To avoid reinventing the wheel, theoretical research in family business has, as it should, concentrated on applying mainstream theories of the firm to explain how family firms may be different from nonfamily ones. Recently, researchers using the strategic management approach have begun to rely more and more on two theoretical perspectives that represent a confluence of insights from the fields of strategic management, finance, and economics: the RBV of the firm and agency theory. Consequently, this review focuses on these two perspectives. We believe that this focus is both appropriate and entirely consistent with a strategic management view of the field because RBV and agency theory potentially assist in explaining important strategic management issues such as the formulation and content of goals and strategies, strategy implementation and control, leadership, and succession in family firms. Furthermore, both theoretical perspectives have a performance orientation. Finally, both contribute to what we believe should be an overarching concern in family business studies—answering the fundamental questions related to a theory of the (family) firm: why they exist, and why they are of a certain scale and scope (Conner, 1991; Holmstrom & Tirole, 1989).
Agency Theory and the Family Business
Agency costs arise because of conflicts of interest and asymmetric information between two parties to a contract (Jensen & Meckling, 1976; Morck, Shleifer, & Vishny, 1988; Myers, 1977). Applying this concept to the capital structure decision of the firm, Jensen and Meckling (1976) define the concept of agency costs to include all actions by an agent that contravene the interests of a principal plus all activities, incentives, policies, and structures used to align the interests and actions of agents with the interests of principals.
While agency problems can arise in transactions between any two groups of stakeholders, researchers applying agency theory to family firms have concentrated primarily on relationships between owners and managers and secondarily between majority and minority shareholders.3 Within these streams, researchers have proposed altruism and the tendency for entrenchment as the fundamental forces distinguishing family and nonfamily firms in terms of agency costs.
Altruism. The original thinkers of agency theory assumed that when ownership and management reside within a family, agency costs would be low, if not absent. For example, Fama and Jensen (1983, p. 306) state, “family members . . . have advantages in monitoring and disciplining related decision agents.” However, drawing on the family economics literature (e.g., Becker, 1981), Schulze et al. (2001, 2003) show how a tendency toward altruism can manifest itself as a problem of self-control and create agency costs in family firms due to free riding, biased parental perception of a child's performance, difficulty in enforcing a contract, and generosity in terms of perquisite consumption. They argue that these agency problems cannot be controlled easily with economic incentives because members of the family are already residual owners of the firm. The empirical evidence supports most but not all of their hypotheses.
However, not all research about agency costs related to altruism in family firms has reached negative conclusions. Early results from economic modeling (Eaton, Yuan, & Wu, 2002) appear to suggest that if altruism is reciprocal (both family owner and family manager are altruistic toward each other) and symmetrical (equally strong reciprocal altruism), it can mitigate agency problems. In fact, Eaton et al. (2002) show that, with reciprocal altruism, family firms have competitive advantages in pursuing certain business opportunities in the sense that they will have lower reservation prices for those business opportunities. Related to this, if altruism leads to family members’ willingness to suffer from short-term deprivation for long-term firm survival, a combination of low overheads, flexible decision making, and minimal bureaucratic processes, can enable family firms to be effective, frugal rivals (Carney, 2005). This competitive advantage bodes especially well in environments of scarcity characterized by low entry barriers and labor-intensive production costs and could provide an explanation for the prevalence of a large number of family firms in service industries, small-scale manufacturing, and franchising environments, where margins are low and labor costs high (Carney, 2005). Another example leading to the conclusion that a family firm could have a lower reservation price for opportunities is the observation by Chua and Schnabel (1986) that if certain assets yield both pecuniary and nonpecuniary benefits, then asset market equilibrium will result in a lower pecuniary return for these assets. This suggests that family firms may have a lower cost of equity.
Using a sample of firms with 5–100 employees, Chrisman, Chua, and Litz (2004) show that while the short-term sales growth of family and nonfamily firms are statistically equal, one mechanism for controlling agency costs—strategic planning—has a greater positive impact on the performance of nonfamily firms. These findings suggest that even if the overall agency costs of family firms are not negative, they are lower than those in nonfamily firms, supporting the traditional point of view in the literature (e.g. Fama & Jensen, 1983; Jensen & Meckling, 1976; Pollak, 1985).4
Entrenchment. In the context of agency theory, management entrenchment permits managers to extract private benefits from owners. Morck et al. (1988) show empirically that management entrenchment decreases firm value. They demonstrate this by showing that there is a nonlinear relationship between the value of the firm and managers’ ownership shares. Initially, as their ownership shares increase from zero, firm value increases. But beyond a certain range, firm value actually decreases with managers’ ownership. They interpret this as agency costs arising from the entrenchment of management made possible by increased ownership.
Gomez-Mejia et al. (2001) provide supporting evidence from family firms. They show that the agency problems caused by entrenchment may be worse in family firms than in nonfamily firms. Gallo and Vilaseca's (1998) research yields similar conclusions. While they find that the performance of family firms in general was not influenced by whether the chief financial officer (CFO) was a family member or not, they also show that when the CFO is in a position to influence the strategic direction of a firm, having a nonfamily member in that position is associated with superior performance.
Ownership entrenchment may also occur and this may have serious consequences for minority shareholders and society. Morck and Yeung (2003, 2004) argue that because entrepreneurial spirit and talent are not necessarily inherited by ensuing generations of a controlling family, it is much easier for succeeding generations to use their wealth and influence to obtain competitive advantages through political rent seeking rather than through innovation and entrepreneurship. This problem is more serious if entrenchment is accompanied by a pyramidal corporate ownership structure (Morck & Yeung, 2003). They suggest that, in this case, a family might engage in the predatory behavior known as tunneling (Johnson, La Porta, Lopez-de Silanes, & Schleifer, 2000). In tunneling, family owners use cost allocation to push expenses down toward subsidiaries in which they have the lowest beneficial ownership and use transfer pricing to pull revenues up toward the holding company in which they have the highest beneficial ownership. Furthermore, because innovation can cannibalize existing businesses, pyramidal family ownership can create disincentives to innovate if the possibility for innovation occurs at levels in the structure where a family's stake in the profits is lower and threatens businesses at levels where its stakes are higher.
However, the implications of entrenchment are not one sided. Pollak (1985) argues that family businesses have advantages in incentives and monitoring vis-à-vis nonfamily firms. Shleifer and Vishny (1997) suggest that family ownership and management can add value when the political and legal systems of a country do not provide sufficient protection against the expropriation of minority shareholders’ value by the majority shareholder. In fact, Burkart, Pannunzi, and Shleifer (2003) show that in economies with a strong legal system to prevent expropriation by majority shareholders, the widely held professionally managed firm is optimal. But in situations where the legal system cannot protect minority shareholders, keeping both control and management within the family is optimal.
Randøy and Goel (2003) find that, as hypothesized, high levels of institutional block ownership and foreign ownership are positively associated with performance in nonfamily firms. Performance is also negatively associated with high levels of ownership by board members in those firms. The authors suggest that such an ownership and governance structure reduces entrenchment and increases monitoring. Interestingly, they find the relationships between governance and performance to be reversed for family firms. Randøy and Goel (2003) conclude that different agency contexts and forms of ownership require different governance structures. Mustakallio, Autio, and Zahra's (2002) research provides further support for that conclusion. These authors suggest that because owners have multiple roles in a family business, the governance of family firms differs from corporate governance for nonfamily firms. Their empirical results generally support their hypotheses that formal and social controls influence the quality of strategic decisions in family firms.
Summary. In summary, researchers have argued that both altruism and entrenchment can have positive and negative effects on family firm performance. Contingencies such as the generation managing the firm, the extent of ownership control, corporate and business strategy, and industry appear to have some influence on whether the influence is positive or negative. Agency issues in family firms may also have broad, societal welfare implications that need to be investigated further. Clearly, research along these theoretical lines is just beginning. But it has already yielded interesting insights for future research.
Resource-Based View of the Family Firm
A key consideration in the development of a theory of the family firm is whether family involvement leads to a competitive advantage because answering this question will provide some insights regarding why family firms exist and why they are of a particular scale and scope. As noted earlier, an RBV approach has the potential to help identify the resources and capabilities that make family firms unique and allow them to develop family-based competitive advantages (Habbershon et al., 2003; Habbershon & Williams, 1999).
The RBV of the firm suggests that valuable, rare, imperfectly imitable, and nonsubstitutable resources can lead to sustainable competitive advantage and superior performance (Barney, 1991). Sirmon and Hitt (2003) provide arguably the most encompassing application of RBV to family businesses. They distinguish between five sources of family firm capital: human, social, survivability, patient, and governance structures, and argue that family firms evaluate, acquire, shed, bundle, and leverage their resources in ways that are different from those of nonfamily firms. Overall, they believe that these differences allow family firms to develop competitive advantages. In support of this, Carney (2005) describes three characteristics of family firm governance—parsimony, personalism, and particularism—that may lead to cost advantages, help in the development of social capital, and encourage entrepreneurial investments. Expanding on Sirmon and Hitt's (2003) proposal of patient capital as a family business resource, Miller and Le-Breton-Miller (2005) show in a study of large, long-living family firms that continuity and the power to institute changes without outside interference or control enables these firms to generate and make exceptional long-term use of patient strategies and relationships with stakeholders.
Some of the differences noted by Sirmon and Hitt (2003), however, such as family firms’ difficulty in shedding human resources, may have negative impacts on economic performance. Elaborating on this, Sharma and Manikutty (2005) discuss how a family firm's inability to shed resources is affected by family structure and community culture. Kellermanns (2005) extends that discussion by explaining how family structure and community culture might also influence resource accumulation both positively and negatively.
Other scholars also suggest that a family business connection may yield unique advantages in the acquisition of resources (Aldrich & Cliff, 2003; Haynes, Walker, Rowe, & Hong, 1999). Again, the benefits are not without limits though. Thus, Renzulli, Aldrich, and Moody's (1998) panel study suggests that a nascent entrepreneur's likelihood of starting a venture is negatively associated with the proportion of kin in the network used for venturing dialogues. In a similar vein, Barney, Clark, and Alvarez (2002) use social network theory to propose that maintaining family ties reduces family members’ ability to maintain other strong social ties. Considering the tendency for the assets of family members to be redundant, they argue that family ties are not likely to be a major source of the rare and specialized resources needed for entrepreneurship and value creation. Therefore, they conclude that family firms will not have advantage in acquiring resources. On the other hand, Barney et al. (2002) suggest that family ties may provide an advantage in opportunity identification because of family members’ greater willingness to share information with each other.
Carney (2005) observes that family firms may enjoy long-term relationships with internal and external stakeholders and through them develop and accumulate social capital. While the fixed costs of creating and maintaining social capital is high, social capital can contribute to economies of scope because the different units of a large diversified family firm can use it advantageously. This could give the family firm a competitive advantage in expanding its scope vis-à-vis nonfamily firms. The results of study of the short-term sales growth of small to medium size family and nonfamily firms confirm Carney's assertions (Chrisman, Chua, & Kellermanns, 2004) about the advantages of family firms in making use of external relationships. Chrisman et al.'s study also appears to support Barney et al.'s (2002) contentions since no performance difference between family and nonfamily firms was found with respect to resources emanating from internal relationships. Finally, Chrisman et al. found that while operating resources affect the performance of both family and nonfamily firms, the former does not appear to benefit from increases in operating resources to the same extent as the latter.
Zahra, Hayton, and Salvato (2004) tested whether organizational culture, which has been proposed as an inimitable resource (Barney, 1986), affects entrepreneurial activities in family firms. They observed that the relationship between entrepreneurship and the cultural dimension of individualism is nonlinear. Too little individualism discourages the recognition of radical innovation while too much inhibits the trust, acceptance, and cooperation required to adopt the innovation. They found, however, that the relationships between entrepreneurship and three other cultural dimensions: external orientation, distinctive familiness (Habbershon & Williams, 1999), and long- versus short-term orientation (James, 1999) are linear and positive. This is again consistent with the theoretical arguments of Carney (2005) and Barney et al. (2002).
Aside from helping us to eventually understand the unique roles and advantages of family firms in the economy, identification of the distinctive resources and capabilities of family firms will help answer a critical question in family firm succession: What resources and capabilities should one generation hand to the next in order to give ensuing generations the potential to realize its vision? As Miller et al.'s (2003) study of 16 failed successions indicates, the transference of acumen is by no means a foregone conclusion.
Case studies by Tan and Fock (2001) suggest that the entrepreneurial attitude and abilities in a successor may be the key to success in family firm succession. Taken together, Chrisman, Chua, and Sharma (1998) and Sharma and Rao (2000) provide cross-cultural evidence that integrity and commitment may be more important to the selection and success of a successor than technical skills. Since such attributes may be associated with a family firm's reputation in the eyes of customers and suppliers, not to mention present and prospective employees, how these attributes can be developed is an important topic for future research. Building on this, Sharma and Irving (2005) draw on the organizational commitment literature to provide a conceptual model of four sources of successor commitment: affective, normative, calculative, and imperative.
Cabrera-Suárez et al. (2001) and Steier (2001) have treated the issue of resource transfer across generations in greater depth. Cabrera-Suárez et al. use resource- and knowledge-based theories to advance the concept of tacit knowledge transfer in succession. Tacit knowledge is situation-specific knowledge that is gained through experience and actions. It is more difficult to transfer than explicit knowledge because the latter is based on facts and theories that can be articulated and codified (Grant, 1996). Cabrera-Suárez et al. suggest that the transfer of tacit knowledge is important for preserving and extending competitive advantage because the continued success of a family business often rests upon the unique experience of the predecessor. In providing a model for the study of knowledge transfer in family businesses the authors not only provide a structure to explain the findings of prior research on family business succession, they also provide a theoretical basis for future studies on one of the key sources of competitive advantage that potentially exist through family involvement in a firm.
Steier's (2001) exploratory study adds to our knowledge of how tacit knowledge emanating from social capital is transferred during leadership transitions and suggests how different methods of transfer may influence postsuccession performance. He points out four modes of succession and transference of social capital across generations. Two of these—“unplanned sudden succession” and “rushed succession”—are caused by unanticipated events or changes in the current management structure. Over half the respondents who experienced these successions indicated a low level of preparedness for succession. In the third type of succession called “natural immersion,” the successors gradually assimilate the nuances of the network relationships. It is only in the “planned” transfers that leaders recognize the importance of transferring social capital and make deliberate attempts to introduce successors to the social networks of the organization.
While RBV helps explain how the possession of resources (e.g., familiness) could lead to competitive advantages and provides some insights for explaining how these resources have been or can be acquired through family involvement (e.g., the development of tacit knowledge), its role in explaining the requirements for preserving the business as a family institution has only begun to be explored. The work by Stafford, Duncan, Danes, and Winter (1999) on sustainable family businesses is a start toward filling this gap. However, Olson et al. (2003) conclude from their household sample study that the effect of the family on the business is greater than the effect of the business on the family.
Concluding Observations about the Two Theoretical Perspectives
As discussed above, the agency theoretic approach to explaining the distinctiveness of family firms is based on altruism and entrenchment. Of the two, altruism is a credible attribute for distinguishing family and nonfamily firms because it is easier to accept its possible existence among family owners and family managers than its existence among nonfamily owners and managers. That it could have both positive and negative impacts on family business performance makes its incorporation into an agency theory of the family firm a very promising direction because the interactions between the family and the business are too complex to be satisfactorily explained by a feature that yields simple conclusions. The strong indications that there are contingencies that might influence the relationship between altruism and performance are also important because it implies that the variations are not random.
Entrenchment flows from concentrated ownership, regardless of whether it is by a family or a nonfamily group. Therefore, an agency theory of the family firm based on entrenchment may have more difficulty explaining differences between family and nonfamily firms.
Conceptually, applications of agency theory to the family business situation would be more useful if the set of goals and objectives proposed is expanded to include noneconomic benefits. If agency costs are the result of managers pursuing goals that are different from those of owners, then many actions considered agency costs in nonfamily firms, because they primarily pursue economic goals, might not be so for family firms, because they pursue a more balanced goal set. The difficulty is that there is likely to be more substantial variations in the noneconomic goals of different family firms than in their economic goals. The measurement of economic performance is relatively straightforward compared to the measurement of noneconomic performance, which might include concerns ranging from family harmony to philanthropy to environmental preservation.
Of course, research that focuses purely on economic goals and performance will continue to be important. The problem is that an exclusive emphasis on economic performance is of only limited utility to family owners and managers who must struggle with achieving a balance between economic and noneconomic goals when making strategic, administrative, and operating decisions. Thus, to better reflect reality, and make a more meaningful contribution to practice, we need to better understand the interests of family business owners, whatever they may be. By doing so we will be in a better position to measure agency costs by the decisions and actions pursued in contravention of owners’ actual interests, and the activities, incentives, policies, and structures owners set up to prevent their interests from being contradicted.
Scholars adopting the RBV perspective have generated an even richer array of ideas about how family involvement may create differences in the performances of family and nonfamily firms. The proposed antecedents and types of distinctiveness for family firms are more numerous and the pathways of influence more complex; as a result, they are less clear-cut. Research has only begun to investigate these ideas and more is clearly needed.
As with agency theory, an important weakness of the RBV approach is the implicit assumption that wealth creation through competitive advantage is the sole goal of family firms. Although it is possible to have an RBV of the family firm as a partial theory dealing with how a firm might achieve wealth creation, an expansion of the goal set remains important for the RBV approach because decisions or behaviors that are intended to achieve other goals could directly impact what and how resources are deployed, with concomitant impacts on the economic performance of family firms. Similarly, agency cost-control mechanisms that might improve economic efficiency might also damage the fabric of a family firm as an institution and therefore reduce its ability to achieve important noneconomic goals. As suggested by Corbetta and Salvato (2004) this may also have long-term implications for the economic performance of a firm if, in lowering agency costs, the motivation of managers to maximize organization effectiveness is reduced.
Recently, Coff (1999) enriched RBV by pointing out that while valuable, rare, inimitable, and nonsubstitutable resources and capabilities may create competitive advantages, a firm may, nevertheless, not create value for its owners. This happens if other stakeholders have enough bargaining power to appropriate the economic rents generated. Coff (1999) notes that owner-managers usually have significant bargaining power because of their role in generating the economic rent, their access to information, and their legitimate residual claims. On the other hand, if owners do not contribute directly to the generation of economic rent but, instead, simply supply financial resources that are generic, fluid, unspecialized, and easy to substitute, then the owners are replaceable. If, in addition, managers are able to control owners’ access to information, then the former can appropriate economic rents from the latter despite the latter's legitimate residual claims. Although asymmetric information, which is central to agency theory, is a necessary component of the argument, it must be combined with an understanding of stakeholders’ roles in and contributions to generating economic rent to explain differences in bargaining power. Thus, there appears to be an opportunity to combine RBV insights with those of agency theory by building on the rent-appropriation concept.
Surprisingly, researchers have not adopted this enrichment to RBV to help explain family firm performance. For example, it may be useful in explaining why family firms tend to congregate in certain industries; these could be industries where nonfamily stakeholders have weaker bargaining power. It might also be used to explain differences in value creation by family firms as ownership passes to succeeding generations. If a successor's role in economic rent generation is reduced, the bargaining power of nonfamily stakeholders could be strengthened. Rent appropriation might even be a driving force for keeping succeeding generations of a family involved in both ownership and management if continued involvement is perceived as necessary to sustain the bargaining power of the family, vis-à-vis other stakeholders.