Altruism and agency in the family firm: exploring the role of family, kinship, and ethnicity.

This article examines the relationship between altruism and agency costs in family business through an in-depth case study of a family firm. We found that altruism reduced agency costs in the early stages of the business, but that agency problems increased as the venture became larger and more established. Moreover, we suggest that altruistic behavior need not be confined to family and close kin, but may extend through networks of distant kin and ethnic ties. We thus present a more complex view of the agency relationship in family business than is often portrayed in the existing literature.

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In a recent article, Chrisman, Chua, and Sharma (2005, p. 559) suggest that the core challenge facing family business research is to identify "the nature of family firms' distinctions" and to determine "if and how these distinctions result from family involvement." As family business researchers have grappled with these issues, they have relied heavily on agency theory, and, in particular, on the notion of altruism. This approach has resulted in a number of important insights, yet the effects of altruism in family business remain uncertain. For example, it is unclear under what conditions altruism reduces agency costs (e.g., Van den Berghe & Carchon, 2003) and under what conditions it increases them (e.g., Schulze, Lubatkin, & Dino, 2003).

This lack of clarity suggests that considerably more work is required in order to develop a comprehensive theory of altruism as a distinctive aspect of family business. Moreover, altruism has implications for the nonfamily members of family firms, and this issue has rarely been examined in the literature. In this article, we report the results of a case study of a family business, which sheds significant additional light on this topic.

Our case study grows out of a larger research project conducted by one of the authors (Karra, 2005). Over the past 3 years, she has conducted a study of entrepreneurial new ventures that began international operations soon after founding. During this research project, it became apparent that many of these companies were family owned and characterized by complex networks of family, kinship, and ethnic ties. One firm from this larger study was selected in order to explore the family dynamics that occurred in the development of these ventures. The firm that was chosen, Neroli, (1) is a medium-sized fashion firm headquartered in Turkey that manufactures and sells a range of leather goods and clothing. It has production facilities in Istanbul and a distribution network spanning much of the former Soviet Union and Eastern Europe.

In exploring the role of family influence in the development of this family-owned new venture, the study makes several contributions to the family business literature. First, we show that in the early stages of family businesses, altruistic behavior has the potential to align the interests of family and kin and to help build a competitive advantage.

Second, we argue that family firms may expand the logic of the family beyond the nuclear family through kinship and ethnicity in order to create a form of quasi-family. In this case, the owner of Neroli leveraged ethnic ties and the shared experience of living under communism to build a network of relationships that shared the characteristics of the family ties that existed at the center of the firm. Our analysis suggests a more fluid conception of "family," one that is at least partly negotiated rather than automatically attributed by virtue of blood or marriage.

Third, we show that there are limits to altruism as family businesses develop and grow, and that agency costs may therefore increase over time. However, we argue that the nature of the agency problems experienced differ between family and near kin and between the quasi-family based on distant kin and ethnic ties. With regard to the former, agency issues take the form of moral hazard; in the latter, they take the form of adverse selection.

The article proceeds as follows. First, we provide an overview of the literature on agency theory and altruism as it relates to family business and outline the research questions that underpin the study. We then explain why we chose Neroli and how the data were collected and analyzed. In the third section, we present the story of Neroli. Building on the case study, in the fourth section we present our findings on the relationship between altruism and agency in family firms. We conclude by considering the implications of the study and discuss some directions for future research.

Agency Theory, Altruism, and the Family Firm

There is a large and growing body of work that considers the ways in which family businesses differ from nonfamily businesses (Chrisman et al., 2005). One of the most successful approaches to developing a theory of the family firm that takes into account the distinctive dynamics inherent in family business, and the role of the business as a family institution, has been agency theory. At the core of agency theory is the potential conflict between the owners of a firm (the principal) and the managers under contract to run the firm on the owner's behalf (the agent).

Agency theory highlights two characteristics of agency relationships (Eisenhardt, 1989a): (1) the interests and objectives of the agent and the principal and (2) the approach to risk of the agent and the principal, both of which are likely to diverge under certain circumstances and which may lead to conflicting decision-making preferences. As a result of asymmetric information, it is difficult for the principal to monitor the actions of the agent. Moreover, because contracts are incomplete and cannot address all possible contingencies, it is impossible for the principal to ensure that the agent acts appropriately in all circumstances (Alchian & Woodward, 1988).

Under the conditions of asymmetric information and in the absence of complete contracts, two main kinds of agency problem may arise (Chrisman, Chua, & Litz, 2004). The first is adverse selection, which occurs when the principal enters into a contract with an agent who is not well qualified or is in some other way unsuitable for the tasks to be performed. The second is moral hazard, a term that "suggests that people cannot be counted on to do what they say they are going to do, and that failure manifests itself in prices and contractual arrangements" (Alchian & Woodward, 1988, p. 68). Moral hazard is a form of opportunism and includes shirking, free riding, and the consumption of perks.

Agency problems such as these inhibit cooperative relationships between agents and principals. To control these problems, principals adopt a series of incentive mechanisms (both hortatory and punitive) to try to ensure that the actions of the agent are consistent with the objectives of the principal. The costs of negotiating and implementing these incentives, as well as the costs of monitoring them, are referred to as agency costs.

Early proponents of agency theory suggested that agency costs in family firms are negligible or absent because the interests of family members are likely to be closely aligned (Fama & Jensen, 1983, 1985). This, it is argued, leads to effective decision making because owners have the capacity to ensure that decisions are made with a view to maximizing family wealth and/or securing a legacy for future generations. Jensen and Meckling (1976) even suggested that formal governance mechanisms in family firms are at best unnecessary, and at worst may actually damage business performance. From this perspective, family business is a very efficient form of organization, with intrinsic advantages over nonfamily organizational forms (Daily & Dollinger, 1992; Kang, 2000).

The assumption of these authors is that individuals, households, and firms are rational actors seeking to maximize their economic utility. In family business studies, however, comparatively few scholars have sought to work within these confines, preferring instead to consider that actors have a range of preferences and objectives (e.g., Chrisman et al., 2004; Lubatkin, Schulze, Ling, & Dino, 2005). More specifically, a key assumption in the family business literature is that in addition to economic goals, families may have noneconomic goals such as providing employment for family members and building family cohesion. (2) This changes the nature of the agency relationship because it is possible for family members to make decisions that lead to a suboptimal business performance by, for example, the excessive consumption of perks, but at the same time exhibit behaviors that are consistent with the objectives of the owner of the firm (Chrisman et al., 2004).

In seeking to explain this characteristic of family firms, the concept of altruism features prominently. Van den Berghe and Carchon (2003) suggest that altruism provides a powerful conceptual tool for understanding why family firms exist. Dyer (2003, p. 408) voices a similar opinion, arguing that it plays "a unique role in family firms that is not generally found in other enterprises."