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|Title: ||The owner-outside manager agency case revisited: Nonfamily CEOs in private family firms.|
|Authors: ||VOORDECKERS, Wim|
|Issue Date: ||2010|
|Citation: ||6th EIASM workshop on Family Firm Management.|
|Abstract: ||Purpose/topic of research
This paper introduces a conceptual model discussing agency consequences of a nonfamily CEO in private family firms. Private family firms have a unique ownership structure in that their founders or descendants are among the largest shareholders (concentrated ownership), often manage the firm and usually have a seat on the board of directors. Consequently, agency theorists (e.g. Jensen and Meckling, 1976; Fama and Jensen, 1983) consider this large overlap between ownership and management in private family firms as a favorable agency condition, leading to minimized or zero agency costs. Recently, family business scholars challenged this premise as ‘too optimistic’ and argued that concentrated ownership and a strong ownership-management overlap in private family firms may entail significant agency costs. These agency costs are originated in a lack of disciplining of the market for corporate control but also parental altruism that could lead to the consumption of perquisites by family members (Gomez-Mejia et al., 2001, Schulze et al., 2001, 2003; Lubatkin et al., 2005).
However, not all private family firms are managed by family CEOs. Ward and Handy (1988) and more recently Bennedsen et al. (2007) reported that a significant percentage of private family firms are managed by a nonfamily CEO (Bloom and Van Reenen, 2007). Given the full separation between ownership and control in these firms, traditional agency theory considers them as cases involving very significant agency costs (Jensen and Meckling, 1976). Surprisingly, the validity of this premise has seldom been discussed and tested in the context of private family firms. We challenge this premise and argue that this view may be ‘too pessimistic’ due to neglected relational (Bouwen, 1998; Bradbury & Lichtenstein, 2000; Lambrechts et al., 2009) and community building approaches of family firms (Miller et al., 2008; Miller et al., 2009), leading to the development of psychological ownership and the creation of a quasi-family including the nonfamily CEO.
A significant proportion of private family firms is managed by a nonfamily CEO. Agency theory assumes that this separation of ownership and control results in potential conflicts of interest (e.g. managerial perquisite consumption and shirking) between the principal (owners) and agents (managers), leading to significant agency costs (Jensen and Meckling, 1976; Fama and Jensen, 1983). Agency costs may arise due to information asymmetries and strains on the limits of bounded rationality among family owners. Agency theory suggests, based on incentive arguments (no alignment between incentives of owners and nonfamily CEO), that a nonfamily CEO may have detrimental (agency) effects on firm performance and as such, would not be an optimal solution in a private family firm (Chua et al., 2003). Residual agency costs could be expected to be significant because of imperfect monitoring by the owner(s) due to a lack of time or inadequate monitoring technologies (Ang et al., 2000).
Nevertheless, recent findings (e.g. Perez-Gonzalez, 2006; Bennedsen et al., 2007; Lin and Hu, 2007; Bloom and Van Reenen, 2007) suggested that nonfamily CEOs perform better than family CEOs while presenting ability arguments to explain this effect. Nonfamily CEO’s would be more qualified in terms of education and experience. Hence, the different theoretical predictions of the relationship between a nonfamily CEO and firm performance seems to be conflicting.
In this paper, we argue that agency theory draws a “too pessimistic” picture of the owner-outside managers case (i.e. nonfamily manager-family owners case) in private family firms. As such, we propose that the incentive and ability effects are not necessarily in conflict with each other. Our argument is that owner-outside manager agency problems in private family firms are likely to be low because the often documented relational (Bouwen, 1998; Bradbury & Lichtenstein, 2000; Lambrechts et al., 2009) and community building approaches of family firms (Miller et al., 2008; Miller et al., 2009) initiate the development of strong feelings of psychological ownership from the nonfamily CEO towards the family firm (Pierce et al., 2001; Wagner et al., 2003). Developing emotional bonds and extending feelings of relatedness towards nonfamily CEOs are an essential component in fostering high levels of loyalty and commitment between family owners and nonfamily CEO (Blumentritt et al., 2007), thereby creating a quasi-family relationship with the nonfamily CEO (Karra et al., 2006). Feelings of psychological ownership may motivate the nonfamily CEO to behave in the best interest of the family firm, align the interests of family owners and nonfamily CEO and as such, is a more efficient and less costly way to cope with the family owner-nonfamily manager agency conflict than more formal monitoring mechanisms.
Contributions to the literature
An important contribution of this paper is the development of a richer model of the agency relationship between nonfamily CEOs and family owners. Recent findings (Miller et al., 2008; Miller et al., 2009) suggested that family firms are strongly characterized by their relational and community building approaches. We introduce these elements in a traditional agency framework and analyze their agency consequences. We conclude that agency theory presents a too pessimistic view of the owner-outside manager agency case in private family firms. As such, our arguments contribute to the theoretical debate about the value of nonfamily executives in private family firms. Prior evidence suggests that professional nonfamily CEOs, by providing extremely valuable services to the firms they lead (Perez-Gonzalez, 2006; Bennedsen et al., 2007), can have a significant positive effect on performance. Perez-Gonzalez (2006) and Bennedsen et al. (2007) explain this result by pointing to the fact that nonfamily CEOs tend to be more highly educated and experienced (ability argument). We add an important additional explanation. In our opinion, the concepts of psychological ownership and the creation of a quasi-family are important in explaining why nonfamily CEOs seem to perform better in private family firms. Both concepts influence the incentive argument. Finally, as psychological ownership and the creation of a quasi-family are enacted through high quality relationships and interactions, we propose that a relational and community building approach may be a much more efficient way to cope with agency costs than more formal governance settings.|
|Type: ||Proceedings Paper|
|Appears in Collections: ||Research publications|
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