Family first? Nepotism and corporate investment

Summary

Focus

This paper seeks to estimate the extent of nepotism in U.S. public firms and assess the implications for corporate investment.

Contribution

This paper provides a first assessment of how widespread nepotistic hiring practices are. While a large number of papers explore the consequences of family ownership, the literature is silent about the implications of family ties among employees in top roles.

As nepotism induces an adverse selection of the managers in charge of investment decisions, a natural question is whether nepotism hinders valuable corporate investment. This paper provides a set of tests to determine whether that is the case and quantify this effect.

Findings

Running a battery of empirical tests, we find that nepotism has an economically significant detrimental effect on both capital investment and investment in research. This negative effect arises because of lower responsiveness to investment opportunities of firms that employ relatives.

We provide suggestive evidence that lower skill and lack of incentives of top managers contribute to explain the lower sensitivity to investment opportunities. We discuss the implications at a macroeconomic level.

Abstract

Nepotism emerges in a multiplicity of contexts from political assignments to firm hiring decisions, but what are its real effects on the economy? This paper explores how nepotism affects corporate investment. To measure nepotism, we build a unique dataset of family connections among individuals employed in strategic positions by the same firm. We address endogeneity concerns by exploiting the heterogeneity in ancestries across U.S. counties to construct a measure of inherited family values. We find that firms headquartered in counties where locals inherited strong family values exhibit more nepotism. Using this measure and the percentage of family households in the county as instrumental variables, we provide evidence that nepotism hinders investment. Overall, our results suggest that underinvestment in these firms is driven by both lower quality of hired workers and lower incentive to exert effort.

JEL classification: G31, G40, J33

Keywords: nepotism, investment, moral hazard, hiring practices, family ties