The Effect of Family Governance on Corporate Time Horizons

• Date: 01 November 2013
• Published date: 01 November 2013
• Author: Thomas Schmid,Imke Kappes
• DOI: http://doi.org/10.1111/corg.12040

The Effect of Family Governance on Corporate

Time Horizons

Imke Kappes and Thomas Schmid*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper empirically tests the effect of family governance on intertemporal choice. We contrib-

ute to the literature on corporate time horizons by formulating an innovative approach to the measurement of long-term

orientation. This approach uses an index that captures investment, employee, and f‌inancing behavior.

Research Findings/Insights: Our research makes use of a dataset consisting of 701 German f‌irms (6,205 f‌irm-years)

observed over the period from 1995 to 2009. We provide evidence that f‌irms actively managed by founders and/or their

families are signif‌icantly more long-term oriented than the control group. Our f‌indings also show that these f‌irms persist in

maintaining a long-term approach in cases in which pressure on short-term results is high.

Theoretical/Academic Implications: This paper supports the hypothesis that trans-generational considerations can result

in family-managed f‌irms having longer time horizons. As such, our f‌indings reinforce prior claims that agency outcomes

can signif‌icantly differ in the context of family governance. Furthermore, our results accentuate the validity of the claim

to separately account for multiple aspects of family governance in family f‌irm research, in particular management vs.

ownership.

Practitioner/Policy Implications: Our results will be helpful for investors in selecting investment targets that match their

personal time preferences. In particular, it appears diff‌icult to exert pressure on family managers to extract short-term

prof‌its. Policymakers may want to consider removing any barriers to the transferring of family f‌irms between generations.

Their orientation towards the long-term can make family-run companies sources of stability in their respective economies.

This is also due to their less pronounced reaction to pressure.

Keywords: Corporate Governance, Family Firms, Intertemporal Choice, Time Horizons, Pressure

INTRODUCTION

Family f‌irms are the most prevalent form of business

around the world (see Faccio & Lang, 2002; La Porta,

López-de-Silanes, & Shleifer, 1999). Many of the studies

exploring the differences between family and non-family

f‌irms build on the assumption that family f‌irms are particu-

larly long-term oriented.Such studies have found that family

f‌irms do tend to out-achieve others in the areas of overall

performance (see Anderson & Reeb, 2003; Miller and

Le Breton-Miller, 2005), investment behavior (see Le

Breton-Miller & Miller, 2006; Sirmon & Hitt, 2003), entrepre-

neurship (see Zahra, Hayton, & Salvato, 2004), and trans-

national wealth effects (see Bertrand & Schoar, 2006). In fact,

some def‌initions of “family f‌irm” do comprise a trans-

generational component (see Chua, Chrisman, & Sharma,

1999; Le Breton-Miller & Miller, 2009). The underlying

concept is that plans for trans-generational succession in

force in familyf‌irms constitute a cross-generational link. This

link motivates family owners to provide their f‌irm with

patient capital. It also incentivizes family managers to focus

on maximization of long-term returns. This is because the

utility of future generations forms part of the current gen-

eration’s utility function. The consequence of this relation-

ship is that it enables family f‌irms to pursue investment

opportunities that non-family f‌irms with short-term hori-

zons do not consider worthwhile (see Bertrand & Schoar,

2006; Zellweger, 2007).

Empirical evidence from a variety of corporate policy

decisions yields a mix of f‌indings on the corporate time

horizons of family f‌irms. One of these f‌indings is that family

f‌irms tend more strongly towards internationalization

(Zahra, 2003). This is indicative of longer time horizons. By

*Address for correspondence: Thomas Schmid,Department of Financial Management

and Capital Markets, TechnischeUniversität München, Arcisstrasse 21, 80333 Munich,

Germany. Tel: 49-89-289-25179; Fax: 49-89-289-25488; E-mail: thomas.schmid@

wi.tum.de

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Corporate Governance: An International Review, 2013, 21(6): 547–566

© 2013 John Wiley & Sons Ltd

doi:10.1111/corg.12040

way of contrast, the majority of studies on R&D suggest

non-family f‌irms to be more long-term oriented (see

Anderson, Duru, & Reeb, 2012; Munari, Oriani, & Sobrero,

2010; Muñoz-Bullón & Sanchez-Bueno, 2011). Another

stream of research focuses on responses to external factors.It

f‌inds family f‌irms to be less sensitive to prof‌it shocks

(Villalonga & Amit, 2010), less averse to cyclical industries

(Zellweger, 2007), and less dependent on cash f‌low in their

investment decisions (Andres, 2011). Family f‌irms have also

been found to have lower rates of divesture during eco-

nomic downturns (Zhou, Li, & Svejnar, 2011) and even prop

up their f‌irms (Friedman, Johnson, & Mitton, 2003), suggest-

ing family f‌irms to have longer time horizons. These studies

provide valuable insights into the individual aspects of

intertemporal choices arising in specif‌ic decision-making

situations. However, only an empirical investigation cover-

ing all aspects of the topic would enable the determinationof

whether or not family f‌irms are viewed as a whole to be

more long-term orientated. Such an investigation would

serve to verify the large body of research that is based on the

assumption that family governance features longer corpo-

rate time horizons. This paper aims to contribute to bridging

this gap between individual considerations and a compre-

hensive scope of examination.

Our objective is to explore in a more holistic way the

relationship between family governance and intertemporal

choice. To achieve this objective, we refrain from solely

focusing on such individual aspects of long-term orientation

as R&D expenditure. Instead, we create an innovative aggre-

gate index. It provides a more comprehensive measure of

long-term orientation, and does so by encompassing aspects

of investment, employee, and f‌inancing policies. This choice

of components included in the index is motivated by the

three long-term orientation categories that Le Breton-Miller

and Miller (2006) identif‌ied as sources of competitive advan-

tage observable in family f‌irms: mission-related investments

(investments), people-related investments (employees),

and external stakeholder-related investments (f‌inancing).

The aggregate structure gives rise to several advantages. It

equips the index to account for trade-offs and for potential

shifts between various aspects of long-term orientation. A

further advantage is that the index is applicable to a wide

range of industries, life cycle stages, and business models.A

f‌inal advantage is that the index is also based on information

taken from f‌inancial statements, which makes the measure

transparent and enables its application in large datasets. It is

for these reasons that the index has the potential to foster the

explicit inclusion of corporate time horizons in empirical

research.

Our hypotheses draw on agency theory to predict how

family involvement affects the time horizons of the f‌irms

they control. We test these hypotheses by using a compre-

hensive dataset. It comprises 701 German f‌irms (6,205 f‌irm-

years) that are observed over the period from 1995 to 2009.

The high prevalence in Germany of family f‌irms among

listed companies makes the country a promising choice for

this type of study. This large number of family f‌irms allows

us to depict and analyze the family f‌irm heterogeneity, with

this particularly including the differences arising from the

ownership/management dichotomy and between family

generations. A further fact speaking for this environment is

that large-sized family f‌irms are not uncommon here. This

obviates any potential bias that might arise between family

and non-family f‌irms due to their size differences. It is for

these reasons that the German market provides an ideal

environment for the gaining of insights into the implications

of family governance. The focus on one institutional setting

ensures that our results are not affected by differences mani-

festing themselves in such characteristics as investor protec-

tion, disclosure requirements, and stock market regulations.

A further benef‌it is that our research will complement the

extant literature, which is focused on the US market. Ours

will thus yield insights into another institutional setting. The

implications of our results will, of course, not be conf‌ined to

Germany. Family governance is, after all, widespread

around the world.

The results of our research support the view that family

governance can reduce time horizon-related agency prob-

lems. The data suggest that the active involvement of the

familyin the f‌irm’s management drives the positive effect on

time horizons in family f‌irms. We f‌ind the differences in the

intertemporal choices made by family and non-family f‌irms

to be particularly pronounced during times of increased

pressure on short-term results. Those family f‌irms facing

signif‌icant short-term pressures tend to maintain their focus

on the long term. This accords with predictions based on

agency theory.

This paper provides several interesting insights into the

behavior of family f‌irms. Its contribution to the agency litera-

ture constitutes the supporting of claims that the assump-

tions of agency theory need to be adapted to the specif‌ic

corporate governance context, which is, in this case, that of

familyf‌irms. In particular, the differences in characteristics of

family owners/managers and of their non-family counter-

parts have to be expressed in utility function assumptions.

Any potential effects on framework requirements, such as

relative information asymmetries, have to be accounted for.

When adapted adequately to the specif‌ic corporate gover-

nance context, agency theory is capable of predicting the

implications of alternative governance models – in our case

family vs. non-family f‌irms – for decision-making outcomes.

The f‌indings also have important implications for practi-

tioners. For investors, our results suggest that it will be

diff‌icult to exert pressure successfully on family f‌irms to

maximize short-term prof‌its in cases in which this would

require the f‌irm to abandon its long-term objectives. The

reason for this is that the concern for satisfying the needs of

future generations is a strong driver of decision making in

family f‌irms. However, if this long-term orientation leads to

a competitive advantage as suggested by Le Breton-Miller

and Miller (2006), then family f‌irms represent an attractive

opportunity for long-term oriented investors.

Furthermore, the results of our investigation emphasize

the importance of the role played by family f‌irms for the

economy as a whole. This importance arises fromtheir long-

term orientation. Because family f‌irms respond less intensely

to pressure, they have the potential to counter economic

cyclicality. Their long-term orientation has a number of

potential benef‌its. It can lead to higher rates of job safety in

the labor market. Tax authorities can possibly prof‌it from

having a greater stability of revenues. Lastly, their higher

degree of independence may reduce the probability of a

548 CORPORATE GOVERNANCE

Volume 21 Number 6 November 2013 © 2013 John Wiley & Sons Ltd