Abstract
Based on the natural reluctance of family-controlled firms (FCFs) to accept external shareholders, in this paper we analyze whether investment sensitivity to internally generated cash flow is a driver of venture capital (VC) participation in those firms. We argue that FCFs are more likely to accept external investors when they are subject to serious financial constraints. We also aim to ascertain to what extent VC involvement contributes to reducing the dependency between investments and internal cash flow. We focus on a representative sample of Spanish privately held FCFs that received the initial VC investment between 1997 and 2006, and compare the investment-cash flow sensitivity of VC-backed FCFs with that of non VC-backed FCFs. We find that FCFs that received VC were more financially constrained than other similar non VC-backed FCFs before receiving VC. This finding is especially true in first generation FCFs, thus providing additional evidence on the reluctance of FCFs to accept external shareholders. We also find that VC-backed FCFs, in particular first generation ones, significantly reduce the sensitivity of investments to cash flow after the initial VC round.
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Notes
Hubbard (1998) surveys other works that provide additional evidence by classifying constrained and unconstrained firms according to different proxies of information costs (e.g., membership in business groups, firm’s age, size and ownership structure).
The ECM is a reduced form model that allows flexible specification for short-run investment dynamics and avoids any a priori specification of adjustment costs.
In addition to traditional agency costs among principals and managers, Young et al. (2008) introduce the concept of the so-called ‘principal-principal’ conflict which gives rise to ‘horizontal’ agency costs, i.e. costs related to the fact that different principals may have heterogeneous interests, preferences and objectives. Family ownership has a relevant influence on the way organizations are run, with both positive and negative outcomes in terms of horizontal agency costs. Colombo et al. (2014b) analyze the relevance of horizontal agency costs in high-tech entrepreneurial firms and control for the presence of family firms. In fact, on the one hand, horizontal agency costs should be reduced as family firms may efficiently monitor family agents’ conduct and settle disputes, thus aligning the interests among family agents and thereby reducing horizontal agency costs. On the other hand, family agents “may exacerbate horizontal agency problems because of high levels of ownership concentration and incentives that favour high levels of perk consumption” (Colombo et al. 2014b, p. 277).
Since in Spain it is common to have two family names, on from the father and another from the mother, it is possible to track the presence of a family in the capital of firms overtime, and even investigate the different family groups with shareholdings and/or the presence in the management of the firm.
We compared the distribution of FCFs in our sample with that of the 1716 firms composing the population of Spanish VC-backed firms from which the sample is extracted. Two χ2 tests show that there is no statistically significant difference between the distributions across geographical area while the difference is significant in terms of industry. In more detail, there is a higher number of FCFs in commerce, and a lower number of FCFs in manufacturing sectors, than that found in the original sample of VC-backed Spanish firms [respectively, χ2 (17) = 13.55 and χ2(6) = 590.16].
The sampling is performed with replacement so that each control group firm can be selected as a match for more than one VC-backed firm (possibly in different years).
The Euler equation approach is based on a structural model that is explicitly derived from a dynamic optimization problem that captures the influence of the current expectations of the future profitability on current investment decisions (Abel 1980; Bond and Meghir 1994). However, this model assumes a symmetric, quadratic structure of adjustment costs that is very restrictive. In fact, the estimates of these structural models are often found to have the wrong signs for the key explanatory variables or to imply implausibly slow speeds of adjustment (Bond et al. 2003).
In the early literature it was customary to use Tobin’s Q to capture investment opportunities. Nevertheless, dissatisfaction with the Tobin’s Q empirical performance and the impossibility of using it in samples that are composed of unlisted companies have led to an interest in models such as the ECM and the Euler equation (Bond and Van Reenen 2007).
We also include regional dummies, year dummies and industry dummies.
The use of a large number of instruments may result in significant finite sample bias. To address this problem, we limit the instrument set with moment conditions in the interval between t − 2 and t − 3 (see Bond 2002).
Estimates using different cut-offs (i.e., 2 and 5 %) are very close to those described in the next sections. They are available from the authors upon request.
Conversely, for following generations FCFs the coefficient β6b is not significant, indicating that VC-backed following generations FCFs are not financially constrained. In contrast, CG following generations FCFs seem to be significantly financially constrained (i.e., the coefficient β5b is positive and highly significant). However, the difference β6b – β5b is equal to -0.3437, but it is not statistically significant.
Conversely, the coefficient β8b is not significant for following generations FCFs indicating a non-significant effect of VC on investment-cash flow sensitivity of invested following generations FCFs.
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Croce, A., Martí, J. Financial constraints in family firms and the role of venture capital. Econ Polit Ind 44, 119–144 (2017). https://doi.org/10.1007/s40812-016-0055-4
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DOI: https://doi.org/10.1007/s40812-016-0055-4
Keywords
- Venture capital
- Family firms
- Family generation
- Investments-cash flow sensitivity
- Financial constraints
- External shareholders