Finance and Governance of Finance and Governance of Family Run Companies y p Joseph A. McCahery SME and Family Business Conference Conference 14 August 2009
The Presentation: 3 Steps The Presentation: 3 Steps • Family characteristics can have a direct impact F il h t i ti h di t i t on firm performance: what factors are crucial? • Families typically rely on control enhancing F ili t i ll l t l h i mechanisms to retain control over the firm: should some CEMs be eliminated due to their should some CEMs be eliminated due to their effect on shareholders? • The absence of a suitable family successor may • The absence of a suitable family successor may lead to an exit by the family: Do MBOs provide family owners with better performance family owners with better performance opportunities?
Step 1 Step 1 • Family control provides benefits: families may y p y provide intensive monitoring of management that attempt to appropriate corporate resources (Type I agency conflict) I agency conflict) • Family priorities may conflict with the objectives of outside investors (Type II agency problem) of outside investors (Type II agency problem) • Economic evidence show that family firms in Asia suffer from significant Type II agency conflicts g yp g y • But, the evidence for US family firms shows they exhibit higher earnings quality relative to non- f family firms, incur lower costs of debt, and il fi i l t f d bt d command a valuation premium • What accounts for the differences ultimately? • What accounts for the differences ultimately?
Corporate Governance Debate: Non-Listed Closely Held Family Company y y p y Fi Financial i l Participation rights / P ti i ti i ht / rights managerial control rights rights Delegate Delegate Shareholders Directors/Managers Directors/Managers Control Control
Corporate Governance Debate: Non-Listed Closely Held Family Company y y p y the role of CG: the role of CG: aligning Interests Delegate Delegate Shareholders Directors/Managers Directors/Managers Control Control
Corporate Governance Debate Listed Family firm with Dispersed Ownership y p p Delegate Shareholders Align Interests / Align Interests / Di Directors/Managers t /M Monitoring Internal Corporate Governance Mechanisms : -Non-executive managers -Fiduciary duties: Duty of care / Duty of loyalty Fid i d ti D t f / D t f l lt -Executive pay -Disclosure and Transparency Disclosure and Transparency -Internal and external audit process
D Does Family-Ownership Matter? F il O hi M tt ? • Listed: Founder Family can reduce Managers g agency problems Family Business on w Informatio symmetries As Low • In Listed Companies and Non- Ownership Listed Companies: in next generations “agency problems” could reduce firm value Family Other Information • Empirical studies suggest that Asymmetries Shareholders Shareholders private equity should buy-out badly run family firms
Variation in Family Firm Performance P Problem: bl – How do we distinguish between those family g y firms that have higher agency problems? • Firms with CEOs that resist replacement after poor Firms with CEOs that resist replacement after poor firm performance may help to identify these firms • By separating family firms run by a founding y p g y y g member and those run by professional CEO, it may be easier to determine the severity of the agency problems in the firm bl i th fi
What Explains Higher Firm Value in the US? • The critical characteristic is not the particular legal standard but the CEO retention decision • Good rule of thumb: the agency problems family firms face depend on the firm type y • Examples: – Professional CEO family firm (valuation premium) Professional CEO family firm (valuation premium) – Family CEO firms (no valuation premium) – Non-family firms Non family firms.
What about European Family Firms? What about European Family Firms? • Research attempts to isolate causal effect of R h tt t t i l t l ff t f family CEOs on firm performance (Bennedsen et al 2007) al 2007) Studies look at the variation in CEO succession decisions that result from the gender of a g departing CEO’s first born child as an instrumental variable • The results are striking: The results are striking: – Family characteristics have economically large effects on decision to promote a family or unrelated CEO p y • Male first-child firms are 32.7% more likely to appoint a family CEO than female first-child firms • Family CEOs have strongly negative impact on performance Family CEOs have strongly negative impact on performance
Summary Summary • Family control can have both positive and negative F il t l h b th iti d ti properties • Segments of the literature show that founder-CEOs have Segments of the literature show that founder-CEOs have positive effect on firm performance (Villalonga and Amit 2004) • As we saw in Step 1, the critical event for firm is the retirement of the founder, coupled with passing the reigns to an heir which leads to a decline in reigns to an heir, which leads to a decline in performance of the firm • The evidence shows furthermore that family control has y positive associations in the US, but exhibits weaknesses when descendants are involved in top management
Step 2 Step 2 Founders and their families when their equity position declines typically rely on control enhancing measures (CEMs) to exercise substantial control over the firm Wedge between families’ control rights and cash- flow rights is prevalent among large family firms in US, East Asia and Western European countries What is the impact of CEMs on firm value? Current focus in on the type of mechanism used Current focus in on the type of mechanism used
Family-run firms predominate in OECD economies OECD i Proportion of OECD Firms That are Family-Run P Percent Italy Italy 99 99 US 90 Sweden 90 EU 85 Spain 80 UK 75 0 50 100 150 Source: Nancy Upton and William Petty, “Venture Capital Investment in Family Business,” Venture Capital, 2000, Vol. 2, No. 1, pp. 27-39
Votes Controlled by Families Votes Controlled by Families • Percentage of votes controlled provides P t f t t ll d id measure similar to those used in studies of ultimate ownership (LaPorta 1999; Claessens et ultimate ownership (LaPorta 1999; Claessens et al 2000; Facio and Lang 2002) • On average, families own 15.3% of their firms’ g equity and 18.8% of the votes. • Non-family blockholders on average own a slightly higher percentage of family firms’ equity slightly higher percentage of family firms’ equity than families themselves (16.2%), yet the voting rights associated are substantially lower (13.2%) rights associated are substantially lower (13.2%) • Share ownership by large blockholders is larger in non-family firms (22.1%) as one would expect
How are family firms controlled in US? • Dual class shares, voting agreements and D l l h ti t d pyramids are most common forms in US What is the impact of control enhancing What is the impact of control enhancing mechanisms on firm value in US? Result differs across CEMs: Result differs across CEMs: 1) dual class has negative impact on value (but not for second and later generation firms) 2) pyramids and voting agreements have a positive effect on value (legitimate business explanations) Villalonga and Amit (2006) explanations) Villalonga and Amit (2006) 3) family control is frequently enhanced through board representation in excess of voting through board representation in excess of voting control and through presence of family CEO
What About Family firms in Europe? • Wide range of CEMS employed in Europe • Dual class shares, voting agreements and g g pyramids are the primary source of the wedge in Europe • Italian research shows that control enhancing devices have positive and significant effect on devices have positive and significant effect on performance – Rationale: more profitable firms may be willing to Rationale: more profitable firms may be willing to block possibility of a change in control (Favero et al 2006)
Summary: Should we Constrain the Use of CEMs? • In US, excess control that families obtain above I US t l th t f ili bt i b equity stake through dual class and disproportional representation comes at a cost disproportional representation comes at a cost of reduced firm value – Thus, since it hard to measure the corresponding – Thus since it hard to measure the corresponding benefits that families gain from controlling firm as well as not being invested in companies’ equity, its difficult to measure the net effect of families employing these h ff f f ili l i h measures – On the other hand, there appears to be additional On the other hand there appears to be additional benefits from firms using these mechanisms, particularly in the US and Europe
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