The Advantages of Family Ownership

While analysts lavish praise on entrepreneurs, they are often less generous to one of the legacies of entrepreneurship — the family firm. Many fear that founding families can too easily work to benefit their own interests at the expense of other shareholders — for example, by treating the company as a family employment service or a private bank.

As a group, however, founding families are unjustly maligned, according to a new study of large, publicly traded U.S. firms. In “Founding-Family Ownership and Firm Performance: Evidence From the S&P 500,” slated for publication in the Journal of Finance, Ronald C. Anderson and David M. Reeb report that companies with significant levels of founding-family ownership or control typically outperform industry peers.

The authors combed through proxy statements from 1992 to 1999 for 403 nonbank, nonutility members of the S&P 500 to identify companies that reported stakes held by founding-family members or had founding-family members serving on the board. Their search revealed 141 family firms, representing 35% of the sample, with an average family shareholding stake of 18%.

Their research measured return on assets as EBITDA — earnings before interest, taxes, depreciation and amortization —scaled by the book value of total assets and controlled for firm age, size, risk, growth opportunities, capital structure, corporate governance mechanisms and industry.

Using regression analysis, Anderson, an assistant professor of finance at American University, and Reeb, an assistant professor of finance at the University of Alabama, discovered that these companies were more profitable than non-family firms. For the average company, the data associated founding-family participation with a boost in return on assets — rising from 15.05% to 16.05%. Similarly, investors tended to value family firms more highly — on average, Tobin's Q, the market value of a company's assets divided by their replacement cost, was 10% higher for this group.

In theory, the same pattern could emerge even if ownership had no impact on performance. However, by employing a statistical technique known as instrumental variable regression, the researchers showed that ownership does influence performance, even if, to some extent, performance also determines ownership.

In explaining why ownership matters, co-author Reeb suggests that family firms are probably more successful at keeping ambitious managers in check. Family members have strong incentives to watch managers closely, since their stake in the business often accounts for a large proportion of their wealth.

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