Real option, idiosyncratic risk, and corporate investment:

Evidence from Taiwan family firms

I-Ju Chena
Yuan Ze University
Chungli, Taiwan

David K. Wangb,
National University of Kaohsiung
Kaohsiung, Taiwan

This version: July, 2017

Abstract

We examine the relation between family presence and corporate investment policy. Our analysis
centers on two incentives that potentially lead to differences in investment policy between family firms
and nonfamily firms: family owners’ risk aversion and their real option to invest. Our findings indicate
that (1) investment patterns differ between family and nonfamily firms; (2) family firms devote
significantly more resources to total investment activity and R&D projects than nonfamily firms; and
(3) the investment policy appears to be driven by the significantly stronger relation between total
investment and idiosyncratic risk for families with more real options (i.e., investment opportunities).
Our robustness tests using IV-3SLS regressions provide further support of the real option argument.
Further testing indicates that family firms receive more patents/patent citations per R&D dollar than
nonfamily firms; suggesting that family monitoring may explain the higher R&D efficiency associated
with family firms. To our knowledge, this paper is the first of its kind to propose the real option
argument to explain the relation between family presence and firm investment policy.

JEL classification: G3; L2; K2; M4

Keywords: Family presence; Total investments; Real option; Idiosyncratic risk; Instrumental variable
three-stage least squares (IV-3SLS) regressions

a
College of Management, Yuan Ze University. Address: 135, Far East Road, Chungli 320, Taiwan. Tel.: +886-3-463-8800
ext.3664; fax: +886-3-435-4624. E-mail: ijchen@saturn.yzu.edu.tw.
b
Department of Finance, National University of Kaohsiung. Address: 700, Kaohsiung University Road, Kaohsiung 811,
Taiwan. Tel.: +886-7-591-6982; fax: +886-7-591-9329. E-mail: dwang@nuk.edu.tw.

Corresponding author. The authors would like to express their most sincere gratitude to the editor, anonymous reviewers,
and seminar participants at the 2017 Financial Management Association (FMA) Asia Pacific conference held at National
Taiwan University (NTU) in Taipei, Taiwan for their valuable comments and suggestions. The authors are also sincerely
grateful to the Ministry of Science and Technology (MOST) of Taiwan for its kind financial support (Grant #: MOST 104-
2410-H-390-011). All remaining errors are our responsibility.

Electronic copy available at: https://ssrn.com/abstract=3198535

“One interpretation is that the family understands the business and that involved family members view
themselves as the stewards of the firm.” – Anderson and Reeb (2003)

1. Introduction

Prior literature indicates that large shareholders use their power and influence to affect corporate
decision-making; in some instances, extracting private benefits from the firm and in other instances,
providing benefits to the firm’s other stakeholders (see, e.g., Berkman, Cole, and Fu (2009)). For
instance, Fama and Jensen (1985) note that large, undiversified shareholders may favor investment
rules based on their own risk preferences rather than the market-based rules preferred by nonfamily
shareholders. Gompers and Lerner (2000) suggest that influential short-term owners prefer to invest
in projects that correspond to their own investment horizons while discounting the interests of other
shareholders. Yet, others note that large, influential owners can mitigate agency problems amongst
firm stakeholders. Edmans (2009) argues that the presence of blockholders alleviates managerial
pressure or incentives to pursue myopic investment decision.

In this paper, we explore the relation between large shareholder ownership and corporate investment
policy by focusing on the effect of family presence on firms’ investment decisions.

Families constitute a prevalent and persistent class of large, concentrated shareholder in US publicly-
traded firms. Anderson, Duru, and Reeb (2009), for instance, observe that families continue to hold
substantial ownership positions in nearly one-half of the largest 2,000 industrial firms in the US, even
decades after going public. These ownership positions thus represent the holdings of long-term,
concentrated investors with arguably different incentives relative to managers or shareholders in firms
with diffuse equity-ownership structures. We examine two incentives that potentially lead to
differences in investment policy between family firms and nonfamily firms: (1) family owners’ risk
aversion and (2) their (real) option to invest.

Family owners represent an important type of large shareholder maintaining an undiversified or

concentrated ownership stake in a single firm. Shleifer and Vishny (1986) observe that large,
undiversified shareholders may force the firm to seek low risk projects and avoid high risk activities,
thereby imposing costs on well-diversified outside shareholders. Compared to nonfamily firms,
Anderson, Duru, and Reeb (2012) argue that family firms can have a particularly strong influence in
mitigating firm risk by affecting the firm’s long-term investment decisions. In this paper, we follow
Anderson, Duru, and Reeb’s (2012) risk aversion argument. We focus on one major component of
corporate investment that regulators require firms to disclose in their accounting reports, namely,
research and development (R&D) spending. Kothari, Laguerre, and Leone (2002) indicate that R&D
spending has a substantially greater impact on firm risk, suggesting that it should be particularly
sensitive to family risk aversion.

Yet, families’ option to invest potentially indicates an opposing effect. If return volatility is correlated
with the volatility of processes underlying firms’ real options, as argued in Leahy and Whited (1996)
and Bulan (2005), we can argue that the higher the return volatility, the more valuable the real options
are expected to be. Moreover, Anderson and Reeb (2003) indicate that family monitoring reduces
asymmetric information problems between shareholders and managers, suggesting that monitoring
overshadows any risk aversion tendencies the family may possess. Coupled with families’ real options,
this viewpoint suggests that family firms should invest more in R&D, because of the uncertain nature
of the R&D process and families’ informational advantage in monitoring. Although the risk
preference/aversion perspective implies that family firms commit fewer financial resources to long-
term investment activities relative to nonfamily firms, the real option argument indicates that family

Electronic copy available at: https://ssrn.com/abstract=3198535

firms commit more resources to investing activities than nonfamily firms.

To our knowledge, this paper is the first of its kind to propose the real option argument to explain the
relation between family presence and firm investment policy.

A common definition for family firms used in prior literature is where the founder or a member of her
or his family (by either blood or marriage) is an officer, director, or blockholder in the firm (see, e.g.,
Anderson and Reeb (2003); Villalonga and Amit (2006)). Our definition of family firms, however,
relies on the categorization by the Taiwan Economic Journal (TEJ) database, 1 which identifies
(Taiwan) family firms as those where (1) the largest controlling shareholder is a family group and (2)
at least two family members are involved on the board of directors or in senior management (see, e.g.,
Chen, Gray, and Nowland (2012)). This is slightly more restrictive than the definition used in prior
(US) studies, and ensures that we are identifying family firms where the family group is more actively
involved in the firm.2

Analyzing the 761 largest, publicly-traded Taiwan firms from 1997 through 2011, we find that (1) (in
agreement with Anderson, Duru, and Reeb (2012)) investment patterns differ between family and
nonfamily firms; (2) (in support of the proposed real option argument) family firms devote
significantly more resources to total investment activity and also R&D projects (a major component
of total investment) than nonfamily firms; and (3) the investment policy appears to be driven by the
significantly stronger relation between total investment and idiosyncratic risk for families with more
investment opportunities (as measured by families’ real options).

To re-examine our primary findings, we develop two instruments for family dummy variables (i.e., (1)
median county income and (2) lagged family dummy) in robust instrumental variable three-stage least
squares (IV-3SLS) regressions. 3 We again find that these controlling shareholders commit more
financial resources to total investments than nonfamily firms, which is in further support of the
proposed real option argument. Further testing indicates that family firms receive more patents per
R&D dollar and patent citations per R&D dollar than nonfamily firms; suggesting that family
monitoring may explain the higher R&D efficiency associated with family firms.4

The rest of this paper is organized as follows. Section 2 describes the hypotheses used in this paper.
Section 3 discusses the data. Section 4 explains the model. Section 5 presents the empirical results.
Sections 6 and 7 reports robustness tests and additional analyses, respectively. Section 8 concludes.

2. Hypotheses

Classic investment theory indicates that shareholders share a common objective of maximizing current
stock price. Yet, because of differing risk preferences, shareholders often intervene in firm matters to
protect or promote their interests (see, e.g., Chen, Firth, and Xu (2009)). We examine two different
arguments on the relation between family influence and firm investment policy: (1) risk aversion and
(2) option to invest.

2.1. Risk aversion hypothesis

1
The company website: https://www.tej.com.tw/.
2
Non-family firms are categorized by the TEJ database as government-controlled, management-controlled, or widely-
held firms.
3
For the IV-3SLS procedure, we follow Adams, Almeida, and Ferreira (2009).
4
Families, as strong, committed monitors - absent in nonfamily firms - may play an especially important role in overseeing
and ensuring productive and efficient R&D expenditures. (see, e.g., Anderson, Duru, and Reeb (2012))

3
Family-owner welfare bears a strong and direct link to firm-specific risk. Because these owners
typically hold a concentrated stake in a single firm, their well-being often depends on firm survival
and performance (see, e.g., Anderson and Reeb (2004)). Family owners thus potentially have
substantially stronger incentives to mitigate firm risk relative to well-diversified shareholders.
Differing risk tolerances suggest that family shareholders potentially do not share the same objective
as well-diversified shareholder. In particular, these large, influential shareholders may be more
cautious and conservative in their investment decisions than managers of diffusely-held firms (see,
e.g., Shleifer and Vishny (1986)).

Although controlling owners can affect the firm’s risk profile through several activities such as
diversifying into unrelated businesses or under-utilizing debt (see, e.g., Anderson and Reeb (2003)),
Anderson, Duru, and Reeb (2012) argue that families can have a particularly strong influence in
mitigating firm risk by affecting the firm’s investment decisions. Firm investments in long-term
projects with uncertain outcomes suggest that concentrated shareholders assume increasingly greater
levels of idiosyncratic risk as the level of investment increases. 5 Well-diversified shareholders, in
contrast, presumably view the risks created by firm-specific investments as less important or
unimportant because they eliminate or minimize these risks by holding a broad basket of securities.
Families affecting investment policy because of high levels of risk aversion, suggests higher discount
rates relative to nonfamily firms; thereby effectively shortening the firm’s investment horizon. These
firm-specific risk arguments suggest that family firms commit fewer financial resources to long-term,
risky investment activities than nonfamily firms. If family owners are more cautious and conservative
in their investment decisions, then we expect that family firms will invest less than nonfamily firms.

Accounting treatment segregates total investments into two distinct classes of expenditures: (1)
research and development (R&D) investments and (2) capital spending. Capital expenditures are
devoted to existing products and/or projects with relatively well-defined economic benefits. R&D
investments, in contrast, represent an investment in new technologies, products, or services with less
predictable outcomes than capital expenditures. R&D investments differ from capital expenditures
along several dimensions including, information asymmetry, project outcome uncertainty (see, e.g.,
Kothari, Laguerre, and Leone (2002)), and flight-risk of human capital6. Kothari, Laguerre, and Leone
(2002) underscore the riskiness of R&D investments by documenting that R&D spending exhibits a
greater effect on the variability of future operating income than capital expenditures by about 30-70%.
Generally, R&D investments expose firms and thus family shareholders to greater levels of uncertainty
or idiosyncratic risk than investments in capital expenditures (see, e.g., Lev and Sougiannis (1996)).
If these controlling shareholders seek to mitigate firm risk, then we expect family firms to devote fewer
resources to R&D spending (and thus more resources towards capital expenditures) than nonfamily
firms.

2.2. Real option hypothesis

One of the main implications of real options theory is that a real option’s value is increasing in the
volatility of an underlying process.7 The main rationale for this relation is that, since firms can change
their operating and investment decisions to mitigate the effects of bad news (e.g., reducing production,

5
Panousi and Papanikolaou (2012), however, demonstrate a robust negative (and likely causal) relation between
idiosyncratic risk and investment for publicly traded firms in the US. They find evidence that the negative effect of
idiosyncratic risk on investment is stronger when executives hold a higher fraction of the firm’s shares, consistent with the
view that this negative effect arises from poor managerial diversification.
6
i.e., key R&D employees leaving for other firms.
7
i.e., demand volatility, cost volatility, or overall volatility of profits.

4
shutting down operations, and deferring investments, etc) and amplify the effects of good news (e.g.,
expanding production, restarting operations, and expediting investments, etc), an increase in the
volatility of an underlying process can have a positive effect on firm value. That is, since operating
and investment flexibility increases the convexity of firm value with respect to the value of its
underlying assets, firm value is an increasing function of volatility, due to Jensen’s inequality. Because
real options constitute a substantial component of firm value, the positive return-volatility relation
documented in Duffee (1995) is found to be driven by the presence of these options (see, e.g., Grullon,
Lyandres, and Zhdanov (2012)).

Perhaps the most common type of real option is the option to invest8 (see, e.g., Brennan and Schwartz
(1985), McDonald and Siegel (1986), Majd and Pindyck (1987), and Pindyck (1988), among many
others). If return volatility is correlated with the volatility of processes underlying firms’ real options,
as argued in Leahy and Whited (1996) and Bulan (2005), (following the theoretical argument that the
value of a real option is increasing in the volatility of the underlying process) we can argue that the
higher the return volatility, the more valuable the real options possessed by family owners. 9 Since
R&D generates investment opportunities (and more return uncertainty), the larger the firm’s relative
R&D expenditures, the more (and valuable) real options the family owners are expected to have.
Therefore, in contrast to the risk preferences argument on investment allocations, our real option
perspective suggests that family firms commit greater resources to R&D investments than nonfamily
firms.

To summarize the two very different arguments on the relation between family influence and firm
investment policy, (1) according to the risk aversion hypothesis, family owners/firms prefer lower firm
risk, devote less capital to (long-term) total investments, and devote fewer resources to R&D spending
(and thus more resources towards capital expenditures) than nonfamily firms; and (2) according to the
real option hypothesis, on the contrary, family owners/firms prefer higher firm risk, devote more
capital to total investments, and commit greater resources to R&D investments than nonfamily firms.

3. Data

To construct our sample, we identify the 761 largest firms in Taiwan as of December 31st, 1997 based
on market capitalization. The data source is Taiwan Economic Journal (TEJ) (website:
https://www.tej.com.tw/).

Following the categorization by the TEJ database, we define family firms as those where (1) the largest
controlling shareholder is a family group, and (2) at least two family members are involved on the
board of directors or in senior management. This is slightly more restrictive than the definition used in
prior studies, 10 and ensures that we are identifying family firms where the family group is more
actively involved in the firm. Nonfamily firms are categorized by the TEJ database as government-
controlled, management-controlled, or widely-held firms.

Foreign firms, regulated public utilities, and financial firms are excluded, because government
regulation potentially affects firm investment choice. We control for survivorship bias by allowing
firms to enter and exit our sample that covers the period from 1997 through 2011. Hall, Jaffe, and
Trajtenberg (2005) note that a primary issue in using firm-level investment data, particularly research

8
i.e., investment opportunities.
9
Higher return volatility also leads to higher return at the firm level, as documented in Duffee (1995).
10
A common definition for family firms used in prior literature is where the founder or a member of her or his family (by
either blood or marriage) is an officer, director, or blockholder in the firm (see, e.g., Anderson and Reeb (2003); Villalonga
and Amit (2006)).

5
and development (R&D) expenditures, is that firms sometimes do not report R&D expense which then
becomes coded into the database as missing. Following prior studies, we set the missing data points to
a zero value for R&D.11 Finally, to eliminate the effect of outliers, we winsorize our data at the 5%
and 95% levels in all specifications.

4. Model

The risk aversion hypothesis posits that as concentrated-undiversified shareholders, families hold
strong incentives to devote less capital to investment projects with uncertain outcomes. Yet, the real
option hypothesis suggests that incentives arising from these controlling shareholders’ (real) option
holdings and their ability to monitor management potentially bolster total investments relative to
nonfamily firms. To determine the dominant effect between these perspectives, we estimate the
following (reduced-form) regression model:

𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 = 𝛽0 + 𝛽1 (𝐹𝑎𝑚𝑖𝑙𝑦 𝑑𝑢𝑚𝑚𝑦) + 𝛽2 (𝐼𝑑𝑖𝑜𝑠𝑦𝑛𝑐𝑟𝑎𝑡𝑖𝑐 𝑟𝑖𝑠𝑘) +

𝛽3 (𝐼𝑑𝑖𝑜𝑠𝑦𝑛𝑐𝑟𝑎𝑡𝑖𝑐 𝑟𝑖𝑠𝑘)(𝑅𝑒𝑎𝑙 𝑜𝑝𝑡𝑖𝑜𝑛𝑠) + 𝛽4 (𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠) +
𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑜𝑟 𝑡𝑖𝑚𝑒 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀, (1)

where the dependent variable is the firm’s total investment, which is measured as noncash asset growth
scaled by total assets (i.e., (𝑁𝑜𝑛𝑐𝑎𝑠ℎ 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡 − 𝑁𝑜𝑛𝑐𝑎𝑠ℎ 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1 )/𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡 , for every
firm i and every year t) (see Mclean and Zhao (2014));12 family dummy is defined as those where (1)
the largest controlling shareholder is a family group and (2) at least two family members are involved
on the board of directors or in senior management, and is a binary variable that equals one when the
family firm is identified and zero otherwise (see Taiwan Economic Journal (TEJ) definition);
idiosyncratic risk is measured using weekly data on stock returns (see Panousi and Papanikolaou
(2012));13,14 real option is defined as three measures of investment opportunities, including (1) the first
(inverse) measure is firm size, defined as the book value of firm assets,15 (2) our second (inverse)
proxy for investment opportunities is firm age, defined as in previous studies as the difference between
current year and founding year, incorporation year, or the first year in which the firm’s stock appears

11
In setting the missing observations to zero, we assume that these firms do not engage in R&D efforts.
12
To ensure non-negative total investment, we set noncash asset growth to zero if it is a negative number. Also, we compute
total investment as a fraction of total assets. Normalizing by total assets allows us to compare over time and across firms.
13
In the absence of any microstructure effects, using higher frequency data yields more precise estimates of volatility.
Thus, when estimating volatility, in principle one should use the highest frequency data available (daily or even intraday).
However, since not all stocks trade every day, using daily data would bias down our estimates of covariance with the market
and other factors, thus yielding upward-biased estimates of idiosyncratic volatility. In addition, this bias would vary with
the liquidity of the firm’s traded shares. Given that most stocks trade at least once a week, we view weekly data as a
compromise between getting more precise estimates and being free of microstructure effects.
14
To estimate a firm’s idiosyncratic risk, we need to remove systematic risk factors that the manager can insure against.
Therefore, for every firm i and every year t, we regress the firm’s return on the Taiwan Stock Exchange (TWSE) value-
weighted market index (TAIEX), 𝑅𝑀𝐾𝑇 , and on the corresponding value-weighted industry portfolio, 𝑅𝐼𝑁𝐷 , based on the
TWSE industry classification. Our measure of yearly idiosyncratic investment volatility for firm i is the volatility of the
residuals across the 52 weekly observations. Thus, we decompose the total weekly return of a firm i into a market-, industry-,
and firm-specific (or idiosyncratic) component as follows
𝑅𝑖,𝜏 = 𝛼1,𝑖 + 𝛼2,𝑖 𝐹𝑖,𝜏 + 𝜀𝑖,𝜏 , (2)
where τ indexes weeks and 𝐹𝑖,𝜏 = [𝑅𝑀𝐾𝑇 , 𝑅𝐼𝑁𝐷 ]. The idiosyncratic volatility is calculated using the volatility of the
2
regression residuals 𝜎𝑖,𝑡 = √∑𝜏∈𝑡 𝜀𝑖,𝜏 . (3)
Our estimate of a firm’s idiosyncratic risk is then the change in its idiosyncratic volatility (i.e., 𝜎𝑖,𝑡 − 𝜎𝑖,𝑡−1 ).
15
Larger firms tend to have larger proportions of their values represented by assets in place, while smaller firms tend to
rely more heavily on investment opportunities (see, e.g., Brown and Kapadia (2007)).

6
in TEJ data files, in that order of availability,16 and (3) our third measure of investment opportunities
is future sales growth, defined as the difference between sales four years after the year of the
observation over sales in the year following the year of the observation divided by sales in the year
following the year of the observation (see Grullon, Lyandres, and Zhdanov (2012));17 control variable
is a vector of controls,18 including (1) debt ratio, measured as year-end long-term debt divided by total
assets, (2) cash flow, measured as firm’s annual net income plus annual depreciation, all divided by
total assets,19 (3) dividend ratio, measured as firm’s annual cash dividends divided by total assets, (4)
asset tangibility, measured as (0.715× Accounts receivables + 0.547× Inventory + 0.535× Property,
plant, and equipment (PP&E) + Cash)/Total assets,20 and (5) blockholder ownership, computed as
sum of the ownership of all blockholders excluding family ownership; 21,22 and industry or time
dummies are dummy variables for each Taiwan Stock Exchange (TWSE) industry code to account for
industry effects and year dummy variables to capture time effects. The variable definitions are
summarized in Appendix A.

5. Empirical results

5.1. Descriptive statistics

Summary statistics for our sample of firms are provided in Tables 1-3. Table 1 shows means, standard
deviations, minimum, and maximum values for our key variables. Table 2 presents differences of
means tests between family firms and nonfamily firms. Table 3 provides a correlation matrix for the
key variables in the sample. All variables are defined in Appendix A, and are winsorized at the 5
percent level to mitigate the impact of outliers.

The sample comprises the 761 largest Taiwan firms (based on total assets) as of year-end 1997, and
spans from 1997 through 2011 yielding 8,086 firm-year observations. Based on the categorization by
Taiwan Economic Journal (TEJ) database, 5,512 observations (68.17%) are classified as family firms
while nonfamily firms represent the remaining 2,574 (31.83%) observations.23

16
Older, more established firms tend to have larger proportions of their value represented by existing assets (see, e.g.,
Lemmon and Zender (2010)).
17
An increase in sales (and production) in the future is likely to be caused by the future exercise of real options. The clear
drawback of future sales growth as a measure of current investment opportunities is that it suffers from the look-ahead
bias. However, it can still be useful in our setting, because the regressions we estimate are not predictive regressions.
Instead, our tests focus on the contemporaneous relation among the variables of interest. Thus, we use realized future sales
growth as an instrument for expected sales growth. In order not to induce spurious correlation caused by contemporaneous
surprises to sales and to firm value, we measure future sales growth starting from the year after the period for which the
relation between returns and changes in volatility is estimated.
18
We control for factors that potentially affect firm investment decisions.
19
See Carpenter, Fazzari, and Petersen (1998).
20
See Almeida and Campello (2007).
21
Blockholders, such as mutual funds and other investment institutions, often maintain large stakes in many family and
nonfamily firms. Therefore, our blockholder variable is calculated as the sum of the ownership of banks, financial
companies, industrial companies, insurance companies, mutual funds, pension funds, and private equity funds (see
Anderson, Duru, and Reeb (2012)).
22
Because cash-flow constraints are important in investment analysis, we capture financing constraints using four
measures as controls: (1) debt ratio - firms with greater amounts of debt likely face higher hurdles in gaining additional
financing relative to firms with little debt; (2) cash flow - differences in firm’s liquidity or ability to internally fund
investments potentially affect the level of capital resources allocated to total investments (see, e.g., Carpenter, Fazzari, and
Petersen (1998)); (3) dividend ratio - financially constrained firms have significantly lower dividend payout ratios; and (4)
asset tangibility - asset tangibility increases a firm’s ability to obtain financing because physical or liquid assets decrease
contracting problems between the firm and external capital providers (see, e.g., Almeida and Campello (2007)).
23
In contrast, Anderson, Duru, and Reeb (2012), e.g., find that, among the 2,000 largest US firms (based on market value)
from 2003 through 2007, only 38.13% are classified as family firms (based on a 5% family-ownership threshold).

7
Table 1 reveals that firm size (book value of assets) in the sample has a mean of nearly $520.30 million.
The average firm is 28.20 years old, with the minimum and maximum firm age being 5.27 and 50.54
years, respectively. Total investment, measured as noncash asset growth divided by total assets, has a
mean value of 3.01%.

[Table 1 about here]

Table 2 presents differences of means tests for our variables between family firms and nonfamily firms.
Family firms, on average, are smaller, older, and more leveraged than nonfamily firms. Specifically,
the average firm size for family (nonfamily) firms is $506.33 ($550.26) million. Average age for family
(nonfamily) firms is 30.13 (24.07) years, and average debt ratio is 44.30% (41.77%). We also find that
families commit 3.07% of assets to total investment, while nonfamily firms devote 2.88%.24

[Table 2 about here]

Finally, Table 3 presents a correlation matrix for some of the key variables in the sample. We note a
positive relation between family dummy (i.e., a binary variable that equals one when the family firm
is identified, and zero otherwise) and total investment. Because real option proxies (i.e., firm size, age,
and future sales growth), idiosyncratic risk, and other firm attributes likely affect investment policies,
we examine our main hypotheses using a multivariate framework.

[Table 3 about here]

5.2. Primary results

Table 4 presents the primary results. To denote family firms, we use a binary variable that equals one
when the family firm is identified, and zero otherwise. Nonfamily firms are the benchmark variable in
the regression analyses.

Consistent with the real option argument, we find that (1) family dummy exhibits a positive and
significant relation to total investment; (2) the sensitivity of total investment to idiosyncratic risk is
negative and also statistically significant; 25 and (3) the coefficients on the interaction between
idiosyncratic risk and each of the real option proxies (except for future sales growth) are statistically
significant with expected signs.26 The results in Table 4 demonstrate that not only family firms devote
more capital to total investments than nonfamily firms,27 but the total investments of family firms
(with characteristics that are likely to be related to more abundant and valuable investment
opportunities (i.e., real options), such as firm size and age) are also more sensitive to idiosyncratic risk.

[Table 4 about here]

24
US family firms, on the contrary, are younger, less leveraged, and committed lesser to total investment than nonfamily
firms (see, e.g., Anderson, Duru, and Reeb (2012), Table 2, page 1750).
25
Our finding that total investment is negatively correlated with idiosyncratic risk is consistent with Panousi and
Papanikolaou (2012).
26
The coefficient estimates on the interaction term bear the similar pattern as the estimates reported in Grullon, Lyandres,
and Zhdanov (2012) (Table 3, page 1509). Specifically, the relation between total investment and idiosyncratic risk is
significantly stronger for firms with small firm size or age (high future sales growth) than it is for firms with bigger size or
age (lower growth).
27
Analyzing US family firms, Anderson, Duru, and Reeb (2012) find an otherwise negative relation between family
ownership (defined as the percent of common equity held by the family) and total investment, which is, on the contrary, in
support of risk aversion argument.

8
Table 5 provides the regression results from subsample analysis, where we divide our sample into
family and nonfamily firms. Consistent with the findings from Table 4, we find that, in case of family
firms (with firm size as the real option proxy), (1) the sensitivity of total investment to idiosyncratic
risk is negative and statistically significant; and (2) the coefficient on the interaction between
idiosyncratic risk and firm size is also statistically significant with expected sign. In case of nonfamily
firms, we find no significant relation between total investment and any of the real option proxies. The
results in Table 5 again demonstrate that the total investments of family firms (with characteristics that
are likely to be related to more abundant and valuable investment opportunities (i.e., real options),
such as firm size) are more sensitive to idiosyncratic risk.

[Table 5 about here]

Prior literature indicates that research and development (R&D) spending, which is a major component
of total investment, exposes firms to greater levels of idiosyncratic risk; suggesting that if families
seek to mitigate firm risk, then these owners will devote fewer financial resources to R&D than
nonfamily firms. Yet, as real-option holders, these controlling owners potentially possess strong
incentives to engage in R&D activities that ensure greater volatility.

To empirically examine these propositions, we re-estimate Equation (1) using R&D investment as the
dependent variable:

𝑅&𝐷 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 = 𝛽0 + 𝛽1 (𝐹𝑎𝑚𝑖𝑙𝑦 𝑑𝑢𝑚𝑚𝑦) + 𝛽2 (𝐼𝑑𝑖𝑜𝑠𝑦𝑛𝑐𝑟𝑎𝑡𝑖𝑐 𝑟𝑖𝑠𝑘) +

𝛽3 (𝐼𝑑𝑖𝑜𝑠𝑦𝑛𝑐𝑟𝑎𝑡𝑖𝑐 𝑟𝑖𝑠𝑘)(𝑅𝑒𝑎𝑙 𝑜𝑝𝑡𝑖𝑜𝑛𝑠) + 𝛽4 (𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠) +
𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑜𝑟 𝑡𝑖𝑚𝑒 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀, (4)

where the construction of the dependent variable differs from the prior regression specification in that
we use the change in the ratio of annual R&D expenditures and beginning-of-year book assets (i.e.,
(𝑅&𝐷 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑖,𝑡 /𝐵𝑜𝑜𝑘 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1 ) − (𝑅&𝐷 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑖,𝑡−1 /𝐵𝑜𝑜𝑘 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−2 ) , for
every firm i and every year t) in our analysis.28

Table 6 presents the results. Across all of the specifications, the results indicate that family presence
bears a positive and significant relation to the portion of total investment devoted to R&D spending;
suggesting that family firms invest more financial resources in R&D projects than nonfamily firms,
and thus providing further support to the real option hypothesis.29

[Table 6 about here]

6. Robustness tests

The risk aversion and real option arguments imply that corporate investment policy flows from family
presence or involvement. Family presence, however, could instead be a function of corporate
investment policy, with these controlling shareholders choosing to remain in firms because of specific
investment policies. Importantly, our hypotheses regarding risk aversion and real option would
continue to indicate similar empirical relations between investment levels and controlling shareholder
ownership regardless of the direction of causality. The intuition underlying the empirical relations,

28
Following prior studies, we restrict our analysis to firms that report R&D expenditures.
29
Moreover, our finding that R&D investment is positively correlated with idiosyncratic risk is consistent with Chen and
Petkova (2012).

9
however, would differ, assuming that investment policies form family decisions to remain in the firm.
The risk aversion hypothesis would then indicate that high research and development (R&D), risky
firms would be less suitable candidates for family investments; suggesting a negative relation between
family presence and R&D spending. Alternatively, the real option argument would suggest that firms
facing investments with high uncertainty may be strong candidates for families with (real) options to
invest; indicating a positive relation between these controlling shareholders and total investments.

To provide further insights into endogeneity concerns, we use an instrumental variable three-stage least
squares (IV-3SLS) approach to estimate the relation between firm investments and family presence.
We follow Adams, Almeida, and Ferreira’s (2009) IV-3SLS procedure (Section 5, page 142): (1) in the
first stage, we estimate a probit (i.e., a binary response model) of the determinants (i.e., the
instrumental, independent, and control variables) of family dummy (or presence); (2) in the second
stage, we regress family dummy on the fitted (or predicted) family dummy (as computed in the first
stage) and its determinants; and (3) in the third stage, we regress total investment on the determinants
of family dummy and it fitted values of the second stage. This procedure is different from the pseudo-
IV procedure of running an ordinary least squares (OLS) regression of total investment on the fitted
family dummy and its determinants. In the latter case, consistency is not guaranteed unless the first
stage is correctly specified, and the standard errors also need to be adjusted.

There are other advantages to this IV-3SLS approach. First, it takes the binary nature of the endogenous
variable into account. Although the two-stage least squares (2SLS) consistency of the second stage
does not hinge on getting the functional form right in the first stage (see, e.g., Angrist and Krueger
(2001)), 2SLS leads to biased estimates in finite samples, and it is not known how misspecification in
the first stage may affect this bias. Second, unlike some of the alternative procedures, it does not require
the binary response model of the first stage to be correctly specified. Third, although some regressors
are generated in the first stage, the standard IV standard errors are still asymptotically valid (see, e.g.,
Wooldridge (2002)).

The primary concern rests on the notion that these influential owners garner private benefits of control
(at the expense of outside shareholders) by affecting firm investment policy (see, e.g., Anderson, Duru,
and Reeb (2012)). Family shareholders’ capacity to extract private benefits from the firm partially
depends on outside investors’ ability to detect and understand their actions (see, e.g., Anderson, Duru,
and Reeb (2009)). Outside investors with greater levels of financial sophistication or affluence can
better understand corporate insider actions than investors with less financial awareness. Because
corporate headquarters are the center of information exchange between the firm and investors (see,
e.g., Prinsky and Wang (2006)), local area investors with greater financial sophistication arguably
better understand and limit insiders’ self-serving actions than local area investors with less
sophistication. Accordingly, we model family presence or their ability to extract private benefits as a
function of the financial sophistication of local area investors. To proxy for financial awareness of
local-area investors, we follow Anderson, Duru, and Reeb (2012), and use the median income of the
population of the county (as an instrument), where the firm maintains its headquarters. Data on the
location of each firm’s headquarter county comes from the Taiwan Economic Journal (TEJ) database.
Data on the median income of the county’s population (for years 1997 through 2011) comes from the
Taiwan census bureau (i.e., the Directorate General of Budget, Accounting and Statistics (DGBAS)
(website: https://www.dgbas.gov.tw/)).

We also follow Andres (2008), and use the lagged family dummy variables (i.e., 𝐹𝑎𝑚𝑖𝑙𝑦 𝑑𝑢𝑚𝑚𝑦𝑖,𝑡−1,
for every firm i and every year t) as an instrument in the IV-3SLS regressions. Table 7 provides the IV-
3SLS results. Panels A and B provide the regression results using median county income and lagged
family dummy as instruments. The IV-3SLS regression estimates bear the similar pattern as the

10
estimates derived from the OLS techniques shown in Table 4. Specifically, we continue to find a
positive relation between the predicted value of family ownership and total investment; suggesting that
after controlling for endogeneity concerns, 30 family firms commit more financial resources to
investments than nonfamily firms, which is consistent with the real option argument.31

[Table 7 about here]

7. Additional analyses

Prior literature suggests that family shareholders act as strong, influential monitors that can potentially
improve the efficiency of the investment process; thereby allowing family firms to achieve better
investment outcomes than nonfamily firms. For instance, the business media often cites Apple Inc. as
possessing an efficient research and development (R&D) process that allows the firm to outperform
their competitors (Wall Street Journal, June 13, 2009). We investigate this family investment efficiency
hypothesis by examining the outcomes of the R&D process in family firms and nonfamily firms.

The investment efficiency argument suggests that family owners’ access to private information, their
incentives to collect information, and their power to monitor managers improves the efficacy of the
R&D process. R&D investments represent inputs to the creative process, while shareholders arguably
have concerns about the outputs of the R&D process. In contrast, the risk aversion (real option)
hypothesis suggests that family owners simply seek to mitigate (increase) risk levels by committing
fewer (more) resources to R&D projects relative to nonfamily firms, consequently, leading to fewer
(more) patents and patent citations in family firms than in nonfamily firms.

Research in economics supports the notion that creation or generation of patents serves as an indicator
of firm R&D effectiveness (see, e.g., Hall, Jaffe, and Trajtenberg (2005)). Within this stream of
literature, prior research hypothesizes that R&D spending serves as a material input in the inventive
and innovative process, and patents proxy for inventive output. However, although the number of
patents represents one measure of a firm’s success in its R&D efforts, this metric is limited by the large
variance in value or influence of individual patents. As a result, prior studies (see, e.g., Jaffe,
Trajtenberg, and Henderson (1993); Hall, Jaffe, and Trajtenberg (2005)) argue that patent citations
arguably represent a better indicator of the value of firms’ R&D efforts than the number of individual
patents.

We garner patent and patent citation data from Taiwan’s Intellectual Property Office under the Ministry
of Economic Affairs (MOEA) (website: https://twpat-simple.tipo.gov.tw/). Because patents (similar to
published research papers) need time in the public domain to accrue citations, we examine firm patents
and patent citations for the period 1997 through 2011.32 Patents granted earlier in the period likely
have larger numbers of citations simply because these patents have existed longer than patents granted
later in the period.

We examine the relation between R&D efficacy and family influence with the following specification:

R&D efficiency= 𝛽0 + 𝛽1 (𝐹𝑎𝑚𝑖𝑙𝑦 𝑑𝑢𝑚𝑚𝑦) + 𝛽2 (𝐼𝑑𝑖𝑜𝑠𝑦𝑛𝑐𝑟𝑎𝑡𝑖𝑐 𝑟𝑖𝑠𝑘) +

𝛽3 (𝐼𝑑𝑖𝑜𝑠𝑦𝑛𝑐𝑟𝑎𝑡𝑖𝑐 𝑟𝑖𝑠𝑘)(𝑅𝑒𝑎𝑙 𝑜𝑝𝑡𝑖𝑜𝑛𝑠) + 𝛽4 (𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠) +

30
The exogeneity of family dummy variables cannot be rejected (the lowest Wald test p-value is 0.125).
31
Overall, the IV-3SLS regression results indicate that the OLS evidence presented in Table 4 is not driven by endogeneity
of family dummy.
32
For each firm in our patent sub-sample, we use proxy statements to trace back through the period 1997-2011 to ascertain
family presence or involvement.

11
𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑜𝑟 𝑡𝑖𝑚𝑒 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀, (5)

The variables are defined in Appendix A. We estimate our regressions using dummy variables for each
sample year and by clustering on the firm-level identifier. Table 8 presents the results from estimating
Equation (5). Panel A presents the results when the dependent variable is computed as the number of
patents divided by R&D expenditures, i.e., patents per R&D dollar. We observe a positive and
significant relation between the family dummy variable and patents per R&D dollar, suggesting that
family firms are more efficient in generating patents with their R&D spending than nonfamily firms.
The investment efficiency hypothesis suggests that if family influence improves the innovative process,
then we should observe greater patent generation per R&D dollar relative to nonfamily firms. Our
analysis lends strong support to this hypothesis.

Hall, Jaffe, and Trajtenberg (2005) note that patent citations can be a useful indicator of the knowledge
creation associated with individual patents, thus providing a gauge of a patent’s value. The dependent
variable in Panel B is measured as the number of patent citations divided by R&D expenditures, i.e.,
citations per R&D dollar. Consistent with our hypothesis on family monitoring efficiency, the analysis
indicates that patents from family firms receive significantly more citations per R&D dollar than
patents from nonfamily firms. The family dummy variable exhibits a positive and significant relation
to patent citations per R&D dollar.

Overall, we find strong evidence that investment efficiency allows family firms to spend more on R&D
to garner better investment outcomes than nonfamily firms. Family firms appear to receive both more
number of patents per dollar of R&D spending and more patent citations per dollar of R&D spending
than nonfamily firms.

[Table 8 about here]

8. Summary and conclusion

The prior literature indicates that shareholders share a mutual goal of maximizing current stock price.
Yet, because of differing preferences arising from risk aversion or option to invest, large, influential
shareholders potentially influence firm investments to promote their individual needs. Using the 761
largest, publicly-traded Taiwan firms from 1997 through 2011, we investigate the effect of family
shareholders on corporate investment policy.

Our analysis indicates that family presence (or involvement) bears a strong relation to firm investment
policy. Specifically, as suggested by the proposed real option hypothesis, we observe that (1) family
dummy exhibits a positive and significant relation to total investment; (2) the sensitivity of total
investment to idiosyncratic risk is negative and also statistically significant; and (3) the coefficients on
the interaction between idiosyncratic risk and each of the real option proxies are mostly statistically
significant with expected signs. Our evidence suggests that this investment policy appears to be driven
by the significantly stronger relation between total investment and idiosyncratic risk for families with
more investment opportunities (as measured by families’ real options). We also document that family
firms devote greater financial resources to research and development (R&D) spending (a major
component of total investment) than nonfamily firms, which is in further support of the proposed real
option hypothesis.

To our knowledge, this paper is the first of its kind to propose the real option argument to explain the
relation between family presence and firm investment policy. To re-examine our primary findings, we
develop two instruments for family dummy variables (i.e., (1) median county income and (2) lagged

12
family dummy) in robust instrumental variable three-stage least squares (IV-3SLS) regressions. We
again find that these controlling shareholders commit more financial resources to total investments
than nonfamily firms. Further testing indicates that family firms receive more patents per R&D dollar
and patent citations per R&D dollar than nonfamily firms; suggesting that family monitoring may
explain the higher R&D efficiency associated with family firms.

References

Abraham, K., Medoff, J., 1984. Length of service and layoffs in union and nonunion work groups.
Industrial and Labor Relations Review 38, 87–97.

Adams, R., Almeida, H., Ferreira, D., 2009. Understanding the relationship between founder-CEOs
and firm performance. Journal of Empirical Finance 16, 136–150.

Almeida, H., Campello, M., Weisbach, M., 2004. The cash flow sensitivity of cash. Journal of Finance
59, 1777–1804.

Almeida, H., Campello, M., 2007. Financial constraints, asset tangibility, and corporate investments.
Review of Financial Studies 20, 1429–1460.

Anderson, R., Reeb, D., 2003. Founding‐family ownership and firm performance: Evidence from the
S&P 500. Journal of Finance 58, 1301–1328.

Anderson, R., Reeb, D., 2003. Founding-family ownership, corporate diversification, and firm
leverage. Journal of Law and Economics 46, 653–684.

Anderson, R., Reeb, D., 2004. Board composition: Balancing family influence in S&P 500 firms.
Administrative Science Quarterly 49, 209–237.

Anderson, R., Duru, A., Reeb, D., 2009. Founds, heirs and corporate opacity. Journal of Financial
Economics 92, 205–222.

Anderson, R., Duru, A., Reeb, D., 2012. Investment policy in family controlled firms. Journal of
Banking and Finance 36, 1744–1758.

Andres, C., 2008. Large shareholders and firm performance- An empirical examination of founding-
family ownership. Journal of Corporate Finance 14, 431–445.

Angrist, J., Krueger, A., 2001. Instrumental variables and the search for identification: From supply
and demand to natural experiments. Working paper, NBER.

Berkman, H., Cole, R., Fu, R., 2009. Expropriation through loan guarantees to related parties:
Evidence from China. Journal of Banking and Finance 33, 141–156.

Bernardo, A., Chowdhry, B., 2002. Resources, real options, and corporate strategy. Journal of
Financial Economics 63, 211–234.

Brennan, M., Schwartz, E., 1985. Evaluating natural resource investments. Journal of Business 58,
135–157.

13
Brown, G., Kapadia, N., 2007. Firm-specific risk and equity market development. Journal of Financial
Economics 84, 358–388.

Bulan, L., 2005. Real options, irreversible investment and firm uncertainty: New evidence from U.S.
firms. Review of Financial Economics 14, 255–279.

Caballero, R., Pindyck, R., 1992. Uncertainty, investment, and industry evolution. Working paper, MIT.

Carpenter, R., Fazzari, S., Petersen, B., 1998. Financing constraints and inventory investment: A
comparative study with high-frequency panel data. Review of Economics and Statistics 80, 513–519.

Chen, G., Firth, M., Xu, L., 2009. Does the type of ownership control matter? Evidence from China’s
listed companies. Journal of Banking and Finance 33, 171–181.

Chen, E., Gray, S., Nowland, J., 2012. Multiple founders and firm value. Pacific-Basin Finance
Journal 20, 398–415.

Chen, J., Kasperczyk, M., Ortiz-Molina, H., 2011. Labor unions, operating flexibility, and the cost of
equity. Journal of Financial and Quantitative Analysis 46, 25–58.

Chen, Z., Petkova, R., 2012. Does idiosyncratic volatility proxy for risk exposure?. Review of
Financial Studies 25, 2745–2787.

Duffee, G., 1995. Stock return and volatility: A firm-level analysis. Journal of Financial Economics
37, 399–420.

Edmans, A., 2009. Blockholder trading, market efficiency, and managerial myopia. Journal of Finance
64, 2481–2513.

Fama, E., French, K., 1997. Industry costs of equity. Journal of Financial Economics 43, 153–193.

Fama, E., Jensen, M., 1985. Organizational forms and investment decisions. Journal of Financial
Economics 14, 101–119.

Galai, D., Masulis, R., 1976. The option pricing model and the risk factor of stock. Journal of Financial
Economics 3, 53–81.

Gompers, P., Lerner, J., 2000. The determinants of corporate venture capital success: Organizational
structure, incentives, and complementarities. In: Morck, R. (Ed.), Concentrated Corporate Ownership.
University of Chicago Press.

Gramm, C., Schnell, J., 2001. The use of flexible staffing arrangements in core production jobs.
Industrial and Labor Relations Review 54, 245–268.

Grullon, G., Lyandres, E., Zhdanov, A., 2012. Real options, volatility, and stock returns. Journal of
Finance 67, 1499–1537.

Hall, B., Jaffe, A., Trajtenberg, M., 2005. Market value and patent citations. Rand Journal of
Economics 36, 16–38.

14
Heckman, J., 1979. Sample selection bias as a specification error. Econometrica 47, 153–161.

Jaffe, A., Trajtenberg, M., Henderson, R., 1993. Geographic localization of knowledge spillovers, as
evidenced by patent citations. Quarterly Journal of Economics 108, 577–598.

Kothari, S., Laguerre, T., Leone, A., 2002. Capitalization versus expensing: Evidence on the
uncertainty of future earnings from capital expenditures versus R&D outlays. Review of Accounting
Studies 7, 355–382.

Leahy, J., Whited, T., 1996. The effect of uncertainty on investment: Some stylized facts. Journal of
Money, Credit, and Banking 28, 64–83.

Lemmon, M., Zender, J., 2010. Debt capacity and tests of capital structure theories. Journal of
Financial and Quantitative Analysis 45, 1161–1187.

Lev, B., Sougiannis, T., 1996. The capitalization, amortization and value-relevance of R&D. Journal
of Accounting and Economics 21, 107–138.

Majd, S., Pindyck, R., 1987. Time to build, option value, and investment decisions. Journal of
Financial Economics 18, 7–27.

Marschak, T., Nelson, R., 1962. Flexibility, uncertainty, and economic theory. International Review of
Economics 14, 42–58.

McDonald, R., Siegel, D., 1986. The value of waiting to invest. Quarterly Journal of Economics 101,
707–727.

McLean, R., Zhao, M., 2014. The business cycle, investor sentiment, and costly external finance.
Journal of Finance 69, 1377–1409.

Mills, D., 1984. Demand fluctuations and endogenous firm flexibility. Journal of Industrial Economics
33, 55–71.

Oi, W., 1961. The desirability of price instability under perfect competition. Econometrica 29, 58–64.

Panousi, V., Papanikolaou, D., 2012. Investment, idiosyncratic risk, and ownership. Journal of Finance
67, 1113–1148.

Pindyck, R., 1988. Irreversible investment, capacity choice, and the value of the firm. American
Economic Review 78, 969–985.

Pindyck, R., 1993. A note on competitive investment under uncertainty. American Economic Review
83, 273–277.

Prinsky, C., Wang, Q., 2006. Does corporate headquarters location matter for stock returns. Journal of
Finance 61, 1991–2015.

Shleifer, A., Vishny, R., 1986. Large shareholders and corporate control. Journal of Political Economy
94, 461–489.

15
Villalonga, B., Amit, R., 2006. How do family ownership, control and management affect firm value?.
Journal of Financial Economics 80, 385–417.

Wooldridge, J., 2002. Econometric Analysis of Cross Section and Panel Data. MIT Press.

16
Appendix A. Variable definitions
This appendix summarizes the variable definitions (alphabetically).
Variable Definition
Asset Following Almeida and Campello (2007), we measure asset tangibility (%) as
tangibility (0.715× Accounts receivables + 0.547× Inventory + 0.535× Property, plant, and
equipment (PP&E) + Cash)/Total assets. Asset tangibility is used as one of the five
controls.

Blockholder Blockholder ownership (%) is defined as the sum of the ownership of all
ownership blockholders, excluding family ownership, and is used as one of the five controls.

Cash flow Following Carpenter, Fazzari, and Petersen (1998), we define cash flow (%) as
firm’s annual net income plus annual depreciation, all divided by total assets. Cash
flow is used as one of the five controls.

Citations Following Hall, Jaffe, and Trajtenberg (2005), we measure citations (%%) as the
number of patent citations divided by research and development (R&D)
expenditures (i.e., 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑡𝑒𝑛𝑡 𝑐𝑖𝑡𝑎𝑡𝑖𝑜𝑛𝑠𝑖,𝑡 /𝑅&𝐷 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑖,𝑡 , for
every firm i and every year t). The change in citations (i.e., 𝐶𝑖𝑡𝑎𝑡𝑖𝑜𝑛𝑖,𝑡 −
𝐶𝑖𝑡𝑎𝑡𝑖𝑜𝑛𝑖,𝑡−1 ) is used in our analysis.

Debt ratio Debt ratio (%) is defined as year-end long-term debt divided by total assets, and is
used as one of the five controls.

Dividend Dividend ratio (%) is defined as firm’s annual cash dividends divided by total assets,
ratio and is used as one of the five controls.

Family Following the categorization by Taiwan Economic Journal (TEJ) database, we

dummy define family firms as those where (1) the largest controlling shareholder is a family
group and (2) at least two family members are involved on the board of directors or
in senior management. Family dummy is a binary variable that equals one when the
family firm is identified, and zero otherwise.

Firm age Firm age (years) is defined as the difference between current year and (1) founding
year, (2) incorporation year, or (3) the first year in which the firm’s stock appears in
Taiwan Economic Journal (TEJ) data files, in that order of availability, and is used
as one of the three real option proxies.

Firm size Firm size ($ millions) is defined as the book value of firm assets, and is used as one
of the three real option proxies.

Future sales Following Grullon, Lyandres, and Zhdanov (2012), we measure future sales growth
growth (%) as the difference between sales four years after the year of the observation over
sales in the year following the year of the observation divided by sales in the year
following the year of the observation. Future sales growth is used as one of the three
proxies for real options.

Idiosyncratic Following Panousi and Papanikolaou (2012), we estimate a firm’s idiosyncratic risk
risk by performing the following steps: (1) for every firm i and every year t, we regress
the firm’s return on the Taiwan Stock Exchange (TWSE) value-weighted market

17
 index (TAIEX), 𝑅𝑀𝐾𝑇 , and on the corresponding value-weighted industry portfolio,
𝑅𝐼𝑁𝐷 , based on the TWSE industry classification; (2) we decompose the total weekly
return of a firm i into a market-, industry-, and firm-specific (or idiosyncratic)
component as 𝑅𝑖,𝜏 = 𝛼1,𝑖 + 𝛼2,𝑖 𝐹𝑖,𝜏 + 𝜀𝑖,𝜏 , where τ indexes weeks and 𝐹𝑖,𝜏 =
[𝑅𝑀𝐾𝑇 , 𝑅𝐼𝑁𝐷 ]; and (3) we calculate the idiosyncratic volatility using the volatility of
2
the regression residuals 𝜎𝑖,𝑡 = √∑𝜏∈𝑡 𝜀𝑖,𝜏 . Our estimate of a firm’s idiosyncratic risk
is then the change in its idiosyncratic volatility (i.e., 𝜎𝑖,𝑡 − 𝜎𝑖,𝑡−1).

Lagged Following Andres (2008), we instrument family dummy variables by their lagged
family values (i.e., 𝐹𝑎𝑚𝑖𝑙𝑦 𝑑𝑢𝑚𝑚𝑦𝑖,𝑡−1 for every firm i and every year t). Adams,
dummy Almeida, and Ferreira’s (2009) instrumental variable three-stage least squares (IV-
3SLS) approach is employed to test the robustness of our results.

Median Following Anderson, Duru, and Reeb (2012), we use the median income of the
county population of the county as an instrument, where the firm maintains its headquarters.
income Data on the location of each firm’s headquarter county comes from the Taiwan
Economic Journal (TEJ) database. Data on the median income of the county’s
population (for years 1997 through 2011) comes from the Taiwan census bureau
(i.e., the Directorate General of Budget, Accounting and Statistics (DGBAS)).
Adams, Almeida, and Ferreira’s (2009) instrumental variable three-stage least
squares (IV-3SLS) approach is employed to test the robustness of our results.

Patents Following Hall, Jaffe, and Trajtenberg (2005), we measure patents (%%) as the
number of patents divided by research and development (R&D) expenditures (i.e.,
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑡𝑒𝑛𝑡𝑠𝑖,𝑡 /𝑅&𝐷 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑖,𝑡 , for every firm i and every year t).
The change in patents (i.e., 𝑃𝑎𝑡𝑒𝑛𝑡𝑖,𝑡 − 𝑃𝑎𝑡𝑒𝑛𝑡𝑖,𝑡−1 ) is used in our analysis.

R&D As in previous studies, research and development (R&D) investment (%) is defined
investment as the ratio of annual R&D expenditures and beginning-of-year book assets (i.e.,
𝑅&𝐷 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠𝑖,𝑡 /𝐵𝑜𝑜𝑘 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1, for every firm i and every year t). We use
the change in R&D investment (i.e., 𝑅&𝐷 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑖,𝑡 − 𝑅&𝐷 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑖,𝑡−1 )
in our analysis.

Total Following Mclean and Zhao (2014), we measure total investment (%) as noncash
investment asset growth, scaled by total assets (i.e., ( 𝑁𝑜𝑛𝑐𝑎𝑠ℎ 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡 −
𝑁𝑜𝑛𝑐𝑎𝑠ℎ 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1 )/𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠𝑖,𝑡 , for every firm i and every year t).33

33
To ensure non-negative total investment, we set noncash asset growth to zero if it is a negative number.

18
Table 1. Descriptive statistics
This table provides summary statistics for the data employed in our analysis. The sample comprises
the 761 largest Taiwan firms (based on total assets) as of December 31st, 1997, and covers 1997
through 2011. Variables are defined in Appendix A, and are winsorized at 5% and 95% level.
Variable Mean Std. dev. Minimum Maximum
Firm size ($ millions) 520.30 743.60 18.03 2,878.06
Firm age (years) 28.20 11.74 5.27 50.54
Future sales growth (%) 38.24 81.73 -50.29 428.07
Idiosyncratic risk -0.12 1.48 -2.73 2.69
Debt ratio (%) 43.50 16.05 14.15 72.84
Cash flow (%) 6.99 6.37 -5.69 20.49
Dividend ratio (%) 2.27 2.75 0.00 9.12
Asset tangibility (%) 37.45 9.40 16.96 51.60
Blockholder ownership (%) 7.26 6.37 0.00 23.38
Total investment (%) 3.01 4.61 0.00 17.84

19
Table 2. Means tests
This table provides the results of difference of means tests for key variables between nonfamily and
family firms for our sample of the 761 largest Taiwan firms (based on total assets as of December 31st,
1997) from 1997 through 2011. Variables are defined in Appendix A, and are winsorized at 5% and
95% level. t-statistics are in parentheses. * denotes significance at the 10% level, ** significance at
the 5% level, and *** significance the 1% level.
Variable Nonfamily firms Family firms t-statistic
Number of observations 2,574 5,512 -
Firm size ($ millions) 550.26 506.33 -2.39**
Firm age (years) 24.07 30.13 21.79***
Future sales growth (%) 38.80 37.98 -0.42
Idiosyncratic risk -0.14 -0.11 1.04
Debt ratio (%) 41.77 44.30 6.41***
Cash flow (%) 7.75 6.63 -7.13***
Dividend ratio (%) 2.82 2.01 -11.75***
Asset tangibility (%) 36.78 37.76 4.22***
Blockholder ownership (%) 8.57 6.64 -12.52***
Total investment (%) 2.88 3.07 1.74*

20
Table 3. Correlation matrix
This table provides a correlation matrix for some of the key variables in the sample. The sample
comprises the 761 largest Taiwan firms (based on total assets) as of December 31st, 1997, and covers
1997 through 2011. Variables are defined in Appendix A, and are winsorized at 5% and 95% level.
Family Debt Cash Dividend Asset Blockholder Total
dummy ratio flow ratio tangibility ownership investment
Family dummy 1.000 - - - - - -
Debt ratio (%) 0.074 1.000 - - - - -
Cash flow (%) -0.082 -0.380 1.000 - - - -
Dividend ratio (%) -0.136 -0.367 0.706 1.000 - - -
Asset tangibility (%) 0.048 0.339 -0.048 -0.155 1.000 - -
Blockholder ownership (%) -0.141 -0.021 0.141 0.197 -0.033 1.000 -
Total investment (%) 0.019 0.035 0.138 -0.020 0.082 0.009 1.000

21
Table 4. Family presence and total investment
This table reports multivariate Tobit regression results of total investments on family dummy/presence.
The sample comprises the 761 largest Taiwan firms (based on total assets) as of December 31st, 1997,
and covers 1997 through 2011. Variables are defined in Appendix A, and are winsorized at 5% and
95% level. t-statistics are in parentheses, and are corrected for serial correlation and heteroskedasticity
by clustering on the firm-level identifier. * denotes significance at the 10% level, ** significance at
the 5% level, and *** significance the 1% level.
Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -1.447 -4.818*** -1.285 -1.273
(-1.150) (-9.111) (-1.020) (-1.011)
Family dummy 0.516** 0.513** 0.522** 0.512**
(2.304) (2.257) (2.335) (2.290)
Idiosyncratic risk - -2.137*** -0.766** -0.118**
(-2.663) (-2.050) (-2.043)
Idiosyncratic risk * Real options - 0.143*** 0.190* -0.097
(2.772) (1.659) (-1.570)
Debt ratio 4.785*** 4.499*** 4.829*** 4.831***
(5.557) (5.351) (5.608) (5.613)
Cash flow 30.570*** 35.980*** 30.300*** 30.390***
(12.760) (15.220) (12.630) (12.700)
Dividend ratio -25.010*** -38.040*** -24.980*** -24.960***
(-4.840) (-7.579) (-4.831) (-4.839)
Asset tangibility 4.914*** 4.587*** 4.904*** 4.857***
(3.885) (3.751) (3.876) (3.847)
Blockholder ownership 3.399** 1.485 3.449** 3.414**
(2.112) (0.932) (2.140) (2.119)
Dummies for industry and year Yes Yes Yes Yes
2
Pseudo R 0.032 0.033 0.033 0.033
Observations 8,086 8,086 8,086 8,086

22
Table 5. Family/nonfamily firms and total investment
This table reports multivariate Tobit regression results of total investments for family/nonfamily firms.
Panels A and B provide the regression results for family and nonfamily firms, respectively. The sample
comprises the 761 largest Taiwan firms (based on total assets) as of December 31st, 1997, and covers
1997 through 2011. Variables are defined in Appendix A, and are winsorized at 5% and 95% level. t-
statistics are in parentheses, and are corrected for serial correlation and heteroskedasticity by clustering
on the firm-level identifier. * denotes significance at the 10% level, ** significance at the 5% level,
and *** significance the 1% level.
Panel A: Family firms Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -0.368 -0.290 -0.250 -0.249
(-0.264) (-0.208) (-0.179) (-0.178)
Idiosyncratic risk - -1.863* -0.620 -0.087
(-1.925) (-1.234) (-1.234)
Idiosyncratic risk * Real options - 0.111* 0.149 -0.106
(1.798) (0.993) (-1.370)
Debt ratio 4.612*** 4.687*** 4.654*** 4.645***
(4.216) (4.291) (4.260) (4.252)
Cash flow 28.528*** 28.527*** 28.364*** 28.508***
(9.464) (9.466) (9.390) (9.460)
Dividend ratio -24.031*** -24.061*** -23.992*** -24.170***
(-3.832) (-3.835) (-3.821) (-3.855)
Asset tangibility 5.018*** 4.995*** 5.017*** 4.974***
(3.115) (3.098) (3.116) (3.093)
Blockholder ownership 2.925 2.954 2.922 2.903
(1.498) (1.512) (1.497) (1.483)
Dummies for industry and year Yes Yes Yes Yes
Pseudo R2 0.032 0.032 0.032 0.032
Observations 5,512 5,512 5,512 5,512

23
Table 5. (cont’d)
Panel B: Nonfamily firms Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -3.699*** -3.395*** -3.413*** -3.399***
(-3.220) (-2.952) (-2.978) (-2.967)
Idiosyncratic risk - 0.523 -0.711 -0.172*
(0.362) (-1.160) (-1.699)
Idiosyncratic risk * Real options - -0.046 0.170 -0.060
(-0.494) (0.858) (-0.556)
Debt ratio 4.989*** 5.046*** 5.031*** 5.057***
(3.726) (3.748) (3.731) (3.762)
Cash flow 35.209*** 34.714*** 34.713*** 34.727***
(8.859) (8.723) (8.727) (8.713)
Dividend ratio -31.711*** -31.270*** -31.589*** -31.282***
(-3.445) (-3.396) (-3.429) (-3.404)
Asset tangibility 4.059* 3.970* 4.007* 3.953*
(1.897) (1.853) (1.865) (1.848)
Blockholder ownership 2.668 2.807 2.870 2.791
(0.977) (1.027) (1.044) (1.020)
Dummies for industry and year Yes Yes Yes Yes
Pseudo R2 0.0353 0.0356 0.0356 0.0356
Observations 2,574 2,574 2,574 2,574

24
Table 6. Family presence and research and development (R&D) investment
This table reports multivariate ordinary least squares (OLS) regression results of R&D investments on
family dummy/presence. The sample comprises the 761 largest Taiwan firms (based on total assets) as
of December 31st, 1997, and covers 1997 through 2011. Variables are defined in Appendix A, and are
winsorized at 5% and 95% level. t-statistics are in parentheses, and are corrected for serial correlation
and heteroskedasticity by clustering on the firm-level identifier. * denotes significance at the 10% level,
** significance at the 5% level, and *** significance the 1% level.
Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept 0.457*** 0.060 0.446*** 0.446***
(6.543) (1.478) (6.394) (6.384)
Family dummy 0.029** 0.028* 0.029* 0.029**
(1.991) (1.880) (1.929) (1.990)
Idiosyncratic risk - 0.111 0.060 0.008
(1.517) (1.434) (1.620)
Idiosyncratic risk * Real options - -0.006 -0.015 0.007
(-1.321) (-1.236) (1.310)
Debt ratio 0.005 0.003 0.001 0.001
(0.127) (0.076) (0.035) (0.037)
Cash flow 0.041 0.204 0.060 0.053
(0.218) (1.062) (0.323) (0.284)
Dividend ratio 0.203 -0.107 0.198 0.197
(0.523) (-0.270) (0.509) (0.508)
Asset tangibility 0.011 0.000 0.011 0.014
(0.164) (0.004) (0.158) (0.199)
Blockholder ownership 0.145 0.156 0.143 0.144
(1.410) (1.515) (1.395) (1.407)
Dummies for industry and year Yes Yes Yes Yes
2
Adjusted R 0.025 0.026 0.026 0.026
Observations 8,086 8,086 8,086 8,086

25
Table 7. Instrumental variable three-stage least squares (IV-3SLS) regressions of total
investments and family presence
This table reports IV-3SLS multivariate regression results of total investments on family
dummy/presence. Panels A and B provide the regression results using median county income and
lagged family dummy as instruments. The sample comprises the 761 largest Taiwan firms (based on
total assets) as of December 31st, 1997, and covers 1997 through 2011. Variables are defined in
Appendix A, and are winsorized at 5% and 95% level. t-statistics are in parentheses, and are corrected
for serial correlation and heteroskedasticity by clustering on the firm-level identifier. Numbers in
brackets are p-values. * denotes significance at the 10% level, ** significance at the 5% level, and ***
significance the 1% level.
Panel A: Instrument (Log(Median county income)) Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -5.979*** -5.879*** -5.826*** -6.008***
(-3.854) (-3.835) (-3.800) (-3.862)
Family dummy 3.558* 3.385* 3.352* 3.610*
(1.787) (1.721) (1.703) (1.809)
Idiosyncratic risk - -1.771** -0.440 -0.007
(-2.196) (-1.148) (-0.112)
Idiosyncratic risk * Real options - 0.111** 0.127 -0.067
(2.151) (1.070) (-1.094)
Debt ratio 4.579*** 4.642*** 4.595*** 4.577***
(4.913) (5.029) (4.979) (4.904)
Cash flow 32.011*** 32.172*** 32.026*** 31.976***
(12.255) (12.374) (12.300) (12.227)
Dividend ratio -21.696*** -22.025*** -22.170*** -21.624***
(-3.145) (-3.219) (-3.245) (-3.129)
Asset tangibility 4.518*** 4.513*** 4.553*** 4.504***
(3.456) (3.475) (3.509) (3.441)
Blockholder ownership 5.681** 5.546** 5.551** 5.717**
(2.516) (2.470) (2.476) (2.521)
Dummies for industry and year Yes Yes Yes Yes
Wald test of model (χ2) 452.340*** 462.775*** 457.429*** 453.956***
[0.000] [0.000] [0.000] [0.000]
Wald test of exogeneity (χ2) 2.281 2.082 2.018 2.355
[0.131] [0.149] [0.155] [0.125]
Observations 7,922 7,922 7,922 7,922

26
Table 7. (cont’d)
Panel B: Instrument (Lagged family dummy) Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -2.242*** -2.124*** -2.087*** -2.075***
(-3.276) (-3.088) (-3.037) (-3.016)
Family dummy 0.547** 0.543** 0.552** 0.543**
(2.362) (2.346) (2.388) (2.346)
Idiosyncratic risk - -1.263 -0.787** -0.107*
(-1.556) (-2.101) (-1.831)
Idiosyncratic risk * Real options - 0.071 0.200* -0.098
(1.375) (1.736) (-1.592)
Debt ratio 4.767*** 4.839*** 4.804*** 4.805***
(5.609) (5.696) (5.655) (5.658)
Cash flow 32.610*** 32.500*** 32.360*** 32.470***
(13.850) (13.810) (13.740) (13.810)
Dividend ratio -26.070*** -26.000*** -26.080*** -26.070***
(-5.091) (-5.078) (-5.089) (-5.101)
Asset tangibility 4.249*** 4.201*** 4.239*** 4.188***
(3.414) (3.374) (3.404) (3.371)
Blockholder ownership 3.415** 3.443** 3.457** 3.421**
(2.078) (2.093) (2.101) (2.079)
Dummies for industry and year Yes Yes Yes Yes
Wald test of model (χ2) 660.000*** 663.900*** 663.800*** 665.100***
[0.000] [0.000] [0.000] [0.000]
Wald test of exogeneity (χ2) 0.079 0.097 0.088 0.095
[0.778] [0.754] [0.766] [0.757]
Observations 7,922 7,922 7,922 7,922

27
Table 8. Family presence and research and development (R&D) effectiveness
This table reports multivariate ordinary least squares (OLS) regression results of R&D effectiveness
(patents and citations) on family dummy/presence. Panels A and B provide the regression results for
patents and citations, respectively. The sample comprises the 761 largest Taiwan firms (based on total
assets) as of December 31st, 1997, and covers 1997 through 2011. Variables are defined in Appendix
A, and are winsorized at 5% and 95% level. t-statistics are in parentheses, and are corrected for serial
correlation and heteroskedasticity by clustering on the firm-level identifier. * denotes significance at
the 10% level, ** significance at the 5% level, and *** significance the 1% level.
Panel A: Patents Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -0.322 -0.341 -0.331 -0.326
(-1.112) (-1.179) (-1.138) (-1.122)
Family dummy 0.184** 0.182** 0.182** 0.183**
(2.162) (2.146) (2.148) (2.149)
Idiosyncratic risk - -0.617** 0.172 0.0194
(-2.405) (1.330) (1.000)
Idiosyncratic risk * Real options - 0.0402** -0.0513 -0.0302
(2.463) (-1.308) (-1.235)
Debt ratio -0.506** -0.500** -0.505** -0.513**
(-2.239) (-2.218) (-2.232) (-2.269)
Cash flow -7.081*** -7.030*** -7.058*** -7.061***
(-7.903) (-7.897) (-7.892) (-7.875)
Dividend ratio 1.645 1.624 1.677 1.613
(0.769) (0.759) (0.784) (0.752)
Asset tangibility -0.542 -0.549 -0.548 -0.543
(-1.418) (-1.439) (-1.432) (-1.422)
Blockholder ownership 0.617 0.614 0.617 0.608
(1.262) (1.258) (1.263) (1.244)
Dummies for industry and year Yes Yes Yes Yes
Adjusted R2 0.070 0.071 0.070 0.071
Observations 8,086 8,086 8,086 8,086

28
Table 8. (cont’d)
Panel B: Citations Proxy for real options
Log(Firm Log(Firm Future sales
size) age) growth
Intercept -0.023 -0.029 -0.017 -0.016
(-0.444) (-0.561) (-0.457) (-0.433)
Family dummy 0.038** 0.038** 0.038** 0.038**
(2.122) (2.111) (2.137) (2.131)
Idiosyncratic risk - -0.097** 0.026 0.005
(-2.017) (1.108) (1.582)
Idiosyncratic risk * Real options - 0.006* -0.007 -0.006
(2.123) (-1.039) (-1.495)
Debt ratio -0.027 -0.027 -0.033 -0.034
(-0.578) (-0.573) (-0.700) (-0.724)
Cash flow -1.268*** -1.255*** -1.295*** -1.292***
(-7.877) (-7.789) (-8.057) (-8.028)
Dividend ratio 0.281 0.272 0.367 0.353
(0.679) (0.658) (0.898) (0.864)
Asset tangibility -0.108 -0.109 -0.118 -0.118
(-1.404) (-1.420) (-1.545) (-1.546)
Blockholder ownership 0.028 0.027 0.035 0.031
(0.258) (0.248) (0.317) (0.285)
Dummies for industry and year Yes Yes Yes Yes
Adjusted R2 0.078 0.079 0.076 0.076
Observations 8,086 8,086 8,086 8,086

29