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DO FAMILY FIRMS AND NON-FAMILY FIRMS DIFFER IN
INVESTING?
Evidence on Finnish SMEs
Abstract
The aim of this study is to examine whether family firms and non-family firms differ in investment behaviour. More precisely, I investigate whether family ownership has an impact on
whether a firm rejects investments or not, and whether family ownership has an influence on the
amount of investment. My results suggest that family firms and firms with higher family ownership
are less likely to pass up an investment than non-family firms do. Furthermore, although family
ownership has a negative influence on the rejection of investments, family ownership does not have
any significant impact on the amount of invested. These results could imply that when firms have
made investment decision, ownership of family does not decrease or increase the amount of
investment.

1. Introduction

In a world of perfect capital markets a firm´s internal and external financing are perfect substitutes,
and its investment decisions are independent of financing and dividend decisions (Modigliani and
Miller 1958). But, capital markets are not perfect and therefore, investment decisions and financing
may be related. In prior empirical literature the role that internally generated funds and financial
constraints play in determining firm investment decisions is mixed. It has been argued that growth
of small firms is constrained by the availability of external and internal finance (Myers and Majluf,
1984; Carpenter and Petersen, 2002). Furthermore, smaller firms are more financially constrained
than their larger counterparts because small firms face higher information asymmetry and agency
costs (Myers and Majluf, 1984). Fazzari et al. (1988) suggest that if firms face relatively high costs
of external finance because of information asymmetry, it will lead to situation, where firms retain
most of their income.
The aim of this study is to investigate whether family ownership has an impact on investment
behavior in small private firms. More precisely, I explore whether family firms are more likely to
reject investments than non-family firms do, and whether ownership of family has an impact on the
amount of investment. The rationale for this investigation is motivated by the generally held view
that family firms are more risk averse than non-family firms because of a higher share of the
owner´s wealth invested in the firm. Moreover, family firms follow conservative financial
behaviour (Gallo and Vilaseca, 1996; Gallo et al., 2004) and also, are more likely to adopt less risky
investment policies than non-family firms (Naldi et al., 2007). Furthermore, agency problems and
financial constraints, either lack of internal funds or availability of external funds, may limit
investing and growth, especially in closely held firms, such as family firms. Based on the previous,
family firms may adopt more conservative and more risk avert investment behaviour.

Many previous studies investigate the relationship whether liquidity affects investment without
considering whether ownership structure may affect investment behaviour. The number of studies
exploring the differences in investment behaviour of small private family and non-family firms is
limited. It has also been suggested that the country context should be taken into account because
corporate governance structures differ by country. Furthermore, the Finnish financing system has
been characterised as being bank-based and banks are the most important sources of funding for
small and medium-sized firms. Most prior studies also use data on large listed firms. This study
uses data on micro-sized small and medium-sized private family and non-family firms in Finland.
My results suggest that family firms and firms with higher family ownership are less likely to pass
up an investment than non-family firms are. Furthermore, although family ownership has a negative
influence on the rejection of investments, family ownership does not have any significant impact on
the amount of investment. These results could imply that when firms have made investment
decision, family ownership may not decrease or increase the amount of how much will be invested.
The remainder of this paper is as follows. Section 2 reviews the related literature and presents my
hypotheses. Section 3 describes the sample, data, and variables. Section 4 presents the results,
section 5 includes the discussion, and section 6 concludes the paper.
2 Literature review

Modigliani and Miller (1958) argue that in perfect capital markets investment decisions are
independent on financing decisions. Therefore, investment policy depends only upon the
availability of investment opportunities with a positive net present value. Furthermore, theory of
finance implies that every positive-NPV project should be taken regardless of whether internal or
external funds are used to pay for it (Myers and Majluf, 1984). However, previous empirical studies
suggest that investment decisions depend on the financial factors (e.g. Gugler, 2003) due to that
small firms face agency problems and information asymmetry (Myers and Majluf, 1984). The level
of information asymmetry is generally larger for smaller firms, such as family firms (Myers and
Majluf, 1984) because managers and other insiders are assumed to possess private information
about the firm´s future earnings, cash flows or investment opportunities (Harris and Raviv, 1991).
Agency problems and information asymmetry may lead to financial constraints and hamper firm´s
ability to invest unless the firms can rely on internally generated funds (Myers and Majluf, 1984;
Degryse and Jong, 2006). As a result of information asymmetry small firms tend to finance their
investment need in a hierarchical fashion: first using internally generated funds, then short and long
term debts, and finally outside equity (Myers and Majluf, 1984).
Agency problems arise due to separation of ownership and control (Jensen and Meckling, 1976).
Divergence of interests may lead to situation that managers may prefer growth rather than value of
the firm which may lead to overinvestment (Jensen, 1986). Family firm is an important type of firm
with concentrated ownership. Family firms should be exempt from agency problems because
ownership and management overlap (Jensen and Meckling, 1976). However, family firms cannot be
regarded as a homogeneous group of people with joint interests (Sharma et al., 1997). Agency costs
may also arise from altruism or because managers act for the controlling family (Chrisman et al.,
2004; Morck and Yeung, 2005; Schulze et al., 2003). But, it is more likely that family firms face
agency problems between the firm and its potential outside suppliers of funds, which increases the
premium paid for external financing (Myers and Majluf, 1984), and drives a gap between the costs
of internal and external funding (Gugler, 2003).
Free cash flow theory suggests that managers may have incentives to invest free cash flows to
unprofitable projects or increase dividends (Jensen, 1986). Jensen (1986) suggests that firms
increase investment in response to the availability of cash flows but firms decrease investment with
leverage because current debt and interest payments force cash out of the firm. Therefore, debt can
be an effective mechanism to reduce the agency cost of free cash flow (Jensen, 1986). Investment-
cash flow sensitivity and the likelihood that a manager wastes internally generated funds can be
mitigated by other governance mechanisms such as dividends (Degryse and Jong, 2006) and by
managerial ownership (Hadlock, 1998). However, managerial ownership and alignment of interests
may be non-monotonic (Morck et al., 1988; McConnell and Servaes, 1990) and investment-cash
flow sensitivity are related in a non-monotonic way (Pawlina and Renneboog, 2005; Andres, 2009).
At lower levels increases in managerial ownership may lead to reduced investment-cash flow
sensitivities, whereas at higher levels of managerial ownership investment-cash flow sensitivity
increases.
Previous empirical literature, e.g. Georgen and Renneboog (2001) and Fazzari et al. (1988),
suggests that in firms with financial constraints investment spending is positively related to
internally generated funds, while Kaplan and Zingales (1997), Cleary (1999) and Kadapakkam et al.
(1998) find opposite results; the more constrained a firm is, the less sensitive investments are to the
cash flows. However, some other studies argue that investment-cash flow sensitivity is higher in
medium-sized firms than their smaller or larger counterparts (e.g. Audretsch and Elston, 2002), and
that investment-cash flow sensitivities increase with managerial alignment (Hadlock, 1998). On the
other hand, because smaller firms may be forced to undertake investments due to lower flexibility
of timing investments, and consequently, independent on the funding, there might be a weaker link
between investments and cash flows for small firms (Kadapakkam et al., 1998). However, Gugler
(2003) find a positive relationship between investment and cash flows in family firms, while Andres
(2009) suggests that family firms are more sensitive to their investment opportunities and seem to
invest regardless cash flow availability although their investment are more sensitive to external
financing constraints.
Growth of small firms is constrained by internal finance (Carpenter and Petersen, 2002) and in case
of financial distress firms may pass up valuable investment opportunities (Myers and Majluf, 1984;
Hyytinen and Väänänen, 2006). Hutchinson (1995) argues that in small owner-managed firms
investment and financing strategies are interdependent. Furthermore, a firm may reject good
investment opportunities because creditors include into cost of capital a risk premium reflecting the
risk of an average investment project (Myers and Majluf, 1984; Stiglitz and Weiss, 1981). Family
firms follow a peculiar financial logic due to their personal preferences concerning growth, risk, and
ownership-control (Gallo et al., 2004). Consequently, family firms use less debt and their
investments are based on the availability of internally generated funds (Hadlock, 1998; Poutziouris,
2001). Family owner-managers are more likely to postpone an investment rather than give up
control over their company (Gugler, 2003). Because family firms are less growth oriented
(Poutziouris, 2001), more risk averse (Naldi et al., 2007), and conservative in their funding
behaviour (Gallo and Vilaseca, 1996, Gallo et al. 2004), family firms may be more likely to reject
an investment than non-family firms are. Based on the previous, I hypothesize:
H1: Family firms and firms with high family ownership rates are more likely to pass up an
investment than non-family firms are.

One of the prime objectives of family firms is to transfer business ownership to the next generation
(Anderson et al. 2003; Chua et al., 2003). Family firms have also non-economic goals (Chrisman et
al., 2003) and make decisions on longer time horizons than non-family firms do (Bartholomewz and
Tanewski, 2006). Families´ interest is the firm´s long term survival and concern for both the firm´s
and family´s reputation (Anderson et al., 2003). Furthermore, families may be more dependent on
steady dividend payments are more likely to withdraw funds that might otherwise be invested
(Andres, 2009). The generally held view is that family firms are regarded as more risk averse than
non-family firms. Owner-managed firms such as family firms may pursue low-risk investment
strategy to moderate the level of business risk (Hutchinson, 1995). Family firms often overlook
growth opportunities (Poutziouris, 2001) and tend to take lower risks than non-family firms do
(Naldi et al., 2007). Also Shleifer and Vishny (1986) propose that large and undiversified investors,
e.g. families, will exercise risk reduction strategies. Prior empirical studies suggest that family firms
and non-family firms differ in their investment behaviour. Cho (1998) find a non-monotonic
relation between insider ownership and investment. Croci, Doukas and Gonenc (2009) propose that
family firms invest more in low-risk, fixed-asset capital expenditures than in high-risk, R&D
expenditures, confirming their non-risk seeking behavior. Gallo, Tapiens and Cappuyns (2004)
argue that family businesses devote a smaller proportion of sales revenue to their own mid- and
long-term development than non-family firms do. Based on the previous discussion, my hypothesis
is the following:
H2: The amount of investments is lower in family firms than in non-family firms.

3 Data and variables

3.1 Data and methodology

The data for this study was collected through a private survey in autumn 2006 and financial data is
collected from the Voitto+ register. Observations include the years 2000-2005. The sample consists
of 600 SMEs operating in Finland. The sample firms are limited liabilities with at least two
employees and represent all industries, excluding primary production. The firms were asked to
provide information on their ownership structure, their willingness to grow and the amount of
investments in 2000-2005, for each year separately. Firms were also asked whether they have
rejected investments during the years 2000-2005 or not, and the reason why if they have passed up
an investment. Because of the quantitative nature of the data, I use panel data estimation models to
investigate whether rejection of investments and the amount of investment differ by family
ownership and between family firms and non-family firms.
3.2 Variables

3.2.1 Dependent variables

Rejection of investments. Firms were asked whether they have rejected investments or not. This
variable is a dummy variable which gets the value 1 if the firm has rejected an investment,
otherwise 0.

Investments and Investments/Total assets
Firms were asked the amount of investments each year and timing. Investments are the amount of
investment, and investments/total assets are calculated by dividing investments by total assets.
3.2.2 Explanatory variables

Family influence/ownership. I perform the analysis using four alternative indicators of family
influence. First, I use family ownership rate (a continuous variable). Second, I use a binary variable
to identify family firms and non-family firms. A firm is regarded as a family firm if family
ownership exceeds 50 %, otherwise a firm is regarded as a non-family firm. Third, I use quartiles of
family ownership (0-25, 26-50, 51-75 and 76-100 %) as my measure of family influence.
3.2.3 Control variables

Firm size Ln (Total assets)
Previous literature suggests that growth of small firms is constrained by the availability of finance.
E.g. Michaelas et al. (1999) suggest that smaller firms may experience greater difficulty for getting
funding than larger firms. I use Ln(Total assets) as a proxy for firm size.

Firm age Ln(1+Age)
My measure of firm age is the natural log of (1+age).
Leverage
Financial constraints have been suggested to be one of the most important barriers to growth
(Storey, 1994). It has also been suggested, that especially small firms face difficulties in obtaining
outside funding and that small firms often have access only to private equity and debt markets.
Investments may decrease with leverage, because high current debt payments force cash out of the
firm. Leverage is included as control variables because high leverage typically makes it difficult for
a firm to obtain additional debts. Becchetti and Trovato (2002) find that firms which have been
credit rationed by their financial institutions are likely to have lower growth rates. I use debt-to-total
assets ratio as our proxy for leverage.

Cash/total assets
I use cash to total assets (lagged value t-1) as a measure of liquid assets.
Cash flow
Cash flow is a proxy measure of the degree to which a firm is subjected to liquidity constraints.
Cash flow/net fixed assets is a lagged value (t-1) and calculated as (earnings+depreciation/fixed
assets).
Willingness to grow
According to Storey (1994), SMEs with growth ambitions above average have better access to
external finance. Willingness to grow is a dummy variable which gets the value of 1 if the firm is
willing to grow little or more, otherwise the value is 0.
Industry
Harris and Raviv (1991) suggest that firms within an industry have more in common with each
other than with firms in different industries, and that there are differences in industry leverage
ratios. Coleman and Carsky (1999) find that service sector may need less capital and have less
capital expenditure. Industry dummies are binary variables that capture industry fixed effects. I add
7 different industry dummies into my models to control for industry effects.
Year (dummy variable)
I add year dummies to my models to control for year effects.
4 Empirical results

4.1 Descriptive statistics

Table 1 lists descriptive statistics for the key variables. The numbers represent average rates across
the entire period of the survey. The average family ownership is 53.54 % and over 53 % of the
firms are family firms. The results show that the average operating profit is 7.038 €, profit for the
financial year is 71.463 € and return on assets is 16.47 %, on average. The average figures of other
measures are the following: sales 1855.555 t€, change in sales 28.88 %, total assets 1125.796 t€,
and retained earnings 60.771 t€. The results show that the average firm age is 13.78 years. Firms
have leverage of 62.18 %, on average. Cash to total assets are 20.046 t€, cash flow 9.220 t€,
investments 106.55 t€, investments per total assets 27.982 and rejection of investments is 9 %, on
average.
(Table 1)
Table 2 presents Pearson correlations. The correlations between the variables do not exceed +/- 0.310 except between the family ownership variables. We dot observe any serious correlations between the variables. Although the correlation results indicated no serious correlation between the variables, I investigate a model with a VIF-test. I do not find any serious multicollinearity because the highest VIF-value is 2.026, and in industry dummies the highest value is 4.960. (Table 2)
I investigate the descriptive statistics and investment variables in more detail in Table 3, where I divide the data into family firms and non-family firms. I use a T-test for independent samples to compare the means to investigate whether variables may differ between family firms and non-family firms. The average size measured by total assets is higher in non-family firms, but profitability is higher in family firms. Leverage and cash per total assets are higher in non-family firms, whereas cash flow and cash flow per total assets are higher in family firms. (Table 3)

4.2 Rejection of investments

I measure rejection of investment by using a dummy variable rejection of investment, which gets
the value of 1 if the firm has rejected on investment, otherwise 0. I employ panel estimation method
in my analyses. More specifically, I run my models using fixed effects model. I investigate the
influence that family ownership may have on the rejection of investments with 3 different family
influence variables in Tables 4 and 5. Column I in Table 4 presents the results on the continuous
family ownership variable. The results in column I suggest that as family ownership increases, firms
are less likely to reject an investment. This result is not expected. The results in column II show that
family firms are less likely to reject an investment. This finding is not expected. In column III my
findings suggest that when family ownership is 0-25 %, firms are more likely to reject an
investment. This result is not expected. In column I in Table 5 the results on family ownership 26-50 % are similar, but not significant. The findings in column II show that when family ownership is 51-75 %, firms are less likely to reject an investment. Finally, in column III I find that in the highest levels of family ownership, 76-100 %, the rejection of investments is, again, lower, but this finding not significant. As far as my control variables are concerned, the results show that firms which are older and willing to grow are more likely face the situation that an investment will be rejected. This could indicate that those firms may be financially constrained. (Tables 4 and 5)

4.2 Investments

I further continue to explore investment behaviour in Table 6 by investigating the amount of
invested and whether there are differences by family ownership rates and between family firms and
non-family firms. The dependent variable is the amount of investments. In column I in Table 6 my
measure of family influence is a continuous family ownership variable and in column II in Table 6 I
divide firms into family firms and non-family firms. The results in column I and II show that neither
family ownership rate nor family firm dummy is significant, which could indicate that although
family influence have an impact on the rejection of investments, it does not have an impact on the
amount of investment after the decision on implementing an investment is done.
As far as my control variables are concerned, the results in Table 6 indicate that there is a positive
relation between the cash flows and the amount of investments. This could indicate that firms may
make their investment decisions based on the cash flows.
(Table 6)

5 Conclusions

The aim of this study was to investigate the impact of family ownership on whether firms with
family ownership and family firms are more likely to reject an investment and whether family
ownership is associated with the amount of investment. Most studies use data on large listed firms.
My study is one of the few that shed light on the relation between investment and ownership
structure, more precisely how family ownership affect investment behavior in a sample of micro-
sized, small and medium-sized firms.
My results suggest that both firms with higher family ownership levels and family firms are less
likely to pass up an investment than non-family firms do. Furthermore, although family ownership
has a negative influence on the rejection of investments, family ownership does not have any
significant impact on the amount of investment. These results could imply that when firms have
made investment decisions, ownership of family may not decrease or increase the amount of how
much will be invested. Furthermore, I used cash flow as a control variable when investigating the
relationship between family ownership and the amount of investment, and cash flow tend to be
increase the amount of how much is invested. This could imply that more liquid firms have better
financing and investment opportunities, and they invest more. My findings contribute to the current
literature by adding understanding on the relationship between family ownership structure and
investment behaviour of the small and medium-sized private family and non-family firms.
References

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This table presents the descriptive statistics on the sample firms. Column I presents the variables. Column II presents the number of observations. Column III presents the average values of the variables and column IV the standard deviations. Variables
Mean t€ Std. deviation
Table 2. Correlation matrix
-0.957 -0.906
0.985 ¤ 1.000 1
0.762 1.000 -0.669 ¤
0.944 0.908 -0.823 ¤
-0.002 -0.002 0.007 -0.016 -0.015 0.002 0.310
0.098 0.110 -0.124 0.080
0.112 0.079 0.274 -0.129 -0.021
0.062 -0.053 0.007 0.037 0.063
-0.087 -0.080 0.090 -0.047 -0.030 -0.075
-0.018 0.033 0.051 -0.135 -0.037
0.115 0.089 -0.059 0.062 0.033
0.052 0.070 0.029 0.026 1
-0.109 -0.101 0.103 -0.039 -0.039 -0.099 -0.110 0.008 -0.040 -0.242
-0.199 -0.068
-0.057 0.161 -0.029 0.015 -0.166
-0.007 -0.017 -0.021 -0.003 -0.147
0.073 0.062 -0.081 0.071 0.024
-0.049 -0.032 -0.066
0.017 -0.018 -0.295 -0.074 0.242 0.309
This table presents Pearson correlations. Data cover years from 2000 to 2005. Correlations significant at the 0.05 confidence level are reported with bold characters. Table 3. Descriptive statistics by family ownership
This table presents the descriptive statistics. Column I presents results for the family firms and column II for the non-family firms. Column III presents p-values of the t-test for the equality of means between the two sub samples. Non-Family
Family firms
Significance
of difference
8.96 0.000
18.35 0.002
0.0397 0.003
Table 4. Rejection of investments
This table presents the results on regressing rejection of investments on explanatory variables. Column I presents the results on family ownership rate, column II presents the results on family dummy variable, and column III presents the results on family ownership rate of 0-25 %. Rejection of
Rejection of
Rejection of
investments investments investments
-0.0081772 0.493 -0.0111778 0.329 -0.0488392 0.000
Explanatory variables
-0.0004053
-0.339915
0.0428138
Firm characteristics
-0.0007782
0.0025488
0.082 0.0024868
0.0000158 0.497 0.0000161 0.490 0.0000155 0.507 0.3301613
0.000 0.3298707
0.000 0.3328788
-0.0000149 0.828 -0.0000157 0.819 -0.0000146 0.831 Table 5. Rejection of investments
This table presents the results on regressing rejection of investments on explanatory variables. Column I presents the results on family ownership rate of 26-50, column II presents the results on family ownership rate of 51-75, and column III presents the results on family ownership rate of 76-100. Rejection of
Rejection of
Rejection of
investments investments investments
-0.024042 0.026 -0.0239749 0.025 -0.0198766 0.084
Explanatory variables
-0.0824941
Firm characteristics
0.0025607
0.081 0.0014629
0.079 0.0025544
0.0000163 0.486 0.0000156 0.502 0.0000163 0.485 0.318297
0.000 0.3295631
0.000 0.3205326
Table 6. Investments
This table presents the results on regressing the amount of investments on family ownership variables. Column I presents the results on the continuous variable family ownership rate and column II presents the results on family firm/non-family firm dummy variable. Investments
Investments

Explanatory variables
Firm characteristics
11.30458
11.30374
Industry dummies

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