Family firms and their nonfamily investors
What can we say about the relationship between majority and minority shareholders?
Family owners have the incentives and the ability to monitor the management of the firm. Their long-term horizon and reputation concerns may make it easier to raise debt capital. At the same time, attracting and maintaining minority equity investment can be a challenge.
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Firms have multiple stakeholders whose interests are often in conflict. Some of the most important conflicts are:
- Conflicts between shareholders and managers (also known as the first or the vertical agency problem);
- Conflicts between majority and minority shareholders (also known as the second or the horizontal agency problem);
- Conflicts between shareholders and debt holders (also known as the third agency problem).
The first agency problem is likely to be an important issue in firms with dispersed ownership. Family firms have large shareholders with the power and incentives to monitor the management of the firm, so the first agency problem is less of an issue. Indeed, the CEO of the family firm is often a family member. We present an analysis of family involvement in the governance of family firms here. The third agency problem may also be less important given that the family is usually a long-term owner committed to the firm.
As a downside, firms with controlling owners may have stronger conflicts between majority and minority shareholders. For instance, the majority shareholders may take advantage of the free cash flows produced by the firm ( tunneling) rather than paying them as dividends and thus share them with all other owners. The temptation to do so may be larger if the majority shareholder owns a relatively small share of equity and therefore receives a small share of the dividends.
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A way to reduce conflicts between majority and minority shareholders is to build a reputation for being a consistent dividend payer. Looking at Norwegian firms following the 2006 tax reform, a recent study found that firms where the share of the controlling owner is lower – and therefore the temptation to extract private benefits is higher – actually pay higher dividends:
This result is consistent with the story that controlling shareholders try to build a reputation of building a reputation for treating minority investors fairly. The study also finds that the high dividend payout is linked to a higher probability of raising capital from outside investors, which indicates the good reputation is indeed useful. A subsequent study shows that when the 2006 tax reform significantly increased the cost of paying dividends, it is the firms facing higher potential conflicts between majority and minority shareholders that decrease their payout less.