We examine the relations among various types of family firms, including those named after their founders (founder-named, or FN, firms), those managed by their founders (founder-managed, or FM, firms), and those named after and managed by their founders (founder-named-and-managed, or FN&M, firms). Our empirical results establish a strong and consistent pattern among family firm types. Consistent with the previous literature, we show that family firms are generally more valuable than their non-family counterparts, and that founder-managed (FM) firms are more valuable than their non-founder-managed (non-FM) counterparts. More important, we provide new evidence that founder-named (FN) family firms have significantly lower market valuations than their non-founder-named (non-FN) counterparts. When we examine the intersection of founder-named and founder-managed family (FN&M) firms, we find that these firms have the lowest market valuations among all family-firm categories (as well as compared with non-family firms). These statistically and economically significant results raise an important question: What is it about the act of naming a firm after its founder that leads to significantly lower market valuations? The intuitive assumption that mere naming should not affect underlying value is succinctly expressed in William Shakespeare’s Romeo and Juliet when Juliet asks “What’s in a name? That which we call a rose by any other name would smell as sweet.” In contrast to this intuition, our empirical results show that naming does indeed affect underlying value (sweetness) when the name in question is that of the founder.
Besides Juliet’s null hypothesis of zero valuation effects, two streams of previous research suggest that the act of naming can produce significantly positive or negative valuation effects. One stream posits that FN firms outperform non-FN firms because FN firms are more concerned about protecting founder reputations. Consistent with this reputation effects hypothesis (REH), previous studies find that FN firms outperform their non-FN counterparts in marketing and customer relations. In contrast, a second stream of research suggests that FN firms will be more susceptible to value-destroying endowment effects than non-FN firms. The endowment effects hypothesis (EEH) posits that the possessor of an object places a higher value on its “current personal use” than on its “potential market exchange” (Kahneman, 2011). Founders who have their names attached to firms are more likely to view such firms in terms of personal-use value as opposed to investor-oriented, market-exchange value. In contrast, “No endowment effect is expected when owners view their goods as carriers of value for future exchanges, a widespread attitude in routine commerce and financial markets” (Kahneman, 2011, p. 297). The EEH argues that outside investors recognize the increased agency conflicts associated with FN firms and discount such firms accordingly.
Since our initial findings are consistent with the predictions of the EEH, and inconsistent with (i.e., opposite to) the predictions of the REH, we focus our empirical investigation on further exploring and developing the implications of the EEH. We begin by hand-collecting family firm data and related variables for a sample of 8,062 total observations. Within our family-firm sample, about 22 percent of our observations are FN firms. Specific examples of FN firms include Anheuser Busch, Bob Evans Farms, and Hilton. Roughly 55 percent of our observations are FM firms, including such examples as Apple and Nike. The intersection of these two subsamples (FN&M firms) represents approximately 5 percent of our observations. Specific examples of FN&M firms include Hess, Dell Corporation, and Ralph Lauren.
We use this hand-collected family-firm database to implement our three-part empirical strategy. First, we examine and document the relation between firm valuation and founder naming. Our main results show that FN family firms are almost 8 percent less valuable than non-FN family firms, after controlling for other variables commonly used in the literature. This result is statistically and economically significant. Even more striking, we show that FN&M family firms are roughly 21 percent less valuable than their non-FN&M counterparts – again, after controlling for other variables commonly used in the literature. Both the FN and FN&M results are robust to alternative model specifications. In contrast to these FN (and FN&M) firms, we find that FM firms trade at a 5 percent market value premium. However, when founders both manage and name their companies after themselves, the underlying firms trade at a significant market discount. These empirical patterns suggest the presence of endowment effects among FN firms.
Second, we develop and test further EEH-related implications by identifying potential mechanisms through which endowment effects can reduce firm value in FN (and especially FN&M) firms. We expect that managers who are susceptible to endowment effects are less likely to engage in value-enhancing mergers and acquisitions. Our empirical results support this hypothesis. Similarly, we expect that managers who are susceptible to endowment effects are less likely to engage in significant restructuring activities (i.e., they have more difficulty letting go of underperforming assets). Consistent with the EEH, we find that FN&M firms engage in less restructuring than other family firms. As an additional test, we examine the stock market reaction to the sudden deaths of founders of FN&M firms relative to the sudden deaths of founders of non-FN&M firms. Consistent with expectations, the market reaction is significantly more positive for the FN&M firms than for the non-FN&M firms. Overall, these results provide additional support to the proposition that FN and FN&M firms suffer from endowment effects that lead to a significant loss in market value.
Third, we examine alternative explanations for the FN (and FN&M) value discount. We first consider the possibility that the value discount is driven by dual class share structures – the use of which is likely to be more prevalent among FN firms. Next, we examine whether the value discount is caused by FN firms imposing large differences between voting rights and cash flow rights. Specifically, we calculate the wedge between insider voting rights and cash flow rights, and then test whether endowment effects remain significant after accounting for differential voting and cash flow rights. We also investigate the possibility that the negative relation between firm valuation and founder naming is driven by FN firms’ greater corporate opacity and whether manager overconfidence can be responsible for our empirical findings. If there is a positive correlation between FN firms and managerial overconfidence, then our endowment-effect results might be attributable to overconfidence effects. Finally, we investigate the possibility that the FN discount is driven by weak internal corporate governance quality. Again, if there is a positive correlation between FN firms and weak internal governance, then our endowment-effect results might be attributable to internal governance effects. We test these alternative explanations and continue to find strong evidence in support of an independent endowment effect (i.e., the EEH).
Overall, our study adds to the family-firm literature in several ways. We confirm earlier findings that family firms are more valuable than non-family firms using a larger data set than used in much of the previous literature. Similarly, we confirm that FM firms are more valuable than non-FM firms. More important, we present new evidence that FN family firms are significantly less valuable (by roughly 8 percent) than their non-FN family firm counterparts. Our results for FN&M family firms are even more striking. We show that these firms trade at a 21 percent discount to their non-FN&M family firm counterparts. These results are statistically and economically significant and include an extensive set of control variables commonly used in the literature. After confirming the EEH, we further develop its implications by showing that FN firms are less likely to engage in comprehensive restructuring activities, such as mergers and acquisitions, spinoffs, strategic assets sales, or significant reorganizations. We also show that the market reacts more positively to the sudden deaths of those managers who are most susceptible to endowment effects. Finally, we test and reject a series of alternative hypotheses, including dual class share structures, differential voting and cash flow rights, corporate opacity, and managerial overconfidence. Overall, our study is the first to document a significant naming discount and to attribute this discount to an endowment effect.
This post comes to us from Professor Paul Brockman at Lehigh University’s College of Business and economics, Professor Hye Seung (Grace) Lee at Fordham University’s Gabelli School of Business, Professor William L. Megginson at the University of Oklahoma’s Michael F. Price College of Business, and Professor Jesus M. Salas at Lehigh University’s College of Business and Economics. It is based on their recent paper, “It’s All in the Name: Evidence of Founder-Firm Endowment Effects,” available here.