(Authors: Bharat A. Jain and Yingying Shao)
Executive Summary prepared by Karen Vinton, Professor Emeritus, Montana State University
Two firms have just successfully completed an IPO. What post-IPO investment policy will the firms implement? How much cash will the firm keep? Will the funds be used for R&D? Or will they be used for capital expenditures? Or will they be used for an acquisition? And what economic consequences will these policies have for the firm? One firm is a family firm and one is a non-family firm. Will this have an impact on what they decide and on the economic consequences of their decisions? These questions are explored by the authors in this paper.
This study compares post-IPO investment policies between family and non-family firms and their economic impacts. The researchers used a sample which consists of 250 family IPO firms and 773 non-family IPO firms all led by an outsider CEO. They used data from the Securities Data Corporation New Issues Database from 1997 to 2004. Additional financial data was obtained from CRSP and Compustat as well as IPO prospectuses.
The major post-IPO investment policy findings are as follows:
- Post-IPO family firms tend to have lower levels of cash holdings, underinvest in R&D and overinvest in capital expenditures, regardless of their motivation for going public.
- Family IPO firms tend to overinvest in capital spending and underinvest in acquisition spending. BUT post-IPO acquisition spending is higher in family firms with low family ownership stakes, which is consistent with the notion that managers have greater flexibility to pursue empire building acquisitions when family control is weak.
The major economic consequences are as follows:
- By underinvesting in R&D, and the reduced wealth effects of that, family firms are not well positioned to achieve a competitive advantage through innovation.
- Contribution of increases in post-IPO acquisition spending to shareholder value is higher for family firms.
Even though family firms, in general, were less acquisitive, the market value of their investments in acquisitions is higher. This suggests that family firms tend to avoid empire building acquisitions and instead focus on a narrower set of acquisitions that are more likely to produce synergistic benefits as well as preserve socioemotional wealth by increasing survival probability.
While this study presents some interesting findings for both practitioners and family firms, it would be interesting to see this study replicated using data after the financial crisis of 2008. This study uses agency and socioemotional wealth theory to hypothesize what happens post-IPO in a family firm. Practitioners should become familiar with these two theories. To learn more about these theories, practitioners can read the “Literature Review and Hypothesis Development” section of “Family Firms and Institutional Investors” by Fernando, Schneible and Suh in the December 2014 issue of Family Business Review. It provides a clear and concise description of agency theory and socioemotional wealth (SEW) theory. Another source of information about SEW can be found in “Socioemotional Wealth in Family Firms: Theoretical dimensions, assessment approaches, and agenda for future research,” by Berrone, Cruz and Gomez-Mejia in the September 2012 issue of Family Business Review.