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Are Family Managers Agents or Stewards? An Exploratory Study in Privately Held Family Firms Article in Journal of Business Research · October 2007 DOI: 10.1016/j.jbusres.2006.12.011 · Source: RePEc
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Journal of Business Research 60 (2007) 1030 – 1038
Are family managers agents or stewards? An exploratory study in privately held family firms James J. Chrisman a,c,⁎, Jess H. Chua b,1 , Franz W. Kellermanns a,2 , Erick P.C. Chang d,3 a
b
Mississippi State University, Mississippi State, MS 39762-9581, United States Haskayne School of Business, University of Calgary, 2500 University Drive NW, Calgary, Alberta, Canada T2N 1N4 c Centre for Entrepreneurship and Family Enterprise, University of Alberta, Edmonton, Alberta, Canada T6G 2R6 d College of Business, Arkansas State University, State University, AR 72467, United States Received 1 July 2006; received in revised form 1 November 2006; accepted 1 December 2006
Abstract Family business researchers are split on whether family managers in family firms are agents or stewards. If family managers behave as agents, family firms are expected to impose agency cost control mechanisms on them, and this will improve performance. The results based on a sample of small privately held family firms indicate that family managers are monitored and provided with incentive compensation. Those who do so obtain higher performance, thus suggesting the existence of agency behavior among family managers. © 2007 Elsevier Inc. All rights reserved. Keywords: Family firm governance; Agency theory; Stewardship theory
1. Introduction Early work in agency theory (e.g., Fama and Jensen, 1983; Jensen and Meckling, 1976) posits that family firms are unique arenas of interest because conflicts between owners and managers are minimized as a result of family involvement in both ownership and management. Recent work on family business (Lubatkin et al., 2005; Schulze et al., 2001) based on behavioral economics of families (Becker, 1981) argues, however, that asymmetric altruism and self-control problems of parents could create unique agency problems for family firms. According to the latter view, even family managers working in family firms may behave as agents. Conversely, stewardship theorists suggest that family managers, regardless of ownership, will generally behave in ⁎ Corresponding author. Tel./fax: +1 662 325 1991/8651. E-mail addresses:
[email protected] (J.J. Chrisman),
[email protected] (J.H. Chua),
[email protected] (F.W. Kellermanns),
[email protected] (E.P.C. Chang). 1 Tel./fax: +1 403 220 6331/282 0095. 2 Tel./fax: +1 662 325 2613/8651. 3 Tel./fax: +1 662 325 3952/8651. 0148-2963/$ - see front matter © 2007 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2006.12.011
the organization's best interest (Davis et al., 1997). Family managers are presumed to behave this way because they subordinate personal goals to family goals, pursue non-financial goals, and abide by relational contracts that govern family firm behavior (Corbetta and Salvato, 2004). Clearly, agency problems between family firm owners and family managers would not exist in the presence of a sole family owner–manager because the owner and manager would be the same person. If other family managers are involved, however, the sole or principal owner, regardless of involvement in management, could still be exposed to agency costs generated by the behaviors of the other family managers. The term family manager is used in this study to refer to managers in family firms who are members of the owning family but are not themselves the principal owner. Inasmuch as the competing depictions of agency and stewardship theories regarding family managers flow logically from very different basic assumptions about how family managers are motivated, the assumptions may be disputed but cannot be assailed on the logic of their implications. As a result, which one is a more accurate description of family managers is an empirical matter. But determining the nature of family managers directly is difficult; thus, this study presents the results of an indirect test of
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the relative validity of the two theories in terms of their conflicting predictions about the behaviors of family managers and owners. The two theories conflict in their implications for family firm behavior with regard to the imposition of agency cost control mechanisms on family managers. If family managers behave more like agents, one should observe: (1) agency cost control mechanisms being imposed on family managers; and (2) firm performance improving as a result. Conversely, if family managers behave more like stewards then one should observe the relative absence of agency cost control mechanisms and a negative relationship between their imposition and performance. This study tests the conflicting predictions of agency and stewardship theories with regard to family firms. Crosssectional data from a sample of small family firms are used for this purpose. The study contributes to the discourse about the motivation of family managers and the extent to which control of their behavior will improve family firm performance. The specific mechanisms studied are incentive compensation and monitoring. Research has shown that agency problems can exist in family firms (Gomez-Mejia et al., 2001; Schulze et al., 2001) and that monetary incentives improve family firm performance (Schulze et al., 2001). However, little to no previous research examines monitoring methods and incentive compensation together or investigates the fundamental assumptions of agency and stewardship theories. The remainder of this article discusses the bases and implications of agency and stewardship theories regarding the imposition of agency cost control mechanisms on family managers in family firms. The hypotheses and methodology are then presented. Finally, a discussion of results and their implications for theory and future research are provided. 2. Implications of the agency and stewardship theories Agency theory and stewardship theory are both concerned with the role of managers in achieving firm goals (Tosi et al., 2003; Wasserman, 2006). The theories diverge in their predictions, however, about how managers will act in this regard because they make very different assumptions about the motivations of managers. 2.1. Agency theory and agency cost control mechanisms in family firms Agency theory assumes that: (a) Owners and managers have conflicting goals; (b) managers may pursue their own goals even to the detriment of owners; (c) owners have difficulty observing some aspects of managers' behavior; and (d) owners have bounded rationality (Jensen and Meckling, 1976; Williamson, 1981). The first two assumptions imply that owners may incur costs if they ignore the self-serving behavior of managers. But if all aspects of managers' behavior are easy to observe, then, at least theoretically, self-serving managerial actions that are detrimental to owners can be eliminated through contracting. If relevant aspects of managers' behavior are difficult to observe, however, then contracts cannot solve the agency problem because owners will not be able to tell whether managers are behaving as
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prescribed in the contract. Moreover, bounded rationality (Williamson, 1981) precludes contracts that completely prescribe managers' behavior in all future eventualities. Therefore, even if all aspects of the behavior of managers were observable, not all aspects of their behavior in all future eventualities could be prescribed in advance in a contract. The solutions are to monitor those behaviors that can be prescribed and are observable and to align as much as possible the interests of managers with owners. Once the interests of managers and owners are in congruence, the fact that managerial behavior is not completely observable does not matter as much because, in pursuance of self-interest, managers will likely act in the interests of owners, even when faced with unanticipated circumstances for which no behavior has been prescribed. Thus, in order to avoid the costs arising from ignoring agency problems, incentives must be provided to align the interests of managers with those of owners and behaviors that are prescribable and observable must be monitored. These control mechanisms are costly, however, and should be used only if they yield positive net benefits. Assuming that implementing agency cost control mechanisms eliminates at least some of the costs of ignoring the problems, then the criterion for implementing agency cost control mechanisms is whether the costs of doing so is less than the costs of ignoring agency problems. Clearly, owner–manager related agency problems arise only if a family firm has at least one family manager who is not the sole or principal owner of the business. If family managers are agents, and family business owners rationally implement agency cost control mechanisms (whenever and only when the benefits exceed the cost), then the following implications flow directly from agency theory: (1) Owners will impose agency cost control mechanisms on family managers; and (2) imposing agency cost control mechanisms on family managers will improve the economic performance of family firms. 2.2. Stewardship theory and agency cost control mechanisms in family firms Diverging from the self-serving human to which agency theory subscribes, stewardship theory has its roots in theology (Thompson, 1960) and suggests that managers behave as stewards devoted to the interests of the owners. This is theorized to happen in a number of ways. For example, within the agency theoretic framework, Chrisman et al. (2005) show that stewardship requires only that family business owners and family managers value the interests of the other as much as their own. Outside the agency framework, researchers appeal to the subordination of personal goals to firm goals, the importance of non-financial goals, and the nature of relational contracts between family business owners and family managers as the sources of stewardship (Argyris, 1973; Davis et al., 1997; Tosi et al., 2003). The personal goals of family managers may be subordinated to firm goals because they are intrinsic to family managers. Family managers may place a high value on integrity and associate integrity with attaining firm goals; they may seek self-actualization in terms of achieving firm goals; or achieving firm goals may have higher utility than achieving individual
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goals. In other words, the motivations for their behavior extend beyond merely economic self-interest. Corbetta and Salvato (2004) argue that pursuance of nonfinancial goals in family firms will motivate family managers to focus on higher order intrinsic needs. For this to have relevance, however, the actions that flow from meeting the higher order intrinsic needs of family managers must be in the owners' interest as well. Corbetta and Salvatto (2004) also argue that emotion and sentiment-laden long-term relational contracts between family business owners and family managers will motivate family managers to pursue owners' interests. In summary, stewardship theorists believe the interests of family managers and family business owners will be aligned if family managers are intrinsically inclined to pursue the interests of owners; when non-financial goals are similar and important to both family business owners and family managers; and when the relationship between family business owners and family managers is long-term and emotion laden. Agency problems would not exist if this is true. Theoretically, in terms of the criteria for implementing agency cost control mechanisms, the cost of ignoring agency problems would be zero and implementing the mechanisms would incur costs and yield no benefit. In fact, Corbetta and Salvato (2004) argue that imposing these mechanisms on family managers may actually “lower stewards' motivation, negatively affecting their pro-organizational behavior, both in the short and long run” (p. 360). Thus, performance may be doubly impaired. Consequently, in its pure form, stewardship theory predicts that: (1) Owners will not impose agency cost control mechanisms on family managers; and (2) imposing these mechanisms on family managers will lower performance. 2.3. Conceptual issues in differentiating agency and stewardship behavior Depending on how one interprets stewardship theory, the evidence required to prove agency behavior would differ. If, as the evidence suggests, the agency problems in family firms are less severe than those in non-family firms but not zero (Chrisman et al., 2004), family managers in family firms may either be seen as agents or as some combination of agents and stewards. Thus, the behavior of family managers may lie along a range of behaviors bounded at one end by a pure stewardship theory where agency behavior among family managers is completely absent, and bounded at the other end by a pure agency cost theory where family managers act entirely in their economic self-interest. A relative rather than absolute view is taken of agency behavior in this paper; thus the presence of agency behavior is seen as supportive of the precepts of agency theory but not to the extent of completely negating stewardship theory as a depiction of family manager behavior in certain decision situations. Testing whether family managers are agents or stewards is further complicated by observations made by researchers that the behavior of family managers is affected not by their nature alone but by their interactions with family business leaders as well. Davis et al. (1997) observe that if assumptions held by family owners and managers about human nature are misaligned, agency problems will be amplified. For example, Lubatkin et al. (2005) observe that
owners can hold up information and operate under agency relationships, frustrating family managers attempting to act as stewards for the organization. Such misalignment could cause stewards to become agents (Corbetta and Salvato, 2004; Davis et al., 1997). These observations imply that the nature of family managers cannot be easily deduced and tests should therefore be based on behavior rather than nature. Thus, the hypotheses and tests in this study are based on how family firm owners treat family managers and the consequences of that treatment. As discussed previously, agency theory has two implications for the monitoring and incentive compensation policies of family firms. The first is that family firms will monitor family managers and provide them with incentive compensation. This is a necessary but not sufficient condition because family firms may impose monitoring and provide incentive compensation to family managers for other reasons. For example, incentive compensation may be used for risk sharing rather than agency cost control (Cadenillas et al., 2004) or, as suggested by neo-institutional theory (DiMaggio and Powell, 1983; Meyer and Rowan, 1977–1978), agency cost control mechanisms may be imposed upon family managers to mimic large professionally-managed non-family firms and signal to non-family managers and other stakeholders that the family firm is “professionally-managed” and “legitimate”. Second, monitoring and incentive compensation are costly. If agency problems exist among family managers and these agency cost control mechanisms are economically efficient in the sense that applying them yields more benefits than costs, then family firm performance should improve. Thus, agency theory, which assumes rationality for both family firm owners and family managers, implies that performance improvement as a result of the imposition of agency cost control mechanisms constitutes sufficient proof that family managers act as agents. Even if family managers behave as agents, family firm owners may, nevertheless, not impose agency cost control mechanisms on them and firm performance may suffer. Alternatively, if family managers impose mechanisms that are higher in costs than benefits, performance will also be adversely affected despite effective control over agent behavior. But, when playing by agency theory rules, the presence or absence of performance improvement is what matters. Thus, if one accepts the agency theory stand that performance improvement associated with the employment of agency cost control mechanisms constitutes sufficient evidence that family managers behave as agents, then the absence of such performance improvement must also constitute proof that family managers do not behave as agents. With this in mind, the two conditions differentiating agency and stewardship behaviors are formally developed below as hypotheses, stated from the agency point of view. 2.4. Hypothesis development Agency problems may exist between family business owners, regardless of involvement in management, and family managers if the latter engage in behaviors that benefit their own interests at the expense of the former. When these conditions exist, family business owners can use monitoring to control observable behaviors and use incentives to align the family managers' interests with their own to
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control unobservable behaviors. But as noted above, agency cost control mechanisms are costly. For example, monitoring requires the preparation of additional or more frequent reports or the employment of auditors or more senior managers who themselves may require monitoring. Incentives, such as bonuses, profit sharing, or stock, are more costly, even when they are not extra but substitutes for fixed pay, because risk aversion demands that their expected values be higher than the fixed pay forgone (Milgrom and Roberts, 1990). Thus, if agency problems between family business owners and family managers do not exist, agency cost control mechanisms would not be needed and, if owners behave rationally, they will not impose them. As a result, according to agency theory, the degree to which agency cost control mechanisms are used on family managers in family firms should correspond directly to the extent that family managers act as agents. From this emerges the following hypothesis, which is a necessary condition for proving agency behavior of family managers: Hypothesis 1. (Necessary condition) Family firms monitor family managers and compensate them with incentives. According to agency theory, family firms will impose agency cost control mechanisms whenever and only when the benefits exceed the costs of imposing the mechanisms, thus enhancing performance. Therefore, agency theory also implies the following hypothesis: Hypothesis 2. (Sufficient condition) Monitoring family managers and compensating them with incentives improve family business performance. 3. Methodology Cross-sectional data were obtained from a larger project designed to assess the economic impact of the counseling activities of the Small Business Development Center (SBDC) program in the U.S. Data from 49 states (excluding South Dakota) and the District of Columbia were collected in 2004. Two mailings of the questionnaires were sent to the entire population of 32,156 operating businesses that received five or more hours of counseling assistance from these SBDCs in 2002. A total of 5779 firms responded to the mailings resulting in an 18% response rate. Given the size of the firms that receive SBDC assistance, the vast majority of the respondents were both the principal owner and principal manager of their firm. However, as noted by Jensen and Meckling (1976), the precepts of agency theory also apply to the hierarchical relationships between managers, regardless of ownership. 3.1. Screening of family firms Although applications of agency theory are not limited only to the situations facing large, public corporations (Jensen and Meckling, 1976), testing the hypotheses nevertheless required a sample of family firms that were of sufficient size and age to have the potential to experience situations involving asymmetric information regarding motivations and unobservability of
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behavior between family business owners and family managers. Accordingly, only those firms (including both family and nonfamily) that had 10 or more employees and had been in business for at least 5 years were considered. To distinguish the family firms in this sub-sample from the nonfamily firms, the theoretical definition of Chua et al. (1999, p. 25) was used. Those authors define a family firm as “a business governed and/or managed with the intention to shape and pursue the vision of the business held by a dominant coalition controlled by members of the same family or a small number of families in a manner that is potentially sustainable across generations of the family or families”. This definition has been used in previous studies as a basis for distinguishing between family and nonfamily firms (e.g., Chrisman et al., 2004). Procedures identical to those used by those authors to operationalize the definition were followed. The constructs included the (1) percentage of the business owned by family members, (2) number of family managers, and (3) expectation that the future successor as president of the business will be a family member, operationalized through a categorical Yes–No response. The quick clustering technique in SPSS yielded a dichotomous classification of family and non-family firms. The cluster solution classified 482 (81%) firms as family firms and 129 (19%) as non-family firms, a proportion consistent with previous research (Chrisman et al., 2004). However, since the objective of this study is to test whether family managers are agents or stewards, non-family firms are not included in the final sample because, by definition, such firms cannot have family managers. Thus, the research is necessarily limited to the study of family firms. The sample also had to be limited to family firms with family managers who were not the primary owner in order to be able to differentiate principals from agents. Thus, only those family firms with at least one family manager (other than the owner– manager) were retained for the analysis. This reduced the usable sample of family firms available to test the two hypotheses to 208. Although unfortunate, such reductions to meet the requirements for hypothesis testing are not unusual in studies using the SBDC data base (e.g., Chrisman et al., 2004). 3.2. Agency cost control variables 3.2.1. Monitoring Five items were used to assess monitoring activities of owners toward family managers. Because monitoring can include a wide array of methods for obtaining information on the activities and performance of family managers, the respondents were asked to indicate how often they used “personal direct observation”, “regular assessment of short-term output”, “progress toward longterm goals”, “input from other managers” and “input from subordinates”, to monitor their family managers. All items utilized a five-point Likert-type scale with scores of 1 indicating that the monitoring procedure was “never” used and scores of 5 indicating that the monitoring procedure was used “very often”. Conceptually, different monitoring methods could be complements or substitutes. They would be complements if the information gathered by each method to deal with information asymmetry is incomplete and does not wholly overlap that
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gathered by another approach; they would be substitutes if sufficient redundancy exists in the information gathered. Thus, a family firm's choice not to use a particular monitoring method would not indicate an absence of monitoring; an overall measure of monitoring is needed. For this purpose, an Overall Monitoring Construct was created based on the average of the five items. Factor analysis confirmed the uni-dimensional nature of the construct. The Cronbach alpha of the scale was 0.88. 3.2.2. Incentives Respondents were asked to indicate which types of incentive compensation were paid in addition to regular wages on a Yes (1) or No (0) basis. Categories included bonuses, profit sharing, and ownership share in the business. Again, because these incentive compensation schemes are substitutes, and in order to have a measure of the overall extent to which incentive compensation is used by family firms on family managers, an Overall Incentives Construct was created by adding the number of different types of incentives. Values ranged from 0, for no incentives provided, to 3 for all three incentives provided to family managers. 3.3. Firm performance variable Performance was assessed by asking respondents to indicate on a 5-point Likert-type scale whether the return on sales of their firm was much lower (scored as 1) to much higher (scored as 5) than competitors over the last 5 years. Although performance was self-reported, research shows that subjective and objective performance data are correlated (Dess and Robinson, 1990). 3.4. Control variables Agency or stewardship relationships between family owners and family managers may vary in different types of family firms depending on the influence of other variables, which must be controlled (Chrisman et al., 2004). First, dummy variables were constructed for firms competing in retail, service, and manufacturing industries. Second, controls for size (natural logarithm of sales) and for the age of the business (natural logarithm of age) were used. The logarithmic transformations were necessary to minimize skewness. Finally, substantial evidence shows that family or concentrated ownership affects business performance (McConaughy et al., 2001; Morck et al., 1988). Consequently, the total percentage ownership of the family was used as a control variable as well. 3.5. Data analysis An ANOVA was conducted to investigate whether significant differences in terms of the utilized variables existed between early and late respondents; none were found. Since later respondents could be expected to be more similar than earlier respondents to non-respondents (Kanuk and Berenson, 1975; Oppenheim, 1966), this test suggests no significant bias in any of the key variables in the study. Since the data were collected via a self-reported questionnaire, the potential for common method variance was present. Various
tests for common method variance discussed by Podsakoff et al. (2003) were performed. The tests showed no evidence of a common method bias problem. Unfortunately, due to government regulations pertaining to the use of SBDC data, an independent verification of the self-reported data was not possible. Testing whether family firms monitor family managers and compensate them with incentives (Hypothesis 1) requires evidence that family firms employ agency cost control mechanisms. Lacking standard tests in the literature, tests specific to this study had to be devised. For monitoring, finding the averages for the individual monitoring mechanisms and the Overall Monitoring Construct were significantly more than “sometimes” (the descriptor for the midpoint of the 5-point Likert scale) was interpreted as support for the hypothesis that family firms monitor family managers. With respect to the incentives provided to family managers, whether the frequencies for individual approaches and the average for the Overall Incentives Construct were significantly higher than zero was used as the determining test. Hierarchical regression was used to test whether the use of monitoring and incentive compensation for family managers improves family firm performance (Hypothesis 2). Performance was first regressed against the control variables. In the second step, the Overall Monitoring Construct and the Overall Incentives Construct were added. 4. Results Descriptive statistics on sales, employment, age, and family manager involvement for the sample are presented in the top panel of Table 1. The middle panel of Table 1 shows that monitoring is most frequently done by direct observation of Table 1 Family firm characteristics and use on family managers of incentives and monitoring Mean Firm characteristics Sales ($000) Employees (number) Firm age (years) Family managers (number)
SD
t-statistic Significance
3546 5924 32.20 38.07 26.86 24.70 2.51 1.11
Monitoring: indicators measured on 5-point Likert scale (1 = never; 5 = very often) ⁎⁎⁎ Observation 3.97 1.12 12.50 ⁎⁎⁎ Regular short-term assessment 3.62 1.16 7.64 ⁎⁎⁎ Progress toward long goals 3.65 1.13 8.30 ⁎⁎⁎ Input from other managers 3.56 1.23 6.50 ⁎⁎⁎ Input from subordinates 3.35 1.24 4.02 ⁎⁎⁎ Overall monitoring construct 3.63 0.95 9.50 (average of the five indicators) Incentive compensation: indicators measured as 1 (Yes) or 0 (No) ⁎⁎⁎ Bonus 0.48 0.50 13.84 ⁎⁎⁎ Profit sharing 0.26 0.44 8.63 ⁎⁎⁎ Ownership 0.25 0.44 8.41 ⁎⁎⁎ Overall incentives construct 1.00 0.88 16.30 (sum of the three indicators) N = 208; ⁎⁎⁎p b 001.
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Table 2 Correlations, means and standard deviations of variables used in regressions
1. Ln (sales) 2. Ln (age) 3. Family ownership 4. Service 5. Retail 6. Manufacturing 7. Monitoring 8. Incentives 9. LT performance
Mean
SD
1
2
3
4
5
6
7
8
14.41 2.96 98.27 0.10 0.21 0.37 3.63 1.00 3.01
1.11 0.79 5.80 0.31 0.41 0.48 0.95 0.88 1.03
0.26⁎⁎⁎ 0.04 − 0.15⁎ − 0.04 0.30⁎⁎⁎ 0.018 0.12 0.16⁎
0.01 − 0.15⁎⁎⁎ − 0.01 0.27⁎⁎⁎ − 0.03 0.07 0.01
0.08 0.01 − 0.06 − 0.12 0.06 0.15⁎
− 0.18⁎⁎ − 0.27⁎⁎⁎ 0.01 0.05 − 0.06
− 0.40⁎⁎⁎ − 0.11 0.04 0.02
−0.01 0.08 0.01
0.14⁎ 0.16⁎
0.22⁎⁎⁎
N = 208; ⁎p b 0.05, ⁎⁎p b 0.01 and ⁎⁎⁎p b 0.001.
family managers' behavior and least frequently done by seeking input from subordinates. The means for the different family manager monitoring methods are all between 3 (sometimes) and 4 (often). Statistically, they are all significantly more than 3.00 ( p b 0.001). The bottom panel of Table 1 shows that 48% of the family firms paid bonuses, 26% had profit sharing, and 25% shared ownership with family managers. The means for the individual incentives and the Overall Incentives Construct are all significantly greater than zero ( p b 0.001). Overall, these two sets of results provide support for Hypothesis 1, which states that family owners impose agency cost control mechanisms on family managers. Correlations, means, and standard deviations for the variables used in the hierarchical regressions are shown in Table 2. The results of the hierarchical OLS regression used to test Hypothesis 2 are shown in Table 3. Model 1 tests the control variables. Only log sales and family ownership are significant ( p b 0.05). The adjusted R2 for model 1 is only 0.02 and not significant. Model 2, which adds the monitoring and incentive variables, shows a significant increase in R2 ( p b 0.001) with an overall adjusted R2 of 0.08 and an F-statistic of 3.26 ( p b 0.01). Both monitoring (β = 15; p b 0.05) and incentives (β = 19; p b 05) are positively and significantly related to performance. These
Table 3 Results of OLS regression: dependent variable is long-term performance
Ln (sales) Ln (age) Ownership by family Service Retail Manufacturing Monitoring Incentives F-statistic R2 Change in R2 Adjusted R2 Number of observations ⁎p b 0.05; ⁎⁎p b 0.01; ⁎⁎⁎p b 0.001.
Model 1
Model 2
0.16⁎ − 0.03 0.15⁎ − 0.07 0.00 − 0.04
0.14 − 0.03 0.16⁎ − 0.08 0.00 − 0.05 0.15⁎ 0.19⁎ 3.26⁎⁎ 0.12 0.07⁎⁎⁎ 0.08 208
1.86 0.05 0.02 208
results suggest that family firms that monitor family managers and compensate them with incentives have better performances. 5. Discussion This exploratory study investigated whether family firms monitor family managers and compensate them with incentives and whether these agency cost control mechanisms improve performance. The first set of findings indicates that family firms make liberal use of both incentive compensation and monitoring mechanisms on family managers while the second suggests that using monitoring and incentive compensation results in a better performance. These findings partially contradict classical agency theory (Fama and Jensen, 1983; Jensen and Meckling, 1976) which assumes that the agency costs associated with family management will approach zero. The results are, therefore, more in line with contentions made by Schulze et al. (2001) who suggest that owners need to manage the unique agency problems caused by asymmetric altruism and self-control. As discussed previously, monitoring and incentive compensation should not positively affect firm performance unless family managers are agents and family business owners are rational in implementing agency cost control mechanisms whenever and only when such implementation will yield more benefits than costs. The results indicating performance improvement from imposing such mechanisms thus suggest that family business owners indeed act rationally in the sense described above. Apparently, their altruism does not blind them to the reality that kinship ties do not unconditionally guarantee appropriate behavior by relatives. The fact that monitoring appears to improve performance also implies that family owners act on the information obtained to control behavior (or at least family managers believe that the information will be acted upon). These findings are consistent with the suggestion of Lubatkin et al. (2007-this issue) that altruism may appear in many different forms. Indeed, the results suggest a type of altruism that operates in a somewhat different manner than previously believed. Thus, rather than involving iron-clad entitlements with few or no consequences for bad behavior, the altruism manifest in family firms appears more consistent with an interpretation that opportunities (that may be unavailable to non-family managers) are provided to family
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members with the stipulation that subsequent behavior can have positive or negative consequences. 6. Conclusions The results of this study contribute to knowledge concerning agency and stewardship relationships in family firms. Earlier research tended to focus on either agency or stewardship theory individually (for an exception see Tosi et al., 2003). This study considered both and obtained results that are more supportive of the presence of agency relationships than stewardship relationships. Furthermore, while prior research addressed the potential of agency costs in family firms (Schulze et al., 2001) and the benefits of stewardship behavior (Corbetta and Salvato, 2004), this study is the first to show that family business owners seem to regard family members as agents. Finally, this study is the first to investigate the use of monitoring mechanisms to control family managers' behavior in family firms. The findings of this study are important in light of earlier findings showing that agency costs in family firms exist due to asymmetric altruism (Schulze, Lubatkin and Dino, 2003). Extensive use of agency cost control mechanisms was found, suggesting that the problems of altruism are better understood and controlled by family owners than prior theory (Schulze et al., 2001) might have led one to conclude. Furthermore, as previously implied, the findings also suggest that the manner in which altruism operates in family firms may be more complicated than previously believed. Future research that leads to a better understanding of the complex relationship between family owners and family managers would therefore be valuable. 6.1. Limitations This study has several limitations that offer opportunities for future research. First, interpretation of the results suffers from a weakness shared with many other strategic management studies in that a neo-institutional explanation for the observed organizational behaviors is possible. Neo-institutional theory would suggest (DiMaggio and Powell, 1983; Meyer and Rowan, 1977–1978) that family firms may monitor and provide incentive compensation to family managers in order to signal to other stakeholders that the firm is “professionally-managed” or “legitimate”. In other words, even though firms that impose agency cost control mechanisms have better performance, this could have come as a consequence of dealing with the agency problems arising from relationships with other stakeholders such as non-family managers or lenders. Second, the study was cross-sectional in nature. Performance was measured as of 2004, at the same time as the monitoring and incentive compensation variables. As a result, assignment of causality between the two sets of variables may be questionable. However, arguments can be made that the problem is not serious for this study. The descriptors for the monitoring variable ratings preclude situations where monitoring methods have been set up only at the end of 2004. For example, a respondent would not have answered “sometimes”, “often”, or “very often” without a
repeated experience. Monitoring methods and incentive compensation schemes are also likely to be stable. Furthermore, if these mechanisms have any impact on performance, the effects would likely be felt quickly in the small family firms studied here. Finally, higher performance is unlikely to cause more monitoring, although admittedly, increased profits may make family firms more willing to pay bonuses to or share profits with family managers, thus providing another explanation for the positive relationship shown by the results. Third, the study only investigated family managers in general and did not distinguish between different kinship ties. Future research could investigate if owners use different monitoring and incentive packages depending upon the level and types of family involvement. For example, an owner's spouse might behave differently and respond to different controls and incentives than children, cousins, or in-laws (Karra et al., 2006). Finally, this study implicitly assumes that family firms are homogeneous (other than by size, age, industry, and family ownership which were controlled) but this is obviously not valid. Although central tendencies have been explored herein, further work to identify different types of family firms in order to tease out the variations and complexities of relationships between family owners and family managers would be desirable. 6.2. Implications for future research In the previous section, the evidence needed to refute stewardship theory as a valid depiction of family managers was discussed; the question asked was whether a single widespread family business practice indicating the presence of agency problems would be sufficient to do this. If one takes an “imperialistic” agency point of view, one could certainly so conclude. As stated previously, however, the supposition used in this paper is that the relationship between the family owners and family managers is much more complex; family managers may behave alternately as stewards or agents in different decision situations, at different stages of the family firm's life, and at different stages of the family manager's life. For example, decisions that have long-term effects on the next generation may be more likely to cause agency problems when some family managers have many children while others have few or none. Family managers in a family business facing a financial crisis may be more (or less) opportunistic. A family manager who has just been bypassed for promotion or is denied an ownership stake in favor of a sibling may be more likely to pursue self-interest at the expense of other family members. Therefore, while the results suggest the presence of agency behavior on the part of family managers, more research is needed to identify the situations, business stages, and personal life stages within which family managers are more likely to act as agents or stewards. Family business researchers, when discussing agency theory, typically use the simple and convenient setting of one owner (or owner block) and a homogeneous group of manager(s). Many situations exist, however, where more than one family manager is involved. For example, the family members in the ensuing generation may consist of many members with varying levels of
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ownership, expected ownership, qualifications, and opportunistic intentions. The family owner group could contract with the family managers individually, as a group, or in separate coalitions, while the family managers could cooperate, partially cooperate, or compete. The dynamics of such combinations of family managers and the resulting agency cost control strategies would be a very fertile field to gain understanding of family business. The economics literature on agency problems of multiple agents (e.g., Demski and Sappington, 1984; Holmstrom, 1982; Ishiguro and Itoh, 2001) would be a good place to start. Longitudinal studies that track family relationships, behavior, and performance over time might reveal patterns that cannot be detected with cross-sectional studies. Indeed, stewardship may take a considerable amount of time to develop (Corbetta and Salvato, 2004) or, alternatively, may even be eroded over time (Karra et al., 2006). Tracking behavior and performance in family firms when succession is imminent would be a particularly interesting way of studying the time element. For example, quasi-natural experimental research could observe whether the behaviors of appointed successors and members of their branch of the family change after succession and the length of time a firm needs to settle into equilibrium. Another question deserving of study is whether family firms treat family managers and non-family managers differently in terms of agency cost control mechanisms. If the agency problems associated with non-family managers arise from asymmetric information but those associated with family managers are caused by asymmetric altruism, the agency cost control mechanisms may have to be different. The problem of comparisons is further complicated by the possibility of different types of altruism (Lubatkin et al., 2007-this issue), each of which might alter relationships between family owners and family managers. A number of other topic areas require further study. For example, control and incentive systems need to be investigated more fully. While this study focused on traditional monetary incentives and traditional organizational controls through monitoring, other non-financial incentives and controls could be investigated. Family firm culture, unique family firm attributes, or normative pressures by family members or family structures might result in an alignment of behavior (Davis et al., 1997; Sharma and Manikutty, 2005). Furthermore, if the long association between family owners and family managers is positive, this should breed trust and, thus, reduce the amount of monitoring and incentives needed to solve the agency problem of moral hazard. On the other hand, since incentive compensation also has a risk-sharing function, because some fixed costs are converted to variable costs, family managers may be compensated with more incentives even when the family firm's agency problems with them are less severe. Additionally, other forms of performance should be considered in family firms. While classical agency and stewardship theories focus on maximizing shareholder wealth (Tosi et al., 2003), this assumption may need to be relaxed in family firms to include both monetary and non-monetary benefits. In family firms that depend on intrinsic rewards, somewhat different control and incentive structures may yield higher pay-offs than those commonly found in non-family
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firms. So far no systematic investigation of this possibility seems to have been conducted. This study has addressed the agency–stewardship debate only from the perspective of moral hazard between family owners and family managers. However, the potential for adverse selection complicates agency–stewardship issues in family firms. Stewardship theory was not meant to deal with problems of adverse selection. Thus, agency and stewardship issues might operate side by side in some family firms. Further research is needed to explore this possibility. Another issue not directly addressed by stewardship theory that requires future research is the relationship between majority and minority owners. This is because studying the potential for agency costs in family firms requires a full accounting of possible conflicts of interest and potential asymmetries of information and altruism between family owners and family managers as well as between majority and minority family owners. In conclusion, this study provided evidence that owners in privately held family firms treat family managers as agents in terms of the compensation packages and monitoring mechanisms used, thus suggesting that family firm managers act as agents, in general. However, the differences between agency and stewardship theories are many and relationships between key constructs can be interpreted in different ways. For example, agency theorists treat CEO duality as a proxy for entrenchment that should be avoided while stewardship theorists believe that CEO duality empowers the positions of owners and stewards (Donaldson and Davis, 1991; Tosi et al., 2003). This study addressed the fundamental contentions of agency and stewardship theories but much more research needs to be done. References Argyris C. Organization man: rational and self-actualizing. Public Adm 1973;33:354–7 [July/August]. Becker GS. A treatise on the family. Cambridge. Harvard University Press; 1981. Cadenillas A, Cvitani J, Zapatero F. Leverage decision and manager compensation with choice of effort and volatility. J Financ Econ 2004;73(1): 71–92. Chrisman JJ, Chua JH, Litz R. Comparing the agency costs of family and nonfamily firms: conceptual issues and exploratory evidence. Entrep Theory Pract 2004;28(4):335–54. Chrisman JJ, Chua JH, Sharma P. Trends and directions in the development of a strategic management theory of the family firm. Entrep Theory Pract 2005;29(5): 555–76. Chua JH, Chrisman JJ, Sharma P. Defining the family business by behavior. Entrep Theory Pract 1999;23(4):19–39. Corbetta G, Salvato C. Self-serving or self-actualizing? Models of man and agency costs in different types of family firms: a commentary on “Comparing the agency costs of family and non-family firms: conceptual issues and exploratory evidence”. Entrep Theory Pract 2004;28(4):355–62. Davis JH, Schoorman FD, Donaldson L. Toward a stewardship theory of management. Acad Manage Rev 1997;22(1):20–47. Demski J, Sappington D. Optimal incentive contracts with multiple agents. Entrep Theory Pract 1984;33:152–71. Dess GG, Robinson RB. Industry effects and strategic management research. J Manage 1990;16(1):7–27. DiMaggio PJ, Powell WW. The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. Am Sociol Rev 1983;48:147–60. Donaldson L, Davis J. Stewardship theory or agency theory: CEO governance and shareholder returns. Aust J Manage 1991;16:49–64.
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