Family firms and crash risk: Alignment and entrenchment effects
Journal of Contemporary Accounting and Economics, 2020, 16 (2), 100204
59 Pages Posted: 9 May 2014 Last revised: 30 Jun 2022
Date Written: May 7, 2014
Abstract
Stock price crash risk could be lower in family firms because the controlling family investors have a longer-term interest, hold greater decision rights and are better informed than investors in diffusely owned firms (alignment effect). However, the agency costs between family and nonfamily investors (entrenchment effect) could affect crash risk in two opposing ways. Non-controlling investor skepticism about insider entrenchment limits overvaluation and reduces the crash risk. In contrast, entrenched insiders could hide bad news to exploit private benefits, which could increase the crash risk. We show that family firms exhibit a lower crash risk than similar nonfamily firms after controlling for lower overvaluation, which is consistent with the better alignment effect. Moreover, we show that better governance further reduces the crash risk, which indicates that the substitutive relationship between strong governance and family ownership shown in countries with low investor protection rights does not carry over to the U.S. where investor protection rights are strong.
Keywords: Family firms; Crash risk; Agency cost; Governance mechanism
JEL Classification: G32; M41
Suggested Citation: Suggested Citation