1. 1 A Governance Perspective on Family Business Successions Soo Lee Department of Management College of Business & Public Administration Faculty Seminar 23 March 2007

2. 2 Why the Study is Important Privately-held, family businesses are the dominant form of economic organization (GDP, employment)  Underrepresented in the study of organizations & management  Succession ensures business continuity No separation of principal-agent in family businesses  Is agency theory generalizable to family businesses? Add to research on firm performance-CEO turnover link from a family business perspective

3. 3 Purpose of Study To examine if boards play a role in governing the firm performance-succession link since there is no separation of principal-agent in family businesses To explore how board-related disciplinary mechanisms work in family businesses

4. 4 Definitions Family Business: –Family (individuals related by blood, adoption or marriage) owns a controlling interest with at least one family member employed in the top management team. Succession: –Process in which managerial control of the business is transferred to another person (outside of retirement, illness or death).

5. 5 Agency Theory: Control/Governance Role of the Board In large, public firms, agency costs arise from separation of principal-agent relationship, info asymmetry & dispersion of ownership (Jensen & Meckling, 1976) Control/governance role of the board (Fama & Jensen, 1983) : –Safeguard principals’ interests by monitoring & ratifying managerial actions to reduce agency costs –Reward/penalize management to maximize shareholder wealth §In family businesses, there is no separation of principal- agent, no info asymmetry with significant ownership concentration  No agency costs in family businesses?  No control/governance role of the board in family businesses?

6. 6 Agency Costs in Family Businesses Agency problems, leading to low firm performance, are caused by: –Self-control problem e.g. ‘doing what I want rather than what I should’ (Thaler & Shefrin, 1981) –Altruism e.g. welfarism (Schulze et al., 2001; 2002; 2003a; 2003b; Lubatkin et al., 2005) –Lack of external control mechanisms e.g. no threat of takeover or no competitive labor market

7. 7 Role of the Board in Family Businesses Protect the value of the business, not shareholder wealth  To ensure business continuity Discipline the principal when resources are misappropriated (firm viewed as a distinct entity)  Involuntary turnover e.g. succession §Effectiveness of the board is affected by its level of independence from the principal

8. 8 Board Independence is related to: Board Composition –Board size –Types of directors –Separation of Chair-CEO Board Structure –Committees Board Process –Frequency & formality of meetings

9. 9 Hypotheses Firm Performance (standard agency theory argument) –Inability to sustain positive firm performance leads to turnover (Fredrickson et al., 1988).  H1: Low firm performance will be positively associated with a succession. –Boards serve as a disciplinary mechanism to reduce agency costs pertaining to value misappropriation but only effective if they can resist principal domination.  H2: The level of board independence will moderate a succession in low firm performance.

10. 10 Empirical Model Succession Firm Performance Board Independence

11. 11 Sample 400 private-limited companies were randomly selected from a Small Business Directory database in Singapore –have a board of directors –> 5 years in operation –< 500 employees Survey items from extant literature & interviews with family business owners. Survey was pretested with 5 family businesses for face validity. Questionnaire was mailed to companies, who responded by fax or mail. Follow-up with 2 nd round mailing, 3 rd round fax and 4 th round telephone calls to appeal for participation over 5 weeks. 81 companies responded (20.25% response rate). 70 usable questionnaires as 9 questionnaires had extensive missing data & 2 were not family businesses.

12. 12 Firm Performance –Sustained firm performance measured by 3-year average % change in revenue growth Succession –Dummy variable measured if founder/CEO of family business was replaced. Board Independence –Board Composition (Zahra & Pearce, 1989) Board size Family ratio (family members who are directors) Insider ratio (non-family employees who are directors) CEO-appointed board members Duality Variable Definitions

13. 13 Variable Definitions (cont’d) –Board Process (Barnhard et al., 1994) 7-item scale measured board structure & process (  =.94) –Board sets up committees to establish compensation & monitor audits –Board meets regularly –Board gives CEO ideas/advice to manage the business –Board is active in seeking information to make decisions –Board provides CEO with business opportunities –Board holds CEO accountable for decisions –Board limits CEO’s approval on capital expenditures above a certain amount Control Variables –Family ownership –Human capital (years as CEO, years in industry)

14. 14 Statistical Method Logistic Regression Partial Least Squares (PLS) –Non-parametric technique, to deal with small sample & data limitations as it does not require assumptions of normal distributions & non-multicollinearity. –Bootstrapping function, in which a large number of sub-samples are created using random selection & replacement of original data, generates stable coefficients.

15. 15 Preliminary Analyses Crosstabs Descriptive statistics T-tests between firms with No-Succession & Succession

16. 16 Crosstabs No Succession (43) Succession (27) Zero-Negative 3-year Average Performance 2320 Positive 3-year Average Performance 207

17. 17 Mean, Standard Deviation & Intercorrelations mean s.d.1234567 1.Succession.39.49 2.Performance 4.6120.46-.27* 3.Board Size3.96.89.24*.05 4.Family Ratio.72.23.16-.06.08 5.Insider Ratio.12.16.21-.01.28* -.46** 6.CEO-appt.69.35.04.09.11.33**.04 7.Duality.67.47 -.76**.09-.17-.04 -.25* -.12 8.Process4.111.57.04-.03.25* -.36**.11.01.03

18. 18 t-tests No Succession (mean), n=43 Succession (mean) n=27 p-value (2-tailed) Performance9.01-2.41.02 Board Size3.794.22.04 Family Ratio.69.77n.s. Insider Ratio.10.17n.s. CEO-appt.68.71n.s. Duality.95.22.00 Process4.074.19n.s.

19. 19 Hierarchical Logistic Regression on Succession βs.e.p-value Block 1 (controls) Family Ownership-.02.02n.s. Years as CEO-.04.04n.s. Years in Industry.01.03n.s. R2R2.04 n.s. Block 2 Performance-.04.02.03 R2R2.12.01

20. 20 PLS on Succession Board Independence Firm Performance x Board Independence Succession Firm Performance

21. 21 PLS on Succession (Positive Performing Firms, n=27 ) Board Size Family Ratio Insider Ratio CEO-appointed members Duality Board Process Succession -.85 (t=4.65) R 2 =86%

22. 22 PLS on Succession (Zero-Negative Performing Firms, n=43 ) Board Size Family Ratio Insider Ratio CEO-appointed members Duality Board Process Succession -.26 (t=1.96).37 (t=2.14) -.64 (t=4.63) R 2 =60%

23. 23 Summary of Results H1: supported (firm performance) H2: partial support (boards matter more in poorly performing firms)

24. 24 Discussion Antecedents to Succession –Agency explanation: poor performance Role of Board: governance or discipline occur in decision control to enhance value appropriation –Poorly Performing Firms: Family board members (protect family assets tied to the economic welfare of the firm) Separation of Chair-CEO (reduce CEO entrenchment) Non-CEO-appointed board (reduce CEO entrenchment) –Positive Performing Firms: Separation of Chair-CEO (reduce entrenchment)  Agency theory is generalizable to family businesses through governance control of the board even without separation of principal-agent relationships

25. 25 Limitations & Areas for Future Research Limitations: –Survey –Small sample size Future Research –Examine antecedents to family firm performance: service role of board in value creation by facilitating CEO decision management Resource dependence explanation – board interlocks Social capital explanation – prestigious external members Human capital explanation – members with high levels of KSAs Design longitudinal study to test a recursive causal model in future