A Closer Look at Socioemotional Wealth: Its Flows, Stocks, and ...

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A Closer Look at Socioemotional Wealth: Its Flows, Stocks, and Prospects for Moving Forward Jess H. Chua James J. Chrisman Alfredo De Massis

We supplement the recent work by Miller and Le Breton-Miller by evaluating more closely two related theoretical aspects of the socioemotional wealth concept: (1) the stocks and flows of noneconomic benefits and how they influence family firm behavior; and (2) the use of prospect theory as an umbrella concept. We, thus, contribute to family business research by delineating a number of important research questions related to these two theoretical aspects that need to be addressed if theories of family firm behavior and performance are to move forward.

Introduction The behavioral theory of the firm proposes that all managers pursue both economic and noneconomic goals. Even if, as financial theorists insist, firm value maximization is the dominant goal, pursuance of noneconomic goals may benefit not only the members of the dominant coalition who control decision making but also other stakeholders as well (Zellweger, Nason, Nordqvist, & Brush, 2013). In family firms, the family controls the dominant coalition by definition (Chua, Chrisman, & Sharma, 1999) and is generally believed to pursue certain family-centered noneconomic (FCNE) goals that mainly benefit the family (e.g., Chrisman, Chua, Pearson, & Barnett, 2012; Kotlar & De Massis, 2013; Tagiuri & Davis, 1992). It is the pursuance of these FCNE goals that many family business scholars believe to be the distinguishing feature of family firms (e.g., Gómez-Mejía, Cruz, Berrone, & De Castro, 2011). In 2007, Gómez-Mejía, Takacs-Haynes, Nunez-Nickel, Jacobson, and MoyanoFuentes began labeling the noneconomic benefits that come from the pursuance of FCNE Please send correspondence to: Jess H. Chua, tel.: +1(403)220-6331; e-mail: [email protected], to James J. Chrisman at [email protected], and to Alfredo De Massis at [email protected].

March, 2015 DOI: 10.1111/etap.12155

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goals collectively as “socioemotional wealth” (SEW). Since then, SEW, the term and the construct, has played an important role in theoretical and empirical studies (for a review, see Gómez-Mejía et al., 2011). In a recent editorial in Entrepreneurship Theory and Practice, Miller and Le Breton-Miller (2014) commented on the utility of the SEW construct; the diversity of types, sources, and outcomes of SEW; and the problems inherent in using the concept to investigate family firm behavior and performance. Miller and Le Breton-Miller also made some proposals for moving forward including distinguishing between SEW priorities and the use of more direct and finer-grained measures of those priorities. If we assume that family firms are different from nonfamily firms and from one another and that one of the primary sources of those differences is FCNE goal pursuance and the SEW that the achievement of such goals produces, then the issues raised in Miller and Le Breton-Miller (2014) are of fundamental importance to the development of the field. While we find ourselves in agreement with the majority of their arguments, we also believe that there is much more to be said and considered as family business scholars attempt to move the field forward. Therefore, our purpose here is to supplement the insights of Miller and Le Breton-Miller by adding our own observations on aspects that they did not cover and proposing some directions for moving the field forward in the form of research questions to address concerns regarding the SEW concept. Specifically, we deal with the contrasting concepts of FCNE flows and SEW stocks and the related concerns regarding prospect theory and its endowment effect derivative.

Flows and Stocks The pursuance of economic goals has flow and stock aspects. Firms engage in productive activities to attempt to achieve their aspirations for profit (flow). If they are successful, assets and other resources will be accumulated and financial wealth is created (stock). Similarly, the pursuance of FCNE goals has flow-like qualities in that family firms invest in activities that will lead to noneconomic outcomes and presumably the accumulation of stocks of affective resources (e.g., social status of the family) that have noneconomic utility or value. Gómez-Mejía et al. (2007) introduced SEW as a stock of FCNE benefits, thereby distinguishing between noneconomic stocks and flows. This is important because as indicated in the strategic management literature, only stocks are a source of competitive advantage or value, whereas only flows can be adjusted in the short term to maintain or create value (Dierickx & Cool, 1989). Before the Gómez-Mejía et al. paper, family business scholars did not explicitly distinguish between these two aspects of FCNE benefits. So this is one of the most important contributions of the SEW construct to family business studies. In the earlier SEW literature, however, the terminology was not precise in terms of distinguishing between stocks and flows. For example, in the paper where the SEW concept was introduced, Gómez-Mejía et al. (2007, p. 108) stated that SEW includes “the ability to exercise authority, the satisfaction of needs for belonging, affect, and intimacy, the perpetuation of family values through the business, the preservation of the family dynasty, the conservation of the family firm’s social capital, the fulfillment of family obligations based on blood ties rather than on strict criteria of competence, and the opportunity to be altruistic to family members,” and added fulfilling “the need for identification” in the following paragraph. Most of the variables included in that list have both stock and flow components and the terminology in which they were presented does not 174

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unambiguously depict them as stocks. In a more recent paper, Berrone, Cruz, and GómezMejía (2012) delineated the five components of SEW (family control and influence, family members’ identification with the firm, binding social ties, emotional attachment, and renewal of family bonds to the firm through dynastic succession) in terms that are, with the exception of the renewal of family bonds, more clearly associated with stocks. However, they all still contain stock and flow components that have not been differentiated. Furthermore, we still have not come to grips with the implications for how the stocks and flows of noneconomic benefits or utilities should be treated in family business studies. The SEW literature has largely theorized based on how SEW stocks affect economic flows (strategies, short-term profits). This raises the question of whether we are modeling the phenomena correctly and completely. For example, if we continue to go this route would it not be better to expand our attention to encompass how both economic and noneconomic stocks may affect both economic and noneconomic flows? Conversely, since flows may lead to the accumulation of stocks, should we also be modeling how flow variables of both the economic and noneconomic varieties influence stocks of both economic and socioemotional wealth? Indeed, the relationship between stocks and flows may be recursive with the relative importance of the effect of stocks on flows and the effect of flows on stocks varying according to the situation. Combined, the relationship between stocks and flows may be an important source of heterogeneity among family firms. Family firms that are driven by concerns for their stocks of socioemotional and economic wealth are likely to be very conservative in their behaviors whereas those that are driven by flows associated with economic and FCNE benefits may behave more aggressively. Concerns for flows over stocks may be a reason that family firms suffering from below-aspiration–level performance are more likely to be risk willing than family firms that are performing above aspirations (e.g., Gómez-Mejía, Makri, & Larraza-Kintana, 2010). Likewise, the difference between flows of FCNE benefits and stocks of SEW may explain why family firms aspiring to the FCNE benefits of dynastic family control (a flow variable that requires investment) follow a more proactive research and development strategy than family firms mainly concerned about their SEW stock in terms of current control (Chrisman & Patel, 2012). This distinction between the flows of FCNE benefits and stocks of SEW raises other important future research questions. Are there stocks of SEW endowed in family firms at birth or do they all need to be developed through investment flows over time? For example, the stock of SEW attached to family control could accompany the establishment of the firm, or could only become manifest after the firm has reached some threshold of success. Likewise, social capital and social ties have clearly been shown to have both stock and flow components (Arregle, Hitt, Sirmon, & Very, 2006; Pearson, Carr, & Shaw, 2008; Sharma, 2008), whereas identification may be a stock variable that requires a flow of social and emotional investments over time. For flows of economic benefits to accumulate into wealth, the flows cannot be consumed completely; part must be saved and reinvested. Is there such an equivalent with respect to the flow and stock of FCNE benefits? For example, the unremunerated extra services and efforts performed by family members could generate a pool of internal, family-oriented social capital (Zellweger, Kellermanns, Chrisman, & Chua, 2012) and cause a strengthening of family members’ identification with the firm. But do family firms consciously and actively seek to accumulate SEW or, as suggested above, does SEW simply accompany the economic success of the business? If family firms actively seek to accumulate SEW, what strategies, structures, policies, and tactics do they use and are these March, 2015

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different from those that nonfamily firms use to build stocks of nonfamily oriented, noneconomic benefits, such as the social status and reputation of the CEO (e.g., Malmendier & Tate, 2009)? And most importantly, how does the flow of FCNE benefits obtained through goal achievement make family firm behavior different from that of nonfamily firms? In other words, while the literature on SEW has focused family business researchers’ attention on the stock of SEW, there is a neglected direction of research about the flow of FCNE benefits that awaits our attention.

Prospect Theory and SEW Related to the discussion of stocks and flows, Gómez-Mejía and his research group show that SEW’s influences on management decisions and actions may be used to explain family firm behavioral patterns that seemingly deviate from those of nonfamily firms (cf. Gómez-Mejía et al., 2011). This is the second and even more important contribution of the SEW concept. Their arguments are accomplished by appealing to reference point dependence and loss aversion, two key assumptions of prospect theory (Kahneman & Tversky, 1979). Prospect theory is one of the many behavioral utility models proposed as alternatives to the expected utility model of decision making under risk (Starmer, 2000). In the expected utility model, the decision is based on the ending size of the decision maker’s wealth. In this model, the ending wealth as a result of each outcome is assigned a utility value according to a utility function. Then the entire distribution of outcome utilities, each weighted by the objective probability of realizing the outcome, is summed into a single number—the expected utility. To maximize expected utility, the decision maker chooses the decision with the highest number. Experiments, however, have produced many counter-examples to the expected utility model. As a result, scholars have proposed many alternatives to explain the deviations from expected utility theory. Among them, prospect theory is seen as the gold standard and has won Kahneman a Nobel Prize in Economics. Prospect theory makes four assumptions about risky decision making (cf. Levy, 1992). First, decisions are not based on final wealth but on gains and losses relative to a reference point. Second, instead of a utility function, outcomes are assigned a subjective preference value using a preference function that is steeper on the loss side than the gain side in the neighborhood of the reference point. Technically, this causes loss aversion (greater preference to avoid loss than to achieve gain before risk considerations) because the steeper slope on the loss side means that a loss of the same magnitude as a gain would cause a bigger decline in the overall preference for a particular decision. For example, a loss of $100 relative to the reference point would lower the overall preference for a decision by more than the increase in overall preference due to a $100 gain relative to the same reference point. Third, the decision maker weights the outcome preferences by subjective probabilities instead of the objective probabilities. The subjective probabilities systematically overstate low probabilities and understate high probabilities. Finally, the impacts of gains and losses relative to the reference point exhibit diminishing sensitivity. This means that a change in gain (loss) of $100 from $1,000 gain (loss) to $1,100 gain (loss) has a lower impact on the overall preference than a change of $100 in gain (loss) from $500 to $600 gain (loss). The overall preference value for a particular alternative decision/action is calculated as the sum of the subjective preference values for the gains/losses associated with each possible outcome, weighted by the subjective probabilities. The decision maker then chooses the decision/action with the highest overall preference value. 176


There is also a simpler and not as technically structured derivative of prospect theory that draws on loss aversion associated with the “endowment effect” (Kahneman, Knetsch, & Thaler, 1991). This version comes from experiments showing that the price at which people are willing to sell an asset is higher than the price at which they are willing to pay for the same asset. In some experiments, the effect appears to be instantaneous. This is explained using loss aversion; once the players in the experiments already own the asset, parting with it would cause a loss because ownership entails an emotional attachment to the asset for which they desire compensation.1 It is important to distinguish between the two loss-aversion effects when applying them to SEW considerations because, in the experiments on which the endowment effect is based, the entire asset had to be given up. The standard application of prospect theory, however, deals with incremental gains and/or losses. There is also a difference in the riskiness of the loss. When the decision involves giving up the entire endowment of SEW, the loss is deterministic. That is not the case when a decision involves an uncertain incremental loss of the SEW stock. Depending on the situation, one may be more applicable than the other. For example, in the study about selling the family business by Zellweger et al. (2012), selling the family business means giving up the entire SEW stock tied to the firm. Therefore, it is more appropriate to use the endowment effect version of loss aversion. In the paper in which Gómez-Mejía et al. (2007) introduce the concept of SEW, as well as their other earlier studies (e.g., Gómez-Mejía et al., 2010, 2011), the SEW-related hypotheses (Gómez-Mejía et al., 2007, 2011) seem to be based on the endowment effect although the term—“preservation of SEW”—may be interpreted as some loss rather than a complete loss. In other words, those hypotheses assumed that the endowment effect would still operate when the owners were faced with losing a portion rather than the entirety of their SEW. Since their theoretical predictions were substantiated empirically, this assumption may have some validity. However, one must also recognize that, theoretically, the standard application of prospect theory may be more appropriate for modeling such decisions. Another major difficulty with applying prospect theory logic to SEW considerations is that the theory does not specify where the reference point should be set; so scholars have typically assumed that it should be the status quo or do-nothing scenarios (Barberis, 2013). Regardless of the reference point, however, the decision can be framed differently by different decision makers. Take the case of introducing a new product that will cannibalize an existing product. There are at least two ways of framing the decision even if the reference point is set at the status quo, as is usually assumed. One way to frame the problem is to define the status quo internal to the firm, ignoring competition. This means the decision makers will be trading-off the profits from continuing to sell only the existing product against the profits from selling both products minus the profits that will be forgone as a result of the cannibalizing. In this case, the cannibalization of the existing product is counted as a cost of introducing the new product. On the other hand, if the status quo is framed to take into consideration that competitors will also be ready to introduce a similar new product, then the cannibalizing is going to happen even if the firm does not introduce its new product. In this case, the decision maker is trading-off the profits from selling the existing product minus the profits lost from the cannibalizing, against the profits from selling both products minus the profits lost from the cannibalizing. Since the cannibalizing appears on both sides of the trade-off, it is a sunk cost and cancels out as a consideration. Inasmuch as new product introduction is the result of R&D expenditures, the above discussion also implies that a family firm’s assessment of the benefits and costs of R&D 1. This behavior is not observed when the asset is purchased specifically for resale.

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expenditures with respect to the status quo might depend on whether competitors’ R&D expenditures are taken into account or not. Thus, even agreement that the status quo should be the reference point may not make the measurement of gains and losses simpler. The implication for theory building is that alternative arguments for the propositions, hypotheses, or empirical observations may sometimes be possible. The problem is further compounded because FCNE benefits and SEW have multiple dimensions that may interact with each other and with economic benefits and firm value (economic wealth) in different ways depending on the strategic behavior and context being considered. Zellweger and Nason (2008) argue convincingly that the noneconomic goals of family firms may overlap, may have causal relationships with each other, may be synergistic, or may be substitutes. It seems that the same can be said about the five components of SEW proposed by Berrone et al. (2012). Do they work in concert or do they sometimes come into conflict? For example, Vardaman and Gondo (2014) argue that family control and identity can sometimes come into conflict causing family firms to shift their emphasis from the former to the latter with concomitant alterations in their behaviors. If that is the case, then family business researchers should not treat SEW either as a collective whole or as a set of five independent components. From a prospect theory point of view, this suggests there could be multiple reference points and multiple possible ways of framing, each of which could lead to a different decision. Related to this, earlier applications of prospect theory to SEW considerations appear to portray the decision situations as a “pure loss.” More recently, Gómez-Mejía et al. (2014) admit that the situation may be one of “mixed gambles” where there might be incremental losses for some SEW components and incremental gains for others as well as trade-offs in economic benefits. By acknowledging the possibility of both gains and losses in SEW, this approach is more in keeping with a traditional prospect theory application to business decision making and more realistic. Furthermore, in such situations, the trade-off between SEW and economic considerations could shift in favor of or against the former depending on how the SEW components interact. For example, if the decision causes gains in some SEW components and losses (gains) in others, then the impact of SEW considerations will be lower (higher). The reference point used to measure gain and loss may also shift, depending on whether the reference point is based on the positive or negative implications of the decision for SEW. Nevertheless, one is forced to wonder if all of this is much ado about nothing since the same predictions and same results seem to obtain from “pure loss” or “mixed gamble” modeling. Perhaps, if only two of the prospect theory assumptions—the switch from considering ending wealth to considering gains/ losses measured from the reference point and loss aversion—are borrowed and the subjective probability and diminishing sensitivity assumptions are ignored, the directional predictions are robust to the conceptual simplification of mixed gambles to pure gambles.2 What complicates this further is that family business scholars have argued that the valences of FCNE benefits and SEW stock may be context and time dependent (Cruz, Larraza-Kintana, Garcés-Galdeano, & Berrone, 2014; Kellermanns, Eddleston, & Zellweger, 2012; Le Breton-Miller & Miller, 2013; Naldi, Cennamo, Corbetta, & Gómez-Mejía, 2013). Furthermore, the effects of managerial decisions on SEW stocks may be nonlinear. Thus, as we have already discussed, selling the firm means giving up the entire SEW stock while many other actions may have only incremental effects. For example, trust is an important part of social capital. Can trust be partially lost or is it completely lost once it is lost? All this means that we are still very far from being able to 2. See Bromiley (2010) for further discussion of the application of prospect theory in management research.

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Table 1 Selected Directions for Addressing Current SEW Concerns and Moving Forward Concerns

SEW implications

1. Distinction between stock and flow aspects of FCNE benefits

SEW literature mostly focused on the stock aspect of SEW, neglecting the flow aspect of FCNE benefits Some SEW components can be either flow or stock

2. Two possible conceptualizations of SEW with different loss aversion effects: the traditional prospect theory version (incremental gains and losses of SEW flows) versus “endowment effect” version (entire SEW stock must be given up) 3. Difficulty in rigorously applying prospect theory logic to SEW considerations: – Where reference point should be set is not specified – Framing affects the relevance of gains and losses – Ambiguity about overlapping, causal, and synergistic relationships and/or substitution effects between components of SEW – Nonlinear effect of managerial decisions on stocks of SEW

The SEW literature has not explicitly or unambiguously acknowledged which of the two conceptualizations is adopted (initial SEW studies seem to be mostly referring to the endowment effect of SEW, whereas most recent work admits incremental SEW gains and losses) The SEW literature has treated SEW as a collective whole without acknowledging the complex relationships between SEW components, thus preventing the possibility of rigorously predicting the net effect on SEW stocks.

Questions for future research RQ1: What are the flow and stock aspects of the five SEW components? RQ2: How do flows of FCNE benefits accumulate into SEW stocks? RQ3: Do family firms consciously and actively seek to accumulate SEW or does SEW simply accompany the economic success of the business? RQ4: If family firms actively seek to accumulate SEW, what strategies, structures, policies, and tactics do they use and are these different from those that nonfamily firms use to build stocks of noneconomic benefits, such as social status of the CEO? RQ5: How does the flow aspect of FCNE benefits make family firm behavior different from that of nonfamily firms? RQ6: Are family firms endowed with some of the stocks of SEW at birth (e.g., family control) or do they have to accumulate all of the different SEW components over time? RQ7: How do flows of economic and noneconomic benefits influence stocks of economic wealth and SEW? How do economic and noneconomic stocks affect economic and noneconomic flows? RQ8: When and under what conditions do managerial decisions involve giving up the entire amount of the SEW stock and under what conditions do managerial decisions involve an incremental loss of part of the SEW stock? RQ9: What are the implications of these two different loss aversion effects? What is the net impact on the SEW stock of the family firm in the two cases?

RQ10: How do the five SEW components affect each other? For example: (a) Does social status add to social capital and vice versa? (b) Does identification with the firm make the family assign a higher subjective preference value to renewal of family bonds through dynastic succession and (c) vice versa? RQ11: In order to more accurately predict family firm behavior, is it more appropriate to treat SEW as: (a) a collective whole, (b) five independent components, or (c) five interdependent components? RQ12: Are the different SEW components of equal value to all family firms? If not, what causes the differences in the value determination? Are their combined effects additive, conjunctive, or disjunctive in forming SEW stocks? RQ13: How do family firm decision makers define reference points? How do they frame their decisions? What affects the framing? How much more loss averse are they than nonfamily firms? Is the variation in their loss aversion higher or lower than that of nonfamily firms? RQ14: Do family firms’ subjective preference functions systematically differ from those of nonfamily firms, even with respect to financial outcomes?

FCNE, family-centered noneconomic; SEW, socioemotional wealth.

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apply prospect theory logic rigorously to SEW considerations, especially if we have to take into account the overlapping, causal, synergistic, and/or substitutive relationships between SEW components when making arguments about the net effect of managerial decisions on stocks of SEW.3

Summary and Conclusions In this article, we attempt to add to the insights provided by Miller and Le Breton-Miller (2014) about the SEW concept in family business studies. In this vein, we argue that the SEW literature has made two very important contributions to the family business literature. First, it has helped make us aware of the flow and stock aspects of FCNE benefits and SEW. This has pointed us to a neglected direction of research about the flow aspect of FCNE benefits. The second contribution is that by applying aspects of the behavioral theory of the firm, particularly as it pertains to prospect theory, the conceptualization of SEW has supplied an abundance of convincing arguments that potentially explain the differences between family and nonfamily firm behavior plus the heterogeneity among family firms. Thus, the main concerns we have focused on in this paper are theoretical ones designed to extend the primary contributions of the SEW concept: the disentanglement of flow versus stock considerations and the best way to use prospect theory logic to help us understand family firm behavior. These two factors lead to a variety of useful research questions, which we have summarized in Table 1. In conclusion, we share Miller and Le Breton-Miller’s (2014) belief in the promise of the SEW concept as well as their concern for the challenges we face in applying that concept in a more rigorous and effective way. Overall, despite its fundamental importance and contribution, the SEW concept needs much more development before it can be considered as the core of a theory of the family firm (cf. Gómez-Mejía et al., 2011). In that regard, we have long argued for the importance of gaining a better understanding of the noneconomic factors that influence family firm decision making but never to the exclusion of consideration of the economic factors. Instead, we advocate a balanced perspective and echo Miller and Le Breton-Miller’s (2014) call for a finer grained characterizations of the components of SEW, both of which are necessary to help us understand why family firms behave differently from nonfamily firms as well as from each other.

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Jess H. Chua is professor of finance and family business governance at the Haskayne School of Business of the University of Calgary, Canada; professor of family business at the Lancaster University Management School of the University of Lancaster, UK; and Fotile Professor of Family Business at the School of Management of Zhejiang University, China. James J. Chrisman holds the Julia Bennett Rouse Professorship of Management and is head of the Department of Management and Information Systems and director of the Center of Family Enterprise Research at Mississippi State University. He also holds a joint appointment as senior research fellow with the Centre for Entrepreneurship and Family Enterprise at the University of Alberta, School of Business. Alfredo De Massis is chair professor of entrepreneurship and family business at Lancaster University Management School (UK), where he is the director of the school’s Centre for Family Business. He is also a member of the Academic Advisory Board of the Institute for Family Business (IFB) Research Foundation.

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