Constraints to the Growth of Firms: All in the Family?

Individuals are born into families that differ in size and managerial skill endowment. Each member of a family has the option to (i) work as a manager in the family firm; (ii) work as a manger in a non-family firm; or (iii) supply non-managerial labor for a wage. We consider two alternative constraints to the growth of firms. In the first model, individual managers may steal a fraction of the joint output and forgo their managerial remunerations. The fraction that they may steal can be reduced by costly monitoring, which determines the optimal size of the firm. In the second model, a firm's size is limited by credit constraints. In the first model, the advantage of a family firm is that family members can monitor one another at no cost. In the second model, its advantage is that credit contracts are perfectly enforced among family members. On the other hand, the limitation of family firms is, naturally, that the size and the managerial skill endowment of a family are exogenously given and immutable. We show that the two models of firms have distinct implications for the incidence and the characteristics of family firms. We use a rich dataset of family and non-family firms from Ethiopia and Ghana to quantify the role of the two constraints---costly monitoring of theft vs. credit constraint---to the growth of firms.