The Role of Family Ties in Agency Contracts.

Abstract

Drawing on data based on the entire population of Spanish newspapers over 27 years , this study shows that firm performance and business risk are much stronger predictors of chief executive tenure when a firm's owners and its executive have family ties and that the organizational consequences of CEO dismissal are more favorable when the replaced CEO is a member of the family owning the firm. The study also demonstrates that executives operating under weakly relational (less ambiguous) contracts are held more accountable for firm performance and business risk outcomes, even under nonfamily contracting.The present study examines a variant of the agency contract, one that involves family ties between principal and agent. We argue that in such family-related contracting, the exchange departs from purely economic motives and that family bonds between principal and agent have as a consequence forms of behavior different from economic rationality. Specifically, we hypothesize that family-related contracting decouples agent's employment from performance and business risk and that the termination of agents who enjoy family status has a salutary effect on firm survival. Empirical results comparing family and nonfamily contracting support these hypotheses. Furthermore, we found that executives operating under more strongly relational contracts tend to be held less accountable for observed results, even under nonfamily contracting. A relational contract is one that broadly states the terms and objectives of an agency relationship. Such contracts are ambiguous rather than explicit; the parties "do not agree on detailed plans of action but on goals and objectives" (Milgrom & Roberts, 1992: 131).The study makes five important contributions to the firm governance literature. First, prior research has not examined the differences between familyrelated and non-family-related contracting. Therefore, the present study advances theoretical understanding of relational contracts, where emotional rather than rational criteria govern the terms of the exchange. Second, the study suggests that family contracting is more likely to increase agency costs as a result of executive entrenchment. Furthermore, the study suggests that when firms engaged in family contracting put safeguards in place to curb these agency costs, firm survival improves. In prior theoretical work on agency theory, scholars have generally assumed that the threat of "moral hazard" and the costs of safeguarding against it are lowest in closely held firms because personal involvement by owner-managers supposedly eliminates the agency problem resulting from the separation of ownership and control (Jensen & Meckling, 1976). Third, the study examines how the nature of a position affects the strength of a relational contract and the implications this has for executive monitoring.Fourth, in a broader sense this study makes a contribution to management theory and practice by addressing the family business research lacunae. Our own reading of this literature confirms the disconce...

Identity in Family Firms: A Theoretical Analysis of Incentives and Contracts

“…Baek and Fazio (2015) also observed that family firms design agency contracts with less incentive mechanisms for family CEOs, especially when they receive material dividends. Interestingly, the authors offer a distinct rationale to explain their results, suggesting that family firms deviate from the tenets of agency contracting, as suggested by Schulze et al (2001) and Gomez-Mejia et al (2001).…”

Are There Non-linear Relationships between Ownership Structure and Operational Performance? Empirical Evidence from Portuguese SMEs Using Dynamic Panel Data

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