INNOVATION AND THE PRESERVATION OF SOCIOEMOTIONAL WEALTH IN FAMILY CONTROLLED HIGH TECHNOLOGY FIRMS...

INNOVATION AND THE PRESERVATION OF SOCIOEMOTIONALWEALTH IN FAMILY CONTROLLED HIGH TECHNOLOGY FIRMS

Professor L. R. Gomez-MejiaTexas A&M University

RESEARCH STREAM ON FAMILY FIRMS:A HISTORICAL PERSPECTIVE

Influence of ValuesAnd Subjective Framing In Decision Making

Ownership Structure

Managerial Practices Of Family Firms

TEXAS A&M UNIVERSITYMAYS BUSINESS SCHOOL

ROLE of VALUES and SUBJECTIVE FRAMING: Value System Makes a Difference in Terms of How Individuals View Situations, Evaluate Information, and Arrive at Decisions

• Gómez-Mejia, Page, Tornow (AMJ, 1982): Importance of jobs and how they are compensated depends on managerial values.

• Gómez-Mejia, (AMJ, 1983): Managerial values differ according to organization, national culture, individual characteristics.

• Gómez-Mejia, (AMJ, 1984): Occupational socialization reduces gender differences in values (what employees want from organizations).

• Gómez-Mejia & Balkin (SMJ, 1987): Managerial values (such as risk sharing, uncertainty avoidance, and long-term orientation) as reflected in compensation system depend on organizational and environmental characteristics (such as life cycle, firm size, firm age, presence of venture capital, Technological intensity) (Research done mostly with start up high-tech firms in Boston 128 Route).

• Gómez-Mejia & Balkin (SMJ, 1990): Compensation strategy (e.g., pay at risk, decentralization, broadbanding etc.) is a reflection of corporate and business unit managerial values (for instance, a prospector orientation associated with more pay at risk).

• Gómez-Mejia (SMJ, 1992): Compensation patterns (algorithmic vs. experiential) of firms are consistent and reflect broad managerial values.

• Gómez-Mejia & Palich (JIBS, 1997): Cultural dispersion and performance consequences for multinational firms. Found no cultural dispersion effects on foreign investment.

• Palich & Gómez-Mejia (JOM, 1998): Theoretical model of effect of cultural similarity and how some firms are more attracted to it than others when internationalize (e.g., family firms).

• Wiseman & Gómez-Mejia (AMR, 1998): Framing of problems and managerial decisions depend on the subjective valuation of individuals of what is more or less important to them and whether they are gaining or losing ground on important dimensions. Hybrid Agency-Behavioral Model.

• Gómez-Mejia, Welbourne & Wiseman (AMR, 2000): Under gainsharing, risks taken by employees in providing and implementing suggestions depends on how they frame problems.

• Balkin & Gómez-Mejia (AMJ, 2000): Innovation drives executive pay in technology intensive firms (where it is highly valued) independent of financial outcomes.

• Miller, Gómez-Mejia, & Wiseman (AMJ, 2002): The firm’s systematic risk influences managerial perception of control over decision consequences and this is reflected in pay-performance relations.

• Makri, Lane & Gómez-Mejia (SMJ, 2006): In technology-intensive industries evidence of “pure science” activities is used by boards to set CEO pay independent of observed financial outcomes.

• Berrone & Gómez-Mejia (AMJ, 2009): Hybrid agency-institutional explanation for how legitimization and organizational values influence linkage of CEO pay-pollution independent of and financial gains.


OWNERSHIP STRUCTURE

• Gómez-Mejia, Tosi & Hinkin (AMJ, 1987): Impact of ownership structure on executive compensation.

• Tosi & Gómez-Mejia (ASQ, 1989): Managerial power and legitimization of executive behaviors.

• Gómez-Mejia & Tosi (AMJ, 1994): Ownership structure and firm performance.

• Werner, Gómez-Mejia, Tosi (SMJ, 2005): Ownership and aggregate employee compensation.

• Larraza-Kintana, Wiseman, & Gómez-Mejia (SMJ, 2007): Perceptions of risk by executives in new ventures and IPO firms does not follow conventional pattern in corporate strategy literature (for instance, high R and D expenditures is seen as a low risk choice).

FAMILY OWNERSHIP AND ENTREPRENEURSHIP RELATED RESEARCH

• Gómez-Mejia & Milkovich (AMJ, 1976): How family values influence decisions to offer child care benefits in a consortia setting, mostly small firms in inner city serving African Americans.


• Gómez-Mejia (SMJ, 1988): Small (non-publicly traded) firms and exporting behaviors, mostly Miami-based family owned Hispanic firms. How they use networks in Latin America and human resource policies to foster exporting efforts.

• Gómez-Mejia, Nunez-Nickel & Gutierrez (AMJ, 2001): Family ownership and managerial entrenchment (longitudinal study of 100 plus years of entire population of Spanish newspaper, mostly very small).

• Miller, Hom, & Gómez-Mejia (JIBS, 2001): Family ties, pecuniary rewards and employee turnover in border town (Mexico-USA) firms (combination of survey, archival data fielded research). Family ties among employees a far more important predictor of employee turnover (negative) than compensation and benefits (not significant).

• Gómez-Mejia, Larraza-Kintana, & Makri (AMJ, 2003): Family Ownership and executive compensation. Broad cross-section firms. Family CEOs get paid less but incurr little risk.

• Gómez-Mejia, Haynes, Nunez-Nickel, & Moyano (ASQ, 2007): Family’s socioemotional wealth and risk taking (longitudinal study of 100 plus years of entire population of family owned oil mills in Southern Spain, mostly with under 20 employees). Preservation of family’s control and “socioemotional wealth” more important than financial gains.

• Jones, Makri, & Gómez-Mejia (ETP, 2008): Family ownership, board composition and diversification (broad cross-section of firms). Specifically, affiliate directors stimulate family firms to pursue diversification strategies by sharing their knowledge and experience with family executives, and hence reducing the perceived risk that may be associated with grown strategies. Affiliates can play this advisory role without reducing the control of family owners, and this facilitates the firm’s willingness to adopt growth-oriented strategies.


• Cruz, Gómez-Mejia, & Becerra (AMJ, 2010): Managerial trust as a function of family ties and its effect on agency contract. (Combination of archival and survey measures for 122 small family firms in Spain).

• Berrone, Cruz, Gómez-Mejia & Larraza (ASQ, 2010): Saving face: Why family firms pollute less. Broad cross-section of family/non-family firms in polluting sectors.

• Gómez-Mejia, Larraza, & Makri (JMS, 2010): Family ownership and diversification (broad cross-section of firms).

• Gómez-Mejia, Cruz & Berrone (Annals of Academy of Management,2011). Family business governance. What we know and what we have yet to learn (80 plus pages providing critical review of family business literature).

• Family firms and supply chain integration (with Elena Revilla and Veronica Villena: Decision Science, 2012.

• Gomez-Mejia, L. R., & Martin, G., Stakeholder Management in Family Controlled Firms (Organization Science, 2012).• Berrone, Gomez-Mejia, Gelabert, Fosfuri. Environmental innovation, institutional pressures and firm ownership (Strategic Management Journal, in press).

• Martin, G., Gomez-Mejia & Wiseman (2012): Strategic Implications of CEO compensation design: Re-visiting the behavioral agency model in family and non-family controlled firms. Academy of Management Journal.

Socio-emotional Wealth (SEW)

SEW refers to the non-economic utility a family receives from ongoing firm ownership and control.

SEW captures the “affective endowment” of family owners, including the family’s desire to exercise authority, enjoyment of family influence, maintenance of clan membership within the firm, the appointment of trusted family members to important posts, retention of a strong family identity, the continuation of family dynasty etc.

In family firms, SEW preservation is a key non-economic reference point for decision making.


9

Contingency Variables• Family Stage• Firm Size• Firm Hazard• Presence of Non Family Shareholders

Family Firm Socioemotional Wealth Preservation

Management Processes• Succession• Professionalization• Human Resource

Strategic Choices• Risk Taking• Corporate Diversification• International Diversification• Acquisition Behavior• Debt• Accounting Choices

Organizational Governance• Role of the Board• Incentive Alignment• Agency Contract

Stakeholder Relationships• Stakeholder Management• Corporate Social Responsibility

Business Venturing• Role of Families in New Ventures• Corporate Entrepreneurship

FinancialPerformance

Figure 1. Family Firm Research from a Socioemotional Wealth Preservation Perspective


Current Study

In family controlled firms, SEW preservation is a key non-economic reference point for decision making which may drive the firm into high financial risk mode. IN HIGH TECHNOLOGY FIRMS THIS TRANSLATES INTO LOWER R&D AND LOWER TECHNOLOGICAL DIVERSIFICATION


INNOVATION AND THE PRESERVATION OF SEW IN FAMILY CONTROLLED HIGH

TECHNOLOGY FIRMS

Agency Theory Perspective & Paradox:

Family owners in high technology industries would (should) tend to actively support innovation because the family normally has most of its wealth tied to one particular firm and lower innovation poses greater risk in these industries where product life cycles are sometimes measured in months.

Hence, according to agency theory greater levels of R&D investment provide the conservative family owners the least risk.



TECHNOLOGY FIRMS

High technology, family controlled firms are less likely to pursue an active innovation strategy even when the context favors such a strategy from an economic perspective.

Why this paradox?

Behavioral Agency Model


BEHAVIORAL AGENCY MODEL

BAM predicts that decision makers are willing to make risky decisions when the situation is framed in negative terms because they are ‘loss averse’.

Hence, “loss aversion” explains a preference for riskier actions in order to prevent losses to accumulated endowment.


MAIN ASSUMPTION For family firms the most important reference point when framing major decision choices is the loss of SEW.

Family owners are more inclined to accept greater probabilities of financial losses (for instance, losing potential market share by not pursuing an aggressive innovation strategy) if that means preservation of SEW. Families resist the economic incentive for high R&D investment because such a strategy may jeopardize the family’s socioemotional wealth (SEW).


Family Ownership and R&D Investments

How/ why R&D investments threaten the family’s SEW endowment?

1. The decision to aggressively expand R&D is likely to uncover existing deficiencies in human capital (as most R&D effort is highly specialized and complex), thus requiring greater use of outsiders – loss of control.



2. R&D investments usually require willingness to experiment and the introduction of new routines and modus operandi that move away from the firm’s “true and tried” methods of operation.

A family controlled high technology firm is more likely to stay closer to the “core” because it is a choice that provokes less anxiety and one that given prior success (particularly if family founders are still active) feels more comfortable to the family.



3. High technology firms usually finance R&D expansion by securing external investments, either in the form of debt or by ceding ownership to parties outside the firm (such as venture capitalists or institutional investors) in exchange for much needed funding.

Hypothesis 1: Family controlled high technology firms invest less in R&D than their non-family controlled counterparts - Supported


Family Ownership and Technological Diversification

Technological diversification refers to the extent to which a firm draws from many different areas of technological knowledge.

Consistent with the arguments for H1, technological diversification would tend to dilute the family’s SEW because this demands a much larger and complex knowledge base and a more diverse set of skills.

Also, family firms tend to diversify less (product –wise) because of a fear of loss of control (Gomez-Mejia, Makri & Larraza-Kintana, 2010). As such, they would have a more narrow scope in terms of products / technological knowledge and they would be less likely to have a mind set of exploration into diverse terrains.

Hypothesis 2: Family controlled high technology firms diversify less technologically than their non-family controlled counterparts – Strong SupportTEXAS A&M UNIVERSITYMAYS BUSINESS SCHOOL

Increasing the Family Owners’ Influence: Family Member-CEO

Family member-CEOs are more likely to be aligned with the desires of the family when they are a member of that family.

The family CEO will make strategic decisions that are closely aligned with the SEW preservation objectives of family owners.

Hypothesis 3: The negative relationship between family ownership in high technology firms and R&D investment is moderated by the CEO’s affiliation, such that when the CEO is a

family member the firm invests less in R&D than when the CEO is not a family member. - Strong Support


Factors Decreasing the Family Owners’ Influence: Declining Performance

As performance declines, the pivotal reference point for family owners may shift from SEW preservation to firm survival and this would increase the family’s willingness to invest in R&D. After all, if the firm fails to survive, the family would lose both SEW and its financial welfare.

Hypothesis 4: The negative relationship between family ownership in high technology firms and R&D investment is moderated by declining performance, such that family firms invest more in R&D than their non family controlled counterparts as firm performance deteriorates. Supported


Factors Decreasing the Family Owners’ Influence: Institutional Ownership The family may need to compromise on the pursuit of its particularistic motives when it has to contend with the presence of institutional investors.

Family firms are more likely to invest in R&D when they are constrained by external investors.

Hypothesis 5: The negative relationship between family ownership in high technology firms and R&D investment is moderated by institutional investor ownership, such that increasing institutional investor ownership weakens the relationship. – Moderate support


Sample and Data

Years 1994-2002 (402 firms over 9 years).

402 firms, 201 of them being family controlled and the rest (201) non- family controlled.

Family firm. 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 stock (5%). We adopted the more conservative cut-off point of 10% to determine if a firm should be included in the sample of family firms.

─ Eligible relationships included father, mother, sister, brother, son, daughter, spouse, in- laws, aunt, uncle, niece, nephew, and cousin.

TEXAS A&M UNIVERSITYMAYS BUSINESS UNIVERSITY

Dependent Variables

R&D investments. R&D expenditures / sales

Technological diversification. The U.S. Patent and Trademark Office (USPTO) classifies technologies into 417 main (3-digit) patent classes. Hall et al. (2001) constructed a measure that reflects the extent to which a firm's patent cites previous patents that belong to a wide set of technologies. This measure reflects the technology breadth of a firm's patent portfolio.

For each equation, the dependent variables were measured two years after the independent and control variables.


Moderator Variables Performance hazard. We use the interaction term of ROA and family control to determine if family owners are more prone than non-family shareholders to invest in R&D at lower (when the performance threat increases) rather than higher (when the performance threat decreases) levels of ROA.

Institutional ownership. % of equity ownership by mutual and pension funds (the two largest groups of institutional investors), calculated as the sum of their ownership divided by common shares outstanding.

Family CEO. This variable was coded as 1 if the CEO was also a family member and 0 otherwise.


Controls

Available slack was measured using a firm’s assets to liabilities ratio and it has been found to influence the amount of funds available for R&D (Baysinger & Hoskisson, 1989).

Potential slack was measured using the debt-to- equity ratio of the firm (Geiger & Makri, 2006).

Firm risk was operationalized as volatility, or the log of the variance of the firm’s stock return during the year.


Descriptive Statistics – Full Sample

Variable Mean s.d.

1 R&D investments 0.10 0.86

2 R&D not reported 0.48 0.50

3 Technological diversification 0.03 0.12

4 Family firm 0.43 0.50

5 ROA 0.03 0.17

6 Institutional ownership 0.17 0.13

7 Family CEO 0.21 0.40

8 Product diversification 0.77 0.74

9 Firm risk -7.00 0.96

10 Firm size (log) 0.84 1.82

11 Cash 125.78 569.63

12 Firm age 29.35 25.58

13 Available slack 2.94 3.01

14 Potential slack 0.66 3.95

15 Number of patents 1.52 14.36


Results of Tobit Random-Effects Regression Models – Full Sample

H1 R&D Investments

H2 Technological Diversification

R&D not reported -9.76 Product diversification

-0.08 -0.18*

Firm risk -0.13 -0.13* Firm size a -0.26*** 0.06+ Cash 0.00* 0.00 Firm age -0.00 0.01*** Available slack -0.03 0.00 Potential slack -0.01 -0.01 ROA -1.92*** -0.24 Institutional ownership

0.78+ 1.34***

Number of patents 0.00 Independent Variable Family Firm -0.28* -0.22** Constant -1.08+ -5.31 Log-likelihood -1440.65 -260.80 Wald χ2 185.46*** 125.95*** χ2 DF 19 19 N 2101 2101

+ p < 0.10* P < 0.05** p < 0.01*** p < 0.001


Results of Tobit Random-Effects Regression Models for Family Member-CEO – Family Firm Sample

H3 R&D Investments

R&D not reported -11.99 Product diversification -0.14 Firm risk -0.38** Firm size a -0.33*** Cash 0.00+ Firm age -0.01+ Available slack -0.05+ Potential slack -0.08 ROA -2.29*** Institutional ownership 0.80 Family member CEO -1.02*** Constant 1.45*** Log-likelihood -605.14 Wald χ2 129.44*** χ2 DF 19 N 902

+ p < 0.10* P < 0.05** p < 0.01*** p < 0.001


Results of Tobit Random-Effects Regression Models for Declining Performance & Institutional Owners – Full Sample

H4 R&D Investments

H5 R&D Investments

H4 & H5 R&D Investments

R&D not reported - 9.73 -9.90 -9.72 Product diversification -0.09 -0.09 -0.10 Firm risk -0.12 -0.11 -0.09 Firm size a -0.26*** 0.27*** -0.27*** Cash 0.00* 0.00* 0.00* Firm age -0.00 0.00 0.00 Available slack -0.03 0.00 -0.03+ Potential slack -0.00 -0.01 -0.00 ROA -1.45*** -1.90*** -1.33*** Institutional ownership 0.78+ 0.44 0.34 Family Firm -0.29* -0.26* -0.27*

Interactions Family Firm * ROA -0.67+ -0.81* Family Firm * Institutional Ownership

1.17 1.51+

Constant -0.96 -0.96 -0.78 Log-likelihood -1439.09 -1439.71 -1437.54 Wald χ2 189.52*** 187.49*** 193.03***

χ2 DF 20 20 21 N 2101 2101 2101



TECHNOLOGY FIRMS

When families are in control of the high technology firm, innovative efforts would be weaker both in terms of input (investments in R&D) and output (patent diversification into a broad set of technology classes) in spite of the potential economic downside of this strategic choice.

The family’s negative influence is expected to be more salient when the CEO is also a family member.

However, family owners do not want to fail thereby fully jeopardizing SEW, and thus are willing to increase innovation investments, when firm performance is declining (thus threatening firm survival) and when other influential owners (i.e. institutional owners) demand such investments. TEXAS A&M UNIVERSITYMAYS BUSINESS SCHOOL

THE PURSUIT OF SOCIOEMOTIONAL WEALTH IN FAMILY CONTROLLED FIRMS

PROF. LUIS R. GOMEZ-MEJIA BENTON COCANOUGHER CHAIR IN BUSINESS MAYS BUSINESS SCHOOL TEXAS A&M UNIVERSITY


WHY SHOULD WE CARE ABOUT FAMILY FIRMS

• 95% of firms start out as family firms

• At least 70% of firms in U.S.A. are controlled by families, including one third of Fortune 500 (e.g., Cargill, Motorola, Ford, Microsoft etc.)

• At least 85% of firms in Southern European countries are controlled by families and 70% in northern countries

• Around the world there is no doubt that families represent the predominant organizational form


STREAM OF RESEARCH SHOWING THAT FAMILY CONTROLLED FIRMS ARE UNIQUE IN THEIR MANAGEMENT PRACTICES

• Gomez-Mejia, L. R. & Milkoveb, G. (Academy of Management Journal, 1976) Population: Day Care Consortium in Minneapolis, MN.

• Gomez-Mejia, L., Nunez-Nickel, N., & Gutierrez, I. (Academy of Management Journal, 2001).

Population: All Spanish newspaper starting in 1948.

• Gomez-Mejia, L., Makri, M. & Larraza-Kintana, M (Academy of Management Journal, 2003).

Population: All Fortune 1,000 Firms

• Gomez-Mejia, L., Haynes, K., Nunez-Nickel, N., Moyana, J. (Administrative Science Quarterly, 2007).

Population: Olive Oil Mills in Jaen(Spain), during 50 year period

• Cruz, C., Gomez-Mejia, L. & Becerra, M. (Academy of Management Journal, 2010)

Population: 122 Spanish firmsTEXAS A&M UNIVERSITYMAYS BUSINESS SCHOOL

34

• Gomez-Mejia, L., Larraza-Kintana, M., and Makri, M. Population: Fortune 1000 firms (Journal of Management Studies, 2010

• Berrone, M., Cruz, C., Gomez-Mejia, L., Larraza-Kintana (Administrative Science Quarterly, 2010) Population: All firms reporting pollution levels to Environmental Protection Agency •Gomez-Mejia, Hoskisson, Makri, Sirmon & Campbell (Forthcoming, 2012). Socioemotional Wealth And Innovation In Family Controlled Firms. Academy of Management Journal.

Population: Two Samples Of 2,000 High Technology Firms


KEY ARGUMENT

FAMILY FIRMS ARE MOTIVATED BY MORE THAN THE MONETARY OUTCOME OF ORGANIZATIONAL ACTIVITY

• The family’s desire to exercise authority

• Enjoyment of family influence

• Maintenance of clan membership within the firm

• The appointment of trusted family member to important posts

• Retention of a favorable family and firm reputation

• The continuation of family dynasty

SOCIOEMOTIONAL WEALTH is an umbrella term that accommodates all socioemotional elements of a family’s utility function that directly relate to the family’s involvement in the firm.

As such, defined as “the stock of affect-related value that the family has invested in the firm.”

INNOVATION AND THE PRESERVATION OF SOCIOEMOTIONAL WEALTH IN FAMILY CONTROLLED HIGH TECHNOLOGY FIRMS...

Documents

Transcript of INNOVATION AND THE PRESERVATION OF SOCIOEMOTIONAL WEALTH IN FAMILY CONTROLLED HIGH TECHNOLOGY FIRMS...