Abstract
This article reviews the literature and applies principal-to-principal (PP) conflict theory to small family based businesses. The lack of accurate measurement and communication of risk leading to issues with innovation, is the primary cause of PP agency costs. Careful analysis of the risk levels reflected in the cost of debt and opportunity cost of equity provides a theoretically robust and empirically estimable process for ascertaining the true PP agency cost. Awareness of the constraining governance structures and the suggested method, based on the cost of capital, to assess small business risk can assist SME owners and financiers to SMEs to promote business efficiency and innovation.
Highlights
This paper presents the application of a finance lens to analyse how governance in small family businesses (SFB) impacts the value of the business using agency cost theory
The controlling family will prioritise actions that keep the management and control of the business firmly in the family’s hand by minimising the amount of outside equity investors, prioritising debt finance and promoting family members to managerial positions within the company. This need to pursue socio-economical wealth can lead to PP conflict which causes agency cost and increases the small family business’ risk
Agency cost exists in small family businesses despite concentration of ownership and control due to the PP conflicts within the business and if left unchecked, it can affect the long-term survivability of the small family business
Summary
This paper presents the application of a finance lens to analyse how governance in small family businesses (SFB) impacts the value of the business using agency cost theory. The various shareholders consist of the founding family member(s), their immediate family, their extended family and external parties such as non-family shareholders or private institutions, each with different goals and intentions with regards to the business and their personal utility (Su et al 2008) This type of agency conflict is known in the literature as principal-principal (PP) conflict (Renders and Gaeremynck 2012; Athayde 2009; Su et al 2008; Ward and Filatotchev 2010; Young et al 2008; Young et al 2003). The relationship between small business risk and PP agency cost will be explored and the various means of measuring and estimating the value of small business risk
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