Innovation and Family Ownership: Empirical Evidence from India

• Author: Suman Lodh,Jean Chen,Monomita Nandy
• Date: 01 January 2014
• DOI: http://doi.org/10.1111/corg.12034
• Published date: 01 January 2014

Innovation and Family Ownership: Empirical

Evidence from India

Suman Lodh, Monomita Nandy, and Jean Chen*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines the direct effect of family ownership on innovation in emerging markets by

using data from Indian family-controlled publicly listed f‌irms as its sample. In particular, we study (1) the direct effects of

family ownership on innovation and (2) the inf‌luences of business group aff‌iliation on these family f‌irms.

Research Findings/Insights: Using an unbalanced panel of 395 BombayStock Exchange (BSE) listed Indian f‌irms during the

years 2001 and 2008, we found that the impact of family ownership on innovation productivity is positive (after controlling

for possible endogeneity). We further emphasized the business group aff‌iliation of family f‌irms and distinguished between

the innovation activities of group-aff‌iliated and stand-alone family f‌irms. We found that aff‌iliating with top 50 business

groups increases the innovation activities of these family f‌irms.

Theoretical/Academic Implications: Theoretically, we complement agency theory by incorporating both the institutional

perspective and the external resourcing perspective to providea more robust framework for examining the impact of family

ownership on innovation in emerging markets. Methodologically, we adopted a more rigorous econometrics method by

providing a panel analysis that used a system GMM estimator and addressed the endogeneity issue thoroughly, which

represented a signif‌icant improvement over the shortcomings of the methodologies found in the existing literature.

Practitioner/Policy Implications: Our f‌indings suggest that the Indian government should provide support for aff‌iliating

family f‌irms with business groups while improving policies on information disclosures; it should also establish a proper

corporate governance mechanism for private and public family business. The f‌indings further suggest that a corporate

governance code should encourage family f‌irms to have an independent professional CEO.

Keywords: Corporate Governance, Patent, Innovation Productivity, Family Firms, Indian Business Group

INTRODUCTION

There is a substantial body of literature that examines the

characteristics and performance of f‌irms with respect to

innovation. However, there is scant evidence about a direct

relationship between family ownership and innovation

(Craig & Moores, 2006). This issue is more important for

emerging markets than for markets in developed economies

because globalization of emerging markets brings both

opportunities and pressure for the domestic family-owned

f‌irms to innovate and alleviate competition for long-term

survival (Aghion, Burgess, Redding, & Zilibotti, 2005). Fur-

thermore, Choi, Park, and Hong (2012) argue that prior

agency theory literature thataddresses the role of ownership

structure on innovation from the agency perspective does

not capture the relationship in emerging markets.

The literature on corporate governance has shown that the

dynamics of ownership structurecan inf‌luence technological

innovation (e.g., Lee & O’Neill, 2003). Family ownership is the

dominant form of business around the world and there is

ample literature that studies family ownership issues (e.g.,

Villalonga & Amit, 2006). However, a salient aspect of that

literature is the absence of studies on the effects of family

ownership on f‌irm innovation. The existing literature on this

topic is rare and inconclusive from both developing (Chen &

Hsu, 2009; Kim, Kim, & Lee, 2008) and developed countries

(Block, 2012; Sirmon, Arregle, Hitt, & Webb, 2008). In addi-

tion, Le Breton-Miller, Miller, and Lester (2011) observe con-

tradictory evidence of investment for innovation by family

f‌irms. For instance, one stream of the literature shows that

familyowners follow strategies of conservatism by maintain-

ing regular income and restricting investment in innovation

to avoid risk, which ensures the security of their wealth

(Claessens, Simeon, Fan,& Lang, 2002). Another stream of the

literature argues that family owners and managers sacrif‌ice

*Address for correspondence: Jean Chen, Surrey Business School, University of

Surrey,Guildford GU2 7XH, UK. Tel: +44-0-1483-689666; E-mail: j.j.chen@surrey.ac.uk

4

Corporate Governance: An International Review, 2014, 22(1): 4–23

© 2013 John Wiley & Sons Ltd

doi:10.1111/corg.12034

their personal interests to invest in innovation to make their

f‌irm healthy and durable and to enhance stakeholders’value

(James, 1999).

Studies on blockholders of publicly traded f‌irms suggest

that the contribution of large shareholders to their f‌irms

often depends on their identity in particular institutional

environments (Claessens, Djankov, & Lang, 2000). In emerg-

ing markets, it is argued that weak investor protection, poor

judicial systems, ineff‌icient intellectual property protection,

corrupt legal systems, under-developed capital markets and

other institutional weaknesses make family ownership more

concentrated, which inevitably affects f‌irm performance

(Khanna & Palepu, 2000a). However, there have been only

limited studies that directly examine the impact of family

ownership on innovation, although it has been increasingly

recognized that innovation can improve f‌irm performance

and f‌irm value (Blundell, Griff‌ith, & Van Reenen, 1999; Cho

& Pucik, 2005). Furthermore, the limited studies on family

ownership and innovation were undertaken either from an

external resourcing perspective (e.g., Sirmon & Hitt,2003) or

from an agency perspective (Choi, Lee, & Williams, 2011;

Morck & Yeung, 2003). There is no noteworthy study that

attempts to reconcile agency theory and institutional theory

to investigate the impact of family ownership on f‌irm value

(Liu, Yang, & Zhang, 2012; Peng & Jiang, 2010), which opens

an avenue to explore this important yet undeveloped issue.

This issue is relevant and important to emerging markets

because these markets have underdeveloped institutions (or

no institutions); this hinders the functionality of markets,

such as in India, in which large family business groups are

some of the most important drivers of innovation and are

responsible for large parts of the country’s economic growth

(Chakrabarti, Megginson, & Yadav, 2008; Piramal, 1996).

Based on these gaps in the literature, this study aims to

complement the agency theory by incorporating both an

institutional perspective and an external resourcingperspec-

tive to provide a better framework for examining the impact

of family ownership on innovation in emerging markets, by

using Indian family-controlled publicly listed f‌irms as its

sample. In particular, we study (1) the direct effect of family

ownership on innovation and (2) the inf‌luence of business

group aff‌iliation of these family f‌irms on innovation. In this

study, our focus is on publicly traded family-controlled busi-

nesses, in which non-family individuals or institutions hold

some of the equity.Therefore, we use a unique data set of 395

Indian f‌irms listed on the Bombay Stock Exchange between

the years 2001 and 2008 as our sample.

Methodologically, we adopt a panel data set of patenting

information on these f‌irms around the world thatno existing

literature in this f‌ield has analyzed. This data set reveals

intra-f‌irm variations in innovation. Controlling for time-

varying decisions of the f‌irms to remain family owned and

for other sources of endogeneity, we apply a well-developed

system-GMM estimator. After addressing reverse causality

between family ownership and innovation, our results show

that Indian family ownership increases innovation output

and improves f‌irms’ innovation capacity. We also f‌ind that

aff‌iliating with top business groups contributes signif‌icantly

to improving f‌irms’ innovation.

We focus our study on Indian f‌irms because India typif‌ies

emerging markets that feature institutional underdevelop-

ment (absence of or underdeveloped institutions that

prevent the functioning of intermediate markets) and is a

good example of a market with dominant family ownership.

Approximately 70 percent of the Indian f‌irms are family-

controlled and they are the driving forces of innovation in

India because of the absence of other types of concentrated

ownership, such as state-owned f‌irms (Chakrabarti et al.,

2008; Piramal, 1996). These family f‌irms usually engage with

the government opportunistically; thus they are not always

closely associated with politicians (such as Chaebol in South

Korea). Indian family f‌irms are free from rigging markets

(such as in Mexico and Israel) and are also under market

pressure imposed by new entrant competition. These fea-

tures make Indian familyf‌irms unique and distinguish them

from comparable f‌irms in other emerging markets.

Moreover, Indian family f‌irms have another distinct

feature. Most are aff‌iliated with large business groups for

external resourcing (for further discussion, see Khanna &

Palepu, 2000b:870). A number of studies have recognized

that business groups in emerging economies can mitigate

the distortion of the labor and capital markets and that

group-aff‌iliated f‌irms can share a group-wide reputation

that might offer access to external credit (Claessens et al.,

2000; Khanna & Palepu, 2000b). Because the groups create

their virtual (internal) capital markets (Manos, Murinde, &

Green, 2007), the group-aff‌iliated family f‌irms can pool and

re-allocate funds in accordance with investment opportuni-

ties (Bertrand, Mehta, & Mullainathan, 2002). These features

of business groups in India make group-aff‌iliated family

f‌irms an important business arrangement to compensate for

institutional underdevelopment (also used as institutional

voids in many studies) and an ineff‌icient capital market.

Therefore, we argue thatthe aff‌iliation of Indian family f‌irms

with business groups can positively inf‌luence the relation-

ship between family ownership and innovation, which

makes the impact of family ownership on innovation even

more unique in India compared to developed and other

developing economies.

The remainder of this paper is organized as follows. The

next section presents the literature review and our hypoth-

eses. We then introduce the dataset and describe the variable

design and econometric models. Thisis followed by an expla-

nationof the empirical results, including robustness tests. The

f‌inal section concludes the study with implications.

LITERATURE REVIEW AND

HYPOTHESIS DEVELOPMENT

Family Ownership and Innovation

Innovation is the process of developing new technological

knowledge and putting that knowledge to productive use.

Cohen and Klepper (1996) differentiate innovation as

process and product innovation – process innovation reduces

production costs and product innovation increases the price

that consumers are willing to pay. Both types of innovation

are associated with the following risk factors: (1) The prob-

ability of the failure of R&D investment is higher than that of

conventional investments; (2) new technologies tend to be

opaque (Rajan & Zingales, 2001), which means that innova-

tion is often less understood by market participants; and (3)

INNOVATION AND FAMILY OWNERSHIP 5

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