«Structured Abstract Purpose: The present paper explores the application of the four-eyes principle (4EP) to management decisions in large family ...»
Applying the Four-Eyes Principle to Management Decisions in the
Manufacturing Sector: Are Large Family Firms One-Eye Blind?
Purpose: The present paper explores the application of the four-eyes principle (4EP) to
management decisions in large family firms in the manufacturing sector, a heretofore
neglected area of business and management research.
Design/methodology/approach: A theoretical analysis was first conducted of the 4EP in
general and its application in family firms based on agency and stewardship theories. A qualitative field study of 15 large Austrian firms from the manufacturing sector with various degrees of family involvement was then conducted to explore how the 4EP is applied in these firms.
Findings: From the theoretical analysis, it can be concluded that the 4EP may generally serve as a mechanism to limit agency conflicts. Due to a theoretically lower level of agency conflicts in family firms than in non-family firms, a lower application of the 4EP in family firms can be expected. However, the field study shows that large family firms also regularly adopt the 4EP and that family-managed firms demonstrate a more flexible and opportunistic usage of the 4EP, limiting both its associated downsides and advantages. The present paper further shows that such flexible 4EP usage in family-managed firms may increase their abilities to make quick business decisions and to display high levels of flexibility; however, it may also increase the risk of making suboptimal decisions and experiencing unfavorable managerial behavior as firms grow in size and international activity.
Originality/value: This is the first paper to analyze the application of the 4EP in large family firms. Six propositions and a preliminary model of the 4EP in family firms are developed in the paper, which may lead to further research on the practical applications of the 4EP.
Keywords: Family Firms, Family Businesses, Management Decisions, Four-Eyes Principle (4EP); Manufacturing Firms Paper type: Research paper 1 Introduction Although family firms have enjoyed increased recognition in scientific research during recent years, their specific characteristics are still considered as under-researched and requiring further investigation (Wright and Kellermanns, 2011; Kraus et al., 2011; Gedajlovic et al., 2012, Xi et al., 2013). In a considerable number of family firm studies, the idiosyncratic qualities of such firms are researched in comparison to non-family firms. These studies are often motivated by the specific governance characteristics of family firms, most importantly the overlap between management and ownership in family-managed family firms (Songini and Gnan, 2013). According to agency theory, this overlap should reduce classical agency conflicts, which are rooted in the separation of ownership and control and the heterogeneity of the goals of the principal and agent (Ang et al., 2000; Chrisman et al., 2004). Consequently, instead of a corporate culture of control and mistrust, a more trust-based culture should be fostered in family firms, which would limit the need for the intensified usage of management control mechanisms and incentive contracts in family firms (Speckbacher and Wentges, 2012;
Hiebl et al., 2012; Mitter et al., 2014; Wessel et al., 2014). Moreover, family involvement in management is also viewed as a vehicle to enable quick decision-making, as lengthy alignment negotiations between ownership and management are not needed (Habbershon and Williams, 1999). However, weak or non-existent control mechanisms in family firms can also lead to unintended outcomes and family firm-specific agency problems. The absence of control may force family members acting as managers into taking ill-considered, irrational and suboptimal decisions, thus threatening the family firm’s survival (Schulze et al., 2003;
Gómez-Mejía et al., 2007). Therefore, family involvement in family firm management may be regarded as both a specific advantage to maintaining efficient decision-making and an entrepreneurial spirit as well as a specific risk (Kraus et al., 2012; Hiebl, 2013a; Craig et al., 2014).
An instrument often used to reduce the risk of inconsiderate, fraudulent or suboptimal decisions in all types of organizations – and not just in family firms – is the four-eyes principle (4EP) (Sutter, 2007; Feldbauer-Durstmüller et al., 2012; Six et al., 2012; Bátiz-Lazo and Noguchi, 2013). This principle usually means that crucial decisions (often defined as those affecting a certain minimum amount of capital) may not be made by individual actors alone but must be jointly made by at least two actors. The inclusion of at least two actors also explains why the principle’s name includes “four eyes”. This approach ensures the rationality
However, employing the 4EP in family firms may be complicated compared with non-family firms but may also bring specific benefits to family firms. In family firms, decisions are often based on emotions rather than rationality or formal decision-making processes. The family members in charge may not allow non-family members or more junior family members to challenge or question their decisions (García Pérez de Lema and Duréndez, 2007; Hall and Nordqvist, 2008; Filser et al., 2013), which would be required if they rigidly followed the 4EP. Non-family managers may also wish not to displease family managers by critically scrutinizing their decisions in accordance with the 4EP, for fear of losing their jobs. These two factors point to a constrained or reduced usage of the 4EP in family firms. However, family firms may enjoy particular benefits by employing a rigorous 4EP, as such a mechanism could help them overcome the family firm-specific control problems and risks discussed above. In this vein, the 4EP might also help secure the traditional non-financial goal of family firms, namely the longer-term survival of the firm (Cater and Justis, 2010;
Laakkonen and Kansikas, 2011; Chrisman et al., 2012).
Against the backdrop of these opposing considerations, the present paper explores whether, how and why family firms may differ from non-family firms concerning the usage of the 4EP.
Due to the scarcity of the literature on the 4EP in general (Schickora, 2010), it does so by first theoretically analyzing the motivations behind 4EP usage in family and non-family firms.
Moreover, a qualitative field study of 15 firms that have different degrees of family influence was conducted to gain insights into the practice of the 4EP. Theoretical considerations and empirical field study data are then used to derive propositions and a preliminary model of 4EP usage in family firms, which is intended to motivate further research on this issue.
This paper contributes to the literature in several ways. First, it is among the first to analyze the application of the 4EP in the business and management literature and to apply the 4EP to family business research. It thus enriches the literature by showing that in addition to preexisting and well-investigated incentive and monitoring mechanisms, the 4EP may be another – albeit less well understood – agency control mechanism. Furthermore, the paper discusses the specific application of the 4EP in family firms and offers six propositions and a
The remainder of this paper proceeds as follows. Section 2 presents the theoretical considerations of the 4EP in family firms, which are based on agency and stewardship theory.
Section 3 then describes the field study’s methodology. The field study’s results are then presented in section 4 and propositions are developed. Finally, section 5 concludes with a discussion of the results, an outlook on potential further research avenues and this paper’s limitations.
2 Theoretical Considerations of the 4EP in Family Firms
2.1 The 4EP as an agency control mechanism Both agency and stewardship theory are used as theoretical lenses through which to analyze the application of the 4EP. These theories are concerned with the relationships between principals (in the case of business organizations, firm owners) and agents (managers) (Tosi et al., 2003; Caers et al., 2006). Agency theory relies (amongst others) on two basic assumptions, namely that principals and agents may have different goals and that agents may act in a self-serving way (Jensen and Meckling, 1976; Eisenhardt, 1985; Eisenhardt, 1989a), thus leading to agency problems. To overcome disparate goals and align the agent’s actions to the principal’s intentions, agency control mechanisms are introduced. Two of these mechanisms are incentive compensation and monitoring (Butler and Newman, 1989; Chua et al., 2009). In this regard, the 4EP as described above may be regarded as a mechanism to monitor and control individual agents’ decisions.
When the 4EP is enforced exclusively within the management team, the controlling authority may be another manager rather than the principal. However, even within the management team, the 4EP may limit self-serving or even criminal behavior (e.g., corruption, fraud) because at least two agents would have to agree on unfavorable actions to enable such behavior (Schickora, 2010; Bátiz-Lazo and Noguchi, 2013). Both would subsequently experience the classical prisoner’s dilemma of not knowing whether the other would blow the whistle in case of distress (Rapoport and Chammah, 1970).
3 Moreover, principals such as firm owners or boards of directors may provide the second pair of eyes and thus act as a monitoring body for agents’ decisions within a 4EP. This would be the case when critical management decisions also need approval by the board of directors or the firm’s owners. Regardless of whether a 4EP is performed within the management team or between management and supervisory bodies, a certain decision-making approach must be established to be effective. For instance, a rule or procedure must be implemented to clarify for which types of decisions a 4EP is necessary and how the (at least) two pairs of eyes have to connect to develop a commonly agreed-upon decision. Therefore, the 4EP involves a certain degree of formality in the decision-making process and adds a layer of control to management decisions, thus serving as an agency control mechanism.
2.2 The 4EP in family firms
The principal–agent relationship displayed above may be different in family firms compared with non-family firms because in the former, firm owners often also serve as managers and thus have a dual role as both principal and agent (Chua et al., 2009; Siebels and zu Knyphausen-Aufseß, 2012). From a purely theoretical perspective, in family firms, the two above-discussed agency problems are thus often absent. Family members may serve as both principals and agents, meaning that divergent goals would not exist. Therefore, self-serving behavior may also be absent as long as the family manager acts in the best interests of the family firm (Corbetta and Salvato, 2004). Consequently, instead of the agency picture of managers, family firm research often refers to the stewardship picture of man. The main tenets of stewardship theory are that the agent serves as a steward to the firm and is willing to subjugate his or her personal interests to secure its longer-term welfare (Wellum, 2007;
Hernandez, 2012). Hence, the steward may be described as being intrinsically motivated to do his or her best for the firm without any need for extrinsic motivation, such as incentive payments (Davis et al., 1997). This theory implies that if managers act as stewards to the firm, no or fewer agency control mechanisms are necessary. In other words, if the principal trusts that the steward is acting in the best interests of the firm, the principal does not need to introduce intense monitoring or incentive pay schemes (Eisenhardt, 1985; Songini and Gnan, 2013). It follows that promoting a stewardship-like culture in family firms should result in a lower need to apply the 4EP. Hence, assuming that managers in family firms indeed act as stewards, family firms should show a lower adoption rate of the 4EP.
4 By contrast, the ownership and management spheres in non-family firms rarely overlap to a significant degree as they do in family firms. Thus, principals cannot assume that agents will intrinsically act as stewards and only in the best interests of the firm. Therefore, the higher usage of control mechanisms, including the 4EP, can be expected in non-family firms compared with family firms (Hiebl et al., 2012; Songini and Gnan, 2013). From this perspective, it follows that non-family firms should use the 4EP more often than do family firms.
Thus far, we have assumed that family and non-family firms stand in stark contrast to one another and that they can be distinguished by the existence of owner-management in family firms and non-owner-management in non-family firms. However, there exist various ownership and management constellations in between these two extremes. In particular, larger and older family firms often rely on non-family managers because they either cannot supply sufficient management personnel and know-how from the ranks of the family or family members simply choose not to work in the family firm (Klein and Bell, 2007; Sonfield and Lussier, 2009; Stewart and Hitt, 2012). Indeed, the term “family firm” may apply to firms that range from fully family-owned and fully family-managed to those that hold only a certain percentage of family ownership and those now fully managed by non-family members (Rutherford et al., 2008). It follows that in family firms that have introduced non-family managers, the classical agency conflict of the separation of ownership and control may apply.
Based on the foregoing, to understand agency control mechanisms and the 4EP, we must distinguish whether non-family-managed family firms show the control characteristics of (1) non-family firms, (2) family firms or (3) something in between (Songini and Gnan, 2013).