DP3234 Family Firms

Author(s): Mike Burkart , Fausto Panunzi , Andrei Shleifer

Publication Date: February 2002

Keyword(s): corporate governance , law and finance

JEL(s): G34

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP3234.asp

We present a model of succession in a firm controlled and managed by its founder. The founder decides between hiring a professional manager or leaving management to his heir, as well as on how much, if any, of the shares to float on the stock exchange. We assume that a professional is a better manager than the heir, and describe how the founder’s decision is shaped by the legal environment. Specifically, we show that, in legal regimes that successfully limit the expropriation of minority shareholders, the widely held professionally managed corporation emerges as the equilibrium outcome. In legal regimes with intermediate protection, management is delegated to a professional, but the family stays on as large shareholders to monitor the manager. In legal regimes with the weakest protection, the founder designates his heir to manage and ownership remains inside the family. This theory of separation of ownership from management includes the Anglo-Saxon and the Continental European patterns of corporate governance as special cases, and generates additional empirical predictions consistent with cross-country evidence.