The Ownership Advantage in Family-Owned Companies

What do Enterprise Rent-a-Car, S.C. Johnson, Hallmark Cards, Ford, Nordstrom’s, Grupo Bimbo and Cemex (Mexico), Hermès (France), Salvatore Ferragamo and Prada (Italy), Bacardí (Puerto Rico), BMW (Germany), LG Electronics (Korea) and Zara (Spain) have in common? For one thing, they are all family-owned or family-controlled businesses. All of them have proud entrepreneurial traditions, and many of them confound management experts by continuing to enjoy success after several generations of ownership by the founding entrepreneurial family. This in an era when, according to a 2010 Bain and Company study, the lifespan of the average U.S. corporation has shrunk to 10 years.

Ownership -- in terms of control, stewardship and owner expectations for long-term economic and socio-emotional returns on invested capital -- is at the heart of the difference between these companies and diffusely owned, management-controlled firms.

How family businesses behave, what strategies they deploy and the results they obtain reflect their owner-managers’ focused and caring oversight. Family firms’ longer-tenured CEOs, and their owners’ longer-term investment horizons, are not only in sharp contrast to standard practice in management-controlled companies but also give rise to comparative competitive advantages.

Family firms’ higher returns

Succession and continuity remain a unique challenge to entrepreneurial and family enterprises. But this should not overshadow their financial out-performance evidenced in the first ever comparative research stream carried out over the last decade. A groundbreaking study by R.C. Anderson and D. Reeb (Journal of Finance, 58:1301-28, 2003), replicated by Business Week, found that family-controlled firms in the U.S. had a 6.65% greater return on assets and return on equity between 1992 and 2002 than their management-controlled counterparts in the S&P 500. Interestingly, the study found that family-controlled companies reinvested much more in the ongoing business and paid out smaller dividends.

The replication of this U.S. study in the European Union, along with recent research done in individual countries like Germany, Spain, France, Japan, Taiwan and Chile, all suggest an annual out-performance of between 6.65% and 16% in return on assets or return on equity over a ten-year period when compared with similar management-controlled companies.

A major differentiating factor for family-owned or family-controlled companies is the relationship between the owning family and its business, especially family members’ strategic influence as managers, directors and owners. And the caring, long-term oversight that united family ownership provides.

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 as much a reflection of the Ford family value placed on independence as much as a purely financial decision.

Ownership as a job

Of course, not all family businesses successfully create the level of shareholder loyalty, shareholder activism and managerial oversight that we are suggesting here is the secret sauce of family owned companies. Just look at Dow Jones & Co., publisher of the Wall Street Journal, which until 2007 was owned by the Bancroft family. Crawford Hill, one of the young Bancroft family members, sent this e-mail to Bancroft family members several weeks before the vote for the $60/share offer by the Murdoch family, owners of News Corporation:

"With all due respect, it is time for a reality check. What is missing from this discussion about Dow Jones and the Bancrofts is a sense of historical perspective and evolution…. What most of you do not know however is that the very same Jessie B. Cox that is mentioned at every turn as "family matriarch" and to whom many of us owe "the legacy" forced her incredibly talented husband, William C. Cox, top student at Milton and Harvard luminary, to retire prematurely from Dow Jones at age 40 so he could be full time in the social swirl of Cohasset. He was a star at the company!"

"As to promoting legacy, neither she nor her daughter Jane, my mom, ever spoke of the legacy of Dow Jones, much less the possibility of actually working there or what it meant to be a steward of the business. There was no effort at promoting legacy, or educating the next generation, whatsoever...We talked about everything under the sun...but never Dow Jones... We never had, by the way, conversations that the Sulzbergers, Grahams and, yes, Murdochs, had every day!"

"There has absolutely never existed any kind of family-wide/cross-branch culture of teaching what it means to be an active, engaged owner and more crucially, a family director." (Source: Wall Street Journal, July 27, 2007.)

We in the U.S. need to rediscover that long-term, committed ownership matters immensely, and that being an owner is important work. Work 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 founding owner who will never transfer his power as a CEO to the next generation.

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 --investments in its ownership are essential.

Preserving the ownership advantage requires:

  1. The redesign of the company’s ownership and control structure by every generation so that it is appropriate for that generation’s governance needs. Ownership structures don’t transfer well across generations.
  2. The financial education of family shareholders along with routine access to information and active communication of timely financial information to family members in a Family Council.
  3. The creation of governance bodies (like family councils, family assemblies and advisory boards or boards of directors with independent outsiders) that govern the interaction between the owners and the firm.

What responsible shareholders do for a family company

  1. Establish reasonable financial and non-financial goals for returns on shareholder equity or invested assets and then demand those returns from top management. Communicate owning-family priorities to management and the board of directors.
  2. Build the dream, build family unity and a win-win, trusting family culture. This represents a significant contribution to the preservation of patient family capital and the ownership advantage.
  3. Issue a wake-up call to top management when past success dampens its sense of urgency in the face of quickly changing competitive conditions. Bill Hewllet and David Packard, already retired but serving on the board of HP did just that when competition from Asian tech firms promised to change the rules of the game in the measurement equipment industry that HP had pioneered.
  4. Provide the values and principles of doing business and ensure they remain instilled in the company. Values often include independence (through low debt-to-equity ratios), continuing entrepreneurship and a strong work ethic.
  5. Re-build the ownership structure during succession so that owners preserve speed, agility and customer orientation in the company; all sources of value for the customer. Only when businesses are capable of creating value for customers by delivering better and faster products/services while maintaining a closer relationship with them, can shareholders recapture the value created by the business in the form of good shareholder returns. — E.J.P.

Ernesto J. Poza is clinical professor of global entrepreneurship and family enterprise at Thunderbird School of Global Management, Glendale, Arizona and the author (with Mary S. Daugherty) of Family Business, 4th ed. (Cengage Publishing, Mason, Ohio, 2013).