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I am indebted to Gary S. Becker, Steve Davis, Samir El-Khouri, Jeffrey Fischer, Connel Fullenkamp, Mohsin Khan, Edward P. Lazear, Sunil Sharma, and Michael Waldman for many helpful comments and discussions. I would also like to thank session participants at the 1999 AEA meetings, and seminar participants at the SEC and at the Midwest Mathematical Economics Meetings, for comments on an earlier version of the paper.
Using a more broad criteria of what constitutes a family business, Berckhard and Dyer (1983) estimate that family-owned businesses account for more than 80% of the businesses in the US alone, generate 50% of the US GDP and employ about half the work force. See also Lansberg (1983), Davis (1983), and Barnes and Hershon (1976). The more conservative criteria used by Shanker and Astrachan (1996) defines a family business as one where multiple generations of the same family maintain control of the business, and are directly involved in running and managing the business.
It is estimated that in 1997 the top 10 families in Indonesia controlled corporations worth more than one-half of the country’s market capitalization, with similar numbers for Korea, Thailand, and Malaysia.
For an analysis of the concentration of family businesses in Sweden, see Rydqvist (1996), in Britain see Megginson (1990), and Kunz and Angel (1996) for family businesses in Switzerland. See also Allen and Gale (2000), Chapter 4.
See, for example, Kirby (1984) for an interesting study of the dynamics of the Quaker Business Society.
The term “manager” here refers to the founder’s role in deciding on the employee’s wages.
This result is also consistent with the empirical observations of successful family businesses, where the founder’s child, although having an inside track into the family firm, works his way up and performs at least as well as other managers (see, for example, Davis (1983) and Lansberg (1983)).
See Bernheim and Stark (1988) for a discussion of moral hazard due to asymmetric altruism, but in the presence of perfect and complete information.
In a recent article, Dunn and Phillips (1997) provide empirical evidence that wills (which may include the family business) provide equally for all children, irrespective of their respective incomes. See also Menchik (1988).
See Sections II C and II D for a discussion of the assumption of competition in the product market.
Note that due to the presence of altruism and information asymmetry, the child’s participation constraint is not binding, and as a result it is not included (see Proposition 2). See Chami (1998) for a discussion of this issue in the context of private information and altruism, and Cox (1987) in the context of altruism but with perfect and complete information.
The mathematical derivation is relegated to the Appendix.
Lansberg (1983) defines nepotism, in this case, as referring to the case where the child’s compensation is not validated by the value of his marginal product.
Each of these rich individuals recognized the disincentive effect of his respective sizeable wealth on the effort decision of their beneficiaries. See, Holtz-Eakin, Joulfaian, and Rosen (1993), Clark (1966), Time (1995).
Note that even if the parent/founder possessed monopoly power, the parent would have the same incentives to limit the divergence of interests between him and the child/employee. See also the discussion in Jensen and Meckling (1976, p. 329).
The assumption of competitive markets seems also to be appropriate, given that family businesses tend to be smaller and more labor-intensive.
This can seen from inspecting the slope of the indifference curve of the altruistic child
That is not to say that nonfamily businesses do not face the same daunting task of finding a replacement and then effecting the transition (see Business Week (1997)).
Rogers (1994, p. 474) argues that young adults have high rates of time preference, with the peak being either in their twenties or thirties. The difference in the rates of time preference between the young adults and their older parents—which may be a source of conflict between the generations—diminishes as the children age.
In this context, the child who does not expect to inherit the business and is selfish (βk= 0) resembles a nonfamily employee.