What was interlocking directorates,” and how did morgan use it to build his empire?

Abstract

This article focuses on the structural aspects of interlocking directorate networks within and among fifteen European countries. The results show large quantitative differences in network densities within countries. These differences are strongly and significantly related to the ‘variety of capitalism’ in place. Second, an analysis of the interlocking directorates across country borders reveals a European interlocking directorate network in which different countries take quite different positions. As it turns out, a country's international position is strongly and significantly related to its EU membership duration. Additionally, there are indications of a link between the structure of the interlocking directorate network within a country and how that country is positioned in the international network. Data were collected in 2006 concerning 362 corporations with 6115 board positions in fifteen European countries.

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Interlocking directorates are the formal links between firms created by the cross appointment of directors between them (Mizruchi, 1996). These individuals are usually selected through a formal process of identification, screening, nomination, and appointment by a vote of the shareholders (Shropshire, 2010). Explicating the determinants of interlocking directorates has long been an important issue in corporate governance research because the director that also sits on another board is assumed to have mixed incentives with dealing with the firm’s governance, strategy and performance matters (Westphal and Stern, 2006, Elsbach and Pieper, 2019).

Two perspectives dominate the literature on director selection: social embeddedness and economic rationality (Withers et al., 2012). The social embeddedness perspective emphasizes the interpersonal processes and factors that drive director appointments (Khurana & Pick, 2004). Accordingly, the reasons for certain individuals to be chosen as directors is the willingness of these individuals to be associated and identified with other directors of similar social status or with whom there exist prior affiliations (Zajac & Westphal, 1996). The economic-rationality perspective holds that directors are appointed to oversee the economic mission of the firm on behalf of its stockholders (Berle and Means, 1933). Therefore, directors with the skills and experience to carry out traditional board tasks and that contribute to positive value creation are preferably chosen (Lee & Phan, 2000).

Within these literature streams, studies on board interlocks have focused on the criteria that lead to the appointments of directors that sit on at least one other board (Westphal and Zajac, 1996). Class hegemony theory, part of the social embeddedness perspective, argues that board interlocks are formed to create a hegemonic class among boards of directors (Caiazza et al., 2019). Directors that appoint their director colleagues from other firms reinforce the economic elite by doing so (Palmer et al., 1993). Resource-dependence theory, part of the economic-rationality perspective, argues that directors serving multiple firms bring useful information and personal networks that confer resource (e.g., information, financial capital, market access, supply chain security, etc.) acquisition advantages to their firms (Caiazza et al., 2019). These advantages add value by improving their firms’ risk management capabilities.

While class hegemony and resource dependence theories are popular in the literature, few studies have empirically determined their explanatory power in family firms (Caiazza et al., 2019). In family firms, family blockholders, defined as family members that control large portions of the company’s shares, often play the dominant role in the appointment of new directors, which implies that the influence of existing directors is low (Chua et al., 1999). Moreover, the influence of these owners may be amplified by their ownership of related firms in the family network (Jones et al., 2008, Sacristan-Navarro and Gomez-Anson, 2007). Such ownership structures potentially affect the logic and criteria for director selection, providing the rationale for further investigating the explanatory power of existing theories when it comes to family firms.

Our study investigates the drivers of interlocking directorates in Italy, where most non-financial businesses are family firms (Morgan & Gomez-Mejia, 2014). We consider the population of non-financial companies listed on the Milan Stock Exchange to compare the family and non-family firms. For this study, we define a family firm as one in which a family owns at least 10% of the voting shares and is represented in the top management of the company (Caiazza & Simoni, 2019). In Italian family firms, family members usually dominate the top management team and the board of directors (Caiazza & Simoni, 2015). Caiazza et al. (2015) report that the largest shareholder in Italian companies owns, on average, more than 50% of the share capital, while the second largest owns, on average, from 8% to 10%. Financial institutions hold a small fraction of the equity and are generally inactive in governance.

To allow for the formation of board interlocks over time, we sampled 16 semi-annual periods to analyze the changes in board compositions. We utilized a logit model to calculate the likelihood of various types of board interlocks that can be formed among the firms. We then evaluated the explanatory power of the theories in use by comparing the results for family firms with those of non-family firms. We find that the formation of family firm interlocking directorates is driven by the willingness to use board interlocks to further embed family firms in the industry where the family has its core economic interest. The paper contributes to the literature on family firms by extending theory to clarify the general process of directors’ selection and providing an explanation for interlocking directorate formation. Our contribution is particularly relevant at now because of increasing attention in Italy on the transparency of governance in family firms.

The paper proceeds in the following way. In the first section, we provide a review of the literature on board interlocks and discuss the relevance of conventional theories to explain the formation of interlocking directorates in family firms. Then, we state and discuss our hypotheses about interlock formation by considering the specifics of the Italian corporate governance system as it applies to family firms. Next, we describe the sample, metrics, and statistical model. We present the results, discuss their meaning, and draw conclusions. Finally, we discuss the limitations of our study and suggest promising areas of future research.

The literature on the selection of directors recognizes two perspectives (Withers et al., 2012): social embeddedness and economic rationality. Social embeddedness states that new directors are chosen based on their social capital and their relationships with incumbent directors that are in charge of appointing new directors (Westphal and Stern, 2006, Zajac and Westphal, 1996). Economic rationality holds that directors are selected for their experience and capability to oversee top management and make valuable resources accessible to the latter (Cannella et al., 2014). Following social embeddedness, class hegemony theory focuses on the social factors that influence the selection process of an interlocking director (cite). The theory argues that board interlocks are a means to maintain cohesion among the social elite that oversees corporate boards (Mizruchi, 1996). Following economic rationality, resource dependence theory argues that directors are selected to close resource gaps faced by the firm (cite). It is understood as a way for the firm to gain access to critical resources is derived from a director’s network position (Mizruchi & Stearns, 1988). Thus far, studies on director selection take for granted the critical role that incumbent directors, sitting on nominating committees, play in the appointment process. In the case of family firms, this assumption may not hold strongly (Roessl, 2005; Steier, 2009).

As noted earlier, a structural feature of family firms is ownership concentration in a single family (Davis et al., 1999; Gomez-Mejia et al., 2003). This concentration results in family control of the firm, which is then extended to other firms through common and cross shareholding mechanisms (La Porta et al., 1999, Sacristan-Navarro and Gomez-Anson, 2007, Villalonga and Amit, 2006). These direct and indirect ownership ties allow a single family to control many firms, and in some cases, achieve market dominance in the industry in which these firms operate (Caiazza & Cannella, Phan, et al., 2019).

As a result of their ownership shares, family blockholders can play a significant role in the selection of board members across their network of firms, which cements family control over the business empire (Bammens et al., 2008). In such situations, directors can serve a mediating role between family and non-family shareholders, and to attenuate the risk of wealth appropriation from the latter by the former (Cho et al., 2018, Ferramosca and Allegrini, 2018, Federo et al., 2020). Another, less formal, role that directors are known play is that of counsellor to the CEO. It is rooted in the construct of stewardship and consists of the advice and mentoring that board members provide to top managers for improving their ability to manage the firm in the context of the portfolio of affiliated firms in the family’s holdings (Lester et al., 2008). In sum, the board of directors in family firms maintain an equilibrium between the controlling family blockholder and other shareholders and stakeholders.

The ability for family blockholders to maximize their wealth at the expense of other shareholders is high when the family enjoys control rights that exceed its cash-flow rights, which are enabled by the portfolio pyramidal holding structure, dual-class voting shares, and the presence of the family in management (Villalonga & Amit, 2010). For this reason, family owners prefer directors that are unlikely to contest their preferences, such as the employment of family members in the firm. Similarly, they are less likely to prefer activist directors that represent special interests, such as the firm’s lending banks.

Over time, directors who serve the boards of a family’s affiliated firms become known to the family and some may even become part of the family (Brundin & Nordqvist, 2008). Such directors are known as family insiders that meet the socioemotional criteria (friendship, kinship, and confidence) family blockholders consider when appointing a director (Berrone et al., 2012, Gomez-Mejia et al., 2007, Morgan and Gomez-Mejia, 2014). The preference for directors who sit on the boards of the family’s affiliated firms is twofold. First, they are more likely to appreciate and be sympathetic to the family’s business culture. Second, they serve as the vector to spread this culture to other firms in which they are also appointed as directors. As such, these directors confer an outsized influence of the family across the business group, even in firms where the family is the minority owner (Perry & Peyer, 2005). Hence, everything else equal, we hypothesize that:

H1a

: The tendency to form board interlocks among firms with cross-shareholding relationships will be higher for family firms than non-family firms.

H1b

: The tendency to form board interlocks among firms with common-shareholding relationships will be higher for family firms than non-family firms.

As noted in the seminal study by Myers and Majluf (1984), firms prefer to finance growth projects with internally generated capital to avoid the scrutiny of experts in the capital market. They use private debt financing for the same reason, and only as a last resort, do they approach the capital market. This phenomenon is truer in family businesses because the incentive to avoid the capital market is paired with the desire to limit the presence of competing claims on the family’s influence over the firm (Ramalho et al., 2018). Therefore, a family firm with significant private debt financing is exposed to the lending bank’s scrutiny of the firm’s operations increases and the possibility of bank representation on the board (Villalonga & Amit, 2006). Hence, everything else equal we hypothesize that

: The tendency to avoid board interlocks with banks will be higher for family firms than non-family firms.

According to the economic-rationality perspective, directors are appointed for the resources they bring, which stem from their experience and personal relationships with other directors (Withers et al., 2012). These resources come in two forms. Directors with expertise and relationships from different industries provide the firm with access to broad knowledge stores and diverse development opportunities. Directors with expertise and relationships in the firm’s industry bring deep knowledge stores and specific development opportunities (Kroll et al., 2007, Kroll et al., 2008). As well, the latter can add value to management at the operational level of the firm (Kor and Misangyi, 2008, Kor and Sundaramurthy, 2009).

Prior studies of family firms report that they tend to focus on specific industrial sectors before diversifying as a response to shrinking opportunities at the late stages of growth (Hafner, 2021). Given the priorities of families to secure employment for family members and build generational wealth (Lee et al., 2016), which implies a risk averse growth strategy, family firms prefer to dominate an industrial sector through related diversification rather than risk unrelated diversification. The strategy of related diversification implies that directors in family firms are more likely to be drawn from core and adjacent industries, since their knowledge stores are more aligned with the firm’s strategic intent.

The appointment of directors that serve on the boards of other firms in the same industry has the added benefit of tying the family firm to actors in the same ecosystem. These interlocks represent conduits of knowledge for business practices and policies adopted by actors in the industry (Palmer et al., 1993). As well, interlocks with competitors facilitate tacit coordination and non-price competition, which has the benefit of protecting the firm’s margins (Carpenter & Westphal, 2001). As we discussed earlier, a director’s deep knowledge of an industry combined with a position on a related firm board translates into strategically relevant knowledge that contributes to managerial capability, in addition to governance capability (Khurana & Pick, 2004). While all firms benefit from such capabilities, we argue that family firms have greater incentives to pay attention to such board appointments because their strategic intent to build generational wealth is more strongly supported by a related diversification strategy than an unrelated diversification strategy. Hence, everything else equal, we hypothesize that

: The tendency to form board interlocks among firms that belong to the same industry will be higher for family firms than non-family firms.

We analyzed the tendency of family and non-family firms to form certain types of interlocks using a longitudinal analysis over 16 semi-annual periods to detect any changes in board compositions. We focused on all non-financial Italian family and non-family firms listed on the Milan Stock Exchange (Barontini and Caprio, 2006, Prencipe et al., 2008). Data on the firms, stockholders and board members came from the database of the national commission that governs the Italian Stock Exchange

Given that the effect of the interaction term in a logit model is non-linear and dependent on the values of all covariates, we provide a graphical representation of the probability of forming new interlocks of a type for family and non-family firms at different values of the total number of new interlocks (Hoetker, 2007). In addition, following Train (1986) we set the other covariates at their observed values to avoid biases that may derive from setting their values at the sample mean.

We first

The empirical results partially support our model. Indeed, whereas some dynamics in board interlock formation were as expected for family firms, others emerged as common characteristics of Italian listed firms in general. In this paper, we proposed an extension to the theory on board interlock formation, where interlocked directors are selected to protect the family blockholders’ interests in their affiliate firms. Our results show that the tendency of family businesses to appoint directors who

From a theoretical perspective, our study helps to clarify the logic behind the formation of board interlocks in family firms. First, our results provide support for the argument that the key agency problem in family businesses is the tendency for opportunistic behaviors by family owners. Indeed, we show that the selection and appointment of directors who sit on other boards are guided by the need of family blockholders to have influence over their affiliate firms, beyond what is given by

All the authors worked on the paper together

B. Villalonga et al.
S.C. Myers et al.
T.J. Morgan et al.
S.H. Lee et al.
S. Ferramosca et al.
K.D. Elsbach et al.
M. Cucculelli et al.
J. Cho et al.
E. Barth et al.
R. Anderson et al.

P.D. Allison

A. Ataay

Y. Bammens et al.

R. Barontini et al.

A.A. Berle et al.

P. Berrone et al.

E. Brundin et al.

R. Caiazza et al.

A. Cannella et al.

M.A. Carpenter et al.

J.H. Chua et al.

J.A. Colquitt et al.

G.F. Davis et al.

R. Federo et al.

G. Gavana et al.

L.R. Gomez-Mejia et al.

An increasing number of studies emphasize the importance of trust between family businesses and their stakeholders. Surprisingly, family business research still lacks a comprehensive understanding of the role of trust in stakeholder relationships; whereas another field—that of organizational behavior—has examined trust-building in depth. Thus, in order to identify specific research gaps and to determine future research directions, we systematically review the literature on trust in the field of family business, as well as in organizational behavior research. Both streams pursue different, hence complementary, approaches in terms of the type of trusting stakeholders, theory building, nomological network (antecedents, components and consequences of trust), level of analysis and type of trust. Whilst family business research maintains a focus on the consequences of trust, organizational behavior focuses rather on its components. We formulate a set of propositions and future research questions as to how insights from organizational behavior research can help to fill existing research gaps and advance our understanding of trust in the management of family business stakeholder relationships.
This study analyzes Chinese family firms to determine how environmental practices influence corporate performance in consideration of the moderating effect of family control. Based on hand-collected data of environmental practices and 698 Chinese listed family firms, the results show that the environmental practices and corporate financial performance (CFP) link can be captured by a U-shape, and environmental practices are positively associated with corporate social performance (CSP). Furthermore, family control positively moderates the relationship between environmental practices and performance. The findings provide systemic understandings of the CFP and CSP of family firms through important insights into environmental practices and family control.
Family firms often struggle to recruit skilled non-family employees. Applying a mixed-method strategy, this article investigates the changing perception of family firms as attractive employers in the context of the COVID-19 pandemic. Experimental results indicate that family firms benefit from a greater popularity amid crises owing to perceptions that they offer greater job security and compensation. Qualitative findings expand on these results by identifying new attractiveness-relevant factors that only come into play amid crises—specifically, multifaceted conceptions of family firms’ crisis responses and their importance for local communities and economies contribute to their situational appeal.
Based primarily on the Resource-Based View and prior evidence, this study gauges the potential differences in innovative behaviour between international family firms and non-family firms when conditions change drastically in the business environment (i.e. from a situation of economic growth to one of downturn, and then to recovery). The research setting is a large sample of Spanish manufacturing firms between 2007 and 2016 (i.e. pre-Covid-19). During this period (2009–2013), the global economic and financial crisis affected Spain. Thus, three sub-periods are distinguished in the empirical analysis: growth, crisis, and recovery. Using Qualitative Comparative Analysis, our findings show that the paths of innovation activities that promote internationalisation via exporting in family and non-family firms are somewhat dissimilar in each sub-period, supporting the argument that the causal effect of innovation on internationalisation is heavily dependent on environmental conditions. Compared to non-family firms, our results show that when family firms internationalise, they follow a wide variety and more stable number of paths in innovation activities. Our findings also provide additional evidence to support the argument of heterogeneity among family firms.
We examine how socioemotional wealth (SEW) influences the relationship between family management and firm performance, constructively replicating and extending Sciascia, Mazzola, and Kellermanns (2014). We apply fuzzy-set qualitative comparative analysis on a sample of 277 privately-owned US family firms and measure SEW both directly and via unidimensional proxies. In agreement with the authors’ findings, our results show that family management relates positively to performance in later-generation family firms. Our findings also show that SEW is sufficient for high family firm performance, challenging the view that family firms face a trade-off between pursuing affective goals and achieving profitability. Both findings, however, hold only when SEW is directly measured, underscoring the importance of adopting a multidimensional and universally accepted operationalization of SEW for an accurate and robust understanding of its true relationship to family firm outcomes.
We assess the corporate performance and corporate governance consequences of mandatory employee board representation through a natural experiment: the passage of the 2015 Rebsamen law in France, which requires 1 or 2 board seats to be allocated to employee representatives. We hypothesize that such formal institutional arrangements to give workers a voice in corporate governance are irrelevant for family firms, which have been shown to commit to implicit contracts with their employees. We find evidence that affected family firms’ share prices reacted negatively to the passage of the law. Moreover, standard OLS regressions of operating performance suggest that family control neutralizes the positive effect associated with employee directors. A more sophisticated difference-in-differences approach shows that affected family firms experienced a significant subsequent decrease in their return on assets. Our investigations of board composition also suggest that family firms rely on avoidance strategies to offset the influence of employee representatives. Overall, this paper casts doubt on the efficiency of minority worker representation in the boardrooms of family-owned companies and thus cautions against a “one-size-fits-all” approach to corporate governance practices.