Patient Family Ownership Matters in Times of Crisis
By Ernesto Poza
What do Wal-Mart, S.C. Johnson, Hallmark Cards, Grupos Femsa, Bimbo and Cemex (Mexico), Hermès (France), Salvatore Ferragamo (Italy), Bacardí (Puerto Rico), BMW (Germany), LG Electronics (Korea) and Zara (Spain) have in common? For one thing, they are all family-owned or family-controlled businesses. All of them have proud entrepreneurial traditions, and many of them confound management experts by continuing to enjoy success after several generations of ownership by the founding entrepreneurial family. And this in an era when, according to a recent Bain and Company study, the lifespan of the average U.S. corporation has shrunk to 14 years.
Ownership – in terms of control, stewardship and owner expectations for long-term economic and non-economic returns on invested capital – is most likely at the heart of the difference between these companies and diffusely owned, management-controlled firms.
How family businesses behave, what strategies they deploy and the results they obtain reflect their owner-managers’ focused and caring oversight. Family firms’ longer-tenured CEOs, and their owners’ longer-term investment horizons, are not only in sharp contrast to standard practice in management-controlled companies but also give rise to comparative advantages that become quite visible during periods of financial distress. Family firms, especially highly leveraged ones, have not been immune to the challenges posed by recessions and financial crises. Nevertheless, the contrasts over the past 18 months have been significant.
Family Firms’ Higher Returns
Succession and continuity remain a unique challenge to entrepreneurial and family enterprises, but this does not overshadow the comparative out-performance we have recently witnessed, which arguably is largely due to the caring, long-term oversight that united family ownership provides. A groundbreaking study by R.C. Anderson and D. Reeb (Journal of Finance, 58:1301-28, 2003), replicated by Business Week, found that family-controlled firms had a 6.65 percent greater return on assets and return on equity between 1992 and 2002 than their management-controlled counterparts in the S&P 500.
Interestingly, the study found that in that last recession year of 2002, family-controlled companies reinvested about 30 times as much in the ongoing business and paid out smaller dividends. The replication of this U.S. study in the European Union, along with research done in individual countries like Germany, Spain, France and Chile, all suggest an annual out-performance of between 6.65 percent and 16 percent in return on assets or return on equity when compared with similar management-controlled companies.
A major differentiating factor for family-owned or family-controlled companies is the relationship between the owning family and its business, especially family members’ strategic influence as managers, directors and owners. In the aftermath of recent corporate meltdowns and ethical lapses, this has proved to be a significant difference indeed! Back in 1930, during the Depression, DuPont, then a family-owned company, boosted its R&D spending to create innovative products for the future. More recently, Ford’s reluctance in early 2009 to sign up for U.S. government bailout funds when both Chrysler and GM did may have been a reflection of the Ford family’s value of independence as much as a financial decision.
We in the U.S. may need to rediscover that long-term, committed ownership matters immensely, and that being an owner is a job, one that is quite different and separate from being a manager or employee in the firm (even if under normal circumstances, it represents only a part-time job). And while relearning ownership’s strategic value, why not reacquaint ourselves with the dark side of ownership: the sometimes unchecked power of owners, reflected in the inappropriately empowered young owner-manager or the entrenched owner-CEO.
If a family business is going to preserve two of its intangible yet well-documented competitive advantages – lower administrative costs due to lean financial controls in the presence of trust and a propensity to invest and manage with a long-term horizon – investments in its ownership are essential.
Patient Family Capital
Trusting and patient family capital requires:
Redesign of the company’s ownership and control structure by every generation so it is appropriate for that generation’s governance needs. Ownership structures don’t transfer well across generations.
Financial education of family shareholders along with routine access to information and active communication of timely financial information.
Emotional sensitivity of all shareholders so that, at a minimum, family owners can distinguish between task and emotional conflict. Task conflict on business strategy, for example, can serve a family business well in issuing a needed wake-up call in the transition across generations. Emotional conflict will often derail it.
Creation of governance bodies (like family councils, family assemblies and boards of directors with independent outsiders) that govern the interaction between the owners and the firm.
Shareholders in a family firm must be treated even more transparently and professionally than shareholders in a management-controlled Fortune 500 company in order to achieve the advantage of patient family capital and caring, active oversight. Family dynamics can undermine their willingness to trust a relative’s assessment of the business and its performance. But because shares in a family company are usually illiquid and unmarketable, peaceful retreats from disagreements via the sale of stock are often out of the question. The implication of this important difference in the continued effective leadership of a family firm is fundamental.
Ernesto Poza is a clinical professor of global entrepreneurship at the Walker Center for Global Entrepreneurship at Thunderbird School of Global Management in Glendale, Arizona.