CAPITAL STRUCTURE IN PUBLICLY HELD FAMILY FIRMS: A BEHAVIORAL AGENCY THEORY ANALYSIS
DOCTORAL DISSERTATION
AURORA CORREA FLORES
MONTERREY, N.L., MEXICO
MAY, 2018
Copyright © By
Aurora Correa Flores 2018
CAPITAL STRUCTURE IN PUBLICILY HELD FAMILY FIRMS: A BEHAVIORAL AGENCY THEORY ANALYSIS
by
Aurora Correa Flores
Dissertation
Presented to the Faculty of EGADE Business School, Tecnológico de Monterrey in Partial Fulfillment of the Requirements for the Degree of
Doctor of Philosophy in Business Administration
EGADE Business School May, 2018
CAPITAL STRUCTURE IN PUBLICILY HELD FAMILY FIRMS: A BEHAVIORAL AGENCY THEORY ANALYSIS
APPROVED BY THE MEMBERS OF THE DISSERTATION COMMITTEE
_____________________________________________________
Teófilo Ozuna Jr., PhD (Chair) Associate Dean of Research EGADE Business School, Monterrey Instituto Tecnológico y de Estudios Superiores de Monterrey
_____________________________________________________
Francesco Chirico, PhD
Professor Jönköping International Business School Jönköping, Sweden
_____________________________________________________
René Cabral Torres, PhD Professor EGADE Business School, Monterrey Instituto Tecnológico y de Estudios Superiores de Monterrey
In accordance with the Tecnológico de Monterrey Student Code of Honor, my performance in this thesis was guided by academic honesty.
Abstract
Family firms represent the world’s most predominant form of organization. Capital
structure refers to the firms’ financing decision between through debt, stock, or a combination of both. Literature shows that sStudies of capital structure in family firms make upare a set of unconnected pieces, sometimes with contradictory results. Furthermore, literature also shows that the unique characteristics of the ‘family’ within family firms family’s unique characteristics shape the capital structure decision. But traditional capital structure theories do not cover these characteristic of family firms characteristics that impact their capital structure decision, and neither do they they explain the contradictory evidence. It is particularly important to highlight that the most relevant characteristics of family firms: - that areis, a strong desire to maintain control and strong desire to avoid risk -, have opposing effects on debt (Matias Gama & Mendes Galvão, 2012). Furthermore, tTraditional capital structure theories (trade-off theory, pecking order theory, agency theory, market timing theory) cannot explain this effect.
This dissertation proposes behavioral agency theory as a theoretical approach that, through its theits family firm variant (of, the socioemotional wealth), can offer an alternative explanation forof the capital structure decisions of family firms. Behavioral agency theory states that
individuals frame their problems by comparing anticipated outcomes versus to a reference point:, when the framed prospects are positive, decision makers will exhibit risk- averse preferences;, and when the framed prospects are negative they will exhibit risk- seeking preferences (Wiseman
& Gomez-Mejia, 1998). The term socioemotional wealth is an umbrella concept that covers the different types of social and affective endowments that accrue within theto family members as a result of controlling a business (Miller and Le Breton-Miller , 2014).
In order toTo accomplish the purpose of theis study, thise dissertation proposes a conceptual model and, it also presents and tests, using econometric techniques, the derived research hypothesis using a sample constitutingof publicly held Mexican firms from 2012 to 2017. The conceptual model proposes that, in order to make decisions, family principals can take into account both financial and socioemotional wealth, using a mixed gamble perspective
(Gomez-Mejia, et al., 2015; Gomez-Mejia, Campbell, Martin, Hoskisson, Makri, and Sirmon, 2013). Under a mixed gamble perspective, firms take their decisions by weighting between the preservation of current socioemotional endowment versus and future financial wealth. Preserving socioemotional wealth is a high priority for family firms. In terms of capital structure, this implies that higher levels of leverage imply preserving current socioemotional endowment, because higher levels of leverage contribute to preservinge the control in the hands of the family (Ellul, 2009), which ). This, which is one of the most important objectives of socioemotional wealth (Berrone, et al., 2012). In contrast, preserving future financial wealth means incurring into lower levels of leverage, because this restrictsreduces the risk of financial distress higher
levels of leverage put at risk the financial wealth of the firm at risk (Anderson, Mansi, & Reeb, 2003).
According to Gomez-Mejia, Patel, and Zellweger (2015), despite the prevalence of socioemotional wealth in the decision making of family firms, the family principals (decision makers) can also consider theo prevention of from losses toin their socioemotional losses and gains and its outcomes respect to financial wealth. This dissertation explores the family firm’s decision that family firms take between preserving socioemotional wealth versus or financial wealth, arguing adds that in this dilemma the overlapping of family and business spheres is also involved. It will also mMeasureing the overlapping , the overlapping of family and business spheres which can be measured with family ownership. When overlapping between the family and business spheres is high, then family firms will prefer to preserve avoiding losses in their financial wealth.
The results of this dissertation’s results show that family firms are more leveraged than non-family firms, asso they want to maintain keep the control in the hands of the family. There is a negative relationship between family ownership and leverage because as family ownership raisesincreases, (the overlpaappingoverlapping between business and family spheres
increasesbetween) both losing socioemotional wealth and financial wealth also rises, so family firms will be more willing to preserve their financial wealth through lower levels of leverage levels. Family generation weakens the negative relationship between family ownership and leverage, whereas the variable, family members, strengthens this relationship. Implications for the Mexican context are also discussed.
This dissertation extends existing literature by including behavioral agency theory as an alternative approach that canto explaining the capital structure decision of family firms. The
inclusion of behavioral agency theory as an approach for analyzing capital structure decisions in family firms contributes to the literature in three ways. First, the consideration of socioemotional wealth, as a critical reference for decision mtaking, broadens the understanding of capital
structure decisions in family firms. Especially because theThis is especially important as the inclusion of socioemotional wealth as a factor that impacts capital structure, allows this
dissertation to take into accountconsider the non-economic motives related to financial decisions.
Thise dissertation shows that capital structure decisions in family firms imply the analysis of both socioemotional wealth and financial wealth. Second, the use of behavioral agency theory as a framework for studying capital structure implies a broader analysis of capital structure in family firms, which previous theories of capital structure do not address. Agency theory has been widely used toin explaining the capital structure decision in family firms. This dissertation shows that behavioral agency extends the agency theory explanation of the capital structure decision in family firms and offers a more flexible framework that could explain contradictory results. And, thirdfinally, thise dissertation contributes to the family firm literature and financial literature by recognizing the influence of family variables on capital structure. Traditional financial theories that study capital structure decisions do not take into account these family characteristics.
The study of capital structure in family firms has important academic and practical implications. On the academic side, the understanding of capital structure decisions in family firms contributes to the a deeper understanding of family firms as the most prevalent
organizational structure in the worldglobally the globe. On the practical side, the relevance of this study relies on the possibility thatof managers and practitioners willto use it to derivate important insights and policies ofinto how the affective endowments of familiesies’ affective
endowments can affect financial decisions, and how family firms take into account both socioemotional and financial wealth, when taking strategic decisions.
Keywords: Capital structure, determinants of capital structure, family firms, publicly held firms, behavioral agency theory, socioemotional wealth.
Acknowledgements
I want to specially thankhave enormous gratitude towards to:
CONACYT and the ITESM for providing me with the funds and scholarship to complete my PhD.
Doctor Teo, my advisor, who was a guide and a mentor. Thanks for all the patience, the counsels, and the assistance, and of course thanks for yourthe sincerity.
And alsoAlso, special thanks to my Ddissertation Committee: Doctor Francesco and Doctor René.
Doctor Carrillo, who was a mentor and an inspiration of scientific humbleness.
Doctor Aydyn Ozkan, who provide me with several pieces of important advices.
All my professors at EGADE Business School, who taught me valuable lessons in of efficiency, achievement, and persistence.
My parents who knew, many years before me, that a scientific life upraises enriches any human being.
To my grandmother Leonor.
Contents
CHAPTER 1 Introduction ... 1
1.1 Statement of the problem ... 5
1.2 Purpose of the study ... 6
... 1.3 Research question ... 7
1.4 Research objectives ... 7
1.5 Significance of the study ... 8
1.6 Organization of the study ... 8
1.7 Chapter’s references ... 9
CHAPTER 2 Literature Review ... 145
2.1 Family firm definition ... 156
2.2 Literature review ... 178
2.2.1 Theories of capital structure ... 178
2.2.1.1 Trade-off theory ... 178
2.2.1.2 Pecking order theory ... 189
2.2.1.3 Agency theory ... 189
... 2.2.1.4 Market timing theory ... 19
2.2.2 Capital structure determinants ... 1920
2.2.2.1 Measurements of capital structure ... 234
2.2.3 Literature review: capital structure in family ... 234
2.2.3.1 Theories applied to family ... 256
2.2.3.2 Determinants of capital structure in family firms ... 2930
2.2.3.2 Differences between family firms and non-family firms ... 378
2.3 Theoretical framework ... 412
2.3.1 Agency theory... 412
2.3.2 Behavioral agency theory ... 434
... 2.3.3 Socioemotional wealth ... 445
2.4 Chapter’s conclusions ... 512
2.5 Chapter’s references ... 534
CHAPTER 3 Empirical and Theoretical Models ... 6970
3.1 Theoretical background ... 712
3.1.1 Capital structure decision: a theoretical framework ... 746
3.2 Conceptual Model... 78
3.1.1 Gains versus losses: a mixed gamble perspective ... 8180
3.3 Empirical Model ... 856
3.3.1 Family Firms versus non-family firms ... 86
3.3.2 Family ownership ... 88
3.3.3 Moderation effects... 8990
3.3.3.1 Family generation... 8990
3.3.3.2 Firm size ... 91
3.3.3.3 Family members ... 92
3.4 Chapter3.4 Chapter’s conclusions ... 923
3.5 Chapter’s references ... 945
CHAPTER 4 The Mexican Context ... 102
4.1 Mexican Macro Context ... 1032
4.1.1 Social, cultural, and political context ... 103
4.1.2 Economic context ... 1053
4.1.3 Financial context ... 106
4.1.4 Business context ... 108
4.2 Firms in Mexico ... 109
... 4.2.1 Research of family firms in Mexico ... 110
4.2.2 Ownership and control enhancing mechanism ... 110
4.2.3 Business groups in Mexico ... 114
4.3 Business families in Mexico ... 120
4.3.1 Family relations in Mexican firms ... 123
4.3.2 Characteristics of publicly held family firms in Mexico ... 130
4.4 Chapter’s conclusions ... 133
4.5 Chapter’s references ... 135
CHAPTER 5 Methods, Results and Discussion ... 142
5.1 Research Design ... 143
5.2 Data ... 149
5.2.1 Data Sample ... 149
5.2.2 Data Collection ... 150
5.3 Methods... 152
5.3.1 Pooled Regression ... 153
5.3.2 Moderation effects... 1543
5.4 Variables ... 154
5.4.1 Family firms ... 154
5.4.2 Dependent variables ... 155
5.4.3 Independent variables ... 155
5.4.4 Moderator variables ...156
5.4.5 Control variables ... 156
5.5 Univariate analysis ... 1587
5.5.1Descriptive statistics ... 1587
5.6 Multivariate analysis ... 1632
5.6.1 Family firms versus non-family firms ... 1632
5.6.2 Family ownership ... 164
5.6.3 Moderator variables ... 1665
5.6.4 Control variables... 1698
5.7 Endogeneity tests... 17368
5.8 Robustness checks... 17568
5.9 Discussion on Mexican family firms... 1795
5.10 Chapter’s conclusions ... 18076
5.11 Chapter’s references ... 18277
CHAPTER 6 Conclusions ... 1872
6.1 Review of the Review of the Study ... 1883
6.2 Summary of selected findings ... 19387
6.2.1 Literature review findings ... 19387
6.2.2 Context findings ... 19488
6.2.3 Empirical findings ... 19589
6.3 Limitations suggestions of future study ... 1950
6.4 Extensions ... 1970
6.4.1 Paradox theory ... 1971
6.4.2 Myopic loss aversion ... 1981
6.5 Contribution ... 1983
6.6 Concluding remarks ... 1993
6.7 Chapter references ... 200194
VITA ... 2060
List of tables
Table 2.1 Capital Structure Determinants... 223
Table 2.2 Review of Measueres of Capital Structure ... 245
Table 2.3 Determinants of capital structure in Family Firms ... 367
Table 2.4 Literature Review Summary ... 389
Table 2.5 Definition of behavioral agency theory terms ... 456
Table 2.6 Theories of decision making ... 501
Table 3.1 Terms of Behavioral Agency Theory Applied to Family Firms... 75
Table 3.2 Theoretical Review: the Benefits and Costs of Debt ... 79
Table 4.1 Ownership Concentration in Mexican Publicly Held Firms... 111
Table 4.2 Publicly held family firms in Mexico ... 121
Table 4.3 Family Types in Publicly Held Mexican firms ... 124
Table 4.4 Frequency of Family Controlled, Family Managed, Family Owned, and Business Family Firms ... 131
Table 4.5 Statistics about Family Characteristics of Publicly Held Family Firms ... 132
Table 4.6 Proportions: Family Characteristics of Publicly Held Family Firms... 133
Table 5.1 Variables Used in the Study... 157
Table 5.2 Descriptive Statistics Overall Sample ... 159
Table 5.3 Descriptive statistics non-family versus family firms ... 1610
Table 5.4 Correlation Among Variables... 1621
Table 5.5 Regression Coefficients Pooled OLS, Partial Effect... 1653
Table 5.6 Regression Coefficients Pooled OLS ... 1710
Table 5.7 Instrumental Regression ... 174
Table 5.87 Robustness Check Hypothesis 1 ... 1761
Table 5.98 Robustness Checks for Hypotheses 2 and 3 ... 1783 Table 5.109 Robustness Checks for Hypotheses 2 and 3, Fixed and Random Effects 1794
List of Figures
Figure 3.1 Behavioral agency theory model of capital structure decisions of family firms...
...854 Figure 4.1 Growth in Mexico, 1985-2016 ... 106 Figure 4.2 Inflation4.2 Inflation in Mexico, over the decades... 106 Figure 4.3 Market capitalization in Mexico ...107 Figure 4.4 Summary of minority investor protection index for Mexico and comparison economies ...108 Figure 4.5 Interlocking boards of directors, 2011...116 Figure 4.6 Corporate governance of Mexican grupos ...117 Figure 4.7 Family business grupos in Mexico ...119 Figure 4.8 Baillères family ...125 Figure 4.9 Azcárraga family. ...126 Figure 4.10 Sada Treviño family ...127 Figure 4.11 Slim family ...128 Figure 4.12 Gallardo Thurlow family ... 129 Figure 5.1 Research Design ...148 Figure 5.2 Moderation Effects Family Generation...17069 Figure 5.3 Moderation Effects Firm Size 17069
Figure 5.3 Moderation Effects Family Members 17069
CHAPTER 1 Introduction
A family firm is a business governed and/or managed by a dominant coalition, the family, that is potentially sustainable across generations (Chua, Chrisman, & Sharma, 1999). Family firms are the world’s most predominant form of organizational structure (Claessens, Djankov, Fan, & Lang, 2002; Faccio and Lang, 2002; Porta, Lopez-de-Silanes, and Shleifer, 1999). Family firms have been represented as a combination of two systems: a non-economic oriented system, the family system;, and an economic oriented system, the business system (Chrisman, Chua, &
Steier, 2005; Distelberg & Sorenson, 2009; Ward, 2016; Zachary, 2011).
According to scholars, financial decisions in family firms differ from other organizations, (Koropp, Grichnik, & Kellermanns, 2013; Koropp, Kellermanns, Grichnik, & Stanley, 2014), because family firms follow both economic and non-economic goals and motivations (Blanco- Mazagatos, de Quevedo-Puente, & Castrillo, 2007; Gallo, Tàpies, & Cappuyns, 2004). One main financial decision is capital structure, which refers to the firms’ financing decision, between through debt, stock, or a combination of both. Thise capital structure decision represents an important feature of firms because of the firm’s need to maximize returns, and also because of the impact of this capital structure decision’s impact on the firm’s competitive ability (Abor, 2005), on the firm’s value (Miller, 1977; Myers, 1977) and on the firm’s ability to survive (Van Auken, Kaufmann, & Herrmann, 2009).
The study of capital structure traces back to the work of Modigliani & Miller (1958) who established that under a perfect capital market and perfect competition assumptions, debt and equity become perfect substitutes for each other. However, if the assumption of perfect market conditions is relaxed, debt and equity are no longer perfect substitutes, and the factors that
contribute to the firm’s choice between debt and equity become relevant. In response to the limitations of the Modigliani & Miller's (1958) theorem, four alternative theories have been developed to explain the capital structure of the firm.
The first theory, trade-off theory, suggests that capital structure decisions depend on the balance between the benefits and costs associated with the use of debt (Miller, 1977). The second theory, pecking order theory, states that firms rank their capital choice: they prefer internal financing over debt and debt over equity (Myers, 1977, 1984). The third theory, agency theory, argues that managers prefer less debt to reduce bankruptcy and human capital risks, while shareholders prefer more debt to reduce the overinvestment problem (Jensen, 1986). Finally, the market timing theory states that firms chose a capital structure based on the market valuation of the debt or equity instruments (Baker & Wurgler, 2002).
Empirical and theoretical studies have used capital structure theories to better understand the family firms’ capital structure decision (Blanco-Mazagatos et al., 2007; López-Gracia &
Sánchez-Andújar, 2007; Romano, Tanewski, & Smyrnios, 2001; Vieira, 2013). The
principles of from agency theory are highly frequently used in the literature of capital structure in family firms studies (Ampenberger, Schmid, Achleitner, & Kaserer, 2013; Anderson, Mansi, &
Reeb, 2003; Bjuggren, Duggal, & Giang, 2012; Blanco-Mazagatos et al., 2007). This theory explains that debt can act as a monitoring mechanism, preventing family members’ from deviating fromof family objectives (Anderson et al., 2003). Studies also show that family firms use the pecking order hierarchy to choose their capital structure (López-Gracia & Sánchez- Andújar, 2007; Romano et al., 2001): they use internal financing in order to maintain control and avoid risk (Vieira, 2013). Molly, Laveren, and Jorissen (2012) explain that the use of a pecking
order is valid, until the point that a family firm decides to growth, and will need, thusat which time it needs to look for external funding.
The family firms’ desire to maintain control and avoid risk can explain a preference for internal sources of financing, which follows the pecking order theory (Vieira, 2013); but when family firms need to grow they will look for external financing (Molly et al., 2012)., Uand under such circumstances, the capital structure choice is not so clear, because family desire to maintain control (Mishra & McConaughy, 1999), and to avoid risk (Schmid, 2013) have opposing effects on debt (Matias Gama & Mendes Galvão, 2012). Other unique characteristics of family firms impact the capital structure decision: the desire to reduce agency costs, (Schulze, Lubatkin, Dino,
& Buchholtz, 2001), and their long term orientation (Molly et al., 2012). Traditional theories of capital structure do not incorporate those elements in their explanaition of capital structure choice.
Furthermore, traditional theories of capital structure fall short in offering an explanation of how family firms chose their capital structure. For example, (Matias Gama & Mendes Galvão, (2012) argue that the different levels of debt observed in family firms challenge the existing capital structure literature. AndFurthermore, Koropp et al. (2013) establish that capital structure theories were not developed with family firms in mind, as the financial behavior of family firms financial behavior follows idiosyncratic policies (Gallo & Vilaseca, 1996).
Moreover, the empirical evidence, on the differences between family and non-family firms’
capital structure, is contradictory. While some studies find that family firms use more debt in comparison to non-family firms (Anderson et al., 2003; King & Santor, 2008; Setia-Atmaja, Tanewski, & Skully, 2009; Vieira, 2013), other studies suggest lower levels of debt inof family firms in relation to non- family firms (Ampenberger et al., 2013; Gallo & Vilaseca, 1996;
McConaughy, Matthews, & Fialko, 2001; Mishra & McConaughy, 1999). Koropp et al. (2014) argue that further investigation is needed to understand why family firms engage in certain forms of financing and the differences between family and non-family firms.
This dissertation expands the literature by using a behavioral agency-theoretical lens to study capital structure decisions in family firms. Thise Bbehavioral agency approach can incorporate onsiders the economic and non-economic considerations that affect family firms’s financial decision-making, how family firms differ from non-family firms, and how family firms balance considerations of control maintenance and risk- avoidance considerations. Behavioral agency theory is an extension of agency theory which is rooted oin prospect theory (Wiseman &
Gomez-Mejia, 1998). In comparison to agency theory, that which establishes stable risk
preferences and does not take into account the risk- seeking behavior, behavioral agency theory states that risk- taking behaviors and risk preferences change not only over time, but with the problem framing. Individuals frame their problems comparing anticipated outcomes versus to a reference point. When the framed prospects are positive (gain), decision makers will exhibit risk-- averse preferences; and when the framed prospects are negative (loss), decision makers will exhibit risk- seeking preferences (Wiseman & Gomez-Mejia, 1998). Behavioral agency theory also considers that agents are averse to losses in their in their individual wealth (Wiseman
& Gomez-Mejia, 1998).
A variant of behavioral agency theory applied to family firms is the construct of
socioemotional wealth (Kumeto, 2015). According to Miller and Le Breton-Miller (2014) the term socioemotional wealth is an umbrella concept that covers the different types of social and affective endowments that accrue to family members as a result of controlling a business. It is also defined as the noneconomic utilities that family members obtain from their businesses
(Gómez-Mejía, Haynes, Núñez-Nickel, Jacobson, & Moyano-Fuentes, 2007). Socioemotional wealth has been applied toin the context of family firms’ context to analyze financial
performance (Gottardo & Moisello, 2015), environmental performance (Berrone, Cruz, Gomez- Mejia, & Larraza-Kintana, 2010), earnings management (Stockmans, Lybaert, & Voordeckers, 2010), research and development (Patel & Chrisman, 2014), and firm exit (DeTienne & Chirico, 2013). The construct of socioemotional wealth is central to incorporatinge these non-economic utilities into the study of family firm financial decision-making.
1.1 Statement of the problem
The last paragraphs showed that family firms can follow a pecking order as long as they do not need to grow, whereas when family firms need to expand and grow they will look for
external financing (Molly et al., 2012), Aand among their financial options, the choice between equity and debt becomes a dilemma, because their desire to maintain control (Mishra &
McConaughy, 1999), and to avoid risk (Schmid, 2013), have opposing effects on debt (Matias Gama & Mendes Galvão, 2012).
In summary, traditional studies do not explain the opposing effects of control maintenance and risk aversion on capital structure decisions, nor do they explain the underlying circumstances that lead family firms to be more or less indebted in relation comparison to non-family firms, and neither do they explain that the financial decision making of family firm’s financial decision- making relies on both economic and non-economic motivations.
Additionally In addition to the theoretical challenges ofto explaining the capital structure decisions, the empirical evidence of capital structure has resulted into a set of different and unconnected research objectives: the applicability of traditional capital structure theories to the family business context (Burgstaller & Wagner, 2015; López-Gracia & Sánchez-Andújar, 2007),
the exploration of the determinants of family firms’ capital structure (Koropp et al., 2013; Vieira, 2013) and the investigation of differences between family and non-family firms capital structure levels (Mishra & McConaughy, 1999). These different viewpoints of capital structure in family firms’ research in research pertaining to family firms research, has resulted in a set of
inconclusive and disconnected empirical evidence, which has conducted intoled to an incomplete understanding of the capital structure phenomena. Thus an encompassing theoretical perspective is needed, in order to explain the idiosyncratic factors that shape capital structure decisions of family firms and, at the same time, provide more coherence to unconnected empirical evidence.
1.2 Purpose of the study
This dissertation proposes the use of a behavioral agency-theoretical lens, as a way to address the above research problem. Despite the analysis thatat other studies have analyzed conducted on the financial decision of family firms and how family idiosyncratic factors affect capital structure electionsdecisions, under behavioral perspectives (Koropp et al., 2014; Schulze, Lubatkin, & Dino, 2003), those studies do not explain how family firms take into account
economic and non-economic considerations whento choosinge their capital structure, and neither do they neither explain the rationalrationale behind capital structure decisions. Through the application of the behavioral agency theory family variant, the socioemotional wealth, this dissertation analyses the capital structure decisions of family principals’ capital structure decisions by taking into account idiosyncratic family factors (the desire to control the firm and risk aversion) that shape capital structure and linking them with previous empirical findings.
Specifically, this dissertation explains that the family firms’ capital structure decision is based on the consideration of both socioemotional wealth and financial wealth.
The purpose of this study is to investigate to what extent the use of a behavioral agency- theoretical lens can contribute to anthe enrichment of the understanding of the capital structure decisions of publicly held family firms. In order to To accomplish the purpose of theis study, thise dissertation: presents a literature review that extends the understanding of the current research problem and provides a theoretical framework that explains behavioral agency theory and its roots; then, presents theoretical propositions based on the behavioral agency theory approach; tests the theoretical propositions using a sample of Mexican publicly held family firms; and, finally, provides conclusions, discussion, and suggestions for future research.
1.3 Research question
The fundamental research question addressed in this dissertation is:
To what extentd, does the use of a behavioral agency-theoretical lens enriches the understanding of capital structure decisions of publicly held family firms?
Two subsidiary questions are also examined:
How does behavioral agency theory explain the capital structure decision of publicly held family firms?
To what extentd does the application of the behavioral agency theory framework predict the capital structure decision of publicly held family firms?
1.4 Objectives
The objectives of the dissertation are to:
Review the existing literature of capital structure, and capital decisions in family firms.
Provide a theoretical framework that allows the development of theoretical propositions.
Develop propositions, based on the behavioral agency theory approach, that explain family firms’ capital structure decisions.
Collect and analyze relevant data.
Test empirically the dissertation’s theoretical hypotheses.
Provide implications, findings and conclusions about the application of behavioral agency theory as an alternative theoretical application to theof capital structure decision of family firms.
1.5 Significance of the study
This study is important because it makes contributions to both theoretical and empirical literature. First, this study proposes and tests a theoretical model of capital structure decision- making in family firms. The model, validated empirically, explains that family principals can take into account both financial and socioemotional wealth, using a mixed gamble perspective Under a mixed gamble perspective, firms take their decisions weighting current socioemotional endowment and future financial wealth. This constitutes an important advance in literature, because it verifies that, forin financial decisions, family principals take into account both economical and non-economical settings, which traditional financial theories disregard.
Second, this dissertation extends previous literature by using the behavioral agency theoretical-lens to analyze capital structure decision-making. No previous studies, that use the behavioral agency theory to explain the capital structure decision of family firms, were
previously identified. This opens an opportunity for future research, for the author and also other for other scholars who want to take into account the results obtained and presented in this study, and use behavioral agency theory to explain capital structure decisions in family firms.
1.6 Organization of the study
This study is organized as follows. Chapter 1 presents the dissertation’s introduction, statement of the problem, and research question. Chapter 2 contains the literature review and the
theoretical framework. Thise chapter reviews the capital structure literature and the studies about capital structure in family firms, and presents a theoretical framework that briefly introduces behavioral agency theory and its theoretical roots. Chapter 3 presents theoretical propositions and the research hypotheses. These theoretical propositions explain the mechanisms that relate therelate the behavioral agency theory approach to the capital structure decision of family firms.
And, and the hypotheses transform theoretical propositions into testable relationships. Chapter 4 describes and analyzes the context of family firms in Mexico. Chapter 5 presents the methods and results of the dissertation’s tests. And Finally, Chapter 6 discusses the dissertation’s findings, implications, and conclusions.
1.7 Chapter’s references
Abor, J. (2005). The effect of capital structure on profitability: an empirical analysis of listed firms in Ghana. The Journal of Risk Finance, 6(5), 438–445.
Ampenberger, M., Schmid, T., Achleitner, A.-K., & Kaserer, C. (2013). Capital structure decisions in family firms: empirical evidence from a bank-based economy. Review of Managerial Science, 7(3), 247–275.
Anderson, R. C., Mansi, S. A., & Reeb, D. M. (2003). Founding family ownership and the agency cost of debt. Journal of Financial Economics, 68(2), 263–285.
Baker, M., & Wurgler, J. (2002). Market timing and capital structure. The Journal of Finance, 57(1), 1–32.
Berrone, P., Cruz, C., Gomez-Mejia, L. R., & Larraza-Kintana, M. (2010). Socioemotional wealth and corporate responses to institutional pressures: Do family-controlled firms pollute less? Administrative Science Quarterly, 55(1), 82–113.
Bjuggren, P.-O., Duggal, R., & Giang, D. T. (2012). Ownership Dispersion and Capital
Structures in Family Firms: A Study of Closed Medium-sized Enterprises. Journal of Small Business & Entrepreneurship, 25(2), 185–200.
Blanco-Mazagatos, V., de Quevedo-Puente, E., & Castrillo, L. A. (2007). The Trade-Off Between Financial Resources and Agency Costs in the Family Business: An Exploratory Study.
Family Business Review, 20(3), 199–213.
Burgstaller, J., & Wagner, E. (2015). How do family ownership and founder management affect capital structure decisions and adjustment of SMEs? Evidence from a bank-based economy.
The Journal of Risk Finance, 16(1), 73–101.
Chrisman, J. J., Chua, J. H., & Steier, L. (2005). Sources and consequences of distinctive familiness: An introduction. Entrepreneurship Theory and Practice, 29(3), 237–247.
Chua, J. H., Chrisman, J. J., & Sharma, P. (1999). Defining the family business by behavior.
Entrepreneurship: Theory and Practice, 23(4), 19–19.
Claessens, S., Djankov, S., Fan, J. P., & Lang, L. H. (2002). Disentangling the incentive and entrenchment effects of large shareholdings. The Journal of Finance, 57(6), 2741–2771.
DeTienne, D. R., & Chirico, F. (2013). Exit strategies in family firms: How socioemotional wealth drives the threshold of performance. Entrepreneurship Theory and Practice, 37(6), 1297–1318.
Distelberg, B., & Sorenson, R. L. (2009). Updating systems concepts in family businesses: A focus on values, resource flows, and adaptability. Family Business Review, 22(1), 65–81.
Faccio, M., & Lang, L. H. (2002). The ultimate ownership of Western European corporations.
Journal of Financial Economics, 65(3), 365–395.
Gallo, M. Á., Tàpies, J., & Cappuyns, K. (2004). Comparison of family and nonfamily business:
Financial logic and personal preferences. Family Business Review, 17(4), 303–318.
Gallo, M. A., & Vilaseca, A. (1996). Finance in family business. Family Business Review, 9(4), 387–401.
Matias Gama, A. P., & Mendes Galvão, J.M. (2012). Performance, valuation and capital structure: survey of family firms. Corporate Governance: The International Journal of Business in Society, 12(2), 199–214.
Gottardo, P., & Moisello, A. M. (2015). The impact of socioemotional wealth on family firms’
financial performance. Problems and Perspectives in Management, 13(1), 67–77.
Jensen, M. C. (1986). Agency cost of free cash flow, corporate finance, and takeovers. Corporate Finance, and Takeovers. American Economic Review, 76(2). Retrieved from
http://papers.ssrn.com/sol3/Papers.cfm?abstract_id=99580
King, M. R., & Santor, E. (2008). Family values: Ownership structure, performance and capital structure of Canadian firms. Journal of Banking & Finance, 32(11), 2423–2432.
Koropp, C., Grichnik, D., & Kellermanns, F. (2013). Financial attitudes in family firms: The moderating role of family commitment. Journal of Small Business Management, 51(1), 114–
137.
Koropp, C., Kellermanns, F. W., Grichnik, D., & Stanley, L. (2014). Financial decision making in family firms: An adaptation of the theory of planned behavior. Family Business Review, 27(4), 307–327.
Kumeto, G. (2015). Behavioral Agency Theory and the Family Business. Theoretical Perspectives on Family Businesses, 78.
López-Gracia, J., & Sánchez-Andújar, S. (2007). Financial structure of the family business:
evidence from a group of small Spanish firms. Family Business Review, 20(4), 269–287.
McConaughy, D. L., Matthews, C. H., & Fialko, A. S. (2001). Founding family controlled firms:
Performance, risk, and value. Journal of Small Business Management, 39(1), 31–49.
Miller, D., & Le Breton-Miller, I. (2014). Deconstructing Socioemotional Wealth.
Entrepreneurship Theory and Practice, 4(38), 713–720.
Miller, E. M. (1977). Risk, uncertainty, and divergence of opinion. The Journal of Finance, 32(4), 1151–1168.
Mishra, C. S., & McConaughy, D. L. (1999). Founding family control and capital structure: The risk of loss of control and the aversion to debt. Entrepreneurship: Theory and Practice, 23(4), 53–53.
Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261–297.
Molly, V., Laveren, E., & Jorissen, A. (2012). Intergenerational differences in family firms:
Impact on capital structure and growth behavior. Entrepreneurship Theory and Practice, 36(4), 703–725.
Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147–175.
Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 574–592.
Patel, P. C., & Chrisman, J. J. (2014). Risk abatement as a strategy for R&D investments in family firms. Strategic Management Journal, 35(4), 617–627.
Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world.
The Journal of Finance, 54(2), 471–517.
Romano, C. A., Tanewski, G. A., & Smyrnios, K. X. (2001). Capital structure decision making: A model for family business. Journal of Business Venturing, 16(3), 285–310.
Schmid, T. (2013). Control considerations, creditor monitoring, and the capital structure of family firms. Journal of Banking & Finance, 37(2), 257–272.
Schulze, W. S., Lubatkin, M. H., & Dino, R. N. (2003). Exploring the agency consequences of ownership dispersion among the directors of private family firms. Academy of Management Journal, 46(2), 179–194.
Schulze, W. S., Lubatkin, M. H., Dino, R. N., & Buchholtz, A. K. (2001). Agency relationships in family firms: Theory and evidence. Organization Science, 12(2), 99–116.
Setia-Atmaja, L., Tanewski, G. A., & Skully, M. (2009). The role of dividends, debt and board structure in the governance of family controlled firms. Journal of Business Finance &
Accounting, 36(7–8), 863–898.
Stockmans, A., Lybaert, N., & Voordeckers, W. (2010). Socioemotional wealth and earnings management in private family firms. Family Business Review, 23(3), 280–294.
Van Auken, H., Kaufmann, J., & Herrmann, P. (2009). An empirical analysis of the relationship between capital acquisition and bankruptcy laws. Journal of Small Business Management, 47(1), 23–37.
Vieira, E. S. (2013). Capital Structure Determinants in the Context of Family Firms. Proceedings in ARSA-Advanced Research in Scientific Areas, 1. Retrieved from http://www.arsa-
conf.com/archive/?vid=1&aid=3&kid=60201-83&q=f1
Ward, J. (2016). Keeping the family business healthy: How to plan for continuing growth, profitability, and family leadership. Springer. Retrieved from
https://books.google.com.mx/books?
hl=en&lr=&id=QtwYDAAAQBAJ&oi=fnd&pg=PR9&dq=Keeping+the+family+business+
healthy:+How+to+plan+for+continuing+growth,+profitability,
+and+family+leadership&ots=-Wp8Rw3F39&sig=aBozgCKHX8UpcIL29TwzgdkWeXk Wiseman, R. M., & Gomez-Mejia, L. R. (1998). A behavioral agency model of managerial risk
taking. Academy of Management Review, 23(1), 133–153.
Zachary, R. K. (2011). The importance of the family system in family business. Journal of Family Business Management, 1(1), 26–36
CHAPTER 2 2 Literature Review
The purpose of this chapter is twofold:, first, to give empirical support to the research problem, and second, to provide theoretical foundations for the dissertation’s propositions that will be presented in Chapter 3. In order to address the purpose, this chapter contains a literature review, and also revises the theoretical framework used to build the dissertation’s hypotheses.
The purpose of the literature review’s purpose is to provide sustainment toevidence for the research problem, and whereas the theoretical background will’s purpose is to provide to the dissertation with theoretical foundations used in the next chapter. Additionally, thise chapter revises the definition of a family firm definition and provides the chapter’s conclusions.
The research problem of the dissertation’s research problem, as presented in Chapter 1, states that the literature on family firms’ capital structure literature formsis a set of unconnected empirical evidence, which results in an incomplete image of capital structure decisions in family firms. The literature on family firm’s capital structure literature can be divided into by three different research objectives: the applicability of traditional capital structure theories to the family business context (Burgstaller & Wagner, 2015; López-Gracia & Sánchez-Andújar, 2007), the exploration of determinants of family firms’ capital structure (Koropp, Grichnik, &
Kellermanns, 2013; Vieira, 2013), and the investigation of differences between the capital structure levels of family and non-family firms capital structure levels (Mishra & McConaughy, 1999). This chapter broadens the explanation of the research problem by presenting how studies have previouslyd explored these research objectives. The literature review presents, in a more detailed way, the shortcomings of the literature shortcomings, identified in the problem statement.
This dissertation addresses the research problem by proposing the use of a behavioral agency theoretical-lens as a way to enrich the understanding of the capital structure decisions in family firms. In order to contribute to the dissertation’s purpose, thisThis chapter introduces the theoretical foundations used to build the dissertation’s propositions and hypotheses.
The chapter goes as follows. The first section of this chapter reviews the definition of family firm. The second section is a literature review, which encompasses topics as family firms definitions, capital structure theories, and capital structure in family firms. The third section describes briefly the theoretical foundations of agency theory, behavioral agency theory, and socioemotional wealth. The fourth section describes presents the conclusions of the chapter.’s conclusions.
2.1 Family Firm Definition
An adequate definition of a family firm has important effects on the resulting theoretical relations and empirical findings in studies of family firms’ studies. According to Westhead and Cowling (1998), variations toon the definition of family firm affects the scale of family firm activity in any economy as, . Since, depending on the definition, the number proportion of family firms can vary from 15% to 85% of the total of firms. In a study about performance, Miller, Le Breton-Miller, Lester and Canella (2007) fouind that if the definition of family firm discards anythe firms owned and founded by a sole individual, then family firms, in any case, outperform the rest of firms. The authors add that a different definition of family firm has important
implications on results.
Literature shows that there are different definitions of family firm. Shanker & Astrachan (1996) differentiate between a narrow and a broader definition of family business. The narrow vision states that a firm can be classified as a family firm when the family is involved in the daily
business. On the other hand, the broader definition states that a firm can be a family firm only ifas long as the family sets the firm’s strategic direction. Chrisman, Chua, and Sharma (2005) use two approaches to define family firms: the components-of- involvement approach and the essence approach. Following the components-of-involvement approach, a firm can be defined as a family firm when a) a family is the owner, b) the firm is family-managed, or c) a family
controls the firm. The main characteristics that constitute the essence approach are the following:
1) a family’s influence regarding on the strategy of the firm, 2) a family’s vision and their intention to keep control and hand the firm over to the next generation, 3) family firm behavior, and 4) distinctive familiness. Familiness refers to the unique set of resources derived from the interaction between the family, family members and the business (Habbershon, Williams, &
MacMillan, 2003).
The following paragraphs show a brief review of different characteristics that scholars take into account fwhenor defining family firms. One important aspect for of a family firm definition is the founder. For example, McConaughy, Walker, Henderson, and Mishra (1998) define a family firm as any firm managed by the founder or the founder’s family members. Other scholars (Anderson & Reeb, 2004; Cronqvist & Nilsson, 2003; Faccio & Lang, 2002; Porta, Lopez-de- Silanes, & Shleifer, 1999) consider any business a family firm as long as the founder or the founder’s family still own a fraction of the company or hoeld a position on the board.
Another stream of literature establishes that the level of ownership is the key feature to defininge a family firm. Gomez-Mejia, Nunez-Nickel, & Gutierrez (2001) establish that thee level of ownership and control of the family can be as low as 5 percent, w. While others studies establish that the level of stock owned by the family must be at least 50 percent (Ang, Cole, &
Lin, 2000).
One of the of most cited definition of family firms is from Chua's et al. (1999), which states that a family firm is a business governed and/ or managed by a dominant coalition , the family, in a manner potentially sustainable across generations. This dissertation usesapplies the definition of Chua's et al., (1999) definition ofwhen using the term family firm.
2.2 Literature Review
2.2.1 Theories of capital structure. The study of capital structure traces back to the work of Modigliani & Miller (1958). They state that, under perfect capital market and perfect
competition conditions, the firm’s value is not related to capital structure, so capital structure is irrelevant. Under such circumstances, debt and equity are perfect substitutes for each other. But, when the assumption of perfect capital markets is relaxed,; taxes and bankruptcy costs,
informational asymmetries, and transactional costs impact the capital structure decisions; and then, the choice between debt and equity becomes relevant.
Different theories surged after Modigliani & Miller's (1958) theorem that to explain why the capital structure choice is relevant. Those theories explain, from different perspectives, how firms chose their capital structure. Mainly fourFour main theories explain the choice between equity: trade-off theory (Miller, 1977), pecking order theory (Myers, 1977, 1984), agency theory (Jensen, 1986) and to market timing theory (Baker & Wurgler, 2002). The following paragraphs briefly explain each of these theories.
2.2.1.1 Tradeoff theory. Miller (1977) proposes tradeoff theory, which argues that there are advantages (i.e. tax benefits), but also costs associated to the use of leverage (i.e. costs of
financial bankruptcy, and financial distress). Firms chose between advantages and disadvantages
related to the use of debt. The election of an optimal or target capital structure depends on the balance between opposite effects of the tax benefits of debt and the costs associated to financial distress.
Low levels of debt, imply an almost-zero probability of financial distress; higher levels of debt imply that bankruptcy costs are relevant and, probably, higher than tax benefits. Firms with greater tax shields of debt, low costs of financial distress, and favorable mispricing of debt relative to equity, are expected to be more highly leveraged (Faulkender & Petersen, 2006).
2.2.1.2 Pecking order theory. Pecking order theory predicts that firms prioritize their
capital choice. They, preferring internal financing over debt and debt to equity (Myers, 1977, 1984). Rather, firmsFirms follow a pecking order: they prefer internal funds, followed by debt, hybrid securities, and issues of new stock (ordinary shares).
The hierarchical use of debt is based on the cost of financing, which increases in the presence of information asymmetries. Pecking order theory suggests that there can be an adverse selection cost toin the issuing of stock (Graham & Leary, 2011). External sources of financing denote higher costs of financing, because information about external creditors implies costs (Myers, 1977, 1984). This leads to a preference for internal funds, because, in comparison with other sources of financing, internal financing has the lowest cost of financing and fewerless information asymmetries.
2.2.1.3 Agency theory. Agency theory states that there are costs associated to the
separation of ownership and control (Jensen, 1986), and that those costs are relevant when issuing debt titles or equity. Managers prefer low financial leverage ratios because this
diminishes the risk of financial distress and protects their human capital. ContrarilyIn contrast, shareholders prefer high financial leverage because thisit reduces the overinvestment problem of
the free cash flow. Managers want to invest, and shareholders want cash at the form of dividends.
Managers want to invest even if the net present value of the project is negative. In order to reduce this behavior, and shareholders can use debt act as a disciplining mechanism for managers (Harris & Raviv, 1991).
2.2.1.4 Market timing theory. Market timing theory is the most recent theoretical approach tohat explains the capital structure decision. This theory takes its name from corporate finance.
In corporate finance “equity market timing” refers to the practice of issuing equity when share prices are high and repurchasing when share prices are low (Baker & Wurgler, 2002). The theory states that the supply conditions of the equity are also important for the capital structure. The main proposition of this theory is that the propensity to issue equity is related to the past equity returns (Baker & Wurgler, 2002). And thusThus, capital structure is related to the past value.
Modigliani & Miller's (1958) theorem (1958) states that there is no possibility of opportunistically gains derived from the switching between debt and equity, because of the perfect substitutability between debt and equity. When the assumptions of Modigliani & Miller (1958) are relaxed, and markets are not perfect but, and are instead inefficient, or segmented, there are gains associated withto the market timing (Baker & Wurgler, 2002). Actualnd there exist actual differences in the costs and gains associated to the use of debt or equity also exist.
The objective of timing the markets is to gain from the fluctuations in the costs of equity relative to the cost of debt, or vice versa.
Firms issue equity instead of debt when the market value is high, (this is in relation to the book value and past market values). Firms tend to repurchase equity when the market value is low. According to the time to market theory of capital structure, low leveraged firms are those that which raised funds when their market valuations were high. On the other hand, low
leveraged firms are those that raised funds when their market valuations were low (Baker &
Wurgler, 2002). In synthesis synopsis, the capital structure depends highly on the past valuations of the firm.
2.2.2 Capital structure determinants. Harris & Raviv, (1991) highlight that literature has identified numerous determinants of capital structure. Even if,Although a lot of variables
determine capital structure,; Harris & Raviv, (1991) argue that there is a consensus, in literature, that leverage increases with fixed assets, non-debt tax shields, investments opportunities, and firm size; and that, on the other side, leverage decreases with volatility, advertising expenditure, the probability of bankruptcy, profitability and the uniqueness of the product. Graham & Harvey (2001) argue that companies with high leverage levels are associated withto size, age, tangible assets, lower market-to-book ratios, less volatile earnings and less R&D intensity. Frank and Goyal (2009) analyzed a sample of publicly traded companies in USA, from 1950 to 2003, they concludinged that the most reliable factors to determine capital structure, with a positive effect, are median industry leverage, tangibility, logarithm of assets, and expected inflation; and that the most reliable factor with a negative effect is the market-to-book assets ratio.
Even ifAlthough multiple studies present different determinants of capital structure, this chapter reviews the work of Deesomsak, Paudyal, and Pescetto (2004) study, which analyzes tangibility, profitability, firm size, growth opportunities, non-debt tax shields, earnings volatility, and share price performance. The authors analyze the expected effect on debt of capital structure determinants, in relation for the capital structure theories. Table 2.1 depicts the analysis that Deesomsak et al., (2004) analysis ofperformed on capital structure determinants, its expected effect according to theory, and the observed empirical effect .
Tangibility refers to the value of collateral assets. According to Rajan and Zingales (1995) tangible assets are easy to collateralize, so they contribute to the reduction of the agency costs of debt. Collaterals serves as a protection to lenders in case of facing problems with shareholders (Deesomsak et al., 2004). Collaterals also serve in case of the liquidation of the firm, with firms with low levels of tangible assets will havehaving higher levels of equity, in relation to debt, because they cannot provide debt collaterals (Scott, 1977).
Profitability refers to the firms’ ability to generate earnings. In agreement with pecking order theory, profitable firms prefer to use internal financing, so they preferring less debt because there is aof the cost associated to the informational asymmetry between managers and outside investors. However,; according to trade-off theory, profitable firms do not want to dilute the shareholders property, so they will prefer debt (Deesomsak et al., 2004).
Size has also an impact on capital structure. According to Rajan and Zingales (1995) size is an inverse proxy for the probability of default, as larger companies are more diversified, and less likely to bankruptcy., Ana expected positive relation between size and debt is in line with
tradeoff theory. Agency theory also explains the positive relation between size and debt, because larger firms have less fewer costs associated to debt, and less a smaller monitoring cost, so they will prefer more debt than the profits of tax shields (Deesomsak et al., 2004). Bigger firms also have better access to credit and present a more diluted ownership. Based on the pecking order theory, larger firms face lower information asymmetries, compared with smaller firms, so they can issue more equity (Delcoure, 2007).
Growth opportunities refer, to the market-to-book asset ratio. Deesomsak, et al. (2004) argue that growth opportunities have an impact on debt, because they provide firms with incentives to invest sub-optimally, expropriating wealth from debt-holders and, increasing the
cost of debt, which increases the use of equity. From a trade-off perspective, firms with high market-to-book ratios have higher costs of financial distress, so debt is less used less often (Rajan & Zingales, 1995).
Firms with a non-debt tax shield prefer lower levels of debt (Antoniou, Guney, & Paudyal, 2008). The trade-off theory predicts that firms will use higher levels of debt if there it presentss an advantage forin corporate saving taxes, as firms can use non-debt tax shields as depreciation as a way to reduce taxes (Deesomsak et al., 2004).
Liquidity refers to the relation between assets and liabilities. Pecking order theory states that liquid firms are not as prone to increase external capital, because liquid firms borrow less.
From an agency perspective, managers have incentives to manipulate liquid reserves from retained earnings in favor ofto shareholders, against debt-holders, increasing the agency cost of debt and, lessening the use of debt (Deesomsak et al., 2004).
Table 2.1
Capital Structure Determinants Variables Expected
theoretical relation
Mostly reported theoretical relation
Theories
Tangibility + + Agency theory: agency cost of debt. Trade-off
theory: financial distress, business risk
Profitability - -
Pecking order theory. Trade-off theory: bankruptcy costs. Other theory: dilution of ownership structure
+
Trade-off theory: tax. Free cash flow theory.
Signaling theory
Firm size + +
Trade-off theory: bankruptcy costs. Agency theory:
agency cost of debt.
Other theories: access to the market, economies of scale.
- Other theory: information asymmetry
Growth
opportunity - - Agency theory: agency cost of debt. Trade-off
theory: financial distress.
+ Signaling theory. Pecking order theory.
Non-debt tax
shield - - Trade-off theory: tax.
Liquidity - -
Agency theory: agency cost of debt. Free cash flow theory. Pecking order theory: use of internal resources.
+ Other theory: ability to meet short-term obligation.
Earnings
volatility/risk - - Trade-off theory: financial distress.
+ Agency theory
Share price
performance - - Market timing theory
Source: Based on: Deesomsak et al. (2004)
Liquidity refers to the relation between assets and liabilities. Pecking order theory states that liquid firms are not as prone to increase external capital, because liquid firms borrow less. From an agency perspective, managers have incentives to manipulate liquid reserves from retained earnings in favor of shareholders, against debt-holders, increasing the agency cost of debt and lessening the use of debt (Deesomsak et al., 2004).
Volatility of earnings refers to the dispersion of earnings. The trade-off theory predicts that higher risk (or more volatility in earnings) increases the probability of financial distress, with firms will being unable to fulfill debt commitments, and so firms prefer less debt (Deesomsak et al., 2004).
Share price performance, is the capital structure determinant that refers to the market timing theory. Market timing theory predicts that historic share prices impact on capital structure (Baker
& Wurgler, 2002). Issuance of new shares is made at a discount, because of the information asymmetry between managers and outside investors. Firms prefer equity to debt when share price rises.
2.2.2.1 Capital structure measurements. There are several and different measurements of capital structure. Table 2.2 depicts the different measurements of capital structure as identified in literature, the variables involved in the measurement , and the studies that use each measurement.
Six different ways of measuring capital structure were identified in the literature onf family firms’s capital structure. As accounting principles vary from country to country, also the accountability terms for measuring each measurement also varies.
2.2.3 Literature Review of Capital Structure in Family Firms. The beginning of the chapter stated that the capital structure literature be can be summarized into aas set of
unconnected research objectives. From the literature review, three different research objectives were have been identified: the applicability of traditional capital structure theories to the family business context, the exploration of determinants of family firms’ capital structure, and the investigation of differences between family and non-family firms’ capital structure levels. This section describes the literature related to capital structure in family firms divided into those three research objectives. First, the section describes the studies which apply the capital structure.
Table 2.2
Review of Measures of Capital Structure
Measure Description Alternative measurement
Leverage
Total debt to total assets (King
& Santor, 2008; Setia-Atmaja, Tanewski, & Skully, 2009)
Total liabilities to total assets
(Ampenberger, Schmid, Achleitner,
& Kaserer, 2013; González,
Guzmán, Pombo, & Trujillo, 2013;
Vieira, 2013)
Long term leverage
Long-term debt total assets (Anderson & Reeb, 2003;
González et al., 2013)
Debt maturity
Short term debt over total debt (McConaughy, Matthews, &
Fialko, 2001) Market definition of
leverage
Book value of long term debt over book value of long term debt plus market value of equity
Total liabilities over market value of total equity plus total liabilities (Ampenberger et al., 2013)
Leverage ratio
Debt over debt and equity (Anderson, Mansi, & Reeb, 2003; Schmid, Ampenberger, Kaserer, & Achleitner, 2008)
Total liabilities over total liabilities and equity (Ellul, 2008; Mishra &
McConaughy, 1999)
Book leverage Total liabilities minus current liabilities to total assets (Ampenberger et al., 2013)
Source: The author
theories applied to family firms. Then, the section reviews the different studies that explain the family factors that impact the capital structure decision of family firms. And thenFinally, a section briefly resumes summarizes the studies that address the debt differences between family and non-family firms. The chapter presents, at the end of this section, a summary of all of the identified studies of capital structure in family firms (Table 2.3).
2.2.3.1 Theories of capital structure applied to family firms. The former section briefly
describeds the most important theories of pertaining to capital structure. This section reviews the literature that explains and tests these capital structure theories in the context of the family firms.
This section explains the rationale of capital structure theories when applied to family firms, and resumes summarizes the literature that tests those theories.
Most of the empirical studies about capital structure in family firms rely on arguments of agency theory. Agency theory is an economic theory well used in management studies with the.
Agency theory’s main argument is that there is agent-principal conflict that occurs when the principal needs to monitor the agent which acts on his/her behalf (Jensen & Meckling, 1976).
Agency theory studies the relationship between managers and shareholders, but there are actually two types of agency problems (Fama & Jensen, 1983). The typeType I refers to the traditional agency conflict between managers and shareholders (Jensen & Meckling, 1976). Typehe agency conflict type II refers to the agency conflict between shareholders and minority shareholders (Morck & Yeung, 2003).
Scholars argue that family firms face less fewer agency costs of debt because of the lesser smaller separation between ownership and control (Anderson et al., 2003; Fama & Jensen, 1983;
Jensen & Meckling, 1976). And, soSo, family firm agency problem type I should be lower in family firms (Anderson et al., 2003), because in family firmshere the manager-shareholder definition is blurred (James, 1999). Nevertheless, in family firms the agency problem type II is higher than in non-family firms, as families tend to expropriate minority shareholder’s wealth (Villalonga & Amit, 2006). This conflict is the base of the agency theory’s explanation of capital structure decisions in family firms.
Referring to capital structure, agency theory proposes that debt mitigates agency costs, when used as monitoring mechanism tohat prevents agent deviation from maximizing behavior (Kochhar, 1996). This argument also applies tofor family firms, because families alsoy have agency costs (Chrisman, Chua, & Litz, 2004; Schulze, Lubatkin, & Dino, 2003a, 2003b;
Schulze, Lubatkin, Dino, & Buchholtz, 2001), so, debt can be used as a controlling mechanisms, preventing family members’ from deviatingons from family objectives (Anderson et al., 2003).
The reason why debtDebt can be use as monitoring mechanism is because debt-holders can monitor for both family members and non-family firm claimants (Anderson et al., 2003).
Moreover, Anderson and Reeb (2003) found that the interests of both the family’s and debt holders’ interests can be aligned. Anderson et al. (2003) propose that the unique incentives of founding families that can contribute to alleviatinge the conflicts between debt holders and shareholders are: firm survival and firm reputation. The first incentive that can alleviate the agency conflict is the family firms’ strong concern for survival (Casson, 1999; Chami, 2001).
Family firms want to pass the firm to future generations, so the family has a concern to preserve not only the career of family members (Curasi, Price, & Arnould, 2004), but also the wealth- generating capabilities of asset for future generations (Zellweger, Kellermanns, Chrisman, &
Chua, 2012). Families may want that successors tocan receive cash flows in form of dividends (Miller, and Le Breton-Miller, 2006), which. This means that family firms are willing to make long-horizon investments. Sirmon & Hitt (2003) use the term ‘patient capital’ to refer to thise financial capital that is invested in a long-term time horizon. Family shareholders are more concerned about the firm value than other types of shareholders, asthose non-family shareholders will focus only oin the maximization of the shareholder’s value maximization. The survival instinct aligns the interests of all stakeholders (Bjuggren, Duggal, & Giang, 2012), and also reducesthe conflicts between bondholders and shareholders can be less (Anderson et al., 2003).
The second concern of family firms is reputation. Family reputation refers to the general level of favorability that stakeholders hold towards a firm, reputation indicatinges the perceived admiration and trust in the firm’s admiration and trust that stakeholders perceive (Deephouse &
Carter, 2005), and the shareholders’ perceptions of the firm, its products, strategies, and employees (Fombrun & Shanley, 1990). Reputation is also an external indicator of the quality and worthiness of the family firm (Rao, Greve, & Davis, 2001). Scholars, John and Nachman (1985), found that reputation, measured as better investment and repayment records, offsets the
