Family firms

Profitability and performance of family firms

How does the performance of family firms compare to other firms in the economy? What are their advantages and their constraints?

A CCGR study documents that Norwegian family-owned firms generally outperform nonfamily-owned firms. The same result has been documented in multiple other countries.

One might take this to indicate that family ownership is a superior ownership form, but this logic suffers from the chicken and the egg problem: do family firms perform better because they are governed better or are highly profitable firms able to retain control within the founding family? In the latter case, superior profitability may arise from some competitive advantage of the firm which alleviates the family's need to sell equity to raise finance.

To the extent that superior profitability is indeed caused by family ownership, it is of interest to identify the driver of profitability. Family firms may have lower monitoring costs and better governance due to an absense of agency conflicts. Alternatively, family firms have limited resources which force them to focus on their most profitable projects.

The higher profitability of family firms

Family firms are generally more profitable than nonfamily firms on average. The difference in profitability is stable across the business cycle:

ROA means years

(You can find more detailed comparisons between family and nonfamily firms here).

The profitability difference is present in all size classes, and it is larger for the smallest firms: ROA by decile means

ROA by size decile medians

The difference in profitability exists in most industries: ROA by industry means

(You can find more information about family firms across industries here.)

The difference is also present across geographical regions. In the graph below municipalities are binned according to their centrality (1=most central, 6=least central) as defined by Statistics Norway:

ROA by centrality means

(You can find more information about family firms and geography here.)

Profitability, agency conflicts, and financial constraints

The higher profitability of family firms may be due to lower agency conflicts: the controlling owners of the family firm are tightly knit group that has the power and incentives to monitor the activities of the firm. There are multiple agency conflicts that can affect the performance of companies: between shareholders and management, between majority and minority shareholders, between active and passive family owners.

Alternatively, the higher profitability we observe may be due to financial constraints. Family firms depend to a large extent on the controlling family for their equity capital, the controlling family is usually not well diversified, and most families are not well known by outside investors. Financial frictions therefore lead the family to apply a higher discount rate and focus on just the most profitable projects.

In our study, we look at the characteristics of the controlling family to examine the two hypotheses. We find that both potential agency conflicts and financial constraints are relevant for the higher profitability of family firms. On the one hand, firms where the CEO belongs to the family (potential conflicts between shareholders and managers are minimal), where the family controls a large portion or the entirety of the firm's equity (potential conflicts between shareholders are minimal), and where there are fewer family owners (coordination is easier) are relatively more profitable. On the other hand, firms with less wealthy and less diversified controlling families, and fewer minority owners are less profitable, pointing to the relevance of financial constraints. Further details and results using a wide array of family characteristics can be found in the study.

Summary