WPS-MGT-07-04
DIVERSIFICATION DECISIONS IN FAMILY-CONTROLLED FIRMS
LUIS R. GOMEZ-MEJIA
Dept. of Management
Arizona State University
Main Campus, PO Box 874006
Tempe, AZ 85287-4006
luis.gomez-mejia@asu.edu
480-965-8221 (voice)
480-965-8314 (fax)
MARIANNA MAKRI
Dept. of Management
University of Miami
Jenkins Building, 414 L
5250 University Drive, Coral Gables, FL, 33146
mmakri@ miami.edu
305-248-8586 (voice)
305-248-3655 (fax)
MARTIN LARRAZA KINTANA
Dept. de Gestión de Empresas
Universidad Publica De Navarra
Campus de Arrosadia,
31006, Pamplona (Navarra), Spain
martin.larraza@unavarra.es
+34-948-168931 (voice)
+34-948-169404 (fax)
© 2007 by Gomez, Makri and Kintana.
No part of this publication can be reproduced or transmitted in any form or by any means –
electronic, mechanical, photocopying or otherwise (including the Internet) – without the written
permission of the authors
1
DIVERSIFICATION DECISIONS IN FAMILY-CONTROLLED FIRMS
Abstract
This study examines diversification decisions of family firms and suggests that on average
family firms diversify less both domestically and internationally than non family firms. When
they do diversify, family firms tend to opt for domestic rather than international diversification,
and those that go the latter route prefer to choose regions that are ‘culturally close’. Further,
results show that family firms tie CEO incentives to international diversification decisions to a
lesser extent than non family firms. The hypotheses are tested using a sample of 360 firms, 160
of them being family controlled and the rest (200) non-family controlled.
Keywords: Family firm, product diversification, international diversification
2
The literature on family firms has identified some key characteristics of these organizations
that lead us to expect that their diversification strategies may differ from those of non-family
firms. The most prominent characteristics are: a) a desire to maintain the firm’s familiness
stemming from a strong personal attachment, commitment and identification with the firm (e.g.,
Habbershon & Williams, 1999; Thomsen & Pedersen, 2000; Anderson & Reeb, 2003; Kets de
Vries, 1993) and b) risk bearing stemming from a concentration of the family’s wealth in a single
organization (e.g., Galve & Salas-Fumas, 2002; Mishra & McConaughy, 1999; Schulze,
Lubatkin, & Dino., 2003; Zahra, 2005). Unfortunately, with some notable exceptions (see, for
instance, Anderson & Reeb, 2003), there has been little empirical research on how family
ownership affects diversification decisions. This study takes some initial steps to fill this gap.
In terms of the first characteristic noted above, Gomez-Mejia, Haynes, Nunez-Nickel,
Jacobson, & Moyano-Fuentes (2006) argue that the ability to exercise authority, the enjoyment
of personal control, a sense of belonging, affection, intimacy as well as an active role in the
family dynasty form a socioemotional endowment that many of these firms believe is critical to
maintain. Using the behavioral agency model developed by Wiseman and Gomez-Mejia (1998),
these authors suggest that family firms are loss averse when it comes to threats to this
socioemotional wealth (or SEW for short). By extension, if diversification implies a loss of
SEW, family owners would prefer to avoid that strategic choice even if confers some risk
protection. This suggests that family firms are pulled in two opposite directions when making
diversification decisions: opt for less diversification in order to preserve socioemotional wealth
or SEW vis-à-vis chose greater diversification (as suggested by portfolio models; see Casson,
1999 and Chami, 1999) in order to dilute or spread concentrated business risk but at the expense
of family SEW. We argue that the first tendency predominates.
3
Specifically, we develop four hypotheses in this study. First, at the highest level of
analysis, we hypothesize that family firms prefer less rather than more diversification in order to
preserve SEW. Second, we propose that even when they choose to diversify, family firms prefer
domestic rather than international diversification since the former involves less threat to SEW.
Third, we argue that when they opt to diversify internationally, family firms limit their choice to
locations with shorter cultural distance as this reduces the potential for SEW loss. Lastly, we
hypothesize that family firms tend to design executive compensation packages that are consistent
with the above diversification preferences. By employing a sample of 160 family firms and 200
non-family firms during a four-year period (1998-2001), we find general support for these
hypotheses.
THEORETICAL FRAMEWORK AND HYPOTHESES
The traditional agency perspective, which is consistent with portfolio models in finance,
argues that risk concentration resulting from an undiversified position increases risk bearing and
in turn induces owners to diversify the firm in order to reduce overall variance in expected
outcomes (Arrow, 1965; Williamson, 1975; Amit & Livnat, 1988; Eisenmann, 2002). Hence,
under an assumption of risk aversity, family firms with highly concentrated risk in a single
enterprise would over time tend to diversify more than non-family firms in order to reduce
dependence on a singular revenue generator.
The behavioral agency model (BAM) developed by Wiseman and Gomez-Mejia (1998),
which is based on a long stream of research that has flowed from Kahneman and Tversky’s
(1979) prospect theory (Bowman, 1982, 1984; Fiegenbaum, 1990; Fiegenbaum & Thomas, 1986,
1988) and Cyert & March’s (1963) behavioral theory of the firm (e.g., Bromiley, 1991; Singh,
1986; Miller & Chen, 2004) relaxes the inflexible assumption from agency theory that decision
4
makers hold consistent risk preferences and instead proposes that decision makers utilize a
contingency – based view to allow for the possibility of varied risk preferences depending on the
context being faced.
According to BAM, a decision maker’s risk preferences, and in turn risk seeking
behaviors, change with the framing of problems. Problems are framed as either positive or
negative using a reference point to compare anticipated outcomes from available options. BAM
predicts that decision makers exhibit risk-averse preferences when selecting among positively
framed prospects and exhibit risk-seeking preferences when selecting among negatively framed
prospects. Underlying this shift in risk preferences between positively (gain) and negatively
(loss) framed problems is the concept of loss aversion. Loss aversion concerns the avoidance of
loss even if this means accepting a higher risk. Hence, “loss aversion explains a preference of
riskier actions to avoid an anticipated loss altogether … risk preferences of loss-averse decision
makers will vary with the framing of problems in order to prevent losses to accumulated
endowment” (Wiseman & Gomez-Mejia, 1998: 135). From this vantage point, risk bearing is
subjective representing perceived threats to a decision maker’s endowment (what the person
believes is important to his or her welfare, that is already accrued and can be counted on).
Gomez-Mejia et al. (2006) hypothesized that for family firms the primary reference point
is the loss of socioemotional wealth. Applying BAM’s logic, they propose that family firms are
likely to frame relinquishing SEW as a crucial loss, and are thereby likely to accept threats to the
firm’s financial well being (i.e., more concentrated business risk) in order to prevent that loss. In
other words, when faced with a context that shows loss of socioemotional wealth, family firms
may be willing to become vulnerable to the possibility of financial losses. Thus, contrary to the
conventional agency-based view, Gomez-Mejia et al. (2006) suggest that family firms are loss
5
averse with respect to socioemotional wealth and hence are willing to incur significant business
risk if necessary in order to preserve that wealth. This creates an apparent paradox in that
organizational failure implies the loss of all socioemotional wealth, yet this is the gamble that
these family firms are often willing to take.
Gomez-Mejia et al. (2006) found support for their BAM-based predictions after
examining the decisions of family owned olive oil mills (N = 1,237) in southern Spain during a
54 year time-span. They showed that family mills were less likely to join co-ops (which greatly
reduces financial risks and increases the possibility of long term survival) because doing so
resulted in a loss of socioemotional wealth. While Gomez-Mejia and colleagues (2006) were not
concerned with diversification issues neither conceptually nor empirically, their logic would
apply there as well. Diversification efforts reduce risk concentration yet family firms are more
likely to avoid it to the extent that these are associated with a loss of SEW. Relatedly, the
incentive system in family owned firms would discourage executives from pursuing
diversification strategies that might result in the loss of SEW. The remaining section develops
these arguments, leading to a set of four hypotheses.
Overall Diversification in Family Firms
There are several reasons to suggest that greater diversification may reduce SEW. First, the
diversification process is complex and usually requires the creation of new routines and modus
operandi that stray away from the firm’s “true and tried” methods of operation (Eisenman, 2002).
This entails greater uncertainty and more delegation, both of which can reduce real or perceived
SEW. Second, in order to diversify the family may need external funding which can be obtained
either by issuing new stocks or through debt financing. The appearance of new actors (i.e.,
stockholders or creditors) from outside the family circle with the capacity to exert some
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influence and control over the strategic direction of the firm, erodes the ability to exercise
unconstrained authority, influence and power which are important elements of socioemotional
wealth (Schulze et al., 2003). To a large extent, a family is in the business of caring for and
developing people. Its boundaries are sustained by face-to-face contact, and membership in that
system is by blood, not necessarily through a criterion of competence. This whole system of
intangible benefits would be made more difficult to sustain if the firm needs to borrow funds to
diversify because creditors tend to emphasize the more tangible and objective financial measures
of business success (Kepner, 1983).
Third, due to the inherent difficulty of the diversification process the family may need
managerial talent and expertise that may not be available within the family group. This would
force owners to hire executives from outside the family, and subsequently to give up some
control over the decision process that may corrode the authority and identification foundations of
SEW (McConaughy, 2000). Hiring outside managers may also increase information asymmetries
and goal conflict, further eroding family SEW (Gálve & Salas, 2002).
Finally, family firms exhibit a strong inertia in the way they act, which makes change
difficult (Casson, 1999). Future generations are conceived as stewards of their inheritance, and
are under duty to conserve and enhance the family dynasty but without substantially changing its
form (Casson, 1999). Incorporating new products and entering new markets may induce
important changes in the way the family-owned firm is organized, and this is likely to engender
resistance from family members who may feel their traditional sphere of influence is being
threatened. Note that we are not assuming that the family firm is typically in a relatively none
diversified state. Rather, we acknowledge that even if the family firm is already in a diversified
state, and even if family members have the requisite experience to manage the diversification
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process, they may be unable to manage the increased volume associated with multiple business
line and need to hire additional managerial talent which may erode SEW for the reasons
explained above. Our first hypothesis follows from the preceding arguments.
Hypothesis 1: Family firms will exhibit lower levels of overall diversification than nonfamily firms.
International Diversification Decisions in Family Firms
For family firms that choose to diversify, there is another important decision that needs to
be made, namely whether to do so domestically or internationally. Global diversification
certainly offers the advantage of risk diversification because it can help reduce fluctuations in
revenue by spreading investment risks over different countries (Kim, Hwang, & Burgers, 1993).
Further, it has been shown to reduce overall firm risk in a firm's portfolio (Lessard, 1985)
because a portion of the systematic risk (economy-wide risk) in the domestic context may
become unsystematic (firm-specific) when the firm operates internationally (Fatemi, 1984;
Lessard, 1985). More specifically, studies have shown that multinational firms have lower total
and systematic risk than domestic firms (Agmon & Lessard, 1977; Collins, 1990; Fatemi, 1984).
Also, international diversification helps reduce costs and increase revenues by increasing a firm's
market power over its suppliers, distributors, and customers (Kogut, 1985).The most prominent
advantage however is that it provides the opportunity to exploit the benefits of internalization
(Rugman, 1979; 1981). Performing activities internally allows for economies of scale, scope, and
learning to be created (Kogut, 1985).
For the family, international diversification poses a dilemma: while it allows firm risk to
be spread across geographic segments, it also carries a higher likelihood of SEW loss. There are
several reasons for the latter. The first one is that international diversification usually requires
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more external funding than domestic diversification (Fatemi, 1984; Lessard, 1985). Dilution of
family holdings, in turn, transfers more real or perceived power to outside investors (such as
banks and venture capitalists) to influence managerial decisions (such as the choice of top
management team and performance evaluation ratings of family executives) (Tosi & GomezMejia, 1989).
Further, as noted by Hitt et al. (1997), “differences encountered across geographic
regions greatly increase managerial information-processing demands. Logistical costs, trade
barriers, and cultural diversity make management of internationally diversified firms highly
complex.” Because of the heightened information processing demands of international
diversification, as well as an inability to adequately understand the operations of each of the
separate businesses competing in diverse markets, the family may be forced to hire executives
from outside the family that have knowledge in international markets. In other words, even if the
family firms’ executives already have substantial international experience, the increase of
information processing demands that accompanies increasing levels of international
diversification may call for hiring additional outside managerial talent. While hiring executives
from outside the family may help overcome the increased risks associated with
internationalization (Ellstrand, Tihanyi, & Johnson, 2002) it could also lead to loss of family
control (Gálve & Salas, 2002); and hence, SEW. Relatedly, as argued by a number of authors
(e.g., Roth & O’Donnel, 1996; Sanders & Carpenter, 1998; Edstrom & Galbraith, 1977),
international diversification is associated with greater information asymmetries between
principal and agent than domestic diversification. This makes it more difficult for principals (i.e.
family) to develop effective monitoring systems.
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These arguments suggest that for family firms the fear of losing socioemotional wealth
may outweigh the benefits associated with diversifying risk via international expansion. Put
differently, in comparison to non family firms, family firms that decide to diversify would prefer
to do so domestically rather than internationally. Formally stated:
Hypothesis 2: Family firms will exhibit lower levels of international diversification
than non-family firms.
The Role of Cultural Distance
When firms diversify internationally they have to go through ‘double layered
acculturation’, adjusting to both a foreign national and a foreign corporate culture (Barkema et
al, 1996) with varying cultural distances between countries (Hofstede, 1980). Cultural distance is
a particularly powerful form of uncertainty for diversifying firms because it implies differences
in managerial values, mind-sets, and norms (Hofstede, 1984) which may lead to losses in
coordination, information flow, and communication within organizations (Shenkar, 1995). A
firm diversifying to a country of great cultural distance may have more difficulty transferring
competencies and capabilities (Kogut & Singh, 1988). Research in international joint ventures
has shown that the more culturally distant two firms are, the greater the differences in their
organizational and administrative practices (Kogut & Singh, 1988; Schneider & De Meyer,
1991) and the more difficult communications between partners can be, leading to managerial
conflicts and early dissolution (Camerer & Vepsalainen, 1988; Lane & Beamish, 1990).
All of the above suggest that the ability to understand the environment and exert some
degree of influence in a foreign context is a negative function of cultural distance (Kogut &
Singh, 1988). For family firms, which place a high value in retaining SEW, this suggests that
whenever they decide to diversify internationally their preference would be to limit their radius
of action to areas that are culturally proximal. Such a strategy would reduce information
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asymmetries as well as the need to hire outside managers with specialized knowledge in the
distant countries. Further, expanding to culturally ‘close’ regions reduces information processing
demands and the need to depend on others outside the family (for instance, consultants, political
analysts and translators) to interpret this information (Johansen & Vahlne, 1977). In short, family
firms that decide to internationalize their operations would prefer ‘culturally close’
diversification to ‘culturally distant’ diversification as the former carries a reduced risk of losing
SEW. Stated formally:
Hypothesis 3: Family firms will show lower levels of ‘culturally distant’ diversification
as a percentage of total international diversification than non-family firms.
CEO Incentives and Diversification Efforts
We have argued so far that family firms, despite their more concentrated risk, prefer to
engage in less diversification than non family firms; and when they do, they tend to prefer
countries that are culturally more proximate. A significant body of literature indicates that
executive compensation and diversification tend to go hand in hand, suggesting that top
executives have an incentive to engage in diversification (e.g., Kroll, Wright, Toombs & Leavell,
1997; Henderson & Fredrickson, 1996). This literature, however, has not examined the role that
families play in the process. As an extension of our arguments, it seems reasonable that family
firms would tend to avoid using incentives in ways that promote diversification efforts in
general; and in particular, the international kind. Put differently, given that family firms place a
high value on their unencumbered ability to exercise and retain control, they are less likely than
non-family firms to incentivize diversification activities.
Firms pursuing an active diversification strategy need to develop the essential capabilities
and acquire the necessary resources to venture into new business and geographical arenas, all of
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which require a long-term orientation (Chatterjee & Wernerfelt, 1991; Wernerfelt &
Montgomery, 1988). Linking CEO long term incentives to diversification reinforces decisions
that keep the firm focused on an extended planning horizon. Based on the arguments made
earlier, since family firms prefer diversification to a lesser degree than non family firms, we
would expect a weaker tie between CEO long term pay and diversification. Stated formally:
Hypothesis 4a: The link between CEO long term pay and overall diversification is lower
in family firms than in non family firms.
Hypothesis 4b: The link between of CEO long term pay and internationalization is lower
in family firms than in non family firms.
DATA COLLECTION, METHODS AND MEASUREMENT
The hypotheses have been tested using a sample of 360 firms, 160 of them being family
controlled and the rest (200) non-family controlled. These firms were identified through a
manual inspection of a randomly selected set of 3000 proxies of publicly traded companies
included in the COMPUSTAT database. While not exhaustive, this large randomized sample was
considered adequate given the labor intensity involved in data collection. Information for each
firm was obtained from two sources during the period 1998-2001, and our data set is composed
of 1,440 entries (360 firms times 4 years of data). Firms’ proxy statements were used to collect
data about firm characteristics, ownership structure, board composition, and CEO stock
ownership. Financial information for the same time period was downloaded from the
COMPUSTAT database.
Measures
Family Firm. Following standard criteria in the literature on family business, a firm is
considered “family-owned” if both of the following conditions are met: two or more directors
must have a family relationship, and family members must hold a substantial block of voting
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stock (Daily & Dollinger, 1993; Allen & Panian, 1982; Gomez-Mejia, Larraza-Kintana, &
Makri, 2003). While most authors have used a 5% threshold1 for the latter (see, for instance,
Allen & Panian, 1982) others have proposed a more stringent ownership threshold of at least
10% (Astrachan & Kolenko, 1994). In this study, we adopted the more conservative cut-off point
of 10% to determine if a firm should be included in the sample of family firms at the beginning
of the period of study. Specifically, we created a dummy variable that takes the value of 1 if at
least two members on the board were family members and the family owned 10% or more of
voting stock in 1998. Those firms that did not meet both criteria were considered non-family
firm and coded as 0. In 1998, we identified 174 family and 200 non-family firms.
The number of family members on the board as well as the percentage of stock owned by
the family may change over time. In order to account for such changes, particularly a decrease in
the level of family ownership and representation on the board, we examined whether the firms
identified as family firms in 1998, still met our definition of family firm during the period of our
study (i.e. retained a minimum of 2 members in the board of directors or owned at least 10% of
1
While the definition of a publicly traded family firm is arbitrary, there is a large amount of research which
indicates that ownership of five percent or more of a company’s stock in a public corporation confers owners a
substantial influence over the firm’s affairs. In the specific case of family ownership, public corporations that meet
the criteria used here differ significantly from those that do not along several key dimensions including executive
compensation and succession practices (Gomez-Mejia et al., 2003), business strategies (Daily & Dollinger, 1991,
1992), permanence of family values and culture created by founders (Anderson & Reeb, 2003), employment
patterns at the top (Allen & Panian, 1982) and the like. There is also a broader literature which shows that owner
controlled firms, defined as those where a single external party holds five percent or more of company stock, share
certain common characteristics including lower executive pay and greater CEO pay-performance sensitivity
(Hambrick & Finkelstein, 1995; Gomez-Mejia, Tosi & Hinkin, 1987; McEachern, 1975; Dyl, 1988), fewer mergers
and acquisitions (Kroll, Wright, Toombs & Leavell, 1997; Kroll, Simmons & Wright, 1990; Wright, Kroll &
Elenkov, 2002); a performance-oriented culture for all employees (Werner, Tosi & Gomez-Mejia, 2005); less use of
political strategies and external parties to legitimize decisions (Tosi & Gomez-Mejia, 1989; Salancik & Pfeffer,
1980) and such. The above results strongly suggest that even when other parties may exert some influence in
organizational decisions for publicly traded firms, singular ownership of at least five percent of a firm’s stock allows
that principal to have a distinct imprint on the firm’s affairs.
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the firm’s stock). Only fourteen firms did not meet these criteria for the four year period (19982001) and were removed from the analyses reducing the sample of family firms to 160.2
Overall Diversification. The extent of overall diversification is measured using the
entropy measure (Hitt, Hoskisson & Kim., 1997). This measure considers both the number of
segments in which a firm operates and the proportion of total sales each segment represents and
captures diversification across 4-digit Standard Industrial Classification (SIC) industries
Following Hitt et al (1997) that measure is calculated as follows:
Entropy = ∑i [Pi × ln (1 Pi )]
Where Pi represents the proportion of sales attributed to business segment “i”.
International Diversification. The level of international diversification was captured as
the degree of foreign sales as a percentage of total sales (Hitt et al, 1997). Data was downloaded
from Compustat for the 1998 – 2001 period.
Cultural Distance. We used two measures to capture cultural distance. The first measure
is a coarse indicator of cultural distance calculated by collecting data from Compustat’s business
segment data and aggregating such data based on the following 4 regions: Africa, Asia-Pacific,
Europe, and the Americas. Hitt et al, (1997) suggested grouping international diversification data
based on the four regions above because they consider those to be distinct global economies.
From that measure we derived four indicators in order to capture culturally close/distant
internationalization. Those were: sales in America/ total foreign sales, sales in Africa / total
foreign sales, sales in Europe / total foreign sales, and sales in Asia-Pacific /total foreign sales.
The second measure is more refined and is based on the cultural distance index by Kogut
and Singh (1988). It reflects the difference between the cultures in which the firm operates and it
2
Our results do not change if these fourteen firms are included in the analyses.
14
is based on Hofstede’s four cultural attribute scores (i.e., individualism, masculinity, uncertainty
avoidance and power distance). This cultural distance index was created using the procedure first
developed by Kogut and Singh (1988). The cultural distance (CD) for each possible subsidiary
country pair was calculated as follows (as per Gomez-Mejia & Palich, 1997):
CD jk =
4
{( Dij − Dik )2 / Vi }/ 4
J =1
∑
Dij reflects the score for subsidiary country j on cultural dimension i, Dik reflects the
score for subsidiary country k on cultural dimension i, and Vi is the variance of the index for
cultural dimension i. Subsidiary data for years 1999-2001 was downloaded from the Mergent
database.
CEO incentives. CEO incentives were measured as the proportion of CEO’s long-term
income to total pay. CEO’s long-term income was estimated as the number of options granted to
the CEO multiplied by 25 percent of their exercise price. Lambert, Larker, and Weigelt (1993),
and Finkelstein and Boyd (1998) found this approach to be highly correlated (.98) with values
derived using the more cumbersome Black-Scholes formula.
Control Variables. Several control variables are employed in this study. Three dummy
variables are used to control for potential year effects and a dummy variable that indicates
whether the firm operates in a manufacturing industry (1) or not (0) is included (Gomez-Mejia et
al, 2003). While initially we used one digit SIC industry dummies for our analyses, in order to
save degrees of freedom we report results using the manufacturing dummy. No significant
differences exist in using one digit SIC codes vs the manufacturing dummy. We also control for
firm performance, measured in terms of ROA, firm size, measured as the natural logarithm of the
firms’ number of employees, and firm age.
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The diversification literature suggests that firm risk may be an important variable to
understand diversification activity, particularly in the case of family firms (Anderson & Reeb,
2003). This is because diversification activity may be a response to a desire to reduce firm risk.
Amihud and Lev (1981) suggest that a CEO’s diversification strategy responds essentially to
“unsystematic” risk, the risk that investors can diversify by choosing the appropriate portfolio of
assets. Thus, we control for and distinguish between systematic and unsystematic risk calculated
using monthly stock prices gathered from COMPUSTAT. In particular, we use the natural
logarithm of systematic and unsystematic risk to correct for skewness.
CEOs are key actors in the decision-making process of the firm and may influence the
board decision-making process. Two characteristics that reflect the CEO’s power are CEO
tenure and CEO duality (Tosi et al., 2000; Gomez-Mejia & Wiseman, 1997; Boyd, 1995). CEO
tenure is measured as the number of years the CEO has been at the helm of the organization,
while CEO duality is a dummy variable that takes the value of 1 when the CEO is also the chair
of the board. We also control for whether the CEO is also the founder of the firm using a dummy
variable that takes value 1 if the CEO is the founder.
Institutional investors have also been pointed as prominent actors in the decision-making
process. Therefore, we control for institutional ownership, using the percentage of a firm’s
stocks owned by institutional investors as a proxy for institutional investors’ influence on firm’s
decisions (David , Kochhar & Levitas, 1998). Institutional investors include public pension
funds, mutual funds, insurance companies, banks, non-banks trusts, and corporate pension funds
(David et al., 1998).
ANALYSIS AND RESULTS
16
As in previous research on the strategic behavior of publicly held family firms (e.g.
Anderson & Reeb, 2003) our hypotheses were tested using pooled OLS estimates and robust
standard errors. Multicollinearity and autocorrelation indexes indicate that estimations are not
affected by such problems. Table 1 reports descriptive statistics and correlations for the variables
used in the study for the whole sample (family and non-family firms).
[Insert Table 1 here]
The first hypothesis examines the differences in degree of product diversification between
family and non family firms. Hypothesis 1 suggests that family firms would, in general, prefer
lower levels of overall diversification than non family firms. As can be seen in Table 2, the beta
coefficient of the family firm dummy shows a negative and highly significant (p < 0.001)
relationship with total diversification which provides strong support for Hypothesis 1.
[Insert Table 2 here]
In Hypotheses 2 and 3 respectively we argue that family firms will diversify internationally
less than non family firms and will do so by diversifying to more culturally ‘close’ regions. As
can be seen in Table 2 the beta coefficient of the family firm dummy shows a negative and
significant (p < 0.01) relationship with total international diversification which provides support
for Hypothesis 2.
In Table 3, we show the results of the test of Hypothesis 3 by using the two measures of
cultural distance described earlier. All things considered, results are consistent with Hypothesis
3. Using the Kogut and Singh (1988) cultural distance index we find that family firms are less
likely to diversify internationally to ‘culturally distant’ regions than non-family firms (p < 0.01).
Using the second measure by Hitt et al (1997), we show a negative and significant relationship
(p=0.052) with culturally distant international diversification (sales in Asia-Pacific), a negative
and moderately significant (p=0.092) relationship with the proportion of foreign sales in Europe
17
and a positive significant (p < 0.001) with culturally close diversification (sales in America)
which suggests that family firms are less likely to diversify internationally to ‘culturally distant’
regions than non-family firms, also providing support for Hypothesis 3.
[Insert Table 3]
Table 4 summarizes the results of the regressions used to test Hypotheses 4a and 4b. These
hypotheses deal with the relationship between CEO incentives and diversification activity. More
specifically, these hypotheses suggest that family firms will link long-term CEO incentives to
product and international diversification to a lesser degree than non-family firms. The negative
and significant (p < 0.01) effect of the interaction term of the family firm dummy and CEO
incentives (CEO Incentives X Family Firm) on international diversification provides support for
Hypothesis 4b. The interactive effect of the family firm dummy and CEO incentives on product
diversification is not significant, providing no support for Hypothesis 4a.
[Insert Table 4 here]
DISCUSSION
Our study provides empirical evidence and theoretical arguments to support the notion that
family firms differ from non family firms in their diversification preferences. We showed that
family firms diversify both domestically and internationally overall less than non family firms
and when they do so they prefer to diversify to regions that are ‘culturally close’, more so than
non-family firms. Further, consistent with the preferences of family and non-family firms for
internationalization, we found that family firms tie long-term CEO incentives to international
diversification decisions to a lesser extent than non family firms.
Finding support for Hypothesis 1 is in line with the behavioral agency model argument that
family firms may prefer lower levels of diversification as a way to protect their sociemotional
18
endowment relative to more diversified shareholders. Relatedly, this is consistent with GomezMejia’s et al. (2006) findings that family owned olive oil mills may be willing to exchange
greater financial risks (by remaining independent and not joining a co-op) if this is what it takes
to preserve family SEW.
Sanders and Carpenter (1998) called for greater consideration of conditions that may affect
the relationship between governance and international diversification. Our study extends that
work by looking at how governance differences (family vs. non family) affect international
diversification degree and type (culturally close vs. distant). We integrate the theoretical
perspectives of agency theory and international management to argue that a firm’s degree and
type of internationalization are affected by its governance structure. More specifically, we build
on the idea that internationalization increases information processing demands and asymmetries;
because both of these weaken principal control, family owners prefer to avoid international
diversification and when they do so they “stay closer to home” culturally. Relatedly, these firms
decouple CEO long-term incentives from international diversification.
Overall, our results suggest that the desire to protect SEW is the most salient factor in
determining corporate diversification in family firms. This is supported by lower overall and
international diversification of family firms vis a vis non-family firms. While there is probably a
constant desire by families to reduce their business risk by diversifying into new business areas
and new markets, that desire is not strong enough to overcome their wish to defend their SEW.
As our findings are supported in a sample of publicly traded firms where parties other than
family members may exert some influence in organizational decisions, we expect that the desire
to protect SEW and its effect on diversification may be even stronger for family firms that are
privately held.
19
Study Limitations and Future Research Agenda
The underlying assumption of this study is that the ability to maintain SEW is a major
factor in the decision making process of family firms and that diversification puts SEW in
jeopardy. In other words, family firms are involved in a constant balancing act between their
desire to maintain SEW and their desire to diversify their concentrated business risk. Whether
the ‘scale tips’ one way or the other is an issue that needs to be explored further, taking into
consideration additional variables discussed in the family business literature such as founder
centrality, market growth, succession concerns, capital structure and the like.
The scope of this study can be broadened to include other growth decisions such as
acquisitions, alliances and joint ventures as well as decisions regarding investments in
innovation. Based on the findings of this study we would expect that family firms prefer to
acquire targets or form alliances with partners in closely related industries. In terms of
innovation decisions, the family firm’s desire to retain control may lead to investing in areas of
technology that are adjacent to its existing technology platforms as opposed to venturing into
new technology trajectories.
Further, future research can explore whether family firms prefer related to unrelated
diversification. On one hand, diversification into related business areas can generate operational
synergies by designing a portfolio of businesses that are mutually reinforcing thus yielding
performance advantages to the family firm (Markides & Williamson, 1994; Seth, 1990). On the
other hand, the benefits of relatedness require a significant degree of cooperation among
involved business units. From a transaction cost perspective (Jones & Hill, 1988; Caves &
Williamson, 1985), a successful related diversification strategy requires extensive intrafirm
exchanges which can lead to higher governance and agency costs. Unrelated diversification may
20
present some unique advantages because it can do more to reduce risk for the family firm since it
involves business units in multiple industries (Amit & Livnat, 1988). Simply put, while related
diversification offers the advantage of economies of scope, unrelated diversification offers
greater risk reduction which is a major concern for family firms. Future research can delineate
the family firm’s preferences regarding diversification type (related Vs unrelated).
While our study takes a first step towards understanding the tradeoffs that family firms
experience in order to balance their desire to diversify their risk and their desire to maintain
SEW, our data reflects the behaviors of publicly traded family firms only. Because the vast
majority of family firms are non-publicly traded, in order to fully understand the strategic
preferences of family firms we need to extent our theoretical arguments and empirical analysis to
a set of non-public corporations. Due to data availability we were not able to do so in this study,
but future research should explore in more detail the balancing act between the desire to maintain
SEW and the desire to diversify risk in privately held family firms. Finally, our findings reflect a
general tendency on behalf of family firms to protect SEW at the expense of increased
diversification. Obviously, this tendency may not hold true for all family firms and future
research could examine those firms that do not fit this pattern as well as the conditions that
influence such tendency.
21
Table 1
Descriptive Statistics and Correlations – Family and Non-family firms N=360
Mean
.373
1 Overall diversification
.156
2 Foreign sales/total sales
1.459
3 Cultural distance index
.214
4 Sales America/Foreg sal
.544
5 Sales Europe/Foreg sal
.258
6 Sales Asia/Foreg sal
.475
7 Manufacturing
29.256
8 Firm age
1.167
9 ROA
.021
10 Systematic Risk
.061
11 Unsystematic Risk
9935.097
12 Number of employees
9.846
13 CEO Tenure
.688
14 CEO Duality
.148
15 CEO founder
13.188
16 %Institutional Investors
.247
17 CEO Incentives
.444
18 Family Firm
13
14
15
16
17
18
Std. Dev.
.467
.208
.921
.303
.307
.274
.500
24.950
21.890
.408
.360
29953.30
8.792
.463
.355
15.284
.264
.497
1
1
0.121**
0.028
0.098
-0.192**
0.057
-0.035
0.228**
0.084**
-0.039
-0.074*
0.119**
-0.075*
0.034
-0.083**
0.019
0.100**
-0.165**
Mean
Std. Dev.
13
1
9.846
8.792
CEO Tenure
.688
.463 0.276**
CEO Duality
.148
.355 0.329**
CEO founder
13.188
15.284 -0.111**
%Institutional Investors
.247
.264 -0.228**
Incentives
.444
.497 0.182**
Family Firm
** p < 0.01 bilateral;
* p < 0.05 bilateral.
2
1
0.060
-0.317**
0.113*
0.288**
0.211**
0.143**
0.065*
-0.030
-0.043
-0.023
-0.113**
-0.085*
-0.033
-0.007
0.155**
-0.123**
14
1
0.193**
-0.001
0.053
-0.205**
3
1
0.089
-0.165*
0.178*
0.100*
0.073
0.102*
0.034
-0.014
0.180**
-0.070
-0.128*
-0.068
-0.055
0.164**
-0.033
15
1
-0.104**
-0.143**
0.185**
4
1
-0.651**
-0.330**
-0.204**
-0.011
0.040
-0.020
-0.057
0.050
-0.150*
0.147*
-0.055
0.114
-0.026
0.024
16
1
0.153**
-0.374**
5
1
-0.426**
0.006
0.009
-0.022
0.037
0.047
-0.137*
0.013
-0.078
0.021
-0.101
0.050
0.027
6
1
0.281**
-0.018
0.026
0.050
-0.015
-0.049
0.069
-0.019
0.046
0.077
0.120
-0.124
7
1
0.180**
0.006
0.023
0.009
-0.065*
-0.019
-0.022
-0.096**
0.020
0.001
0.000
8
1
0.106**
-0.024
-0.049
0.187**
-0.088**
-0.101**
-0.193**
-0.076**
-0.041
0.026
9
1
-0.003
-0.035
0.058*
0.081**
0.002
-0.050
0.011
0.106**
-0.089**
10
1
0.924**
-0.011
-0.032
0.015
-0.006
0.036
0.040
-0.014
11
12
1
-0.027
-0.040
0.000
0.003
0.011
0.021
0.010
1
-0.091**
-0.037
-0.093**
-0.040
0.175**
-0.032
17
1
-0.465**
23
Table 2
Product Diversification and Internationalization Decisions of Family vs Non Family
Firms (Hypotheses 1 and 2)
Control Variables
Dummy year 1999
Dummy year 2000
Dummy year 2001
Manufacturing
Firm age
ROA
Systematic Risk (log)
Unsystematic Risk (log)
# of employees (log)
CEO Tenure
CEO Duality
CEO founder
% Institutional Investors
Overall diversification
Foreign sales/total sales
Non-standardized β
Non-standardized β
.0798*
.1019*
.0953*
-.0524†
.0026***
-.0010
-.0101†
-.0613***
.0506***
-.0052***
.0536†
.0542
-.0014
.0337†
.0371†
.0517**
.0768***
.0006*
.0003
.0003
.0091
.0044
-.0016*
-.0341†
.0444*
-.0008†
Family Firm
-.1202***
-.0453**
R2
Adj. R2
F
.185
.172
17.61***
.088
.072
6.09***
Independent Variables
† p < 0.10, * p < 0.05, ** p < 0.01, *** p < 0.001. Regressions with robust standard errors.
24
Table 3
Cultural Distance in Internationalization Decisions of Family Vs Non Family Firms
(Hypothesis 3)
Cultural
distance index
Control Variables
Nonstandardized β
Sales
Sales
America/Foreign Europe/Foreign
sales
sales
Nonstandardized β
Nonstandardized β
Sales AsiaPacific/Foreign
sales
Nonstandardized β
-.0638
(dropped)
.1214
.2704**
-.0009
.0025
-.0155
.2380***
.1569***
-.0052
-.1419
-.0422
-.0105***
-.0177
-.0230
.0292
-.0920*
-.0008
.0001
-.0081
-.0191
.0905***
-.0030
.1754***
-.0183
.0059**
-.0271
-.0326
-.0500
-.0255
.0012†
-.0000
.0022
.0204
-.0554**
-.0006
-.0780*
-.0074
-.0037†
.0371
.0849
.0154
.1665***
-.0003
.0004
.0166*
-.0014
-.0114
.0017
-.0556
.0707
.0000
Family Firm
-.3230**
.1982***
-.0760†
-.0733†
R2
Adj. R2
F
.143
.109
7.21***
.281
.229
6.68***
.095
.050
2.25**
.148
.092
3.30***
Dummy year 1999
Dummy year 2000
Dummy year 2001
Manufacturing
Firm age
ROA
Systematic Risk (log)
Unsystematic Risk (log)
# of employees (log)
CEO Tenure
CEO Duality
CEO founder
% Institutional Investors
Independent Variables
† p < 0.10, * p < 0.05, ** p < 0.01, *** p < 0.001. Regressions with robust standard errors.
25
Table 4
CEO Incentives and Diversification - (Hypotheses 4a and 4b)
Overall diversification
Foreign sales/total sales
Nonstandardized β
Nonstandardized β
Nonstandardized β
Nonstandardized β
Dummy year 1999
Dummy year 2000
Dummy year 2001
Manufacturing
Firm age
ROA
Systematic Risk (log)
Unsystematic Risk (log)
# of employees (log)
CEO Tenure
CEO Duality
CEO founder
% Institutional Investors
.0786*
.0905*
.0775†
-.0506†
.0030***
-.0005
-.0061
-.0628***
.0480***
-.0056***
.0552
.0717†
-.0024*
.0784*
.0899*
.0778†
-.0506†
.0030***
-.0005
-.0062
-.0626***
.0474***
-.0056***
.0561†
.0712†
-.0025*
.0328†
.0380†
.0460†
.0657***
.0008*
.0003
-.0003
.0099
.0030
-.0012
-.0363†
.0519*
-.0007
.0337†
.0399†
.0452†
.0663***
.0008*
.0003
.0001
.0088
.0047
-.0013
-.0382†
.0543*
-.0005
Independent Variables
CEO Incentives
Family Firm
-.0648
-.1232***
-.0832
-.1237***
.0721*
-.0334†
.1302***
-.0290
Control Variables
Interactions
CEO Incentives X Family
Firm
R2
Adj. R2
Δ R2
F
.0558
.203
.188
14.36***
.203
.187
.000
13.48***
-.1688**
.087
.067
5.00***
.095
.074
.008
5.26***
† p < 0.10, * p < 0.05, ** p < 0.01, *** p < 0.001. Regressions with robust standard errors.
26
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