A Family Firm is Forever. But Not Everywhere

HANNES WAGNER AND CO-AUTHORS, IN A PAPER FORTHCOMING IN THE REVIEW OF FINANCIAL STUDIES, SHOW THAT IN COUNTRIES WHERE THE LEGAL PROTECTION OF MINORITY SHAREHOLDERS IS WEAK AND FINANCIAL DEVELOPMENT IS LOW, FAMILY FIRMS DO NOT FOLLOW A LIFE CYCLE, BUT LIVE VIRTUALLY FOREVER

In The Life Cycle of Family Ownership: International Evidence (forthcoming in the Review of Financial Studies), an analysis of over 27,000 private and public firms from twenty-seven European countries, including the United Kingdom, France, Germany and Italy, Colin Mayer (University of Oxford), Julian Franks (London Business School), Paolo Volpin (London Business School) and Hannes Wagner (Bocconi University) show that family firms follow an ownership life cycle and evolve into widely held companies, but only in countries where investor protection is strong and financial markets are well developed. Elsewhere, family firms live virtually forever.

The authors set out to answer a question that had been raised in a seminal study by Berle and Means in the 1930s, that had never been tested. Their question is whether the shareholder structure of a firm follows a life cycle.Traditionally, the life cycle of a firm has been thought of as being a linear path from concentrated to dispersed ownership. By definition, most firms start life as small or very small entities, founded by entrepreneurs. In the modern language of financial economics, these entrepreneurial firms are first-generation family firms. The assumption is that these family firms evolve over time from closely held, family owned enterprises into large companies that are publicly traded and held by large numbers of minority shareholders. Along this transition of the family business, professional managers are hired, outside financing is raised for investment projects and over time, slowly but surely, the large ownership block of the family is eroded. At some point, typically as ownership is passed from one generation to the next, the family faces a decision – whether to keep the remaining voting block and maintain control, or to sell out. Most of the family’s wealth is invested in the firm and the fortune of the family is thus tied to the firm. In the end, many factors contribute, and the family members finally sell their remaining stake in the firm to the highest bidder.

What are the factors that contribute to the disappearance of family control over time? The proposition underlying the authors’ analysis is that it is the degree of investor protection, the development of financial markets, and the activity of the market for corporate control that determine the prevalence and speed of the life cycle of family control. A family firm becomes a widely held firm when the amount of voting rights held by family members declines below a certain threshold, beyond which the family no longer controls important decisions.

The authors show that in countries that are similar to the U.K. in having strong investor protection, high financial development, and active markets for corporate control, family control disappears relatively fast. In contrast, in countries that are similar to France, Germany, and Italy in having weak investor protection, low financial development and less active markets for corporate control, family control is very stable over time. In addition to that, family firms tend to disappear over time in industries that grow fast, require significant amounts of financing and experience high levels of M&A activity – but this effect only arises in countries that share the characteristics of the U.K.

One striking conclusion to emerge from the paper is that while the life cycle view of firms is one of the most widely cited “stylized facts” about firms, it receives little empirical support from international evidence. The life cycle of family control applies in some countries, but not in most. Where it does not apply, family firms empirically live virtually forever. In these countries, that happen to have weak regulation and low financial development, family businesses may be so influential that they are able to shape institutions and overcome financial constraints without giving up control.

by Hannes Wagner