A Theory of Family Ownership (with Jin Yu)

We develop a financial contracting model to analyze the effect of family control on corporate risk-taking. The ex post optimal (second best) risk-taking policy maximizes the controlling party’s interest and usually fails to internalize those of other claimholders. This may give rise to inefficiency as financiers capitalize the risk-taking policy into financial contracts and, therefore, the ex ante optimal (first best) risk-taking has to maximize the total firm value. We show that family control emerges as an optimal mechanism because a family owner’s propensity to take on risk features both an equity component (equity ownership stake) and a debt-like component (default-able private benefits). Therefore, the optimal family ownership is an outcome of a trade-off between alleviating over-conservatism and reducing excessive risk-taking. The model generates several novel empirical predictions and policy implications.


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