Does Family Control Shape Corporate Capital Structure? An Empirical Analysis of Eurozone Firms

• Author: Ignacio Requejo,Chabela la Torre,Julio Pindado
• DOI: http://doi.org/10.1111/jbfa.12124
• Date: 01 September 2015
• Published date: 01 September 2015

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 42(7) & (8), 965–1006, September/October 2015, 0306-686X

doi: 10.1111/jbfa.12124

Does Family Control Shape Corporate

Capital Structure? An Empirical Analysis

of Eurozone Firms

JULIO PINDADO,IGNACIO REQUEJO AND CHABELA DE LA TORRE∗

Abstract: This study investigates the relationship between family control and corporate

capital structure considering the dynamic nature of the debt policy and the ownership structure

of family firms. Our results show that the sensitivity of debt to fluctuations in cash flow is

less pronounced in family firms and highlight that family control increases the speed of

adjustment toward target debt. Four dimensions of the family business model explain these

results: deviations of voting from cash flow rights, the presence of a second blockholder in the

company, involvement of family members in management, and the generation in charge of

the business. The weaker negative impact of cash flow on debt is driven by family firms with no

control-enhancing mechanisms, companies with active family participation in management and

family businesses that are still controlled by the first generation. By contrast, the more severe

agency conflicts between owners and creditors in family firms with a second blockholder lead

to more pronounced pecking order behaviour. Furthermore, the higher flexibility in corporate

decision-making of family firms managed by the family and under the influence of the first

generation explains why family companies are able to rebalance their capital structure faster.

Keywords: family control, capital structure, speed of adjustment, second blockholder, panel

data, Eurozone

∗The first author is from IME and the Family Business Centre, Universidad de Salamanca, Spain and from

the Leeds University Business School, University of Leeds, UK. The second author is from IME and the

Family Business Centre, Universidad de Salamanca, Spain. The third author is from the Family Business

Centre, Universidad de Salamanca, Spain. This research was completed while Ignacio Requejo was a visiting

scholar at the Centre for Corporate Governance at London Business School. He appreciates the facilities

and hospitality received. We would like to thank Inga van den Bongard, Soku Byoun, Kelly Carter, Ettore

Croci, Kevin Keasey, Susana Men´

endez-Requejo, David M. Reeb, Jungwon Suh, the Associate Editor, Paul

Andr´

e, and an anonymous referee for comments and suggestions on previous versions of this paper. The

authors benefited from the comments of seminar participants at the 2011 Annual IFERA Conference in

Palermo, the 2012 Annual Meeting of the EFMA in Barcelona, the 2012 FMA International Annual Meeting

in Atlanta, the 2012 Finance Forum in Oviedo and the 2012 Family Business Symposium in Salamanca.

They are also grateful to the Research Agency of the Spanish Government, DGI (Grant ECO2013-45615-

P). Pindado and de la Torre acknowledge financial support from the Education Ministry at the Regional

Government of Castilla y Leon (Grant GR144), and Requejo appreciates financial support from the Spanish

Ministry of Education and Science. Any errors are the responsibility of the authors.

Address for correspondence: Julio Pindado, Universidad de Salamanca, Instituto Multidisciplinar de

Empresa (IME), Salamanca, E37007, Spain; Tel.: +34 923 294763; fax: +34 923 294715.

e-mail: pindado@usal.es.

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1. INTRODUCTION

Given the prevalence of family firms around the world (La Porta et al., 1999; Claessens

et al., 2000; and Faccio and Lang, 2002) and considering the peculiarities of the family

business model,1there is nowadays growing interest in better understanding how fam-

ily control affects specific corporate dimensions, including a firm’s capital structure.

Anecdotal evidence highlights the conservative approach of family firms when it comes

to debt and financial risk policies (Hall, 2005; and Milne, 2010). However,to date there

is no consensus among finance scholars on the debt preferences of family firms.

Family firms could be reluctant to use debt financing because of the constraints that

creditors can impose on them (King and Santor, 2008) or because they can get funds

from other related businesses (Masulis et al., 2011). The undiversified portfolios of

family owners could also affect the capital structure of family firms due to the increased

risk associated with leverage (Holmen et al., 2007). Despite these arguments, some

studies conclude that family firms do not differ from their non-family counterparts in

their levels of debt (Anderson and Reeb, 2003b). And more recent research supports

higher debt levels in family firms due to family owners’ control motivations and

their concern over the dilution of family control (Croci et al., 2011; and Schmid,

2013). Therefore, whether and how family control shapes a firm’s capital structure

is an issue that requires further examination. It is important to better understand

the arguments for the financing preferences of family firms due to the implications

for firm performance of adopting an adequate capital structure (Marchica and Mura,

2010; and Gonz´

alez, 2013).

In this context, our main objective is to investigate whether family firms differ

from non-family firms in two important dimensions of the financing policy that

receive no attention in previous family business studies: (i) the sensitivity of debt to

fluctuations in cash flow, and (ii) the speed of adjustment toward target leverage.

In so doing, we evaluate the severity of agency problems between family owners

and debt providers. Going a step further, we analyse whether this type of agency

conflict is aggravated in family firms with certain ownership structures and specific

management styles. Therefore, the present study covers a number of issues that

continue to arouse scholars’ and practitioners’ interest in the corporate finance and

governance fields such as the family business model, corporate ownership structure

and leverage decisions.

Toexplain how family control shapes a firm’s financing choices, we take the pecking

order theory as our starting point. We first examine whether the negative impact

of cash flow on debt depends on family control. This approach enables us to shed

new light on the severity of agency conflicts between shareholders and debtholders

in family firms. Then, we analyse the differences between family and non-family

firms in their speed of adjustment toward target capital structure. Any variation in

the sensitivity of debt to cash flow and in the adjustment speed toward target debt

across types of firms will be due to varying degrees of information asymmetries

and agency problems. Finally, we study how the combination of family control with

certain ownership structures and management types affects family firms’ reliance on

internally generated funds and their speed of adjustment. Specifically, we take into

1 See, among others, the works by Anderson and Reeb (2003a), Andres (2008) and Hillier and McColgan

(2009) for a detailed discussion on the benefits and costs associated with family control.

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consideration four important dimensions of the family business governance system:

(i) deviations between voting and cash flow rights of family owners, (ii) the presence

of second blockholders in family firms, (iii) whether family members hold managerial

positions, and (iv) the family generation that controls the business. By accounting for

these governance characteristics of family firms, we are able to disentangle whether

the agency problem between owners and creditors, and the resulting negative effect

of cash flow on debt, as well as the different adjustment speed toward target debt

expected in family firms are mainly attributable to a subset of family companies.

Our findings confirm that the negative relationship between internal finance and

leverage proposed by the pecking order theory is weaker in family firms. This result

supports the argument that the long-term involvement and the large stake of the

family in the business reduces asymmetric information and agency problems between

owners and creditors in family firms. Regarding the speed of adjustment toward target

debt, family firms rebalance their capital structure faster. The easier access to debt

financing and the lower adjustment costs of family firms enable them to fill the gap

between actual and target leverage at a higher speed. Subsequent analyses reveal that

the sensitivity of debt to cash flow and the adjustment speed of family firms depend on

specific important dimensions of their ownership structure and management.

In particular, the use of control-enhancing mechanisms which lead to deviations

between the family’s voting and cash flow rights results in more pronounced pecking

order behaviour. Regarding the presence of a second blockholder in family firms,

when two families control the business, the risk of collusion restricts the external

funds that they can get. In addition, although the supervising role of non-family

blockholders alleviates agency conflicts between the controlling family and minority

investors in family firms, they aggravate the agency problem between owners and

creditors. Consequently, family firms with a second blockholder experience a stronger

negative effect of cash flow on debt compared to family firms with no second large

shareholder.

Conversely, involvement of family members in the management of the company

is a sign of the family’s commitment to the business that mitigates the sensitivity

of debt to fluctuations in cash flow. Active family management also enables more

flexible decision-making processes and such flexibility helps family firms to rebalance

their capital structures faster. Finally, our results suggest that the easier access to debt

financing and the higher speed of adjustment toward target leverage of family firms

are mainly driven by first generation family businesses. Thus, family firms that are

still controlled by the founder are the ones that exhibit reduced agency conflicts with

creditors and lower transaction costs when pursuing target debt.

The present study makes several contributions to the corporate finance and

governance literature. First, we contribute to prior research that investigates the direct

effect of family control on a firm’s capital structure and attempts to disentangle

whether family control and debt are positively or negatively related. This study adopts

a new approach and, based on the pecking order theory, investigates the sensitivity

of debt to fluctuations in internally generated funds differentiating between family

and non-family firms. We conclude that information asymmetries between owners

and creditors, and the resulting pecking order behaviour, are less pronounced in

family firms. The weaker negative relationship between cash flow and debt in family

firms confirms lower agency conflicts between large shareholders and debtholders

in this type of corporation (Anderson et al., 2003). Our empirical evidence offers

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