Panikkos Poutziouris is Associate Professor in Entrepreneurship and Family Business at the Cyprus International Institute of Management and Visiting Fellow at Manchester Business School, UK.
Despite the diminishing role of family-controlled firms in the UK stock market, evidence suggests that the family business PLC model works and can offer value to all stakeholders. Panikkos Poutziouris presents the evidence
In light of recent corporate scandals which have been undermining capital market efficiency geared to deliver equitably value added growth and prosperity to all stakeholders, commentators have voiced their scepticism about the compatibility of family business capitalism and capital markets. Shining the family silver and tuning the governance schemes to sustain family control has been under the microscope of financial analysts and authorities monitoring the performance of capital markets.
Despite the general view about the inefficiency of the quoted family business model, a series of econometric studies and benchmarks have established that the family-controlled public limited company (PLC) can add value for stakeholders provided certain conditions are in operation. More recently via the prism of a Family Business Index covering the 1999-2005 period, UK family-controlled PLCs were found to outperform their FTSE peers by 40% – in terms of shareholder returns. The research investigation into the The UK Family Business PLC economy, was sponsored by UBS Wealth Management and supported by the Institute for Family Business. The study included a series of in depth case studies, which offer a clear message: it is paramount for the family business model to work that there is a sustainable corporate marriage of responsible family owners committed to the long-term, faithful talented managers and loyal long-term looking investors that have faith in the family stewardship.
The financial development of the family business
Globally, the family firm is the most prevalent form of business organisation. As industrial statistics indicate, the role of family firms in business activity is more central at the early stages of the business life cycle – where the founders and owner managers, and their family ties, are the main source of entrepreneurial drive and financial capital. In terms of financing the growth of private companies, their owner-managers adhere to the pecking order philosophy, ie a sequential preference of internally generated funds followed by short-term bank finance (overdraft being the main source of external funding) and then external equity finance.
Not surprisingly, many family business owner-managers are characterised by an antipathy towards institutional equity finance (be it private equity-venture capital, or public equity via a flotation etc) as this erodes family control and entrepreneurial zeal to pursue a long-term sustainable development strategy in line with the values of the founders/controlling family owner-managers. In fact, equity finance is only sought when debt financing is exhausted, a practise which is symptomatic of the over-gearing that characterises smaller companies rendering them more vulnerable to changes in the business cycle. Many family businesses fail because of insufficient capital and heavy debt loads, especially when the economy slows down.
The equity route – the flotation option
Growth inspired family firms that pursue innovation-led organic, acquisitive development strategies and international expansion have to broaden their financial options provided the deal structure addresses certain restrictive aspects which are not compatible to the ethos of their owner-managers, eg dilution of control, governance, exit options etc.
The flotation is particularly vital for growth and global oriented family firms aiming to build a long-term and sustainable capital base. Compared with the private placement option, the capital that can be raised on the market is usually larger and less expensive. On the other hand, in the long-term the access to the stock market increases the company's borrowing power and enhances its bargaining power for the reduction of borrowing costs. In addition to the strategic financial factors and governance triggered professionalisation course, the flotation can allow for the development of a more market-based valuation method for family shares and can promote the restructuring of the ownership regime. It can provide liquidity for patient/passive investors including retiring family owner-managers wishing to exit or pass on their shareholding.
Historically there is evidence showing that the stock market flotation would widen the share ownership of the firm, and ultimately could lead to dilution of control by the original founding and/or descendant family owner-managers, or even bring about an ultimate loss of family control due to hostile take-over. Thus, controlling family owners will consider mechanisms that can allow them to succeed in simultaneously raising capital and retaining power. This objective can be achieved through the free float of a limited portion of total shares combined with dilution of outside shareholdings. Alternatively, the issue of preference shares, the use of different classes of shares (which can multiply voting power) can allow controlling family shareholders to externally issue additional capital without diluting their block holding/majority position.
The proliferation of family business PLCs
With the emergence of managerial capitalism which is fuelled by the separation of ownership and control coupled by the growth and financial development of large private companies via public equity markets, the role of families in terms of ownership and control diminishes, but still remains important.
A series of investigations indicate that, the proportion of family-controlled quoted companies in main equity capital markets across OECD economies is substantial ranging from 10% to over 50%. It is argued that family shareholding in quoted family companies depends on the development of capital markets and their evolving model of regulation. It is also governed by the family business culture and the appetite of business families for control via the use of multi-classification of shares (with enhanced block holding voting power), pyramids and cross-shareholding schemes.
In contrast to the persistence of family capitalism in continental European capital markets, scholars report that the UK family shareholding has been on the decline. It is estimated that during the 1990-2005 period more than one-third of family-controlled PLCs have been taken over. Over time, with smaller stakeholding, rising hostile takeovers, demanding institutional shareholders, increased capital market regulation and takeover reforms, families find it very challenging to sustain control. In recent years, we have also experienced the exodus of family-controlled PLCs from the stock market through the public to private deals.
Performance of family business PLCs
Despite the diminishing role of controlling families in the UK PLC economy, the Investors Chronicle (2003), cited evidence revealing that family-controlled quoted companies were outperforming their counterparts. This was in line with the findings of other business surveys and academic investigations which focused on the financial performance of family quoted firms in the US (Business Week, 2003), and in Europe (Miller, Karen, Lowry: Newsweek, 2004).
More specifically, research by Thomson Financial for Newsweek (12 April 2004), found that family-controlled quoted companies were outperforming their rivals on all six major stock markets in Europe, from London's FTSE to Madrid's IBEX. The Thomson research team created an index for both family and non-family PLCs and tracked their performance over a 10-year period through to December 2003. In addition, they also produced a list of the top 10 fastest growing family companies in terms of shareholder returns. The key results are:
- In Germany, the family index soared 206% (led by BMW) while the non-family stocks climbed just 47%.
- In France, the family index surged 203% (led by the likes of Sanofi-Synthelabo, L'Oreal and LVMH) while its counterpart rose only 76%.
- The family-controlled PLCs outperformed their peers in Switzerland, Spain, the UK and Italy.
In addition to these benchmarks a number of academic investigations looked into the impact of family ownership and managerial control on performance. The theoretical base of such inquiries has been the agency costs theory which expound a series of monitoring costs and problems such as: restraining the opportunistic behavior of managers; the expropriation of wealth by controlling owner-managers of private benefits at the expense of minority shareholders; the emergence of arrested development due to entrenchment practices; information asymmetries which can lead to under-valuation of the firm and restrained investment activity so that the owning family does not experience an erosion of their financial autonomy (by borrowing excessively) and/or relinquish control by issuing new shares; altruism leading to nepotism and favouritism for family insiders and loyal outsiders; managers acting solely for one single stakeholder (the family) and overlooking the interests of the other shareholders.
Others argue that, the owner-managed family firms by virtue of their intra-familial altruistic elements, clan control, and induced goal congruence could be exempted from serious problems of traditional agency conflict. Arguably, the large family stakeholding could reduce agency problems due to the incentives and capabilities of highly committed family shareholders (especially founders) to monitor management.
In the widely publicised investigation into US quoted family firms, by Anderson and Reeb (2003), the relation between founding-family ownership and firm performance and found family firms to out-perform their non-family counterparts was examined. They conclude that founder CEOs and hired CEOs are associated with the greatest value gains and warn that families have to optimise their level of control to mitigate for the danger of higher entrenchment and poor performance.
In a similar study, Villalonga and Amit (2004) found that family ownership creates value only when the founder is active in the business either serving as the CEO of the family firm or as its chairman with a hired CEO. Their study also revealed that family voting enhancement tactics, such as dual share classes, pyramids and voting agreements reduce the founder's premium. Paradoxically, they found that family descendants serving as CEOs tend to destroy firm value. Family firms run by descendant-CEOs were characterised by higher agency costs between family and non-family shareholders compared to the agency costs characterising owner-managed non-family firms.
Overall, the above research findings come in antithesis to the argument that minority shareholders are adversely affected by family ownership. They counter-balance negative messages associated by coverage of US-based Adelphia, Swiss Erb Group, Italian Parmalat etc, that expounded certain family-controlled businesses as scandalous, where controlling families have been administering mechanisms to promote their interests at the expense of other shareholders.
In the light of the aforementioned review, a new investigation, The UK Family Business PLC Economy, aimed to address the following research inquiries:
- What is the role of family ownership control in the main UK equity market? and
- How do UK family-controlled PLCs perform against their peers?
Researching the UK family business PLC economy
In the light of renewed academic interest in the financial affairs of quoted family firms, the aim of the investigation is, to direct the microscope to the UK London Stock Exchange in order to understand the structure and performance of the family controlled quoted companies. The two-year study involved desktop research, surveying and interviews with family business owner-managers and other executives, and this culminated in the creation of a Family Business Index. The Family Business Index evaluates the performance of family-controlled PLCs in terms of shareholders' returns. A family business PLC is defined as a quoted company where the family controls at least 10% of its shares, has active family members on the board, and there has been succession from founder to the next generation of family owner-managers. Alternatively a quoted business could be classified as a patrimonial family business where a certain family (and its units) is the dominant shareholder.
The profile of the family business PLC economy
Out of the 673 quoted companies that are constituents of the FTSE All-Share index, only 42 companies met the criteria for the classification as a family-controlled or a patrimonial PLC. Thus, the Family Business PLC Economy represents only 6.2% of the number of FTSE quoted companies across FTSE 100, FTSE 250 and FTSE SmallCap (excluding the Fledgling sector). The total adjusted (for free float) market capitalisation of the family-controlled/patrimonial companies is approximately £60 billion and represents 3.86% of the market capitalisation of the FTSE All-Share. Distribution of the capitalisation of quoted Family Business PLCs across the FTSE categories reveals that FTSE 100 family firms account for about 84% of the market.
About 45% of family business PLCs operate in manufacturing since the sector is hospitable to more traditional and mature industrial companies. According to the age distribution analysis (based on the year of incorporation), it emerges that the family business PLCs tend to be older than their mainstream FTSE peers. It can also be argued that the family capitalism in the UK is relatively more active in traditional industries, with the new wave of family firms exhibiting less enthusiasm for flotation in the main market.
In terms of their capital structure, family business PLCs have a tendency to invest more in tangible assets and adhere more to the principles of the pecking order. They reinvest more profits; use more long-term loans and raise lower share capital.
The comparative analysis in terms of performance parameters reveals that family business PLCs exhibit a lower growth rate in terms of sales turnover and accumulation of assets but record higher profitability rates when compared to their FTSE peers.
Factors shaping superior performance of family business PLCs
In order to verify the role of family owner-managers in shaping the out-performance of family-controlled quoted companies, a qualitative research investigation was pursued. The methods used for obtaining data included structured questionnaires and semi-structured interviews, secondary sources of information such as press archives, and observations and company reports from the firms and Companies House. Executives from the following family business PLCs were interviewed and case studies have been documented:
- Associated British Foods PLC: the global food masters.
- Caledonia Investments PLC: the long-term investors in growth.
- Huntleigh Technologies PLC: the innovators.
- Town Centre Securities PLC: the builders of value.
The interviews and case study research have highlighted a number of positive attributes that family controlled PLCs have, which are summarised as follows:
- Devotion and commitment instilled from generation to generation since family wealth and heritage is linked to the family business.
- Long-term strategic horizon: they are not in the business of adventurous growth to impress opportunistic investors with short-term returns.
- Financial prudence is symptomatic of the drive to sustain financial health and autonomy; this is so as to insulate the family wealth creation from outside interferences.
- Strategic focus in the core business: the respondents had developed special capabilities to exploit exposure opportunities in their sectors.
- Stability and stewardship drawn from the dominant owning family.
- Harmonious relations with loyal investors who respect and understand the family way of governing growth and development.
- Culture of trans-generational sustainable development as they are driven by duty of responsible ownership to steer their companies across business cycles.
- Defensive: they are administering control schemes, eg trusts that will block hostile takeovers.
- Vision to keep the family at the helm of the business, as they are custodians of their heritage and guardians of their destiny.
Considering their views as to where family ownership could pose problems, a number of issues have been identified:
- Family domination coupled with the absence of a governance scheme to regulate the role of family members could lead to damaging conflict.
- The chasm between family values versus business practises that professional non-family managers promote could erode goal alignment of stakeholders.
- Nepotism that could not only jeopardise the business performance but also strain relations with outside investors.
- The failure of family to evolve, adopt open thinking and be ready for change in areas such as corporate governance, financial strategies etc.
- The expropriation of special benefits for the family at the cost of other shareholders.
- Management of 'sacred cows' syndrome: the failure of family owner-directors to decide whether to divest, or dispose of, assets which have sentimental value to the family.
The future of family controlled companies in the capital market
Despite the chronic diminishing role of UK family business PLC capitalism, evidence from this empirical study (which mirrors other findings in the US and other capital markets) suggests that the family business PLC model works and can offer value to all stakeholders.
The superior performance of family-controlled companies could offer comfort to investors who are worrying about the practice of despotic altruism, by business family dynastys continuously administering schemes to sustain family control. It is evident that their superior performance is shaped by strategic focus in serving their profitable market niches.
Family-controlled PLCs enjoy the fruits of enhanced goal alignment, as there is more agreement about the avenue and pace of growth, provided of course there is in place the optimal ownership regime and governance structure that insulate the business from dysfunctional experiences (emanating both from the family heartland and corporate landscape). The central question governing the trans-generational development of family business PLCs is, to what extent this tripartite partnership is sustainable given the seas of change which includes among other: intensified competitive arena due to new technologies, business models, globalisation trends, pressures for strategic alliances coupled with new regulations for corporations operating in capital markets.