Authors: Haoyong Zhou (Copenhagen Business School)
Publisher: Social Science Research Network Working Paper Series
Date Published: January 2012
Public companies that are substantially owned or operated by families are prevalent worldwide; in the U.S., they account for one-third of the S&P 500. This paper finds that a segment of these firms were able to outperform nonfamily companies during the Great Recession, offering lessons that could be applied by companies in general when confronted by economic turbulence in the future.
Previous studies have failed to reach consensus on whether family firms, because of differences in the way they are managed, outperform nonfamily firms. But those studies typically assessed the comparative performances in normal economic times and largely ignored periods of depression or recession.
This paper examines the performance of family and nonfamily firms from 2006 through 2010, the period during which the global economic crisis formed, hit with full force, and began to recede. Although family firms didn’t outperform across the board, one type of family corporation did, the author found. That segment — companies with a founder who was still active (as CEO, board member, or significant shareholder) — did better than nonfamily firms, on average, by 2 percent during the five-year period, as measured by operating return on assets. And at times during two of those years, 2009 and 2010, those family firms outperformed others by as much as 18 percent.
The superior results could be explained, in large part, by the fact that founder firms had fewer administrative costs and invested significantly less, even though they retained better access to the credit market. Unlike nonfamily firms, the author writes, whose managers may be tempted, in an effort to save their jobs, to over-invest in risky projects and boost short-term earnings in harsh economic times, founder firms operated with a generally conservative long-term investment strategy during the crisis.
The economic crisis provides an ideal setting for studying corporate performance, the author notes, because of its origins and scope. It began when consumers were unable to service subprime mortgages and eventually spilled over into the corporate world, producing a shock to the entire system. The global scale of the crisis enabled the author to analyze international data rather than just regional information (in contrast with the situation involving, for example, analyses of the financial troubles that shook Asia in 1997).
Accordingly, the author studied 658 of the 710 firms in the S&P 500 (U.S.), FTSE 100 (U.K.), DAX 30 (Germany), CAC 40 (France), and FTSE MIB 40 (Italy). (The study excluded firms for which data wasn’t available for the full five years analyzed.) The firms in the sample represented 61 industries, and 35 percent were family companies.
The author defined four types of family firms, in line with other recent studies. Founder firms are companies in which the founder is a board member, CEO, or blockholder (a shareholder with at least 5 percent of the outstanding shares). Heir firms are companies in which the heir (by blood or marriage) of the founding family is a board member, CEO, or blockholder. Family-owned firms are those in which one person or several from the same family control 10 percent of the outstanding shares either directly or indirectly through another family firm or fund. Leader/owner firms have a CEO or board member who is also a significant shareholder with an outstanding stake of at least 5 percent.
Combining several databases to track the top managers, ownership history, and family connections for each sample company, the author merged the demographic information with accounting data from Compustat. Large owners who took control of a firm through a spin-off or leveraged buyout were excluded, as were some large investment management companies, whose funds are owned and directed by a wide range of investors.
After controlling for country, industry, and firm-specific characteristics, the author found that family firms overall did not have better results during the crisis than nonfamily firms. This result was tied to two metrics — accounting performance (as measured by return on operating assets) and stock market performance (following Tobin’s Q, a commonly used rating that calculates the market value of a company against the value of its assets).
Only the founder firms stood out, and only as measured by return on assets. The same advantage was not evident in the Tobin’s Q rating, the author found, which “implies that the financial crisis may have a disparate effect on corporate cash flow based performance and market value based performance.”
Put another way, the return on operating assets is a revenue-based measure of profitability driven by several factors — including business strategy, management skills, and operating efficiency — whereas Tobin’s Q is mainly driven by the price of stocks. The author ascribes the lack of a boost in founder firms’ stock value to investors’ irrational overreaction to bad market conditions and high volatility during recession times.
Delving deeper into why founder firms produced better returns during the crisis, the author found that their administrative costs were much lower, leading to the conclusion that in addition to being visionary or inspiring leaders, founders are also “good expense controllers.”
Further, founder firms invested much less during the crisis. But they also took on more short-term loans and higher levels of debt, to help them through rough patches. On average, founder firms during the crisis had US$431 million more in short-term debt than nonfamily firms, the author calculated, and their capital structures were more leveraged. Prior to the crisis, founder firms were less leveraged and invested more relative to nonfamily companies.
“Founder firms substantially change[d] their investment and financial strategy during the crisis,” the author concludes. “The fact that founder firms raise[d] their debt level during the crisis suggests that [they] have more financing resources than nonfamily firms in bad times, when financial institutions tighten credit.”
Although family firms overall did not outperform nonfamily companies during the global economic crisis, one type did: those benefiting from the active involvement of their founder. These firms controlled their expenses better and implemented a more conservative investment strategy once the crisis hit.