Max Peter Leitterstorf IPO Financing of Family Firms Dissertation for obtaining the doctor degree of economic science (Dr. rer. pol.) at WHU – Otto Beisheim School of Management Date of submission: January 31, 2013 First Supervisor: Prof. Dr. Sabine Rau Second Supervisor: Prof. Dr. Markus Rudolf ACKNOWLEDGMENT This thesis is a result of my work as a doctoral student at the WHU – Otto Beisheim School of Management in Vallendar, Germany, between February 2011 and January 2013. I would like to express my deepest appreciation to everybody who supported me during this time. I would like to especially thank my first supervisor, Prof. Dr. Sabine Rau, who encouraged me throughout my time as a doctoral student and always provided very constructive feedback. Special thanks also go to my second supervisor, Prof. Dr. Markus Rudolf. I would like to express my warmest gratitude to my parents and my wife, who always supported me unconditionally. In addition, I am very grateful to The Boston Consulting Group for kindly supporting my leave of absence. Max Leitterstorf I CONTENTS TABLES ...................................................................................................................... II ABBREVIATIONS ................................................................................................... III INTRODUCTION TO THE THESIS .......................................................................... 1 ESSAY 1: CAPITAL STRUCTURE OF FAMILY FIRMS: A SYSTEMATIC LITERATURE REVIEW .......................................................................................... 11 Introduction ............................................................................................................ 11 Literature selection ................................................................................................. 13 Literature analysis .................................................................................................. 16 Discussion and conclusion ..................................................................................... 30 ESSAY 2: SEW AND IPO UNDERPRICING OF FAMILY FIRMS ...................... 42 Introduction ............................................................................................................ 42 Theoretical background and hypotheses ................................................................ 46 Methods .................................................................................................................. 58 Discussion and conclusion ..................................................................................... 72 ESSAY 3: AGENCY COSTS AND IPO VALUATIONS OF FAMILY FIRMS .... 78 Introduction ............................................................................................................ 78 Theoretical background and hypotheses ................................................................ 81 Methods .................................................................................................................. 89 Discussion and conclusion ..................................................................................... 96 DISCUSSION AND CONCLUSION OF THE THESIS ........................................ 100 REFERENCES ......................................................................................................... 108 AFFIRMATION – STATUTORY DECLARATION ............................................. 120 II TABLES Introduction to the thesis Table 0-1: Overview of different types of agency costs 4 Table 0-2: Overview of the three essays in this thesis 6 Table 0-3: Number of family and non-family firm IPOs from 2004 to 2011 9 Essay 1 Table 1-1: Overview of included articles and journals 15 Table 1-2: Family firm variables and leverage aspects 39 Essay 2 Table 2-1: IPO underpricing explanations 50 Table 2-2: Descriptive statistics and correlations 65 Table 2-3: Hierarchical regression results 67 Table 2-4: Model 2 differentiated by family firm definition 68 Table 2-5: Model 2 differentiated by different sub-groups of family firms 70 Table 2-6: Different closing prices employed in the calculation of underpricing 71 Essay 3 Table 3-1: Descriptive statistics and correlations 94 Table 3-2: Hierarchical regression results 95 Discussion and conclusion of the thesis Table 4-1: Overview of topics addressed in this thesis 101 III ABBREVIATIONS CEO Chief executive officer CSR Corporate social responsibility e.g. Exempli gratia; for example FFS Family firm status F-PEC Family influence scale (power, experience, and culture) i.e. Id est; that is IPO Initial public offering ln Natural logarithm n Number of observations n/a Not applicable OLS Ordinary least square p P-value Prof. Professor R2 Coefficient of determination SD Standard deviation SEW Socioemotional wealth SIC Standard industrial classification TMT Top management team U.K. United Kingdom U.S. United States WHU Wissenschaftliche Hochschule für Unternehmensführung Introduction 1 INTRODUCTION TO THE THESIS Background and motivation: Why are family firm IPOs important? Family firms are an increasingly popular topic both for society in general and for academic scholars in particular. Public opinion on family firms often has a positive bias because family firms focus on long-term objectives and account for a large part of employment in many countries around the world (Klein, 2000; Le Breton-Miller & Miller, 2006). Scholars are interested in family firms because they are distinctly different from non-family firms in particular with respect to firm goals and interactions between different stakeholder groups (e.g., Chrisman, Chua, & Litz, 2004; Gómez-Mejía, Haynes, Nuñez-Nickel, Jacobson, & Moyano-Fuentes, 2007). These distinct differences are caused by strong family influence relative to the influence of non-family shareholders. Thus, although there is still no widely accepted definition of family firms (e.g., Astrachan, Klein, & Smyrnios, 2002; Klein, Astrachan, & Smyrnios, 2005; Chrisman & Patel, 2012), most definitions of family firms focus on whether a family controls a certain percentage of the respective firm's equity. The threshold of required family ownership to fulfill the various definitions usually ranges from 5% (Anderson, Mansi, & Reeb, 2003) to 50% (Coleman & Carsky, 1999). The European Commission (2009) defines family firms as firms in which 'the person who established or acquired the firm or their families or descendants possess 25% of the decision-making rights'. I follow this definition because under German law 25% equity ownership allows families to block major firm decisions (Franks & Mayer, 2001). Financing of family firms is important because the availability of financial resources is one of the main determinants of long-term survival of family firms Introduction 2 (Romano, Tanewski, & Smyrnios, 2000). In particular, small family firms find it difficult to obtain financial resources (e.g., Coleman & Carsky, 1999; Harvey & Evans, 1995; Maherault, 2000). In recent years, the introduction of Basel II and the financial crisis starting in 2008 have reduced the availability of bank loans which traditionally were the main source of capital for many family firms (Heid, 2007; Ivashina & Scharfstein, 2010; Romano et al., 2000). The link between the availability of financial resources and family firm survival is even more important given that only 30% of family firms survive past the first generation and only 15% of family firms survive past the third generation (Davis & Harveston, 1998; Handler, 1990). An initial public offering (IPO) is a potential solution to the financing difficulties of many family firms. Compared to bank loans and other forms of financial debt, an IPO allows a family firm to raise capital while reducing its leverage and thus its bankruptcy risk (Baker & Wurgler, 2002). Compared to external equity from private equity investors, an IPO allows a family firm to better protect family control (Cronqvist & Nilsson, 2005). Previous studies have shown that even ten years after an IPO, many families continue to control their respective firms (Ehrhardt & Nowak, 2003). Options for ensuring prolonged family control of the respective firm after an IPO include issuing non-voting shares, bundling the family's shares in a holding, and ensuring a disproportionate representation of family members on the supervisory board of the firm (Cronqvist & Nilsson, 2005; Gorton & Schmid, 2000; Holmén & Högfeldt, 2004; Masulis, Pham, & Zein, 2011; Villalonga & Amit, 2008). In summary, family firms are a crucial part of our economy, their survival depends (among other factors) on the availability of financial resources, and an IPO Introduction 3 offers the potential to raise financial resources while maintaining family control. A better understanding of family firm IPOs might convince more family members to consider an IPO and more non-family investors to invest in family firms. In this context, it is important to understand the goals of both family members and non- family investors in order to reconcile potentially diverging goals. Theoretical foundation: Agency theory and socioemotional wealth (SEW) An IPO can strongly impact a family firm because the family normally has to partly cede control to non-family investors. Thus, an additional stakeholder group is introduced to the firm, which can result in additional conflicts between different stakeholder groups. Moreover, family-specific non-economic goals such as creating and sustaining a family dynasty (Casson, 1999) are more difficult