The Credit Suisse Family Index, a composite index based on an universe of 172 large US and European family companies, has regularly outperformed other major global indices like MSCI, S & P 500, etc. There are, in fact, various surveys conducted from time to time which generally conclude that family managed companies perform better than non-family managed companies. In the Indian context, an Economic Times analysis published in their issue dated September 22, 2006, avers that there is no clear difference in the performance of family and non-family companies. Yet, public debates in the recent years have mostly depicted the former in a very poor light. This article attempts to examine whether family companies are indeed the villains of the corporate world.
All data, analysis and arguments put forth in this article are in the context of listed companies alone for obvious reasons. Secondly, non-family company’s universe would include Government-owned companies which face certain challenges unique to them, but are not discussed in this article.
We now look deeply into the many pros and cons of family companies versus non-family companies normally tendered in any discussion on this subject. These can be grouped broadly under five categories and then objectively assessed. These five categories are as follows.
A. Family wealth versus Company wealth
By far the largest number of arguments against family companies is that they have poor standards of corporate governance. Many lay persons carry the impression that owner families tend to treat family wealth and company wealth as fungible. Memories are fresh of robber barons who in the past have expropriated a disproportionate wealth from public companies under their control.
Good governance is, without any doubt, a fundamental attribute of a ‘good company’. However, on the other hand, one cannot just assume that a non-family company would have passed the governance test automatically. The latter, if controlled by self-serving professionals, could be as bad. There is enough evidence to bear this fact.
Hence, at the end of the day, a robust regulatory environment and an active set of independent board members can alone ensure similar standards of governance in either class of companies.
B. Control versus Ownership
The second issue is that families exert control over their companies far in excess of their economic interests. Though it appears serious on the face of it, we think it is a non-issue for three reasons.
(i) At the end of the day, whether professionals or families, there has to be a single point of control over the affairs of the company. Without this, the company will not pull in one direction. As long as the governance issues are reasonably addressed, it does not matter the percentage holding of the controlling entity.
(ii) In India, in fact, there is a tendency of the family to keep its holding as high as possible. Data shows that during the last decade many of India’s top families have increased their stake in their leading companies. (ET dated 20th June, 2011).
(iii) And, finally, the market now has a takeover code that would dissuade families to mismanage their companies whilst having a small stake.
The above two categories cover most of the issues that are listed as negatives of family companies. These were, in fact, very significant negatives of such companies in the past. It is our case that in the current environment they are not necessarily applicable to only one class of companies. On the other hand, the next three categories of arguments definitely favour family companies.
C. Entrepreneurship versus Professionalism
Even the strongest critic of family companies cannot deny that (i) entrepreneurship is the sine quo non of a commercial venture, and (ii) this quality is to be generally found with families who risk their wealth. Yes, professionals are likely to be better qualified on the average (though lately the gap is narrowing) and bring more scientific rigour to the decision-making process. But they sometimes fall prey to what is crudely termed ‘paralysis from analysis’ syndrome.
Finally, key decisions, are driven by a combination of intuition and entrepreneurial dreams. Family companies will certainly score better on this front.
Another point that finds mention is that non-family companies have elaborate systems and processes unlike in family companies. Well this is not entirely true. Family companies also have systems but they are more informal and centred around the promoter. (This issue becomes serious when more members of newer generations come on board and each wants his/her own informal system.)
D. Long-term versus Short-term Families, especially in Asia, tend to create and build for their progeny. Therefore, they tend to take a very long-term view of all value-creating propositions. On the other hand, professionals do not have any incentive to look beyond their own tenure. In addition, it is felt that performance-based remuneration militates against taking a long-term view. Interestingly there are reports that the tenure of a professional CEO is becoming shorter and shorter. In short, the family companies are more likely to work towards long-term goals.
E. Personal reputation versus Company reputation
And, lastly, the family equates its own reputation with that of the companies it manages. Nonperformance of one impacts adversely the family’s ability to tap the capital markets for fresh funds. So much so, one very often comes across a family placing its private wealth and personal guarantee as collateral to help out a listed company during financial difficulties. It is very unlikely that a professional director would pledge his personal reputation, let alone his wealth, to bail out the company which he manages.
Based on the above discussions we now face a conundrum. Empirical studies indicate that family companies perform as well as non-family ones, if not better. The dissertation of the anatomy of both these classes of companies lead to a conclusion that family companies are more likely to create long-term value for all stakeholders. Yet, popular opinion is almost against the former as a preferred model for managing companies. What is the reason for the disconnect between facts and perception ?
The reasons lie partly in history and partly in definitions.
Historically, as stated earlier, because of a weak regulatory framework, there have been many instances of corporate misdeeds. But more important, different sectors/companies in an economy do become uncompetitive and slowly decay or disappear. This is economics at work. Sometimes changes in government policy, labour laws, etc. have adverse consequences. Unfortunately, failures arising out of such developments tended to be family companies as there were hardly any professionally managed Indian companies in the early days of Indian corporate history. Therefore, public memory tends to associate corporate failures with family managements.
A more rational reason may be found in the way people, subconsciously, define ‘family’ and ‘professional’. Let us take, as an example, a venture started by a bright IIT engineer with no history of business behind him. After nurturing the business successfully for, say, five years he floats the company through a listing. Even as a listed company, he will continue to hold a stake and will control the company for many more years. But, in popular perception, this company will be bracketed as a professional company and will command relatively higher valuation. On the other hand, the perception of a similar venture started by an old-economy family company would be quite different even if that venture were to employ equally bright IIT engineers as employees.
This leads us to believe that the markets are not averse to ‘family’ per se. What it is saying is that so long as the Board/Management team exhibits entrepreneurial energy, sound domain knowledge and unitary control, it is does not matter if the promoter/family runs it. In the second example we gave above, whilst the promoting family may still be good entrepreneurs, the board would typically have members of the extended family with little domain knowledge. Hence the poor treatment by the market.
To put it differently the markets are, perhaps, saying that they prefer a family company as long as the founding family member is still firmly in control. But with the passage of time the family members grow in number, control gets diffused and domain knowledge diluted. Therefore, as the company moves from generation to generation, the role of professionals in the decision-making process should increase exponentially for this company to enjoy higher valuation.
Long ago, a popular topic for school debates used to be: Which is more important — Art or Science. Whilst all argued their respective cases vociferously, the moderator always used to sum it up by saying that both are important for the well-being of the human race. In the similar vein, both family and non-family companies have important roles to play depending at what stage of the evolution the company is in.
