controlled firms, which constitute the majority of private firms, one interesting ... firms, we examine employment practices in private equity (PE) backed family ...
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WORKING FOR DIVERGENT PRINCIPALS: EFFECTS OF PRIVATE EQUITY ON EMPLOYMENT PRACTICES IN FAMILY FIRMS JEROEN NECKEBROUCK Vlerick Business School Ghent University Reep 1, 9000 Ghent, Belgium SOPHIE MANIGART Ghent University MIGUEL MEULEMAN Imperial College INTRODUCTION In recent years, the stagnation of lending in the Euro area has been accompanied by a growing number of private companies exploring alternative sources of financing. For family controlled firms, which constitute the majority of private firms, one interesting alternative may be to seek for minority investments from external equity providers. These investments allow family owners to strengthen their firm’s balance sheet without having to give up dominant control. Investors, however, may worry whether such investments leave them with enough influence over the companies’ strategy. Such concerns are not unfounded. Corporate governance scholars have recently started to examine how agency problems may not only pertain to shareholders and managers, but also between shareholders. Within this literature on principalprincipal conflicts, the key premise is that controlling shareholders may employ several mechanisms to encourage a firm’s management to engage in behavior that is aligned with their own objectives, but which may come at the expense of others (e.g. Villalonga & Amit, 2006; Shleifer & Vishny, 1997). Interestingly, however, the above literature has focused on owner conflicts in public firms and left owner conflicts in private firms largely unexplored. While one may argue that such conflicts will be less likely in private firms, for example because close relationships should facilitate the alignment between owners, principal-principal conflicts could also be more fundamental in privately controlled firms. Most importantly, while corporate governance mechanisms related to market oversight, voting and market liquidity may protect owners from such conflicts in public firms, these governance mechanisms do not equally operate in privately owned companies (Schulze, Lubatkin & Dino, 2003; Jensen & Meckling, 1976). Research on corporate governance in private firms has extensively investigated how owner preferences, and consequently firm behavior, differ across private firms. The family business literature, for example, is replete with studies comparing the behavior of family controlled firms and nonfamily controlled firms. In contrast, research has not yet substantially explored how owners holding divergent preferences align within private firms. Will agency problems between such owners prevail as agency theory suggests? Or will principles of reciprocity dominate and will close relationships lead to a natural alignment of interests? Answers to these questions can enrich corporate governance theory, which still focuses primarily on public firms, while overlooking private firms and the challenge of achieving within-group goal alignment (Schulze et al., 2003).
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In this paper, to increase understanding about principal-principal relationships in private firms, we examine employment practices in private equity (PE) backed family firms. PE-backed family firms represent a particularly interesting setting for theory building related to principalprincipal conflicts in private firms because the objectives of PE investors and family owners regarding the firm’s strategic behaviour may be particularly divergent. Family owners typically have most of their wealth tied to one firm (Morck & Yeung, 2003; LaPorta, Lopez-de-Silanes, & Shleifer, 1999), are particularly concerned about noneconomic family goals in order to preserve socioemotional wealth (Gómez-Mejía, Haynes, Núñez-Nickel, Jacobson, & Moyano-Fuentes 2007), and usually have more long-term objectives (James, 1999; Le Breton Miller & Miller, 2006). PE investors, in contrast, are professional and active investors who provide equity capital to a portfolio of mature private firms, and are foremost concerned about the realization of capital gains through medium-term exits (EVCA, 2007). Despite these differences, PE-backed family firms constitute an increasingly prevalent form of private firm governance. In the European PE market, family firm deals currently represent about 42% in number of deals, most of which are minority investments (CMBOR, 2014). We focus on employment practices as outcome variable because the PE and family business literatures show how the divergent preferences of PE investors and family owners may be particularly acute with regards to employment related decisions. Decisions to hire or lay off workers, for example, or to invest in good employment terms, have different consequences for family owners and PE investors. While family owners are particularly concerned about retaining stable and long-term relationships with employees to protect socio-emotional wealth (Deniz & Suares; Miller & Le Breton-Miller, 2005), PE investors may worry that offering high employment security and high wages only benefit the self-interests of employees and do not contribute to the maximization of firm value (Fox & Marcus, 1992). HYPOTHESES DEVELOPMENT PE investors, family control and short term layoffs Family owners are reluctant to support downsizing decisions, even when that would lead to improved financial performance. Family principals are concerned about maintaining long-term relationships with employees because of the family’s emotional attachment with the firm, their concern for reputation and their long-term horizon. Given that downsizing actions of firms usually do not go unnoticed and are often broadcasted in the media, downsizing decisions may irreversibly damage company’s reputation (Flanagan & O’Shaughnessy, 2005; Love & Kraatz, 2009). As such, family owners try to avoid actions such as downsizing. In contrast, PE investors are mostly focused on value maximization and, following an investment, are more likely to engage in downsizing when that could increase efficiency. PE investors force the managers of their investee firms to speedily reduce sub-optimally high levels of employment and divest value-destroying parts of the business. Therefore, we expect: Hypothesis 1: In the short term, PE control engenders a decrease in employment levels in investee family firms. Nevertheless, PE investors can only influence strategic decisions in their investee firms when they have enough votes to shape policy. As such, behavioural differences may exist between majority and minority PE investments. When PE firms acquire a majority stake in a
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family firm, there is no need for compromises and medium-term value maximization becomes the key objective. Hence, we expect Hypothesis 2: The negative short-term impact of PE control on employment levels in investee family firms is weaker in the case of minority investments as compared to PE majority investments. PE investors, family control and employment terms Family owners are likely to invest more in favourable employment conditions as a mean to preserve socioemotional wealth. First, business’s decision-making processes in family businesses are often influenced by family emotions (Baron, 2008). Altruistic sentiments which are present along family members (Berrone, Cruz, & Gomez-Mejia, 2012) may also affect relations with employees. Second, more than PE investors, the identity of family firm owners is inextricably tied to the identity of the firm (Ashforth & Mael, 1989; Riketta, 2005). As such, family firms try to maintain good relationships with employees in order to preserve a positive family image and reputation (Sharma & Manikuti, 2005). Third, family principals typically have long time horizons as compared to PE investors. Even though investments in good employment terms do not result in immediate economic gains, due to their long-term horizon, family owners could be more likely to understand the value of these investments. In comparison with family principals, PE investors are less likely to support investments in employment terms (e.g. Amess & Wright, 2007; Lichtenberg & Siegel, 1990). First, investments in employment terms represent immediate costs of which the economic returns are uncertain and difficult to measure. Instead, by implementing tight debt repayments, using equity incentive schemes and close monitoring, PE firms force managers to maximize firm efficiency lowering wages and offering fewer permanent contracts. Second, PE investors gain less noneconomic utility from investing in employment relationships and are less concerned about potential damage to their personal reputation. In sum, we expect that PE control reduces a family firms’ willingness to invest in good employment terms. Hypothesis 3: PE control engenders a deterioration of employment terms in investee family firms. Similarly, PE investors can only fully control decision making when they acquire a majority stake. Therefore: Hypothesis 4: The negative impact of PE control on employment terms in investee family firms is weaker in case of PE minority investments as compared to PE majority investments. METHODS Our empirical analyses are based on a sample of Belgian family firms that received a first PE investment during the period 1998 to 2011. We focus on Belgian PE-backed firms because this setting offers access to unique and detailed employment and employment term data at firm
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level that typically can only be accessed through surveys. Yearly ownership and board data were collected from Belfirst, a commercial database consisting of all Belgian firms that file accounts. We defined family firms as firms in which: (i) the ultimate largest shareholder is an individual or a family, and/or (ii) at least two of the board members which are or had been active in the company share the same last name and represent more than 20% of the total number of board members. In order to control for selection effects related to the PE investment in family firms, we built several control groups and used propensity score matching with difference-indifferences as a modelling strategy. Our final dataset consists of 317 PE-backed firms, 102 of which were family firms. The control group of non-PE backed firms consisted of 1239 firms, of which 353 family firms. In the year before PE investment, on average, family firms were 21 years old and had 125 employees. Non-family firms were slightly younger (18 years on average) and larger (156 employees) We considered four dependent variables: (i) employment level, measured as the average number of full time equivalents during a given year, (ii) level of employee departures measured as the number of employees leaving a firm during a given firm-year divided by the number of employees at the beginning of that firm-year, (iii) average wage cost per hour, and (iv) level of temporary contracts measured as the percentage of employees with a temporary or replacement contract rather than a long-term permanent contract. We use several independent variables. We use a binary measure postPE to distinguish between the years post PE investment (= 1) and pre PE investment (= 0). We further used dummies in order to distinguish between PE-backed firms and the control groups (PE investment), to distinguish Family firms from Non family firms and to distinguish PE majority investments from PE minority investments. We refer to minority investments when PE investors hold less than 50% of equity. We further controlled for firm fixed effects and year effects. Models were estimated using fixed effects OLS regressions with robust standard errors. RESULTS We argued that, in the short term, PE control negatively impacts employment levels in family firms (H1), with majority investments having a stronger impact than minority investments (H2). Unexpectedly, our results showed that PE engenders an increase, rather than a decrease, in employment in the short term. In line with our hypotheses, we also investigated the impact of PE on employment terms. We argued that PE investments negatively impact employment terms in family firms (H3) with PE majority investments having a stronger impact than PE minority investments (H4). In contrast to expectations, our results did not support these hypotheses. Nevertheless, we did find differences between ownership structures. PE control generally did not lead to increased departures in family firms. Only in the case of PE majority investments in nonfamily firms, departures were higher in the two years following the investment. Furthermore, in family firms PE control had a positive impact on wages in the case of minority investments but not in the case of majority investments, in which the coefficient were negative. In non-family firms, results were opposite and more in line with our expectations, as PE majority investments did lead to reduced wages but PE minority investments did not. Finally, PE control did not increase the usage of temporary contracts in family firms. DISCUSSION & IMPLICATIONS
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Our findings make several contributions to the literature and provide practical insights to family firm owners, PE firms and policy makers. First, we extend understanding of agency theory by examining how owners with divergent interests impact decision making in private firms. As such, our study fits in a relatively young and important stream of research which is exploring how varied principal interests impact executive actions but which has focused on public firms (e.g. Connelly et al., 2010). Second, we contribute to the family and PE literature by providing evidence about the impact of PE control on family firms, a topic which has received little attention in the literature so far. Most importantly, PE investors play a different role when they hold a minority rather than a majority shareholding in family firms. Additionally, we provide new evidence on the impact of PE on employment practices. While several studies analysed the impact of PE on employment, most of these studies focus on large “going private” buyouts rather than (minority) investments in private family firms. Our results are in strong contrast with the dominant view of PE investors creating value through efficiency gains but highlight the role of PE investors as agents of strategic renewal. Finally, evidence on the impact of PE on employment terms is scarce. Our results show that PE investments do not necessarily lead to worse employment terms. Third, our results provide valuable insights for family firm owners, PE firms and policy makers. For family firm owners, our results suggest that PE investments do not necessarily lead to employment reductions or worsened employment terms. Additionally, we show that PE firms should carefully consider differences between minority and majority investments as well as between family firms and non-family firms. Lastly, the results inform policy makers in the debate regarding the regulatory framework in which the PE industry operates. REFERENCES AVAILABLE FROM THE AUTHORS
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