Nielsen, Pérez-

González, & Wolfenzon, 2007; Chen, Dasgupta, & Yu, 2014;

Claessens, Djankov,& Lang, 2000; La Porta, Lopez-de-Silanes,

& Shleifer, 1999; Morck & Yeung, 2004; Villalonga & Amit,

2006). Consequently, considerable research has focused on

comparing the economic eff‌iciency of family f‌irms relative to

non-family f‌irmswith mixed results. For instance, whilesome

studies indicate family f‌irms outperform non-family f‌irms,

others suggest the opposite (Anderson & Reeb, 2003; Andres,

2008; Barontini& Caprio, 2006; Bennedsen et al.,2007; Caprio,

Croci, & Giudice, 2011; Jaskiewicz, Gonzalez, Menendez, &

Schiereck, 2005; Miller, Breton-Miller, Lester, & Cannella,

2007; Morck & Yeung, 2004; Villalonga & Amit, 2006, 2009).

Recent researchhas focused on identifying the extentto which

family f‌irmsdiffer from non-familyf‌irms in terms of corporate

policy choices and the impact of these policy differences on

f‌irm performance (Anderson, Duru, & Reeb, 2012; Chen

et al., 2014; Jain & Shao, 2014).

Firm f‌inancing behavior represents an important avenue of

corporate policythat could explain differencesin performance

between family and non-family f‌irms, particularly in the

context of publicly traded f‌irms. In particular, agency and

behavioral considerations are likely to lead to differential

f‌inancing behavior in family f‌irms relative to non-family

f‌irms. Focusing initially on agency effects, research suggests

that family ownership can mitigate some forms of agency

conf‌licts while exacerbating others relative to dispersed own-

ership f‌irms. For instance, as a result of management partici-

pation and/or access to control enhancing mechanisms,

family f‌irms are better positioned to mitigate the adverse

effects of manager–shareholder conf‌licts (Anderson & Reeb,

2003; Demsetz & Lehn, 1985; Jensen & Meckling, 1976). Simi-

larly, family owners relative to diversif‌ied shareholders are

more likely to avoid the pursuit of risky investments due to

greater sensitivity to economic lossesand f‌irm failure, thereby

reducing theagency cost of debt (Anderson & Reeb,2003). On

the other hand, family ownership can exacerbate conf‌licts of

interest with minority shareholders either due to expropria-

tion of resourcesor through the pursuit of conservative corpo-

rate policies that disproportionately benef‌it family owners

(Anderson & Reeb, 2003; Fama & Jensen, 1983; Shleifer &

Vishny, 1986, 1997; Villalonga & Amit, 2006). Since agency

conf‌licts among various f‌irm stakeholders inf‌luence capital

structure choices (Barclay et al., 2006; Chen et al., 2014; Croci,

Doukas, & Gonenc ,2 011; Hart & Moore, 1995; Morell ec, 2004;

Stulz, 1990), differences in agency effects between family and

non-family f‌irms as described above should lead to funda-

mentally different f‌inancing behavior and their economic

effects for these two types of f‌irms.

In addition to agency effects, socioemotionalwealth consid-

erations are also likely to lead to differences in f‌inancing

behavior in family and non-family f‌irms. Drawing from be-

havioral agency theory, the concept of socioemotional wealth

is based on the premise that families receive utility from

the emotional and non-economic aspects of owning a busi-

ness that serve to meet their affective needs like identity

and family dynasty (Gómez-Mejía, Haynes, Núñez-Nickel,

Jacobson & Moyano-Fuentes, 2007; Zellweger & Astrachan,

2008). As such, actions taken to enhance control, perpetuate

family dynasty, and sustain family reputation and wealth

are viewed as central to the preservation of socioemotional

wealth (Berrone, Cruz, Gomez-Mejia, & Larraza-Kintana,

2010; Berrone et al., 2012; Gómez-Mejía, Cruz, Berrone, &

De Castro, 2011). The socioemotional wealth perspective

largely assumes that family owners weigh both economic

and socioemotional wealth consequences when evaluating

alternative corporate policy choices and when in conf‌lict,

choose policies that preserve socioemotional wealth even at

the expense of economic gains (Berrone et al., 2010, 2012;

Cennamo, Berrone, Cruz, & Gomez-Mejia, 2012; Gómez-

Mejía et al., 200 7, 2011).

The impact of socioemotional wealth considerations on

family f‌irm f‌inancing behavior, however, remains a relatively

unexplored area of research. The limited research on family

f‌irm f‌inancing behavior has largely focused on agency con-

siderations as the theoretical framework and indicated that

control considerations and risk aversion drive f‌inancing be-

havior in family f‌irms (Anderson & Reeb, 2003; Chen et al.,

2014; Croci et al., 2011). Further, these studies have focused

on larger, established publicly traded f‌irms that have a track

record of raising external capital and are characterized by

greater transparency and sophisticated capital structures. Re-

latively little is known, however, as to whether and how

family f‌irms differ from non-family f‌irms in terms of capital-

izing on the opportunity to go public to raise capital.Further,

since an IPO is a transformational event with signif‌icant

changes to the ownership and governance structure of the

f‌irm, in addition to agency effects, socioemotional consid-

erations are likely to be particularly important to family

owners when evaluating post-IPO f‌inancing choices. An eval-

uation of the post-IPO f‌inancing choices of family and non-

family f‌irms provides an opportunityto assess the underlying

motivation for family f‌irms to go public and the economic

consequences of their f‌inancing choices. As such, drawing

from agency theory, socioemotional wealth perspective, and

informationasymmetry theory,we develop theoreticalpredic-

tions and empirically test them on the link between family

ownership and variousfacets of post-IPO f‌inancing behavior.

Additionally, we evaluate the extent to whichpost-IPO capital

raising behavior inf‌luences f‌irm investment eff‌iciency and

performance in family and non-family f‌irms.

Our analysis proceeds in three stages. First, we focus on

post-IPO f‌inancingbehavior related to choiceof debt maturity

structureand extent and composition of externalcapital raised

subsequent to the IPO. We focus on debt maturity structure

because research suggests that the choice between short- ver-

sus long-termdebt is a vital element of a f‌irm’sf‌inancialpolicy

453FAMILY GOVERNANCE & FINANCIAL POLICY IN IPOFIRMS

© 2015 JohnWiley & Sons Ltd Volume 23 Number 5 September 2015