Interorganizational familiness: how family firms use interlocking directorates to build community-level social capital (1).

We draw on the concept of community-level social capital and apply it to the situation of a family-controlled public corporation. While traditional agency theory argues that agency costs are minimized in a family-controlled business (FCB) due to an improved alignment of owner and manager interests, we argue instead that FCBs endure additional agency costs uniquely related to the family firm organizational structure. To mitigate these additional costs, we propose that FCBs use board interlocks to build and maintain community-level social capital. That is, the intercorporate network of FCBs generates shared understandings, values, problem solving techniques, and approaches to dealing with family issues. Further, the network generates a level of social support for family business owners and managers grappling with challenges endemic to family control of public corporations. We generate a number of propositions that can be used in future research to test the theory developed here. We conclude with the assertion that the community-level social capital generated by the network of FCBs is an important reason for the survival and persistence of individual family firms, despite the existence of additional family-related costs.

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Long discounted by both scholarly researchers and the business press (e.g., McCarthy, 2004), the topic of family business is reemerging with new vigor (e.g., Anderson & Reeb, 2004; La Porta, Lopez-de-Silanes, & Shleifer, 1999; Villalonga & Amit, 2006). (2) While family ownership in large U.S. corporations is quite pervasive and common across a broad range of industries (Schulze, Lubatkin, & Dino, 2003), many of these firms also appear to have survived, often intact, over longer periods of time than their nonfamily counterparts (Miller et al., 2005).

While recent scholarly discourse focuses largely on performance differentials, we are more interested in examining the perpetuation of the family firm structure. How is it such firms are able to maintain their family status over time, given the obvious difficulties and costs associated with this form of ownership? Our interest lies in examining family firms in which two or more persons with kinship ties work as executives in the business, have the power to determine the composition of the board of directors, and have the objective of passing the firm to the next generation of family members. Throughout this article, we will refer to these organizations as family businesses or family-controlled businesses (FCBs).

We begin with the notion that public corporations structured as family businesses confront more, or at least different, challenges than similar, nonfamily, corporations. These differences exhibit themselves in a number of ways, at times clearly in line with firm survival and shareholder interests and at other times not. Gersick, Davis, Hampton, and Lansberg (1997) suggest these costs and issues arise from distinctions made between family, ownership concentration, and business issues. We can think of many related and intersecting issues when a family firm is viewed in such a context: e.g., succession, cousin consortiums, sibling rivalry, free riding, and unprofessional or unprepared management.

Accordingly, we do not attempt to parse the differential nature of family costs into categories and, while we recognize their existence, leave the latter for other research. Suffice it to say that while all corporations must deal with business and competitive concerns, and all public corporations have an additional burden of meeting the regulatory restrictions of public ownership, family corporations must also deal with an additional matter--family issues (Miller et al., 2005; Paisner, 1999). Miller et al. (2005) describe this second set of complexities, noting the parallels and differences between the agency costs created by the traditional separation of ownership and control, and the so-called costs of conflict, referring to the problem of dispute resolution among powerful family owners. If these additional family costs rage out of control (and there are many examples), the end result can be of significant damage to the corporation and all of its owners.

As an example, previous work on family firms has concluded that: (1) Two thirds fail in the transition to second generation (Handler, 1990; Ward, 1987); (2) they experience slower growth (Chandler, 1990); (3) they are often characterized by vulnerability and inertia in decision making (Meyer & Zucker, 1989); (4) they endure high agency costs (Morck, Shleifer, & Vishny, 1988); and (5) they can fall victim to predatory managers (Morck & Yeung, 2003). How then do family firms (3) maintain their status over long periods of time?

We adapt the notion of community-level social capital (Bourdieu, 1983; Putnam, 1993) as an important mechanism through which family owners protect and nurture their family businesses. Many readers are more familiar with the instrumental approaches to social capital, characterized by the works of Burt (1979, 1980, 1992) or Nahapiet & Ghoshal (1998). The instrumental approach emphasizes network position, and how network position influences the information flows among individual network members, as well as individual-level benefits that accrue. In contrast, a community-level approach emphasizes concepts such as shared values, trust, norms of reciprocity, and social support shared broadly among members to a community, and it is much less concerned about network position except as an indicator of particular characteristics. (4) In our study, the executives, directors, and owners of family businesses form the community under study.

Our article is organized as follows. We first review recent information about the existence and persistence of family companies in the United States. Then, we discuss the concept of community-level social capital, and provide some early clues as to its application and appropriateness for the family business setting. In the third section, we review the theory of interlocking directorates, as we believe that director interlocks will form an important mechanism for information sharing and the creation of community-level social capital among family business owners. Finally, we apply these theories to family corporations, emphasizing the situation in which the family business is publicly traded. Discussion and conclusions end the article.

Family Control of Public Corporations

Recent research has indicated that family control of large public corporations is widespread in the United States. Family ownership constitutes approximately 35% of large publicly traded firms in the United States and is evident across a broad spectrum of industries and firm sizes (Anderson & Reeb, 2004; Gomez-Mejia, Larraza-Kintana, & Makri, 2003; Schulze et al., 2003). Additionally, much of the wealth owned by the richest families in North America is corporate wealth (Allen, 1987). This wealth is often created through substantial stockholdings in a single corporation and through management of that corporation by members of the founding family or its descendants. Kinship ties tend to bind family members together. Yet those same ties can become disruptive influences or distractions when there are sharp disagreements among family members. As noted earlier, Miller et al. (2005) describe the costs associated with intra-family conflict--costs that are not endured by nonfamily businesses.

Although there are few theoretical treatments of agency theory dealing with the costs of intra-family conflict as we have defined them, (5) a perusal of scholarly research on FCB suggests that most authors assume these costs are substantial. Put differently, most authors seem to believe that family control of large businesses is inherently inefficient. This should not come as a surprise, given that traditional assumptions about market competitiveness, coupled with the tendency to perceive managerial interests as sharply divergent from shareholder interests (Lane, Cannella, & Lubatkin, 1998) contrast sharply with those few authors who view family firms as stewards of resources (Schulze, Lubatkin, Dino, & Buchholtz, 2001). Indeed, the very persistence of family companies seems to challenge the notion of market competitiveness, as FCBs face challenges comparable to all other firms and often must additionally deal with costly intra-family issues. If they outperform regular public corporations, the logical conclusion would seem to be that they are better governed than regular public corporations--a hard pill to swallow for free-market economists.

Of course, the existence of public corporations was also a difficult thing to acknowledge until it was better understood. Our article argues that the social capital generated by family business linkages to one another is an important reason for the survival and prosperity of this organizational form. Through these linkages to other firms, family businesses develop a strong identity, core values, and knowledge about how "family businesses" respond to challenges, both intra-family and competitive. This is not to argue that the mechanism is perfect--there are numerous examples of poorly run family firms, and family firms in which the family, or some of its members, looted the company. Yet, the three large-sample studies of family business in the United States that we are aware of have consistently concluded that family businesses outperform nonfamily businesses (e.g., Anderson & Reeb, 2003; Miller et al., 2005; Villalonga & Amit, 2006). (6)

Community-Level Social Capital