All in the Family
Belén Villalonga ([email protected]) and Raphael Amit ([email protected]), “How Do Family Ownership, Control, and Management Affect Firm Value?” Click here.
A surprisingly large proportion of public corporations are family controlled. One 1999 study examined the 20 largest publicly traded firms in the 27 richest economies and concluded that families or individuals controlled 30 percent of them. In the U.S., these included Wal-Mart, Hewlett-Packard, Ford Motor Company, and Kellogg. Obviously, many families want to maintain their grip on the businesses they founded, but is this beneficial to other shareholders?
To answer this, Belén Villalonga, an assistant professor at Harvard Business School, and Raphael Amit, the Robert B. Goergen Professor of Entrepreneurship at the University of Pennsylvania’s Wharton School, compared the market and book value of family and nonfamily companies in the Fortune 500 between 1994 and 2000.
Initially, the authors defined family firms as those in which the founder or a member of his or her family is an officer, a director, or a blockholder (an owner of 5 percent or more of the firm’s equity, either individually or as part of a group). Of the 508 companies in their sample, 37 percent were family firms by this definition.
But, as the authors learned, the definition is not so simple. When a founder or a family is a stakeholder in a Fortune 500 firm, their holdings tend to be minimal — on average, about 16 percent of the equity in the company. Yet, in 50 percent of the companies that the authors first defined as “family firms,” additional “control-enhancing mechanisms” entitle the families to a greater proportion of the total votes than their share ownership stake. These mechanisms include dual share classes with different voting rights, cross-holdings, and voting agreements.
In 1994, Berkshire Hathaway (of which Warren Buffett and his wife owned approximately 43.8 percent) held 14.8 percent of the Class B shares in the Washington Post Company. (Class B shares carry fewer voting rights than Class A shares.) But Berkshire Hathaway and its subsidiaries granted Donald Graham a proxy to vote the shares at his discretion. (Mr. Graham is the newspaper’s publisher and eldest son of Katharine Graham, the former chief executive of the Washington Post Company and daughter of the founder.)
The complex nature of family influence in corporate boardrooms led Professors Villalonga and Amit to make a distinction between ownership, control, and management. As a result, their research ultimately addressed this question: Does family ownership, control, and/or management create or destroy value?
Their central finding was revealing: Family ownership creates value for shareholders — both family and nonfamily — only when the founder is still active in the firm, either as CEO or as chairman with a nonfamily CEO. But when a descendant of the founder serves as CEO, value is diminished — minority (nonfamily) shareholders fare worse than they would in nonfamily firms — even if the founder is chairman.
The effect of control-enhancing mechanisms also varies according to which generation of the family holds the commanding stake. In companies led by founder-CEOs, the presence of control-enhancing mechanisms reduces shareholder value below what it would be without such arrangements. The authors argue that markets penalize the share price because of the CEO’s disproportionate level of influence. Despite this, however, minority shareholders are still likely to be better off investing in these companies: On average, firms with founder-CEOs that have control-enhancing mechanisms perform 25 percent better than nonfamily firms.
In firms with CEOs who are descendants of the founder, control-enhancing mechanisms actually have a small positive impact. This is either because descendant CEOs are not perceived by the markets to be as dominating as founder CEOs, or because markets are allocating a tiny premium for continuity. Overall, however, minority shareholders in descendant-CEO companies are still worse off than they would be investing in a nonfamily firm.