A broad-brushed view of family firms sees owners as a unitary group with shared interests; however, this observation neglects the variety within the group of family firm owners. Multiple family owners likely differ in their financial and non-financial interests, which can lead to potential family feuds and conflict that consequently could have an adverse impact on a firm’s fortunes and the family wealth.
Although family owners may be aligned in their overall desire to increase the economic value of their stakes, a misalignment of interests within a blockholder group can occur. For instance, family members may exhibit heterogeneous preferences in terms of their risk appetite, asset classes, liquidity, dividends, time horizon, non-economic goals and socio-emotional wealth.
This heterogeneity in part arises from the natural drift of families across generations and the resulting increase in the complexity of family ownership over time. In contrast to founder-controlled firms, many later-generation family firms are controlled by multiple family owners, and long-lived family firms, such as the German Haniel group founded in 1756, are sometimes controlled by several hundred family owners.
Better governance
“Building on agency theory, we argue that the growing complexity within a group of family blockholders gives rise to what we label family blockholder conflicts,
defined as conflicts within a group of family owners,”
says Thomas Zellweger. “There is a need for coordination among family member interests and hence mitigation of family blockholder conflicts, which can arise in situations of multiple family owners with diverging goals.”
Better governance structures would negate a range of risks, such as conflicts over the preferred strategic path of the firm and, most often, the allocation and fair distribution of family wealth.
Four commonly observed family governance structures with different levels of separation between family and business are uncoordinated family, embedded family office, single family office and family trust. These governance structures vary in their ability to solve family blockholder conflicts and in their susceptibility to double-agency costs arising from the separation of the family from its wealth.
Generally, families curb family blockholder conflicts by establishing an intermediate organisational entity, such as a family office or a family trust, which separates the family owners from their assets. Such intermediary entities create a buffer between family owners and their assets to avoid the uncoordinated interference of the family in the business and thus to limit the destructive dynamics emanating from family blockholder conflicts.
Double-agency costs
However, in their attempts to curb family blockholder conflicts, families often run into double-agency conflicts. These arise from entrusting a fiduciary as an intermediary between family owners and their wealth.
“Implementing organisational solutions give rise to double-agency costs because professional managers who serve as the intermediaries between principals and the agents who actually manage the family’s assets occupy a very powerful position,” explains Nadine Kammerlander.
By placing assets in the hands of intermediary agents such as trusted advisors or related governance entities (e.g., family offices and trusts), family owners thereby insert a powerful first-tier agent between owners and the second-tier managers of assets, she adds.
This results in a double-agency relationship in which agents monitor other agents in a vertical sequence of separation between ownership and control. Mitigating these double-agency conflicts is especially costly, as owners must align the interests of multiple layers of managers, each of whom have numerous, idiosyncratic opportunities to be in misalignment with owners’ interests.
Governance structures
“The management of family firms and, more broadly speaking, family wealth is a finely woven web of agency conflicts. Families vary in the degree to which they separate themselves from their assets, i.e., their level of delegation of power to an intermediary governance structure,” says Kammerlander.
She adds that inferences can be drawn about the stability of the governance forms and ultimately the distributive effect for family wealth over time (see table 2). Generally speaking, the progressive separation of family and assets reduces family blockholder costs but simultaneously increases double-agency costs.
Uncoordinated family
Here, control over the management of wealth is kept in the family’s hands, without any coordination of family member interests. As there is no separation of family and assets, family wealth is likely to be rather rapidly dissolved and distributed to individual family members, given the existence of rampant family blockholder conflicts.
“Despite advantages in terms of minimised expenses, increased privacy, and particularly the lack of double-agency costs due to the absence of an intermediary, the uncoordinated family constellation is highly susceptible to family blockholder conflicts,” says Zellweger.
Embedded family office
In this structure, the family installs a hybrid two-tier structure to manage its affairs by appointing a fiduciary from within the existing asset structure. For instance, the family may ask the accountant, treasurer or chief financial officer to also manage its wealth.
Family wealth is kept intact, but is at risk of being managed according to family-political instead of efficiency-based criteria. Embedded family offices (EFOs) aid little in aligning diverging family member interests with regard to the firm and in alleviating family blockholder conflicts due to lack of guidance given to family members.
It is also important to consider that an embedded fiduciary serves two masters, the family and the firm, which sometimes have diverging interests. “The ensuing dilemma about which master to serve comes in many forms, such as a risky private investment for which a family member seeks financial backing from the firm, family members’ preference for tax structures that protect their private interests to the detriment of the firm, or pressure to pay dividends when the firm needs additional equity injections,” says Kammerlander.
Single family office
Single family offices (SFOs) directly address family blockholder conflicts owing to the formalisation of investment guidelines and the delegation of all wealth management tasks to one professional fiduciary. “SFOs serve as a unifying force that thwarts the centrifugal forces inside the family owing to generational drift and the related dilution of wealth so that the family maintains cohesion and power over time and preserves its wealth,” says Zellweger.
Depending on the family officer’s level of alignment with the interests of the family, SFOs are susceptible to double-agency costs. Such costs could be severe in SFOs run by non-family professionals because both the first-tier agent (the family officer) and the second-tier agents (the managers of the various assets) work in different organisations and thus are outside the reach of hierarchical intra-organisational control.
Although SFOs tend to be small, the personnel costs for professionals, as well as the costs for office and technology infrastructure, are often significant in relation to the wealth to be managed. In the single family office the family itself pays the bills rather than the firm. This is in contrast to the embedded family office where the costs are at least partly passed along to minority owners and creditors. The overall efficiency of the family office will thus be a significant concern inside the family, creating an incentive for the family to carefully monitor the cost-conscious behaviour of family officers.
Family trusts
Finally, trusts entomb family wealth and create significant agency costs, which should gradually deplete family wealth over time.
There is no efficient market for stakes in private trusts, which would provide price signals and thus meter trustee performance, so to some degree at least, the trustee thus becomes a manager without an owner.
Appointing a trustee or multiple trustees to manage family wealth also leads to direct costs from the bureaucratisation of wealth in trust form. To administer a diversified portfolio of assets, trustees need asset-management expertise; thus, they must hire professionals who will require compensation for their services. These costs are likely lower for a trust than for a family office where all costs accrue to a single family. Professional trustees work for multiple clients; hence, they can offer their services at lower costs compared with a single family office.
“Similarly, we expect double-agency costs and principal-agent costs to be particularly pronounced if the legal and organisational setup of the wealth administered through the trust is opaque. Indeed, in our 2014 descriptive study of the hundred wealthiest families in Germany, we find that the wealth of these families is mostly concentrated in one to three dominant equity stakes,” says Kammerlander.
However, the total wealth of these families is held by 75 legal entities on average, such as intermediary holdings and investment vehicles, as well as foundations and trusts. These entities are often connected in a non-transparent web of horizontal and vertical crossholdings, which create a separation of family and wealth to a particular degree; thus, they create strong opportunities for self-dealing across the multi-tier structure.
Thomas Zellweger, Professor and Chair of Family Business, and Nadine Kammerlander, Assistant Professor, Centre for Family Business, University of St. Gallen, Switzerland.
This article is based on a more in-depth study ‘Family, wealth, and governance: an agency account’ to be published in Entrepreneurship Theory and Practice.
