# I. INTRODUCTION

Family are ubiquitous, particularly in emerging economies (e.g. La Porta, Lopez-de-Silanes and Shleifer 1999). While the evidence is mixed on whether family ownership is beneficial to firm performance, a large and growing literature suggests that family-managed firms have substantially worse managerial quality and performance than those with professional managers. Understanding the forces that drive the decision of firms to be family-managed is therefore potentially important in explaining productivity differences across countries.

This paper provides new evidence on the way in which weak contracting environments affect the choice of firms to be family-managed, and assesses this channel’s importance in explaining cross-country productivity differences. First, we construct a new dataset on firm management and ownership structures that includes over 119,000 firms from 134 regions across 11 European countries. Second, to guide our analysis we develop an equilibrium model where heterogeneous firms sort across family and professional management modes when the latter are subject to contracting frictions. Third, we test a number of unique predictions from the model using regional variation in a proxy for contracting institutions–trust–within countries. In contrast to the prior literature which has relied on cross-country comparisons, this allows us to to difference out country-level unobservables. Our results support the idea that by increasing the cost of hiring professional managers, weak contracting environments lower productivity by constraining the large firms who hire them and causing more firms to use less productive family managers.

Theories of family can be broadly into two categories. On the one hand, family ownership can provide a “competitive advantage” allowing firms to achieve superior economic outcomes than non-family counterparts. On the other hand, the “private benefits of control” view emphasizes that family firms might maximize value for the family rather than investors overall (Bertrand and Schoar 2006, Villalonga and Amit 2010). The empirical evidence established so far, though, is mixed. The positive effect of family ownership on firm value has been documented by Anderson and Reeb (2003), Villalonga and Amit (2006) and Fahlenbrach (2009), where the latter two emphasize the role of the founder CEO on firm value. This supports the efficiency of family firms inherent to the competitive advantage explanation.<sup>1</sup> While there is evidence of the potential negative effects of family ownership,<sup>2</sup> a growing literature emphasizes the detrimental effects of family management on firm performance. Bloom and Van Reenen, (2007) show that family firms in Europe are characterized by worse managerial practices, confirmed for a broader sample including developing countries by Lemos and Scur (2018). Morck, Strangeland and Yeung (2000), Pérez-González (2006) and Villalonga and Amit (2006) show that family firms’ performance falls once the active management of the firm transitions from the founder to his or her descendants. This supports the

> 1This could arise, for example, if family owners have longer time horizons than investors which improve long-run firm performance. Botticelli and Barnes (1997) and Eisenmann (2000) provide evidence in support of this in the history of the US media industry. Bertrand (2009) highlights how family owners may also be more committed to the firm that outside investors. Khanna and Palepu (2000) and Sraer and Thesmar (2007) are two other notable examples of family firms performing better than their counterparts. Indeed, this view is contained within a long strand of literature going back at least to Berle and Means (1932), see Bertrand and Schoar (2006) for a review.

> 2For example, Bertrand, Mehta, and Mullainathan (2002) provide evidence that family owners in India can “tunnel” resources out of firms for their own benefit. Bertrand et. al. (2005) study business groups in Thailand and show that firm performance declines

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