“Family Companies”—Editorial Synthesis of Special Issue

Abstract

This paper presents an editorial synthesis of the three substantive papers published in this Special Issue. The lens for this synthesis concerns the joint contribution of the three papers in identifying potential bases for explaining variation in Type 2 agency costs of equity in family companies. The papers included in this Special Issue, using data from Portugal and Africa, suggest three bases. These bases are Small-to-Medium Enterprise status, prevalence of third parties to reduce information asymmetry between the principals and agents, and domicile in South Africa (for African family businesses). It follows from the paper using data from Jordan that degree of tax avoidance would be a suitable measure of Type 2 agency costs of equity. Hence, it would be appropriate for future research to investigate whether this metric varies systematically, across family companies, according to these three bases.

1. Introduction

The purpose of this paper is to synthesize the three substantive papers published in the Special Issue from the viewpoint of their joint contribution to achieving the purpose of the Special Issue: to propose potential bases for explaining variation in Type 2 agency costs of equity (Ali et al. 2007), in addition to bases already identified in previous studies. This understanding would enhance prospects for reducing Type 2 agency costs of equity.

The principal features of this Special Issue are as follows. Two of the three papers (Roque and Alves 2023; Iwu et al. 2024) are descriptive. These papers focus on Portugal and Africa (in its entirety), respectively. The third paper (Almaharmeh et al. 2024) uses data from Jordan and focuses on tax avoidance as a manifestation of Type 2 agency costs of equity (Ali et al. 2007). The results produced by Roque and Alves (2023) suggest that Portuguese family companies (mostly Small-to-Medium Enterprises) suffered a deterioration in internationalization performance as a result of COVID-19. The study conducted by Iwu et al. (2024) is a structured literature review of prior African studies examining the benefits of incubation services for family companies. The studies reviewed indicate that incubators may assist African family businesses in achieving their long-term goals, diversifying business operations, establishing networks, and transitioning from the founder generation to the second generation. The findings of Almaharmeh et al. (2024) indicate that, in Jordan, there is a positive association between degree of family ownership and tax avoidance.

The Portuguese and African papers jointly suggest three possible bases for explaining variation in Type 2 agency costs of equity within family companies. All three bases are binary: whether the family company is a Small-to-Medium Enterprise, the prevalence of third parties to reduce information asymmetry between family and non-family companies, and (for African family companies) whether the company is domiciled in South Africa or elsewhere on the continent. The Jordanian paper indicates that degree of tax avoidance may be a suitable measure of Type 2 agency costs of equity within family companies. Hence, it would be appropriate for further research to investigate whether this metric varies systematically, according to the three aforementioned bases.

The remainder of this editorial synthesis is structured as follows: Section 2 discusses Type 2 agency costs of equity and three principal bases, already identified in the literature, for distinguishing types of family companies. Section 3, Section 4 and Section 5 discuss each of the three bases for distinguishing types of family companies, jointly suggested by the Portuguese and African papers within this Special Issue. Section 6 makes suggestions for further research based on the three research papers. Section 7 concludes this editorial synthesis.

2. Bases for Explaining Variation in Type 2 Agency Costs of Equity Already Identified in the Literature

Type 2 agency relationships of equity are between non-family shareholders, as principals, and management (doubling as family shareholders), as agents (Ali et al. 2007). Expropriation of wealth from non-family shareholders to family shareholders (“tunneling”) is a key cost of Type 2 agency relationships of equity (Gama 2012). At least three principal bases for explaining variation in Type 2 agency costs of equity have been identified in the literature.

The first basis concerns whether the family company has founder generation status or whether it has made the transition to the second generation (or subsequent generation(s)). Evidence indicates that after control has passed to the second generation, family companies tend to suffer deterioration in financial performance, due to the second generation lacking the drive, commitment, and expertise of the founder (Pérez-González 2006; Muttakin et al. 2014; Luo et al. 2023). This decline may be ameliorated via the involvement of qualified, non-family members, whether on the board or in an executive capacity, in the second generation (Bertrand et al. 2008). Another effective agency mechanism is requiring the second-generation family members to have tertiary qualifications in order for them to ascend to executive status (Pérez-González 2006).

Hence, a second basis, related to the first, is to distinguish family companies according to the degree of involvement of non-family, professional staff in an executive capacity and on the board of directors (Chen et al. 2013). Expertise from outside the family can help the company grow and diversify into industries and geographical regions outside the founders’ expertise (Yeung 2006).

A third basis for explaining variation in Type 2 agency costs of equity may be whether a family company is subject to blockholding by a large shareholder from outside the family, such as a private sector or government-related institutional investor. This type of investor may be resourced to monitor management, to prevent tunneling (Gama 2012).

3. Distinguishing Family Companies According to Their Status as Small-to-Medium Enterprises

Capital market research into SMEs is as an emerging paradigm. This is a wholly appropriate extension to research using larger listed companies. Roll’s (1977) critique indicates that SMEs are part of the “market”. Hence, they are still rightly the domain of “capital market research”, notwithstanding the fact that many SMEs are not exchange-traded. Furthermore, some SMEs are exchange-traded. For example, SMEs are listed on the National Equities Exchange and Quotations stock exchange in the People’s Republic of China (Wu and Xu 2020).

Extant research into SMEs tentatively suggests that corporate governance outputs and the efficacy of corporate governance mechanisms differ between SMEs and larger companies. For example, using data from the People’s Republic of China, Wu and Xu (2020) provide evidence that venture capitalists reduce the agency costs of debt faced by SMEs, enhancing performance. It is not possible that this result would generalize to the global population of companies. The purpose of venture capitalists is to invest in startups (Wu and Xu 2020). Furthermore, SMEs rely on private debt funding to a greater extent than other types of companies (Cheratian et al. 2024). However, conclusions about corporate governance differences between SMEs and non-SMEs can only be made tentatively. There is a dearth of empirical studies directly comparing these types of entities.

There are empirical studies comparing entities on the basis of two distinctions that are related (but not identical) to the distinction between SMEs and non-SMEs. The first concerns the distinction between publicly listed companies and private, unlisted companies. Evidence from the entirety of the European Union suggests that, in the era following mandatory adoption of International Financial Reporting Standards, capital expenditure of public companies “crowded out” capital expenditure of private companies. This is because the enhanced quality of public companies’ disclosures eroded the ability of private companies to compete for private debt financing (Liu et al. 2023). The second distinction is between companies listed on a publicly regulated securities exchange versus companies listed on a privately regulated securities exchange. Gerakos et al. (2013) provide evidence from the United Kingdom suggesting that companies listed on the privately regulated Alternative Investment Market underperform compared to similar companies listed on public exchanges. In particular, their findings indicate that Initial Public Offerings on the Alternative Investment Market have shorter survival periods than otherwise similar companies that float on publicly regulated exchanges.

By focusing on SMEs, the Portuguese and African papers included in this Special Issue (Roque and Alves 2023; Iwu et al. 2024) contribute to the growing body of capital market research on such entities. In particular, Roque and Alves (2023) provide evidence regarding the impact of a macroeconomic shock (COVID-19) on the performance of SMEs. This generates the question of whether non-SMEs respond differently to the same macroeconomic shocks.

Hence, both of these papers support an emerging (albeit tentative) conclusion emanating from this literature that SMEs differ from non-SMEs with respect to corporate governance characteristics and the magnitudes of agency costs of debt and equity (both Types 1 and 2). Family companies, in addition to the general population of companies, vary with respect to SME status. It is likely that these three types of agency costs also differ within the population of family companies. Hence, Roque and Alves (2023) and Iwu et al. (2024) contribute to the goal of this Special Issue by proposing SME status as a possible basis for explaining variation in Type 2 agency costs of equity (Ali et al. 2007).

4. Distinguishing Family Companies According to Extent of Usage of External Parties to Reduce Information Asymmetry

The literature review conducted by Iwu et al. (2024) indicates that incubators are a bedrock of support for African family businesses. Incubators assist small family businesses via helping them diversify from their original industry, establish networks of contacts, and ease the transition from the founder generation to the second generation. An agency theory perspective can explain this finding as follows: The incubation services reduce information asymmetry between family and non-family shareholders (Wu and Xu 2020). This can cause a reduction in Type 2 agency costs of equity and, hence, improve the performance and value of small African family businesses (Ali et al. 2007).

The extant literature abounds with examples of other third parties who similarly reduce information asymmetry and, hence, agency costs. These parties include auditors (Becker et al. 1998); venture capitalists, especially those searching for promising startups (Wu and Xu 2020); nominated advisors, especially those for companies listed on the Alternative Investment Market (Gerakos et al. 2013); and underwriters for firms going public (Brown et al. 2024). Hence, the literature review conducted by Iwu et al. (2024) suggests that status regarding whether an incubator was used may be a suitable basis for explaining variation in Type 2 agency costs of equity.

5. Distinguishing African Family Companies According to Whether They Are Domiciled in South Africa Versus Any Other Country on the Continent

The papers covered in the review conducted by Iwu et al. (2024) suggest that South Africa is leading the rest of the continent with respect to providing incubator services for small family businesses. A likely explanation for this is that South Africa has higher country-level corporate governance quality than other African countries (Amewu and Alagidede 2019). This is reflected in indicators such as control of corruption, government effectiveness (regarding matters such as the quality of government services), political stability and absence of terrorism, quality of private sector regulations, rule of law, and voice and accountability (Hearn 2013, 2014). The findings of Hearn (2013) indicate that in West Africa, country-level corporate governance mechanisms play a stronger role than company-level mechanisms in arresting director expropriation of shareholder wealth. In the context of family companies, wealth expropriation by management and directors is a manifestation of Type 2 agency costs of equity (Ali et al. 2007).

It follows that, within Africa, Type 2 agency costs of equity may be systematically lower for companies based in South Africa compared to those in other African countries. Amewu and Alagidede (2019) corroborate this position. Their study produces evidence that managerial wealth extraction via excessive executive remuneration is more efficient in South Africa than elsewhere on the continent (Core et al. 1999).

6. Suggestions for Further Research

The findings of Almaharmeh et al. (2024) suggest that tax avoidance is positively associated with the degree of family ownership and that company-level corporate governance mechanisms do not attenuate this association. The results of Almaharmeh et al. (2024) also indicate that accrual manipulation is used as a mode of tax avoidance. Previous findings support the conclusion that opportunistic accrual management is used to disguise management wealth expropriation, reflecting higher Type 2 agency costs of equity (Gopalan and Jayaraman 2012). Hence, considered jointly with prior findings, the evidence presented in the study of Almaharmeh et al. (2024) points to the degree of tax avoidance as a possible measure of Type 2 agency costs of equity within family companies. Identifying this metric is a key contribution of the Jordanian paper, in view of the purpose of the Special Issue.

A suggestion for further research is to investigate whether the three aforementioned bases (for distinguishing types of family companies) emanating from this Special Issue have explanatory power for tax avoidance, measured as in the study performed by Almaharmeh et al. (2024). The regressions would have tax avoidance as the dependent variable.1 The independent variables of interest would be (a suitable subset of) the three aforementioned potential bases for categorizing types of family companies. For example, a paper using data from Africa could use tax avoidance as the dependent variable and, a dummy, flagging companies domiciled in South Africa, as the independent variable of interest. A negative coefficient attached to the dummy would corroborate the conjecture that South African family companies engage in less tax avoidance and hence have lower Type 2 agency costs of equity than family companies from elsewhere in Africa.

An important caveat is in order. In implementing this suggestion, researchers would need to assess the suitability of their chosen measure of Type 2 agency costs of equity with respect to their chosen institutional setting. For example, Sánchez-Ballesta and Yagüe (2024) provide evidence that, for Spanish SMEs, tax avoidance activities are negatively associated with agency costs of debt, due to the use of tax savings as a liquid resource. Agency costs of debt may be regarded as similar to Type 2 agency costs of equity. Hence, the Spain-centric evidence provided by Sánchez-Ballesta and Yagüe (2024) contrasts with the Jordan-based evidence of Almaharmeh et al. (2024). As such, it follows that the degree of tax avoidance may be an unsuitable measure of Type 2 agency costs of equity in the context of Spanish SMEs.

7. Conclusions

The purpose of this paper was to present an editorial synthesis of the three substantive papers published in this Special Issue (Roque and Alves 2023; Almaharmeh et al. 2024; Iwu et al. 2024). These papers were synthesized from the viewpoint of identifying potential bases for explaining variation in Type 2 agency costs of equity within family companies.

The Portuguese and South African papers suggest three possible bases. All of these bases are binary. The first is related to distinguishing family companies according to their status as Small-to-Medium Enterprises (Roque and Alves 2023; Iwu et al. 2024). The second basis concerns whether, as a startup, the family company utilized the services of an incubator to reduce information asymmetry. The third basis is related to distinguishing African family companies according to whether they are domiciled in South Africa, as opposed to a different African country (Amewu and Alagidede 2019; Iwu et al. 2024).

The Jordian paper in this Special Issue (Almaharmeh et al. 2024) contributes evidence supporting the suitability of a measure of Type 2 agency costs of equity within family companies. This metric is the effective tax rate, capturing tax avoidance. Use of this metric is predicated on prior evidence that accrual manipulation is used to effect wealth expropriation (Gopalan and Jayaraman 2012). Hence, the principal suggestion for further research derived from this Special Issue is to investigate whether effective tax rates vary systematically, in accordance with the three aforementioned bases.

There are two principal limitations to the presented editorial synthesis. Firstly, none of the papers actually compare Small-to-Medium Enterprises with non-Small-to-Medium Enterprises. Furthermore, there is a paucity of papers of this nature in the literature. Similarly, the conclusion that Type 2 agency costs of equity may vary according to this basis can only be made tentatively. Secondly, Africa is a developing continent, displaying institutional heterogeneity across regions (Southern Africa, Western Africa, Central Africa, Northern Africa, and the Horn of Africa). There is a dearth of empirical evidence from Africa (Iwu et al. 2024). Hence, inferences emanating from the African paper presented in this Special Issue must be made cautiously.