Family firms in India: family involvement, innovation and agency and stewardship behaviors

Abstract

Family firms and business groups play an important role in many emerging economies. In this paper we study how different aspects of family involvement influence technological innovation in a firm. Arguments drawn from agency theory and particularly the principal-principal agency hypothesize a negative influence of family involvement with respect to technological innovation. In contrast, stewardship theory predicts a positive influence of family involvement on technological innovation. Drawing on these theoretical lenses with contrasting directionalities with regard to the impact of family involvement on technological innovation, we study how family involvement in ownership, management and board of directors, and business group affiliation influence R&D investments and patents obtained by the firm. The hypotheses are empirically tested on a seven-year panel of 172 firms from the pharmaceutical industry in India. Our results indicate that family shareholding and family control over both CEO and chairperson positions have a positive and significant influence on the firm’s R&D investments, broadly lending support to stewardship theory. We also find a positive influence of business group affiliation on R&D investments and patents applied by the firm. Our conjecture is that the high technology opportunity environment in the Indian pharmaceutical industry facilitates stewardship behavior which in turn promotes innovation in these firms.

Emerging economy firms are playing an increasingly important role in the world economy (Lu, Au, Peng, & Xu, 2013; Sharma, 2012). Taking advantage of economic liberalization and institutional reform in their home countries (Chari & Banalieva, 2015; Krug & Hendrischke, 2012), some indigenous firms in emerging economies have transformed themselves from consumers of foreign technology to developers of innovative products and services (Hoskisson, Eden, Lau, & Wright, 2000; Li, Chen, Liu, & Peng, 2014; Zeng & Williamson, 2007). Prior studies on innovation have identified the firm’s corporate governance system, especially the ownership structure, as one of the key determinants of innovation (e.g., Ahuja, Lampert, & Tandon, 2008). Yet many of these studies have been carried out in the context of United States and the United Kingdom, where firms are characterized by diffuse ownership with large shareholding by institutional investors (e.g., Baysinger, Kosnik, & Turk, 1991; Bushee, 1998; David, Hitt, & Gimeno, 2001; Hoskisson, Hitt, Johnson, & Grossman, 2002; Kochhar & David, 1996). Even though family firms are the most common ownership and governance structures in the world (La Porta, Lopez-de-Silanes, & Shleifer, 1999), only in recent years have studies started to systematically examine the influence of family involvement on technological innovation (De Massis, Frattini, & Lichtenthaler, 2012), especially in the context of emerging economies. In this paper, we study the influence of family ownership and control on technological innovation in emerging economy firms and empirically examine the relationship in the context of the Indian pharmaceutical industry.

The literature on the influence of controlling family on firm’s conduct and performance is based on two directly conflicting theoretical perspectives (Le Breton-Miller & Miller, 2009; Le Breton-Miller, Miller, & Lester, 2011). According to the principal-principal agency perspective (Young, Peng, Ahlstrom, Bruton, & Jiang, 2008), which has received considerable attention, family firms can have a divergence of interest between the controlling family members and the minority shareholders (Dharwadkar, George, & Brandes, 2000). Controlling family members can be more concerned with the family self-interest rather than the overall welfare of the firm. Such behavior can result in expropriation of firm resources, risk aversion, and nepotism, which can result in underinvestment in firm renewal and competency building activities such as R&D. Stewardship theory (Davis, Schoorman, & Donaldson, 1997) provides an alternative perspective to examine the family influence on innovation. Owing to their long tenure and socio-emotional relationship with the firm, controlling family members are thought to act more like stewards. As stewards, they focus on the continuity of the business, nurturing a community of employees, and developing closer connections with various stakeholders of the company (Miller, Le Breton-Miller, & Scholnick, 2008) which could facilitate higher R&D investments and innovation.

In this paper, we assess the conflicting predictions of agency and stewardship theory to examine the influence of controlling family on technological innovation. Innovation is increasingly recognized as important to firm growth (Ahlstrom, 2010) and that of the economy in general (Aghion & Howitt, 1992; McCloskey, 2010; Romer, 1990). We express family involvement through family ownership, family management, and CEO duality (having both CEO and chairperson from family). In emerging economies, the family influence is amplified in the presence of a business group (Morck & Yeung, 2003). Hence we also look at the influence of business group affiliation on innovation. The relationship between family involvement and innovation is examined as a set of competing hypotheses. Drawing on the principal-principal agency theory (Young et al., 2008), one set of hypotheses predicts a negative influence of family ownership, family management, duality, and business group affiliation on technological innovation. A second set, drawing mainly on the stewardship perspective (Davis et al., 1997), argues for a more positive influence.

We use a seven-year panel data of 172 firms in the Indian pharmaceutical industry to test the hypotheses. We operationalize technological innovation through both innovation input (R&D investments) and innovation output (patents received by the firm). In doing so, we found that family ownership, duality, and business group affiliation has a positive and significant influence on R&D investments, while business group affiliation has a positive and significant influence on the number of Patent Cooperation Treaty (PCT) applications filed by the firm. The results broadly support the stewardship perspective of family influence. This adds support to the view that as stewards, controlling family members provide continuity of business, nurture a community of employees, and develop closer connections with various stakeholders which facilitate innovation in the firm. We attribute the high technological opportunity context of the Indian pharmaceutical industry for the predominance of stewardship behavior by family executives as against the agency behavior.

We seek a threefold contribution in this study. First, we put forward a stewardship perspective of family involvement and provide empirical support for the positive influence of controlling family on innovation. This is also in line with the anecdotal evidence in India, for what has been called the “India Way” of management (Cappelli, Singh, Singh, & Useem, 2010), where family executives were found to have a long-term vision for the firm, created a family like culture among the workforce and were more open to experimentation and failure. In contrast, much prior research has found that family involvement negatively influenced R&D and innovation (De Massis et al., 2012). Second, this study contributes empirically in utilizing a sample of large Indian firms as many of the prior studies are carried out in the context of developed economies of North America and Western Europe. Recent research has increasingly recognized the direct effects of institutions on firm behavior and performance (Meyer, Estrin, Bhaumik, & Peng, 2009; Rodrik & Subramanian, 2003; Wang, Ahlstrom, Nair, & Hang, 2008) as well as their role in influencing the family firm’s strategic actions and their consequences (Gedajlovic, Carney, Chrisman, & Kellermanns, 2012). The context of the Indian pharmaceutical industry with a high technological opportunity environment and lower technological firm capabilities provides an interesting setting to study the family influence on innovation. In addition, this study contributes a major empirical examination of the key emerging economy of India (Chaudhuri & Khanna, 2014; Nair, Ahlstrom, & Filer, 2007). This study supports the role of firm’s strategic context in facilitating or impeding the stewardship and agency behavior in family executives and thereby influencing the firm’s strategic decisions. Third, in contrast to most prior studies, we undertake a more comprehensive analysis of family influence by analyzing the impact of family involvement through ownership, board, and management, that is, across the entire “corporate governance tripod” (Van den Berghe, 2003). We also undertake a more comprehensive view of innovation by analyzing both innovation inputs (R&D investments) and outputs (patents received). Prior studies, in contrast (e.g., Chen & Hsu, 2009; Munari, Oriani, & Sobrero, 2010) have only examined either innovation input or output solely.