Regional economy as a determinant of the prevalence of family firms in the united states: a preliminary report.

The formation of family firms, as well as their scale and scope, is likely to be influenced by the characteristics of the environment. This study presents preliminary findings on the relationship between economic development and the prevalence of family vs. nonfamily firms in the United States. We use three samples consisting of 15,918 firms aggregated at the state level and two methods of estimating the proportion of family businesses in each state. Our results indicate that regardless of the method of estimation, there is a negative relationship between the proportion of family firms in a state and gross state product per capita. Implications and research directions are provided.

Introduction

Recent contributions to the development of a theory of the family firm have focused on internal dynamics and resources (Habbershon, Williams, & MacMillan, 2003; Schulze, Lubatkin, & Dino, 2003; Schulze, Lubatkin, Dino, & Buchholtz, 2001; Sirmon & Hitt, 2003), but the use and utility of any resource will vary depending upon the environmental opportunity to which it is applied (Barney, 1991; Hofer & S chendel, 1978). Thus, a family firm's formation and continued existence, as well as its scale and scope, are likely to be influenced by its external environment. Consequently, the development of a theory of the family firm will benefit from a better understanding of the external conditions that allow family firms to flourish or that constrain their development.

Unfortunately, relatively little is known about where family firms tend to appear. Beyond the fact that family firms are ubiquitous in economies throughout the world (Becht & Mayer, 2001; Klein, 2000; Morck & Yeung, 2003; Shanker & Astrachan, 1996), we do not know what conditions foster or inhibit family firm development, in comparison with the development of nonfamily firms. Given that family firms may be fundamentally different from other organizations in terms of their goals, governance structures, and other important strategic processes (Carney, 2005; Chrisman, Chua, & Litz, 2004; Sharma, Chrisman, & Chua, 1997), the external conditions necessary for their formation, survival, and growth may also be different. Answering the "where" question will help us gain a better understanding of the economic reasons family firms tend to be so prevalent. Furthermore, although the importance of family firms to the world economy is not in dispute, their contributions to economic development may not be uniformly positive (Morck & Yeung, 2004). Consequently, gaining knowledge about the external conditions that are related to the prevalence of family firms may also help us understand the economic implications of family firms' formation and growth.

To begin to fill this gap in the literature, this preliminary, exploratory study investigates environmental conditions related to the prevalence of family firms in regional economies (i.e., the ratio of family firms to total firms). To guide this investigation, we focus on state-level economic conditions in the United States. Specifically, we hypothesize that a region's economic development affects the prevalence of family firms. This hypothesis is tested using a regression model estimated with a total of 15,918 firms aggregated at the state level from three samples taken from among the clients of the Small Business Development Center (SBDC) program.

The study makes several important contributions to research on family business. First, it introduces a research topic of both theoretical and practical significance that has received relatively little attention in the family business literature. Second, it begins to answer the question about the conditions that give rise to the formation of family firms, as opposed to firms that are started with some other type of governance structure. Third, because our findings suggest that the development of a regional economy might have an important impact on the efficacy of the family form of organization, we contribute to the understanding of variables that should be controlled for in empirical research on the strategic, administrative, and operating factors that influence the creation, survival, and performance of family firms.

In the remainder of the article, we develop our framework, discuss our methodology and results, and conclude with implications for future research.

Theory and Hypothesis

Similar to the requirements for developing a theory of thefirm, a theory of the family firm must address two central questions (cf. Conner, 1991): (1) why do family firms exist? and (2) what are the factors that influence their scale and scope? However, because family firms represent a particular type of organizational form, developing a theory of the family firm largely involves gaining an appreciation of why that particular governance system is selected as opposed to some other system, such as entrepreneurial, managerial, or alliance governance (Carney, 2005). For the purpose of this article, we use three theoretical lenses: agency theory, the resource-based view (RBV) of the firm, and stakeholder theory. While the first two have often been used by researchers studying the differences between family and nonfamily firms, we add stakeholder theory (Freeman, 1984; Mitchell, Agle, & Wood, 1997) as a third theoretical lens because the varying goals and salience of family stakeholders leads to a political process of value determination that can have a profound influence on the creation of family firms (Chrisman et al., 2003).

Taken together, these three theories allow us to develop an initial understanding of why family firms might be different in their fundamental behaviors from nonfamily firms. In addition, these theories each point to certain exogenous factors that could facilitate or inhibit the creation and growth of family firms. After providing an overview of the context of interest in this study, we briefly review the precepts of each of these theories and then use them to explain how economic development considerations might influence the prevalence of family firms in a region. In presenting these explanations, we stress the relative importance of economic development on decisions to organize as family firms. Thus, our study focuses on a critical economic factor that could influence the selection of a family firm as organizational form over other organizing options.

Characteristics of an Economically Less-Developed Region

A region with a less developed economy will be characterized by lower average incomes, leading to lower demand for goods and services, potential scarcity of financial capital and skilled labor, and possibly lower profitability. In addition, a less developed economy may suffer from an overall shortage of social capital (La Porta, Lopez-de Silanes, Shleifer, & Vishny, 1997; Morck and Yeung 2004). For example, research suggests that in regions with less developed economies and low economic growth, the actual or perceived threat of managerial opportunism is high due to legal and ethical systems that make it difficult to trust strangers to manage the firm (Burkart, Pannunzi, & Shleifer, 2003; Fukuyama, 1995).

Under these conditions, firms that have lower costs of operation, lower costs of capital, or better access to resources will have critical advantages. If, in general, family firms differ from nonfamily firms in terms of costs or access to resources, then the prevalence of family firms in a region will be affected by the region's level of economic development. Based on the three theories mentioned previously, we argue in the sections below that family firms in comparison with nonfamily firms may have lower cost of operation, lower cost of capital, and better access to resources. Specifically, we discuss how both agency theory and RBV argue that family firms may have lower costs of operation, how RBV argues that family firms may have better access to resources, and how stakeholder theory argues that family firms may have lower costs of capital. Utilizing these arguments, we then hypothesize that family firms will be more prevalent in regions that are less prosperous.

An Agency Theory Perspective

One of the major contributions of agency theory is its explanation of the consequences and costs of conflicts of interest, asymmetric information, and bounded rationality arising from the separation of ownership and management (Jensen & Meckling, 1976). Traditional applications of the theory based on asymmetric information suggest that agency costs in family firms will be very low because owners (principals) and managers (agents) are either the same individuals or are members of the same family (e.g., Fama & Jensen, 1983). In the former, there would be no separation of ownership and management, while in the latter, asymmetric information is assumed to be minimal. Expanding on this, Carney (2005) argues that because family firms tend to make decisions affecting the family's own wealth (i.e., the managers making decisions are also owners or quasi-owners), they have an incentive to keep costs low, use capital sparingly and intensively, and, generally, maintain close control of operations. Such behavior would not be as likely in nonfamily firms. Carney (2005) then goes on to argue that family firms' propensity for "parsimony" makes them well equipped to compete in environments characterized by scarcity such as those found in economically depressed or less-developed regions.