Description
The Value of Family Ownership, Control, and Management
In collaboration with Professor Raphael Amit of Wharton, Belén Villalonga is investigating how family ownership, control, and management affect firm value. Their forthcoming Journal of Financial Economics article shows that family ownership creates value only when the founder serves as the CEO of the firm or as its Chairman with a hired CEO. Control mechanisms that create a wedge between the fractional shares and votes held by the family reduce but do no eliminate the founders positive contribution to value. These mechanisms include dual share classes, pyramids, and voting agreements.
They also find that, when it is the founders descendants who serve as CEOs or Chairmen, family firms are significantly less valuable than nonfamily firms. This effect appears to be non-monotonic across generations of families, however. The negative impact of descendants is entirely attributable to second-generation family firms. Third and later generation family firms are not significantly different in value from nonfamily firms. In fact, the incremental contribution of third-generation firms is positive.
Professors Villalonga and Amits research sheds light on a longstanding question in corporate governance that affects minority shareholder in both closely-held and widely-held corporations: which of the two conflicts of interest that minority shareholders can be exposed to is more damaging to firm value, the classic agency problem between owners and managers, or the conflict between large controlling shareholders and small, minority holders? Their research suggests that, in the context of family firms, the answer to this question hinges crucially on whether the firm is managed by its founder or by a descendant: the classic owner-manager conflict in nonfamily firms is more costly than the conflict between controlling (family) and minority (nonfamily) shareholders in founder-run firms, but less costly than the conflict between family and nonfamily shareholders in descendant-run firms.
The Value of Corporate Diversification
Belén Villalongas research has been one of the first to challenge the conventional wisdom that diversified corporations trade at an average discount of 1530% relative to single-business firms in the same industries. In her article Does diversification cause the diversification discount?, Professor Villalonga uses recent econometric developments about causal inference to investigate whether the discount can actually be attributed to diversification itself. Because diversification is an endogenous choice made by corporate managers, firms that diversify differ from firms that do not diversify in a wide range of factors. These factors include firm size and age, industry, prior performance, ownership structure, investment policies (R&D, capital expenditures, acquisitions), and macroeconomic conditions at the time of diversification. As a result, the traditional estimates of the discount, which are based on mean differences in excess value between the two groups of firms, need to be corrected for self-selection bias. The excess value measures implicitly match firms on size and industry, which amounts to assuming that those are the only two characteristics in which diversified and single-business firms differ. Yet matching on all differential characteristics seems like an intractable problem, known in econometrics as the curse of dimensionality.
Propensity score matching is a statistical technique that solves the curse of dimensionality problem and corrects for self-selection by using the estimated probability that a firm will diversifythe propensity scoreas a summary measure on which to match diversifying firms with a comparable set of single-business firms. Professor Villalonga has applied this technique to a sample of firms similar to those in prior studies finding the existence a discount and found that, when a more comparable benchmark based on propensity scores is used, the diversification discount disappears. This finding implies that, even if diversified firms trade at a discount relative to their single-business counterparts, the finding cannot be causally attributed to diversification. In other words, diversification does not destroy value.
This article was the first prize winner of the Addison-Wesley Prize for the best paper published in Financial Management between 2002 and 2004. Earlier it received the 2001 Free Press Outstanding Dissertation Award from the Business Policy and Strategy Division of Academy of Management Association, and an honorable mention in the Strategic Management Society 1999 McKinsey Best Conference Paper Award.
In her article Diversification discount or premium? New evidence from BITS establishment-level data, Professor Villalonga examines whether the finding of a diversification discount is only a data artifact. This research is based on a new database that covers the whole U.S. economy (the Business Information Tracking Series, or BITS). Segment data may give rise to biased estimates of the value effect of diversification because segments are defined inconsistently across firms, and that inconsistency does not occur at random. In contrast, BITS data can be used to construct business units that are more consistently and objectively defined across firms, and thus more comparable. Using a sample of firms that exhibit a diversification discount according to segment data, Professor Villalonga finds that, when BITS data are used, diversified firms actually trade at a significant average premium.
One likely explanation for the results is that the two databases provide different but complementary measurements of diversification. Hence there may be a discount to unrelatedor conglomeratediversification (what Compustat measures), but a premium to related diversification. Because related diversification is likely to predominate over conglomeration, when all diversification types are pooled together as they are in BITS, the net effect on firm value is a premium. Another plausible explanation that cannot be totally distinguished from the previous is strategic accountingthat diversified firms aggregate their activities into segments in ways that may make them appear as artificially low performers relative to single-segment firms in the same industries.
This article was awarded the first prize of the 2004 Brattle Prize for outstanding papers in the Journal of Finance. Earlier it received the Barclays Global Investors Award at the European Finance Association 2002 Annual Meeting.