Blood and Money: Kin altruism, governance, and inheritance in the family firm

Using the kin altruism framework (Hamilton, 1964), this paper models descendant family firms. Kin altruism makes relatives soft monitors, leading to a “policing problem” within family firms. This policing problem results in both increased managerial diversion and increased monitoring expense at fixed compensation levels. When incentive constraints determine compensation, increasing kinship always increases the efficiency of the family firm under family management but may not increase firm value and promotes nepotistic hiring. When labor market reservation constraints determine compensation, kinship always lowers efficiency, sometimes increases firm value, and does not induce nepotism. Regardless of the binding constraint, kinship increases the cost of external capital and generates a divergence between the policy and bequest preferences of founders and their direct descendants.