INTERGENERATIONAL SUCCESSION IN SMALL FAMILY BUSINESSES - BORROWING CONSTRAINTS AND OPTIMAL TIMING OF SUCCESSION

Small family businesses differ from non-family businesses in that thei r functioning is not independent of the life cycle of the owner-operat or, and in that other family considerations sometimes lead to sub-opti mal managerial decisions from the point of view of the business. This is why a smooth intergenerational succession is essential to the profi tability of the business, and to the welfare of the family as a whole. Succession within the family involves first of all the choice of a su ccessor. The choice is affected by birth order, age differentials, and qualifications of potential successors. Choosing a successor means re aching an agreement about the timing of succession and income distribu tion before and after succession. This paper focuses on the decision o f the business-operating family when to bring in the designated succes sor. A utility-maximizing time is shown to differ from the income-maxi mizing time only in the presence of binding borrowing constraints. Suc h constraints are likely to enhance an earlier succession in order to use the successor's accumulated off-business assets to ease the constr aints and to increase future business income due to earlier accumulati on of business-specific human capital by the successor. An additional model shows that the successor will not be willing to wait indefinitel y for the formal ownership transfer of the business, because of the ri sk of being disinherited in some future period. The consequences of po ssible strategic behaviors of both the owner and potential successors on the results of these models is discussed informally.