Finance and Governance of Finance and Governance of Family Run - - PowerPoint PPT Presentation

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

F il h t i ti h di t i t

• Family characteristics can have a direct impact
• n firm performance: what factors are crucial?

F ili t i ll l t l h i

• Families typically rely on control enhancing

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

• pportunities?

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
• f outside investors (Type II agency problem)
• f 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 il fi i l t f d bt d family firms, incur lower costs of debt, and 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 i l P ti i ti i ht / Financial rights Participation rights / managerial control rights Delegate rights

Shareholders

Delegate

Directors/Managers

Control

Directors/Managers

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

Shareholders

Delegate

Directors/Managers

Control

Directors/Managers

Control

Corporate Governance Debate Listed Family firm with Dispersed Ownership y p p

Shareholders

Delegate

Di t /M

Align Interests /

Directors/Managers

Align Interests / Monitoring Internal Corporate Governance Mechanisms:

• Non-executive managers

Fid i d ti D t f / D t f l lt

• Fiduciary duties: Duty of care / Duty of loyalty
• Executive pay
• Disclosure and Transparency

Disclosure and Transparency

• Internal and external audit process

D F il O hi M tt ? Does Family-Ownership Matter?

Family Managers

• Listed: Founder

can reduce

Family Business g

• n

agency problems

w Informatio symmetries

Ownership

Low As

• In Listed Companies and Non-

Listed Companies: in next generations “agency problems”

Family Shareholders Other Shareholders

Information Asymmetries

could reduce firm value

• Empirical studies suggest that

private equity should buy-out badly run family firms

Variation in Family Firm Performance

P bl

– How do we distinguish between those family

Problem:

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 bl i th fi agency problems in the firm

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?

R h tt t t i l t l ff t f

• Research attempts to isolate causal effect of

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

• n 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

F il t l h b th iti d ti

• Family control can have both positive and negative

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 i OECD economies

Proportion of OECD Firms That are Family-Run P

99 Italy

Percent

90 99 US Italy 85 90 EU Sweden 80 Spain 75 50 100 150 UK

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

P t f t t ll d id

• Percentage of votes controlled provides

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?

D l l h ti t d

• Dual class shares, voting agreements and

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?

I US t l th t f ili bt i b

• In US, excess control that families obtain above

equity stake through dual class and disproportional representation comes at a cost disproportional representation comes at a cost

• f 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 h ff f f ili l i h to measure the net effect of families employing these 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

Step 3 Step 3

S i t th bi t h ll t

• Succession represents the biggest challenge to

family run firms

• We are all familiar with the studies that show
• We are all familiar with the studies that show

that only one in six family firms survives to the third generation g

• One in eight survive to the fourth generation
• Clearly succession can also mean selling the

firm

– Despite resistance by some family members to sell, the owner’s aim should be to maximize family welfare the owner s aim should be to maximize family welfare – Poor governance may block succession by encouraging an insiders culture reducing firm value

• Fig. 1: Reasons for the Sale of the Business

No suitable successor A h b f il t Approach by intermediary/advisor No successor available Poor growth prospects Need additional capital for growth Approach by non-family management Lack of profitability Cash Flow problems Death of illness of the CEO 0.5 1 1.5 2 2.5 3 Liquidation Lack of profitability

Source: CMBOR/EVCA

Score

• Fig. 2: Succession Options Considered

Sale to private equity company Engage advisor to sell business Sale to existing management with private equity Sale to external management with private equity Sale to/merger with another company Sale to e isting management itho t pri ate eq it Sale to external management without private equity Employ new management but retain ownership/control 0.5 1 1.5 2 2.5 3 3.5 4 Pass business on to next generation Sale to existing management without private equity

Source: CMBOR/EVCA

Score

Equity to the Succession of F il B i I E Family Businesses In Europe

Source: EVCA 2005)

Succession Option Succession Option

T f i th b i t th f il

• Transferring the business to another family

member When a suitable family successor is not available. There are three other possibilities: There are three other possibilities:

• Sale to internal or external management

Sale to internal or external management (management buy-out/in)

• Trade sale (sale to another firm)
• Listing on a stock exchange

Dynamics Associated with Buyout Decision of Family Members

O hi t f i t it

• Ownership transfer process is opportunity

to align family and business interests

• Evidence from US suggests 2/3 of family

firms fail to carry out intergenerational y g succession planning

• Dynamics associated with buyout: loss of
• Dynamics associated with buyout: loss of

independent identity, absence of qualified 2nd tier to run business approach by 2 tier to run business, approach by intermediary

Buyouts of Family Firms Buyouts of Family Firms

B i f i i t d ith th t

• Business performance is associated with the outcome
• Non-executive director associated with positive
• utcomes
• utcomes
• Family owners can rearrange wealth portfolio and

maintain involvement

– Average 8.9% post-MBO

• Professionalization increases post MBO/I
• Re-emergence of family culture post-professionalization

– Recognition of positive aspects of family – Negative family culture removed Negative family culture removed

How Family Firms Keep “L t ” t B “Locusts” at Bay

Concentrated Family Ownership

Non-listed family firms with family- Type I N li t d li t d f il fi Type II Non listed family firms with family management / Listed family firms with a controlling family stake and family-management Non-listed or listed family firms with a controlling family stake, but no family management

Family Management No Family Management

Non-listed or listed family firms with control-enhancing mechanisms but no family- Non-listed or listed family firms with control-enhancing mechanisms and family- mechanisms, but no family- management Type IV mechanisms and family- management Type III

Diluted Family Ownership

P i t E it d P bli G d Private Equity and Public Good

Average Annual Employment Growth

Source: EVCA/CEFS 2005 (2000-2004) Source: Global Insight/NVCA 2004 (2000-2003) Source: BVCA/IE Consulting 2005 (2000-2005) Source: Finance/DBAG 2004 (1998-2003)

The Private Equity-Family Firm P t hi Partnership

Exit Strategies Building Trust Building Trust Know Your “Partner” Establish/Maintain Relationship B d i Boundaries

P t S l ti Partner Selection

Investors (Limited Partners) Manager

Capital/loans Repayment of loans and profit distributions (80%) Management Fee

F il

Limited Partnership

General Partner

Carried Interest (20% profits)

Family

• Experience
• An effective family

governance structure

Company

with family firms

governance structure

• Strong interface with

the private equity partner

Company

• Smaller fund

size

partner

• Fund’s

investors

I t t D i Investment Design

Investors (Limited Partners) Manager

Capital/loans Repayment of loans and profit distributions (80%) Management Fee

Family

Limited Partnership

General Partner

Carried Interest (20% profits)

y Shareholders

Company p y

• Ownership and

Control

• Board Seats

A Case Study: Dirickx Groupe - 3i 3i

Minority Stake:

Buy-out family members Buy out family members Acquisition program “The deal has enabled my family s y f y to successfully secure a portion of its assets while allowing Dirickx to remain independent and l l accelerate its international

• development. 3i brings a global

network of contacts and its strategic vision to our company” strategic vision to our company

Th F l The Formula

Financial Capital S b li C it l Symbolic Capital Emotional Capital F il B i Family Managers Trust, Commitment, Long term view Family Business

ation ries Low Informa Asymmetr

Ownership

L

Financial Capital Value-added Services Family Shareholders Identifiable Shareholders

Low Information Asymmetries

Empirical Work: Scholes et al 2007 Empirical Work: Scholes et al 2007

• Alternatives to succession within the family

If f il i t il bl illi l t – If a family successor is not available or willing, sale to a private equity firm and/or incumbent management is most popular alternative.

• Ownership

– When solely family are in control of the firm prior to the buy-

• ut/in, there is significant scope for growth and expansion.
• ut/in, there is significant scope for growth and expansion.
• Governance

– NEDs appear to have a beneficial effect on company strategy t t i h i l h th h b t as strategic change is less when they have been present. – Should a venture capitalist be involved in the succession process, the most likely outcome is a drive towards efficiency improvements.

• Debt

– Debt levels have little effect on strategic direction post buy- – Debt levels have little effect on strategic direction post buy-

• ut/in.

Summary Summary

F il CEO d f fi ith

• Family CEOs underperform firms with

professional managers as CEOs Whil t f il fi l t l

• While most family firms rely on control

enhancing mechanisms to retain control over the firm it is hard to measure the net effects of firms firm, it is hard to measure the net effects of firms using these mechanisms

• Buyouts offer family members a means to align
• Buyouts offer family members a means to align

market and family interests and, if structured

• ptimally a mechanism to retain involvement
• ptimally, a mechanism to retain involvement

while potentially enhancing firm profitabiltiy