Outsiders on the board of directors and firm performance: Evidence from Spanish non-listed family firms

OUTSIDERS ON THE BOARD OF DIRECTORS AND FIRM PERFORMANCE: EVIDENCE FROM SPANISH NON-LISTED FAMILY FIRMS Abstract: The aim of the study is to analyze the effect of the presence of outsiders (affiliated and independents) on the board of directors on firm performance in family SMEs, also considering the generational effect. To test our hypotheses whether outside directors act as agents or stewards, we examined the relation between firm performance and the proportion of affiliated and independent directors on the board, using data from nonlisted family firms in Spain. Our findings show the existence of a positive impact of affiliated directors on firm performance in family firms. It is also important to note the different behaviour between family firms run by the first generation and those run by subsequent generations. In this case, the presence of independents on the board has a positive effect on performance when the firm is run by the first generation. When the firm is run by second and subsequent generations, the presence of independents has no effect on performance. Key words: Affiliated directors, independent directors, generation, non-listed firms, family firms 1.- INTRODUCTION Within the management research area, corporate governance is one of the topics receiving increased attention. Specifically, corporate board structure and its impact on firm behavior has been one of the most debated issues in literature (Anderson and Reeb, 2004; Huse, 2000; Zahra and Pearce, 1989). There are many studies that analyze the board of directors from different perspectives. Some of them analyze the determinants Blanca Arosa, Txomin Iturralde, Amaia Maseda This is the accepted manuscript of the article that appeared in final form in Journal of Family Business Strategy 1(4) : 236-245 (2010), which has been published in final form at https://doi.org/10.1016/j.jfbs.2010.10.004. © 2010 Elsevier under CC BY-NC-ND license (http:// creativecommons.org/licenses/by-nc-nd/4.0/) 2 of board composition (Fiegener et al., 2000; Voordeckers et al., 2007; Jaskiewicz and Klein, 2007; Bammens et al., 2008; García-Olalla and García-Ramos, 2010; Giovannini, 2010). Minichilli et al. (2009) study the antecedents of board tasks performance, developing and empirically testing a theoretical model on the impact of board characteristics on board task performance for a sample of 2000 largest Italian industrial companies. Other studies analyse the effect of board composition on firm performance but, in general, the empirical evidence is not conclusive. Some empirical findings regarding board composition towards performance finds that outside directors could improve board effectiveness and firm performance. For instance, Weisbach (1988), McKnight and Mira (2003) and Anderson and Reeb (2004) find a positive and significant relationship between outsiders’ proportion and firm value. However, others like Baysinger and Butler (1985), Hermalin and Weisbach (1991), Agrawal and Knoeber (1996) and Giovannini (2010) find a negative relationship between the proportion of outside directors and firm performance. Dalton et al. (1998), De Andres et al. (2005) and Jackling and Johl (2009) find no relation between the two variables. Differences in findings have in part been attributable to the differences in the theoretical bases of investigation and different measure of firm performance (Jackling and Johl, 2009). Private firms have more degrees of freedom than publicly-listed firms as to whom they appoint to the board. Furthermore, family firms are the predominant form of business in economies around the world, and they contribute extensively to gross national products and job creation (IFERA 2003). However there is little research on the effect of the role of outside directors on firm performance in privately owned family SMEs. And the little research that does exist often uncritically adopts concepts and theories developed for large corporations without adjusting them to the particular contexts of 3 privately owned family firms the situation to differences in for example ownership involvement, and the general lack of internal resources that often characterize these ventures (Huse, 2000; Daily et al, 2002). There consequently seem to be deficiencies in our knowledge of the role and contribution of outside directors in SMEs (Gabrielson and Huse, 2005). Boards of directors are a central institution in the internal governance of a company. In addition to strategic direction, they provide a key monitoring function in dealing with agency problems in the firm (Fama, 1980; Jensen, 1993). In a diffuse ownership context, the monitoring function must focus on reducing the agency problems between disperse shareholders and management (Hermalin and Weisbach, 2001). In the context of companies with high ownership concentration, on the other hand, the agency conflict in the firm is between controlling shareholders and minority shareholders (Lefort and Urzua, 2008; Morck & Yeung, 2003). According to agency theory, the role of the board of directors, and outside board members in particular, is to safeguard against selfserving behavior of a dominant family owner coalition and to prevent the eventual expropriation of minority shareholders (Anderson & Reeb, 2004). However there is some debate about the usefulness of agency theory in the family firm context (Pieper, 2010; Westhead and Howorth, 2006), since agency theory may provide only a partial explanation of the dynamics found in private family firms (Howorth et al. 2004). Stewardship theory, in contrast with agency theory (Davis et al. 1997), defines situations in witch managers and employers are not motivated by individual goals, but instead behave as stewards who motives are aligned with objectives of the organization (Corbetta and Salvato, 2004a; Muth and Donaldson, 1998; Pieper et al., 2008). The typical ownership pattern of small and medium sized family firms (Forbes and Milliken 1999) reduces the need for the board’s control role so, the appearance of outside 4 directors will reflect the service and advice needs of the CEO rather than the control role (Fiegener at al., 2000). According to stewardship theory, the board’s primary role is to service and advise, rather than to discipline and monitor as agency theory prescribes (Hillman and Dalziel, 2003; Corbetta and Salvato, 2004a,b). The aim of this study is to analyze the effect of the presence of outsiders on the board of directors on firm performance in privately owned family SMEs, also considering the generational effect. While most studies have treated outsiders as an indistinguishable group of nonexecutive directors, following Anderson and Reeb (2004), we classified them in two groups, affiliates and independents. Affiliate directors are directors with potential or existing business relationships to the firm, but are not full time employees and may play an important role in any firm, and in the case of family firms their influence is likely to be greater given the more permanent and personal relationship with firm’s management (Jones et al., 2008). Independent directors are individuals whose only business relationship to the firm is their directorship. The most basic distinction between affiliate directors and independent directors rests upon the economic tie between the affiliate firm and the focal firm. To test our hypotheses whether the role of outside directors is to advise or to monitor managers, we examined the relation between firm performance and the proportion of affiliated and independent directors on the board. Our findings show the existence of a positive impact of affiliated directors on firm performance in family firms. It is also important to note the different behavior between family firms run by the first generation and those that are run by subsequent generations. In this case, the presence of independents and the affiliates on the board has a positive effect on performance when the firm is run by the first generation. These results indicate that outsiders perform as stewards in family firms in this generation. 5 This study makes several contributions to the literature on the impact of board composition on firm performance. First, our findings provide a new perspective on the role that outside directors (affiliated and independents) play in corporate governance of family firms, considering both the monitoring and advising role. Second, our study is one of the first to examine the distinction among outside directors in family firms. The role of affiliate directors has generally been overlooked in corporate governance research, and, typically, affiliate directors have been lumped in the overall category of outside directors (Jones et al., 2008). Third, previous studies on the role of outside directors in family firms focused on relatively large publicly-traded family firms (S&P 500). Our study, on the contrary, focuses on non-listed family SMEs and sheds new light on an important, yet under-researched, segment of firms. The remainder of this paper is organized as follows. Section 2 describes the theoretical basis and the hypotheses to examine. Section 3 sets out the data and procedures for analysis used in undertaking this empirical study. Section 4 presents the main results of the investigation. Section 5 presents and discusses the results. Section 6 concludes the paper with some conclusions and implications for management theory and practice, and indicates paths for further investigation. 2. BOARD OF DIRECTORS AND FIRM PERFORMANCE: THEORICAL BACKGROUND AND HYPOTHESES Corporate board structure and its impact on firm behaviour has been one of the most debated issues in literature (Anderson and Reeb, 2004; Huse, 2000; Zahra and Pearce, 1989). In recent years, the discussion has focused on the structure of the board of directors, the most outstanding governance mechanism of the internal control systems (Jensen, 1993). Researchers studying corporate governance have used a diverse set of 6 theoretical perspectives to understand the characteristics, roles and effects of board of directors (Corbetta and Salvato, 2004a; Pieper et al., 2008). Although agency theoretic arguments represent one explanation in describing the relation between owning families and boards of directors, stewardship theory provides an alternative explanation (Anderson and Reeb, 2004). It is not necessary to choose one theoretical perspective over another. Indeed, one can obtain a better understanding of family business boards of directors by trying to integrate different theoretical perspectives (Corbetta and Salvato, 2004a; Minichilli et al., 2009). Board structure has relied heavily on agency theory concepts, focusing on the control function of the board (Hillman and Dalziel 2003; Fama and Jensen 1983; Jensen and Meckling 1976). Agency theory treats the company as a nexus of contracts through which various participants transact with each other (Jensen and Meckling 1976). Since assets are the property of the shareholders, a principal–agent problem may arise because managers have to make decisions concerning the productive use of these assets. Installing a board of directors can be an effective instrument for monitoring top managers and coping with this problem and to reduce agency costs (Fama and Jensen 1983). Thus, agency theory is used to examine the role that the board of directors may play in contributing to the performance of the organizations they govern (Jackling and Johl, 2009). However, the agency problem seems less important in the context of family firms with high ownership concentration, given that the controlling shareholders have sufficient incentives, power and information to control top managers (Jensen and Meckling, 1976). High ownership concentration can trigger other problems with corporate governance and other types of cost. Asymmetric altruism, free-rider problems, family members’ entrenchment could cancel or even exceed the benefits derived from the agency agreement between owners and managers (Chua et al., 2009; Oswald et al., 7 2009; Schulze et al., 2001, 2003). If there are controlling shareholders, they are more likely to be able to use their power to undertake activities intended to obtain private profit to the detriment of minority shareholders’ wealth (La Porta et al., 1999; Morck & Yeung, 2003; Villalonga and Amit, 2006). The main contribution of independent directors according to agency theory is consequently their ability to be independent when overseeing operating matters, protecting the assets of the firm, and holding managers accountable to the firm’s various key stakeholders to ensure the future survival and success of the enterprise (Gabrielson and Huse, 2005). Stewardship theory, in contrast with agency theory (Davis et al. 1997), defines situations in witch managers and employers are not motivated by individual goals, but instead behave as stewards who motives are aligned with objectives of the organization, that is, people are not inclined to opportunism, and managers want to sincerely pursue shareholders’ interests (Davis et al. 1997). Arrègle et al. (2007, p. 84) maintain that: “Family members are concerned about the firm because it is part of their collective patrimony and is often the main asset of the family.” Family owners’ and managers’ stewardship stems from their socio-emotional attachment to the business, which can be very high since the company can serve to satisfy needs for security, social contribution, belonging, and family standing (Ashforth and Mael 1989; Gomez-Mejia et al. 2007; Lansberg 1999). The results of stewardship conduct, generous investment in capabilities, people, and long-term relationships, may be sustainable business value. The expectation is that businesses will build competitive advantages and thereby outperform their peers in growth, returns, and market valuations (Le Breton-Miller and Miller, 2009). Recent research employing a stewardship perspective has shown that effective family relationships and processes contribute to firm performance (Eddleston & Kellermanns, 2007; Eddleston et al., 2008; Pieper et al., 2008). 8 In this view, boards of directors are groups of competent people that help managers to enhance their decision-making process, e.g. contributing to the boardroom debate through their experiences, competences and different viewpoints (Minichilli et al, 2009). In other words, board members provide advice and support to top managers, and thus represent a valuable resource for corporate boards (Donaldson and Davis, 1991). Organizations might require less control from a board when goal alignment between owners and managers is high (Davis et al., 1997; Luoma and Goodstein, 1999; Muth and Donaldson, 1998; Sundaramurthy and Lewis, 2003). Stewardship theory suggests that the main role of the board of directors is to advise and support management rather than to discipline and monitor as agency theory prescribes (Brunninge et al., 2007; Corbetta and Salvato, 2004a,b; Daily et al., 2003; Gubitta and Gianecchini, 2002; Hillman and Dalziel, 2003; Muth and Donaldson, 1998; Pieper et al., 2008). Acting as stewards, families may place outside directors (independent and affiliate) on the board to provide industry specific expertise, objective advice, or generally act as advocates for corporate health and viability. They can play an important role in the development of strategic change processes in family businesses (Brunninge et al., 2007, Fiegener et al., 2000; Voordeckers et al., 2007). Stewardship theory as such, potentially offers an alternative explanation for observing a relation between outside directors and firm performance (Anderson and Reeb, 2004). Consequently, a relation potentially exists between board independence and firm performance because of the counsel and advice that outside directors offer, as opposed to their monitoring and control activities (Anderson and Reeb, 2004). Agency theory and stewardship theory indicate that independent directors exhibit a positive relation to firm performance, but the role of the board of directors is different in each theory. Under agency, independent directors monitor and control insiders and/or 9 the family. Under stewardship, independent directors provide valuable outside advice and counsel to the firm. In this context, the first hypothesis proposes that a higher proportion of independent directors on the board will be associated with a positive impact on performance due to the role, monitor or advisor, which these directors play in firms. Accordingly, we present the following hypothesis: H1: The proportion of board independent directors of non-listed family firms is positively associated with firm performance. Agency theory and stewardship theory offer an alternative explanation for observing a relation between board independence and firm performance as outlined under our first hypothesis. To provide insights into which of these competing theories better explain the role of boards in family firms, we analyze the role of affiliate directors following the approach by Anderson and Reeb (2004), The most basic distinction between affiliate directors and independent directors rests upon the economic tie between the affiliate firm and the focal firm. Affiliate directors are non-employee board members with existing or potential business ties to the firm (Daily et al., 1998) and may play an important role in any firm, and in the case of family firms their influence is likely to be greater given the more permanent and personal relationship with firm’s management (Jones et al., 2008). The economic link between the affiliate firm and the focal firm provides the basis for increased interaction and the potential for the development of social capital between the affiliate director and the top management team of the focal firm. An agency perspective suggests affiliate directors, in seeking to protect or enhance their business relationship with the firm, are less objective and less effective monitors of the 16 Board composition: We use a two tier categorization of board members; independent and affiliated (Anderson and Reeb, 2004). Affiliate directors (AFFILLITED) are directors with potential or existing business relationships to the firm, but are not full time employees. Consultants, lawyers, financiers, and investment bankers are example of affiliate directors. Independent directors (INDEPENDENT) are individuals whose only business relationship to the firm is their directorship. Our primary measure of independent and affiliate director influence is the number of independent/affiliated directors divided by total board size (fraction of independent/affiliated directors). Family firm: One of the primary concerns in defining the independent variables has been to define the notion of the family firm. As mentioned with regard to selection of the sample, for the purposes of this research a family firm was considered to be one in which one or more families can be shown to have at least a 50% holding (Voordeckers et al., 2007; Westhead and Howorth, 2006), allowing them to exercise control over the firm while at the same time they participate actively in management with family members on the board. We have corroborated this definition through the survey and, besides, the survey also shows the family's desire to remain in the business, what it could not be detected with the database information. Following Anderson and Reeb (2003) and Wang (2006), a dummy variable (FD) was created with a value of 1 when the firm meets the conditions necessary to be considered a family firm and 0 otherwise. Generation managing the firm: Another dummy variable has been created for family firms to determine the generation heading the firm's management. Given the different characteristics displayed by family firms depending on the generation that manages them, it is necessary to make this distinction in order to obtain the conclusions in the most appropriate way, differentiating between the different possible types of family firm. We can thus determine whether the behavior of family firms varies depending on 17 the generation managing them. We distinguish between first generation family firms and family firms run by subsequent generations. We therefore created the GEN variable, which takes value 1 if the firm is managed by the first generation and 0 otherwise. Control variables: Following authors such as Anderson and Reeb (2003) and Villalonga and Amit (2006) we also created a variable to reflect insider ownership (INSOWN). This variable measures the percentage of ownership in the hands of inside directors and the CEO and was created to take into account the possible effects of incentives resulting from the proportion of ownership in the hands of insiders. Board Size (BOARDSIZE) was measured using the natural logarithm of total number of members of the board of directors (Anserdon and Reeb, 2003, De Andrés et al., 2005; Jackling and Johl, 2009). The number of directors is a relevant feature that can have much to do with the board’s monitoring and control activity. Whereas the ability of the board to monitor can increase as more directors are added, the benefits can be outweighed by the costs in terms of the poorer communication and decision-making associated with larger groups (Lipton and Lorsch, 1992; Jensen, 1993). Size of firm (SIZE) was measured using the natural logarithm of total assets (Anderson and Reeb, 2003; Carter et al., 2003; Barontini and Caprio, 2006; Wang, 2006; Santalo and Diestre, 2006). Growth opportunities (GROWTHOP), following Scherr and Hulburt (2001) were calculated as Sales0/Sales-1. In this case, firms that grew most in the past were considered to have most chance of growth in the future. Borrowing level (LEV) was measured as the quotient between total debt and total assets, (Coles et al., 2005; Wang, 2006). 18 Firm age (AGE) was measured as the natural logarithm of the number of years since the firm was incorporated. Industry sector (SECT) was measured by means of Dummy variables, using the standard industrial classification (Clasificación Nacional de Actividades Económicas). 4.- RESULTS The relation between firm performance and the independent variables is examined through an OLS regression. Table 2 presents descriptive statistics for the variables in the analysis. We show mean values for family firms in the sample. These firms show a significant diversification, with nearly 64% reporting only one line of business. It should be noted the significant proportion of independent directors in family firms boards of directors. These boards have a composition which, at first sight, seems efficient in order to maintain family firm interests represented and separated. The evolution of this composition tends to reduce the presence of insider directors in favour of affiliated, maintaining also a significant presence of independent directors, regardless of which generation manages the firm. It is therefore necessary to determine the possible effect the presence of different type of directors might have on firm performance due to the greater monitoring or counselling capacity. In relation to control variables, it can be highlighted the high insider ownership, due to the CEO’s percentage of ownership, which is, on average, 20%. It is also noteworthy that family firms have an average age of 40 years, suggesting that our firms are well established. Table. 2 – Descriptive statistics of sample firms: Mean values for variable measures Family Firms Number of observations 369 Board of Director’s composition (Outsiders %) % insiders % affiliated % independent 37.48 1st Gen 74.39 16.48 9.13 2nd Gen 68.58 17,89 13.53 3rd Gen 51.99 33.65 14.37 19 Control variables Insider ownership (%) 50.17 Board of Director’s size (Number of directors) 5 Return on Assets (%) 6.42 Growth opportunity (Sales0/Sales-1) 1.14 Leverage (Total Debt / Total Assets) 61.98 Firm’s size (Total Assets) 27309.48 Firm’s age (years) 40 As shown in Table 3, the correlation coefficients are weak and do not violate the assumption of independence between the variables. To test for multicollinearity, the Variance Inflation Factor (VIF) was calculated for each independent variable. Myers (1990) suggests that a VIF value of 10 and above is cause for concern. The results indicate that all the independent variables had VIF values of less than 10. Table. 3 - Correlation matrix Variables VIF 1 2 3 4 5 6 7 8 9 1 Independent 1.38 1 2 Affiliated 1.07 0.38*** 1 3 Insider ownership 1.12 -0.06 -0.07 1 4 Board size 1.21 0.01 0.02 -0.20*** 1 5 ROA - -0.05 0.09 0.03 0.20 1 6 Growth opportunities 1.08 -0.05 -0.01 -0.00 0.06 0.24*** 1 7 Borrowing level 1.15 -0.03 -0.03 0.12** -0.11 -0.29*** -0.24*** 1 8 Firm size 1.07 0.03 -0.01 -0.08 0.18*** -0.02 -0.05 0.13** 1 9 Firm age 1.05 -0.04 -0.01 -0.11** 0.16*** -0.01 -0.01 0.3 0.01 1 *** Correlation is significant at the 0.01 level Table 4 sets out the results of our linear regression evaluating the influence of board composition on business performance for family firms. Table 4.- Relationship between board composition and firm performance ROA I II III IV V VI Constant 0.112 0.142 0.186 0.150** 0.144** 0.143** Independent -0.022 -0.040 -0.025 -0.019 Independent*Generation 0.089** 0.081** Affiliated 0.070* 0.089* -0.004 -0.003 Affiliated*Generation 0.072*** 0.067*** Insider ownership 0.029 0.028 0.022 0.010 0.003 0.011 Board size 0.002 0.002 0.002 0.002 0.006 0.003 Growth opportunities 0.273 0.385 0.444* 0.335*** 0.327*** 0.327*** Borrowing level -0.105** -0.109* -0.112** -0.113*** -0.103*** -0.106*** Firm size -0.001 -0.002 -0.003 0.001 0.001 0.001 Firm age 0.009 0.008 0.009 0.002 0.004 0.003 F value 2.15 2.17 2.3 4.28 4.61 4.30 20 R2 0.18 0.19 0.20 0.22 0.25 0.26 *** ,** and * indicate significance at 1%, 5% and 10%. In our first and third regressions we examined the influence of independent directors on firm performance (Table 4, column I and III). Our results show a nonsignificant relationship (β1 = -0.022 and -0.040) between independents and firm performance. Thus, firm performance seems to be insensitive to the presence of independent directors in the board. Hypothesis 1 was not supported. These results show that monitoring and counseling by independents does not necessarily imply efficiency improvements for family firms. The Hypothesis 2a predicted that the greater the fraction of affiliated directors in family firms, the better the performance of the firm and Hypothesis 2b predicted a negative effect. The coefficient (β1 in column II) is positive and significant, so there is a positive effect between the presence of affiliated directors on board and firm performance. The results (β2 in column III) are similar if we include independent and affiliated directors in the same regression. The results support the hypothesis 2a. Columns IV, V and VI show the effect of board composition considering which generation is running the firm. When the family firm is run by subsequent generations, the results are not expected. The dummy variable takes value 1 if the family firms are run by the first generation. In this case, the coefficient is (β1 + β2), but as β1 is no significant and β2 is significant, we only consider β2. So, the coefficient for the interaction between the percentage of independents on the board and the dummy corresponding to the first generation (2) is positive (0.089) and significant. We may therefore conclude that when the family firm is run by the first generation, the presence of independents on the board improves business performance. If we split the sample in two groups, first generation family firms 21 and those run by subsequent generation, the results are similar (these results have not been included). The dummy variable takes value 0 if the family firms are run by subsequent generations. In this case, the coefficient is β1, but the coefficient 1 (column IV) is no significant, so we can not confirm the relationship between the presence of independent directors in the board and firm performance. The results are similar for affiliated directors. The coefficient 1 (column V) is no significant, so we can not confirm the relationship between the presence of affiliated in the board and firm performance for firms run by subsequent generations. For first generation family firms the coefficient (2) is positive (0.072) and significant. The presence of affiliated directors, as independent ones, improves firm performance. We may conclude from the results that Hypothesis 3 is not accepted. The finding show a bigger relationship between the percentage of outsiders on the board (independents and affiliated) and firm performance in family firms run by the first generation. The result shows a clear difference in behavior between family firms run by the first generation and those run by subsequent generations. Concerning the control variables, we find that firm performance is positively related with growth opportunities and we note a negative relationship between firm performance and leverage. These results are generally consistent with findings in earlier research (Anderson and Reeb, 2004; Villalonga and Amit, 2006). There is no relationship between sector variables and firm performance. 5.- DISCUSSION We do not find any robust relationship between independent directors and firm performance, thus, Hypothesis 1 was not supported. These results are partially 22 consistent with those obtained for other types of firms by authors such as Baysinger and Butler (1985), Hermalin and Weisbach (1991), Mehran (1995), Klein (1998), Baghat and Black (2000), De Andrés et al (2005) and Jackling and Johl (2009), who find no evidence relating the proportion of outsiders on the board and different measures of business performance or market value. However, we have advanced further than these authors, since we have differentiated between the independent and affiliated directors. These results do not support the assumption that independent directors have an important controlling and advising function and in contrast can justify the presence of affiliated and insider directors in family firms. The reasons put forward to explain the inexistence of a relationship between the presence of independent directors and performance vary. Hermalin and Weisbach (1991) suggest that both insider and outsider directors may fail to perform their job of representing shareholders’ interests properly, i.e., it cannot be concluded that outsiders perform their activity better than insiders. Likewise, Mace (1986) and Vancil (1987) argue that inside directors facilitate the process of succession in the firm, offering advice and conveying knowledge to the CEO on the firm's day-to-day operations. The presence of insiders on the board makes it easier for the other directors to view them as potential top executives, since they can assess their skills more simply from seeing them act on the board itself (Bhagat and Black, 2000). Maug (1997) demonstrates that for firms with important information asymmetries –and this is the case of family firms– it is not optimal to increase monitoring through the incorporation of independents, since transferring specific knowledge about the firm to independents can prove costly. On the other hand, the CEO and management are characterised by their high level of commitment to the organisation and by sharing its values. It also needs to be said that each type of director has a specific role on the board (Baysinger and Butler, 1985). 23 Inside directors have a greater knowledge of the firm than outsiders (Raheja, 2005), who are often unfamiliar with the working of the firm. Nevertheless, the results show a clear difference in the behaviour of first-generation family firms and those run by subsequent generations. When the family firm is run by the first generation, having independent directors on the board improves firm performance, implying that independent directors potentially play an influential role in moderating family power and alleviating conflicts amongst shareholder groups as well as being advisors. These findings are consistent with both theory perspectives. Specifically, families acting to protect and promote corporate welfare could select directors based on their expertise and decision-making abilities rather than the independence or lack of independence from the family. To differentiate between agency and stewardship based explanations of our results, we conducted additional tests to examine the interplay of family influence and board structure. We examined another group of outside directors; affiliate directors. According to affiliated directors, our findings support the stewardship predictions, confirming the positive relationship between the proportion of affiliated directors on the board of non-listed family firms and performance. In non-listed family SMEs, affiliated act as stewards of firm value, promoting corporate health and firm performance. Directors classified as affiliates often can maintain skills in knowledge based fields such as law, finance, accounting, and consulting; suggesting that families seek these directors for their value-adding advice and counsel (Anderson and Reeb, 2004). In sum, these results are consistent with the stewardship explanation on the role of outside director, but are inconsistent with the monitoring or agency hypothesis. Based on the different roles directors have to fulfill within a private family firm context, we can conclude that, as mentioned by Voordeckers et al. (2007), it is not the 24 independence of an outside director that is important but rather the added value to the firm. Hence, board composition and especially the adoption of outside directors should then be driven by the governance, resource, advice, and information needs of the firm (Grundei and Talaulicar 2002). Taking into account the clearly differentiated behaviour of first-generation family firms and those run by subsequent generations, the reason may be that in the case of first generation firms, independent directors really are more involved in their work on the board and perform their function effectively. First-generation family firms have a smaller proportion of independent directors than family firms run by subsequent generations. Although they have a smaller presence, this may be the right composition for the first phase in the life of a family firm, when the insider directors' knowledge of the firm's strategic planning is needed given the long-term perspective of these firms. In this way, independent directors monitor insiders and/or family members and also offer important and helpful advice and counsel. Outsiders (independents and affiliated) have a more moderate presence during this first phase of the firm's life, which is unsurprising, given that the company equity is in hands of a small number of people, who are properly represented on the board. It therefore appears that the outsiders have been selected appropriately for performing their function, perhaps prevailing the advice and counsel roles. When the firm is run by second and subsequent generations, the presence of outsiders (affiliated and independents) do not have any effects on performance. These results are consistent with those obtained by Voordeckers et al., (2007) for a sample of Belgian SMEs family firms. This might seem surprising, given that as the various generations succeed and the share base becomes more diverse, the presence of independent directors may become more necessary to ensure that the interests of the different shareholders are 25 properly represented and that no decisions are taken that are detrimental to the interests of minority shareholders, since independent directors may play a vital role as arbitrator in the case of conflict between family members. These regression results can be explained in a logical way because generation can be considered as an interaction variable or proxy for several other possible board determinants (Voordeckers et al., 2007). A higher generation can be a proxy for a well-developed internal knowledge base in the firm. Higher generation successors are often better educated than the first generation owner manager. Therefore, the need for external advice and counsel decreases (Voordeckers et al., 2007). Moreover, the results suggest that in such cases independents are probably not acting in this way. If we analyze the board composition in firms run by second and subsequent generations, we see that they have an ever greater presence but their monitoring role has no effect on firm performance. It would be interesting to examine the degree of independence and specific expertise held by the outside directors on the board. Perhaps, the criteria for choosing directors also can vary, and personal friendship could play a relevant role. One might therefore consider that independents may not be acting objectively, given their many overlapping interests with the firm. Brunninge et al. (2007) indicate that one might suspect that outside directors often have close relations to the SME manager and owner based on friendship or professional ties. This may result in lack of real power and potential to contribute more extensively to the firm’s strategy. 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