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Family Office – Financial Performance of the Firm

For most of the 20th century, the financial performance of corporations had not been conclusively proven to be related to the presence of independent outsiders on the governing board.This held true until groundbreaking research on board composition in family-controlled firms in the S&P 500 found that companies where independent directors balanced the
influence of founding families on the board performed better and created greater shareholder value. On the other hand, firms that retained founding-family ownership and had relatively few independent directors on the board performed significantly worse than nonfamily or management-controlled firms. Return on assets was higher for family firms with greater board independence (75% with independent directors) than Financial Performance of the Firm for family firms with insider-dominated boards (25% with independent directors). This same study found that as affiliate directors (i.e., lawyers, bankers, or accountants with a preexisting relationship with the firm) assume a greater proportion of total board seats, the
performance of the family firm deteriorates. Affiliate directors do not seem to bring to board deliberations the same high level of contention, diversity of perspective, objectivity, and healthy influence that independent directors bring. Similarly, when family control of the board exceeded that of independent directors, the firm’s performance was significantly poorer, and when family control was less than that of independent directors, company performance was better.

Family-Controlled Firms Outperform Management-Controlled Firms Worldwide

  • In the U.S., family-controlled firms (which constitute 34% of the S&P 500) achieved a 6.65%
    greater annual return on assets and equity than their management-controlled counterparts (which account for the other 66% of the S&P 500) for the decade studied (1992-2001.)
  • Similar results in Business Week replication of Anderson and Reeb (1992-2001).
  • Study has now been replicated for the EU as a whole and for individual members like Germany, France, and Spain. Study more recently done in Chile, Japan and Poland. All studies are long-term studies of financial performance since they look at 5 and 10 year returns.
  • Family-controlled firms have consistently outperformed management-controlled firms. Worldwide outperformance runs between 6.65% and 16% annually in ROE terms.
  • A year after the first U.S. study, the same researchers revisited their analysis and controlled for board composition. This time, their study of board composition in family-controlled firms in the S&P 500 found that where independent directors balanced the influence of founding families on the board, companies performed better and created greater shareholder value.
  • Firms in which founding family ownership remained dominant (and relatively few independent directors served on the board) performed significantly worse than nonfamily firms.
  • The findings of this research support earlier findings that pointed to effective governance requiring both active, caring oversight by shareholders and significant influence by independent directors.

This does not mean that family directors do not also play an important value-adding role on the board. The findings of this research agree with earlier findings that pointed to effective governance requiring active, caring oversight in addition to independence. And, indeed, the value of caring control has been evident recently in the initial public offerings (IPOs) of
Google, LinkedIn and Facebook, where the founding entrepreneurs have insisted on two classes of stock, notwithstanding Wall Street’s aversion to it, in order to ensure their continued caring, and independent owner control. (Mark Zuckerberg, Facebook Inc.’s CEO, owns 28% of Facebook’s stock but controls 57% of its voting rights.)
Family-Controlled Firms Outperform Management-Controlled Firms Worldwide In the U.S., family-controlled firms (which constitute 34% of the S&P 500) achieved a 6.65% greater annual return on assets and equity than their management-controlled counterparts (which account for the other 66% of the S&P 500) for the decade studied (1992-2001.) Similar results in Business Week replication of Anderson and Reeb (1992-2001). Study has now been replicated for the EU as a whole and for individual members like Germany, France, and Spain. Study more recently done in Chile, Japan and Poland. All studies are long-term studies of financial performance since they look at 5 and 10 year returns. Family-controlled firms have consistently outperformed management-controlled firms. Worldwide outperformance runs between 6.65% and 16% annually in ROE terms. A year after the first U.S. study, the same researchers revisited their analysis and controlled for board composition. This time, their study of board composition in family-controlled firms in the S&P 500 found that where independent directors balanced the influence of founding families on the board, companies performed better and created greater shareholder value. Firms in which founding family ownership remained dominant (and relatively few independent
directors served on the board) performed significantly worse than nonfamily firms. The findings of this research support earlier findings that pointed to effective governance requiring both active, caring oversight by shareholders and significant influence by independent directors. Because of the unavailability of public records on privately held companies, studies similar to the ones just discussed have not been done on the extent to which this applies to private companies. At this
point we can only speculate that the rationale for the findings above, given the incentives present, applies to private family companies too. In fact, given that private firms receive less scrutiny (from analysts, bankers, government, and the media) we would argue that complementing family directors with independent directors plays an even more important role in the
success of these companies.

For further information please contact us directly.

Sources

Dalton, D., Daily, C., Ellstrand, A., & Johnson J. (1998). Board Composition, Leadership Structure, and Financial Performance: Meta-Analytic Reviews and Research Agenda, Strategic Management
Journal

Anderson, R. & Reeb, D. (2004). Board Composition: Balancing Family Influence in S&P 500 Firms, Administrative Science Quarterly

Anderson, R. & Reeb, D. (2003). Founding Family Ownership and Firm Performance. Journal of Finance, July 2003; Weber, et al., Business Week, November 2003

Zajac, E. & Westphal, J. (1996). Director Reputation, CEO-Board Power, and the Dynamics of Board Interlocks, Administrative Science Quarterly, 41,and Chatterjee, S. (2005).

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