Faculty Column: Rediscovering the value of patient family ownership

Courtesy: Thunderbird School of Global Management
Courtesy: Thunderbird School of Global Management

By Ernesto Poza

What do Hallmark Cards, Grupo Bimbo and Cemex (Mexico), Hermès (France), Ferragamo (Italy), BMW (Germany), LG Electronics (Korea), Reliance Industries (India), and Zara (Spain) have in common? For one thing, they are all family-owned or family-controlled businesses. Companies with proud entrepreneurial traditions that 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 2007 Bain & Company study, the lifespan of the average U.S. corporation has shrunk to 10 years.

Family firms’ longer-tenured CEOs, their owners’ longer-term investment horizons, and their active oversight of managerial results, 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’ higher returns

A groundbreaking study by R.C. Anderson and D. Reeb (Journal of Finance, 58:1301-28, 2003) found that U.S. family-controlled firms in the S&P 500 list had a 6.65% greater return on assets and return on equity between 1992 and 2002 than their management-controlled counterparts. Interestingly, the study found that in the 2002 recessionary year, family-controlled companies reinvested about 30 times as much as their counterparts in the ongoing business and paid out smaller dividends. 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 was undoubtedly a reflection of the Ford family value placed on independence as much as a financial decision.

The replication of the comparative study for the EU, along with research done in individual countries like Germany, Spain, France, Poland, Taiwan and Chile, all suggest an annual out-performance of between 6.65% and 16% in return on assets when compared with similar management-controlled companies. (Only some of these studies have controlled for size and sector effects.) A McKinsey study in 2010 found that family controlled companies in the industrial, IT, consumer staples and consumer discretionary sectors outperformed management-controlled firms in total shareholder returns on a worldwide basis. Only family enterprises in the financial and healthcare industries did not outperform.

Patient Family Ownership

Not all family businesses successfully create the level of shareholder loyalty and managerial oversight that we are suggesting here as the norm for family enterprises. Just look at Dow Jones & Co., publisher of the Wall Street Journal, which until 2007 was owned by the Bancroft family. It took the Murdochs to provide Dow Jones with newly committed, active ownership.

We 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–educational investments in its ownership are essential.

Financial literacy and committed ownership

Family shareholders expecting to fulfill their responsibility of aligning management interests with shareholder priorities need a thorough understanding of financial statements and a board with independents that can help them hold the CEO accountable, even if the CEO is family. They must be able to make sense of what the numbers say about the firm and its competitiveness. Financial and strategic literacy is essential for every shareholder, not just those active in company management.

Family shareholders inactive in the business can bring about significant erosion of the founding entrepreneurial culture, which valued the role of hard work and patient capital and tacitly understood the benefits of owner–manager alignment.

Ernesto J. Poza is the author of Family Business, 4th ed., Cengage, 2013 and the upcoming Family Governance, Macmillan, 2014.

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