Agency Costs and Ownership Structure: 

Evidence From the Small Business Finance Survey Data Base

Jacky Yuk-Chow So, Ph.D., Texas A&M International University, Laredo, TX 78041-1900

2005. [32] pages. Under contract SBAHQ-04-M-0136 

This report was developed under a contract with the Small Business Administration, Office of Advocacy, and contains information 

and analysis that was reviewed and edited by officials of the Office of Advocacy. However, the final conclusions of the report do not 

necessarily reflect the views of the Office of Advocacy.

Agency problems* arise when a corporate organization (the principal) employs a professional manager (the agent) and thereby separates the business 

owner(s) from control of the business. Most previous 

studies of such agency problems used data from publicly traded companies. Applying these study results 

to small owner-controlled business reveals two limitations. First, in most publicly traded companies, 

the largest shareholders seldom own more than 50 

percent; therefore, the results may not be applicable 

to problems faced by smaller, family/owner-managed 

firms. Second, since control is not separate from 

ownership, these small firms should, by definition, 

have no agency problem. Family shareholders usually are less likely to expropriate bondholder wealth 

than other shareholders; family firms may also have 

incentive structures that result in fewer agency conflicts between equity and debt claimants.

The author hypothesizes that agency problems 

suffered by larger firms are not statistically significant for smaller owner-manager or family-owned 

firms. The Federal Reserve Board’s 1993 National 

Survey of Small Business Finances (NSSBF) database was used to test the hypotheses.

Findings

1. Agency costs of owner-managed and outsidermanaged firms—as measured by the ratios of operating expenses to sales and sales to assets—are not 

significantly different. Similar results are documented for the family-owned small company. However, 

owner-managed firms are statistically different from 

outsider-managed firms in ratios of cash flow to 

assets for 100 percent management-owned firms 

and firms in which no owner or family owns more 

that 50 percent (diffused ownership). These results, 

together with the higher efficiency of the diffusedownership firms, show that agency problems do not 

exist for smaller firms.

2. The above results do not take into account the 

interactive effect of internal monitoring, derived 

from ownership, and external monitoring derived 

from bank loans/debt holders. When regression analysis is used to study all these effects, it can be said 

that a large number of nonmanager stockholders will 

decrease the efficiency of small firms. The overall 

effect of bank monitoring is negative; therefore, the 

benefits of bank monitoring may be outweighed by 

the associated “hold-up” costs. For example, if a firm 

has only one creditor, it may incur higher refinancing 

costs because borrowing from other creditors is more 

costly.

3. Since the coefficients associated with family 

ownership are not significant statistically, but the 

debt-to-assets ratio is, it appears family ownership 

cannot mitigate, nor is it related to, agency problems 

of small firms.

4. After factoring in the “interactive effect” by 

using a more powerful statistical method, the above 

findings are maintained with the exception that family ownership indeed plays an important role in eliminating agency problems. The empirical evidence, 

therefore, supports the alignment-based governance 

system proposed by John and Kedia.

Implications for Business Owners

The study’s findings have significant implications 

for small business owners. Because owner-managers are the most effective mechanism for eliminating agency costs, it is important for owners of small 

December 2005 No. 268

*In this paper, “agency” refers to the relationship between a principal, 

such as a business owner or owners, and his or her agent, such as a 

manager.
firms to participate actively in investment and financial decision-making. When the size of the company 

increases, as measured by sales, and when professional managers are recruited, delegation of authority 

becomes necessary. To reduce the associated agency 

costs, corporate control mechanisms involving family members and/or banking relationships should be 

established to monitor the behavior of the nonowner 

managers. Otherwise, the Wall Street scandals that 

plagued the Fortune 500 companies may become a 

reality for the small firm.

Methodology

To test the hypotheses, the author used, as proxies to 

measure agency costs, ratios of operating expenses 

to sales and sales to assets. Their joint effect is 

analyzed using the ratio of cash flow to assets. It is 

assumed that these three variables are affected by log 

sales, industry effect, firm age, different ownership 

(internal control dummy variable) schemes (ownermanaged; >50 percent family owned; >50 percent 

primary owner), log of number of nonmanager stockholders, and external monitoring (number of banking 

relationships, length of the longest banking relationship, and debt-to-asset ratio).

Firms of two types—owner-managed and outsider-managed—are also grouped into six sub-groups: 

1) all corporations; 2) corporations in which the primary owner owns 100 percent of the firm; 3) corporations in which the primary owner owns more than 

50 percent of the firm; 4) corporations in which a 

single family owns more than 50 percent of the firm; 

5) corporations in which no owner or family owns 

more than 50 percent of the firm; and 6) proprietorships. The average of each of the agency cost proxies 

was estimated and t-tests or z-tests were performed 

to examine the differences between owner-managed 

and outsider-managed firms.

The ordinary least squares (OLS) method was 

used to study the relationship between the dependent 

variables (the agency costs) and the independent 

variables mentioned previously. Since the multiequation system was more appropriate for studying 

the optimal governance system, the author employed 

the seemingly unrelated regression (SUR) method 

to simultaneously test the variables of these ratios: 

operating expenses to sales, sales to assets, and 

cash flow to assets. The estimates from the SUR are 

believed to be more efficient than the OLS estimates.

This report was peer-reviewed consistent with 

Advocacy’s data quality guidelines. More information on this process can be obtained by contacting 

the director of economic research at advocacy@sba.

gov or (202) 205-6533.

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