Family blockholders in European Union

My aim is to analyze how significantly the economic performance of public firms in the European Union are impacted by the presence of large blocks of family owners, namely in two key areas; how involved the family owners are in the operating decisions of the firm as well as the impact other blockholders have on the capital structure of the institution. Historically the belief has been that the majority of publically traded firms are widely held, and that the challenge was to address the agency problems between owners and shareholders that may result in loses to shareholders.

Recent studies have revealed however that there are a large number of firms traded in the marketplace that do not have widely held ownership, and generally they have only one or two large holders that are made of families, state governments or other European industrial holding companies or financial institutions. These new findings have rejuvenated analysis on the implications of family ownership of the performance of the firm, and it relationship with general shareholders. Prior research seems to infer that a firm with a majority family ownership typically faces reduced agency costs, and as a result contribute more value for their shareholders. Families with large blocks of equity in a firm are incentivized to exercise careful control on the management of the firm as they have a large portion of the their own personal wealth vested in the operations of the company, as a result all shareholders become the beneficiaries. Demsetz argued that a firms ownership structure has no impact on the value of the firm, and that organizations inherently chose a form that keeps agency costs at a minimum (Demsetz, 376). It is generally accepted that having a large shareholder present does reduce agency costs, however the benefits can be limited by the creation of other agency issues that arise. Blockholders would be more successful in their attempts to influence decisions that serve their best interests, while at the same time ignoring or even harming small shareholders of the firm, of which the withdrawal of personal funds is the biggest problem. In a sample of 39 markets, Dyck and Zingales found private benefits of control amount to, on average, 14% of equity value (Dyck & Zingales, 538). Theoretically, it's not clear which of these effects is most prevalent, the increased monitoring of firm managers that results in common points of interest for both owners and managers is viewed positively, where as the withdrawal of funds can be detrimental to smaller shareholders.

Isakov addressed this question using information that he compiled for companies listed on the Swiss stock exchange between 2003 and 2007, his findings support the argument of higher performance of majority family owned companies as opposed to non-family firms in terms of both market and balance sheet performance. Profitability was the highest for families holding 20 to 50% of their company (Isakov, 4). Family firms not only outperformed non-family firms in general, but they also drew favorable comparisons against firms with other ownership structures. Analysis showed that not every family owned firm created equal value, only those companies where a family member was actively involved in the day to day management of the operations of the firm created value, especially those acting as executive managers (Isakov, 6) In addition the existence of additional family shareholders possessing a position of between 5 and 10% of voting rights increased market valuation and profitability.

There have been a number of studies on the performance of family-owned firms and studies on the structure of ownership and agency issues when a large shareholder is present in the organization the first such studies were completed for firms in the United States and Canadian equities markets. D.L. McConaughy in Canada and Ronald Anderson & David Reeb for the S&P 500 in the United States deduced that firms whom were majority family owned outperform their non-family counterparts, especially in the United States when a founding family member was retained as CEO the firm was more profitable. (Anderson & Reeb, 1305) From these studies, it would appear that active management by the family, especially a founding member, is an important factor for the firm needed to create value and increase profits. Villalonga and Amit expanded on the original studies in 2006, researching Fortune 500 firms in an effort to further the analysis of Anderson & Reeb to see if different results could be obtained, choosing to focus on characteristics of the family owned firm and their impact on performance. They found that when an founding member is a acting as a CEO or other Executive Manager they performed far better than when the firm was under the administration of a descendant. A variety of ownership and controls like pyramid structures, dual class shares, and cross-holdings had a negative impact on the performance of the firm as well (Villalonga & Amit, 390). In contrast to the research of Anderson & Reeb it exhibited that it was incorrect to assume that all family owned firms out perform non-family run entities. Also the findings of F. Perez-Gonzalez in his 2006 study show evidence that hereditary control has negative implications on firm valuation as well as profitability, which may lead investors to believe the management of the firm is entrenched since an outside CEO was not hired.

In Europe, there were two cross-country studies, one by Barontini & Caprio (2006), the other by Maury (2006) that observed family firms in an effort to determine if they had higher market valuations as calculated via Tobin's Q and higher profitability. Barontini & Caprio found similarities in their studies to those conducted by Villalonga & Amit, confirming that firms with a family-founder CEO outperformed other firms, however their findings on firms owned by decendants differed from what was found in the US study. In Europe if the descendant took a position as a non-executive manager, the firm outperforms others and if they did become CEO they performed at a level equal to other non-family owned firms (Barontini & Caprio, 714). Maury contradicts, saying that involved management on the poart of the famil y only increases profitability, and has no real impact on firm value, saying instead that ownership and the lvel of controls drive the Market and accounting performance of the firm, suggesting that the benefits of family ownership begin to fade as the amount of control increase. Tobin's Q is at its highest for firms where the family exercises low levels of control, which may be an indicator that the family frequently extracts benefits from the firm, and may have significant power (Maury, 332). The firms profits, on the contrary, increase with the level of control the family has, showing that management by the family improves efficiency, but that small shareholders can't profit from it.

Research performed in individual European nations show the same results, with family-owned firms outperforming the competition. In their study of family owned firms listed on the French Exchange Sraer & Thesmar found that family owned operations out performed widely held firms regardless of the founder, a descendant of the founder, or an outsider running the firm (Sraer & Thesmar, 723). In addition Sraer & Thesmar found that most of the performance experienced by a family owned-managed firms can be explained by management links with the pool of laborers, wage controls, and productivity (Sraer & Thesmar, 741). In contrary, in his studies of firms listed on the Italian exchange, Favero found evidence to suggest that the performance of family owned firms in the marker were no different from other companies, and that prior findings were largely the result of incorrect measurements being used (Favero, 5). Consistent with the findings of Sraer & Thesmar, Christian Andres found that the performance of firms listed on the German exchange increased relative to others when the firm was managed by a founding member of the family (Andres, 435). The analysis of family-owned firms would then indicate that there is a reduction in the value of a firm where the family takes no position of ownership or control that allows for increase profitability, and benefit extaction, and the presence of a second blockholder could reduce this effect so long as they are not a family member. This infers that when there is two families, or two large holders from the same family in a firm it destroys more value than it creates, where as the presence of a non-family member prevents the extraction of value.

Firms that are family owned and run exhibit a higher return on assets, using both EBIT and EBITDA in the numerator of the equation, this was used as a measure to show their superior accounting performance. The Family owned firms however do not exhibit a statistically significant outperformance in the measure of market performance, Tobin's Q. To enhance their control, 38% percent of family owned firms employee multiple share classes, compared to only 6% of non-family owned firms, suggesting the family's make diligent efforts to preserve their control of the company. In the last 20 years a good number of firms on the exchange in Geneva that employee multiple classes has decreased, showing an increased inclination to move toward the one share equals one vote model (Kunz, 34). Family firms have also exhibited less investment activity, and take on less debt on their balance sheet, this is consistent with the studies of family firms in the United States by Anderson & Reeb and Villalong & Amit, but in contrast to the US firms the European firms share prices are far less volatile. This supports the logic that the family run firms have a more long term outlook which stabilizes their equity issues over those firms with far shorter horizons. Both classes of firms, family owned and non-family owned, average an age of 71 and 64 years respectively, so they can both be considered established.

The Return on Assets measure of accounting performance in both of its forms indicates strongly that family firms outperformed non-family entities. When the family has a stake of more than 50%, those firms outperform the family owned firms where the stake is only 20-50%. Tobin's Q, however, is far lower for firms where a family member is the majority shareholder. This would indicate that in a company that is family owned and managed the family has total control, and can work more profitably, however investors favor firms where the family does not hold the majority of the voting rights for the stock

This analysis suggests that firms owned by families outperform the non-family companies, however it is not clear if the family owned firms outperform all others disregarding their ownership structure, or if the widely-held companies underperform all companies that are held in significance by one or a few block holders. To examine this question a study was performed that dissected the data of non-family firms into categories of widely-held government owned, widely held corporation, and miscellaneous; for the firms held by families a threshold of 20% of ownership was used. The study suggests that the type of ownership has a different effect on the performance of the firm. In the markets, family owned firms were valued the highest, and the other results on other types of blockholders had an insignificant impact. The performance of firms in terms of Return on Equity (EBIT) shows that while the family owned firms were the best performers, the could not differentiate themselves from widely held firms at a level that was statistically significant, the same holds true for Return on Assets (EBITDA). Companies that are government owned and operated where also shown to operate quite efficiently, but Isakov indicates that this could be the result of bias due to a smaller sample size (Isakov, 18). It's also a possibility that the depreciation and amoritization on the financial of a government run company take a different form, changing the results so that only Return on Assets (EBITDA) would yield the difference.

These findings stand in contrast to those witnessed in the German markets in the study by Christian Andres, he found evidence that the family owned firms outperformed widely held companies in terms of both market and accounting performance. He also found that the other blockholder types underperformed with regard to accounting performance, but not in terms of market valuation.

Prior finding on the performance of family owned firms indicates that it would be incorrect to evaluate these firms with out seeking further differentiation, as the performance may be dependent upon other factors, such as the involvement of the family member in the management of the firm. Villalonga & Amit found conducted a study that looked in to the the position a family member takes with a firm. What they found was that in firms where a family member that was a founder operated as a Chief Executive Officer performed far better, versus firms with a CEO that is a descendant of the founder underperformed compared to widely held firms (Villalong & Amit, 397). They also found firms in the descendant stage only perform well if the descendants do not take an active role in the management of the firm. Contrary to this, Favero found that the founding mem ber of the firm only outperform other market participants when market performance measures were used, where as descendants performed at their best when accounting performance was analyzed (Favero, ), the finding of Sraer & Thesmar also suggest that descendant CEO's do not perform any worse than founder CEO's (Sraer & Thesmar, 729).

In the case where none of the family members are actively involved in the management of the firm, the poorest results are yielded. It would appear that simply holding the shares of the company does not offer any sufficient reason as to the performance of the firm, and the the family must participate in managing the company in some capacity (Isakov, 18). The investors favor a founder CEO over a descendant CEO, but both significantly outperform widely held firms. In terms of accounting performance those firms with descendents on the management team are significantly more profitable than widely-held firms, and founders only yield higher profitability when Return on Assets (EBITDA) is used. It becomes apparent that there is some value to be derived from the knowledge of the family when it comes to running the company, this may be attributed to superior skill or the added incentive to enhance the value of the firm beyond the gains of reduced agency costs between shareholders and management that result from their large holding. The analysis of the Chief Executive Officer position indicates that outsider hires for the position do not exhibit higher performance than that of a widely held firm. The investors seem to value not only the founder, but their descendants as well when it comes to this position. with better overall performance for founder CEO's and superior profitability for descendant CEO's.

In the research discussed the results would suggest that family ownership does in fact add value to a firm by reducing the agency costs that are typically associated with the management of the firm and the shareholders. It was not determined however if the agency problem between family blockholders and minority shareholders are present. The possibility of their existence is clouded because it is possible that the reduction of the management-shareholder costs offset them. To reduce this uncertainty one can turn their attention to the secondary blockholders of the firm, as they are able to reduce the ability of the largest blockholders to extract their benefits from the firm. The largest, family blockholders can extract funds from the company at any time if they have a large enough share, which would raise the agency costs between the large blockholders and secondary shareholders. In an effort to reduce this problem a company can have a second large blockholder that is not a family member to counter some of the family's power to extract from the resources of the firm.

There is evidence that the performance of a family-owned firm can be improved by the presence of another non-family blockholder, so long as the size of their ownership is significant enough to counter the family position, but not so large that it could result in a power struggle. Research shows that family run companies that do not have a secondary blockholder with at least a 5%, or that have a second blockholder with more than a 30% equity position in the firm do not perform any better than non-family firms. The optimal range for the secondary ownership percentage is somewhere between 5 and 10%, this allows for significant control of the the family's share, without the ability to block every decision. With this structure both the accounting performance and the performance of the firms equity shares outperform those of non-family firms.

Unlike the United States, many of the firms in the developed nations of the European Union are not widely held, and have an ownership structure that likely includes the presence of a family member in a blockholders position. Due to this unique structure additional analysis of these firms is needed as the structure may change many generally accepted financial norms and agency issues. Since they are able to reduce the number of agency problems by decreasing the amount of conflict between the managers of the firm and shareholders, the corporate governance rules also need to be looked at, as they may be different; we also have to be cognizant of the fact that this also presents the possibility for agency problems between the blockholders and minotiy shareholders to emerge. When bockholders exercise their right to extract private benefits from the firm they can dilute the value of the organization, even though research indicates that family owned firms create more value and are mor profitable than other non-family owned companies, it does not guarantee that they will act in the interests of the minority shareholders. There is however a chance that the reduction in agency costs reaped from the family ownership will offset any extraction of their equity from the value of the firm itself, and the presence of a second large blockholder that is not a family member can also help with this.

The Swiss market, as studied by Isakov, took a detailed look at the dichotomy of effects the presence of family has on the firm, it's consistent with most other Western European equities markets where a family member is a blockholder 52% of the time. Isakov found that the family firms did more to create value, and were more profitable than the non-family firms. The same results were also witnessed when family run companies were compared to firms that are not widely held but have a large blockholder that is not a family member. It's of equal importance if a family member is an active Executive Manager, but it would seem as if the family members running these companies have some superior knowledge on how the company operates and how it should be run, and this knowledge is not only privy to the founder, but to their heirs that actively manage the firm as well. There is also evidence presented that additional blockholders that obtain values in the range of 5 to 10% of the voting shares is even more beneficial and leverages the performance of the firm, as outside participants see value in a third party having some control over the family. It fully plausible that the identity of the second blockholder can have an influence on the outcome of the firms performance, just as much as firms being run by the founding family, but that's another study all in it self, as it would also be possible that in some incidents the second large blockholder may align with the largest holder, and could further the plight of minority shareholders.

Works Cited

  1. Anderson, Ronald C., David M. Reeb, 2003, Founding-Family Ownership and Firm Performance: Evidence from the S&P 500, Journal of Finance, 58, 1301-1327.
  2. Andres, Christian, 2008, Large shareholders and firm performance-An empirical examination of founding-family ownership, Journal of Corporate Finance, 14, 431-445.
  3. Demsetz, H., 1983, The Structure of Ownership and the Theory of the Firm, Journal of Law and Economics, 26, 375-390.
  4. Dyck, A., L. Zingales, 2004, Private Benefits of Control: An International Comparison, Journal of Finance, 59, 537-600.
  5. Favero, Carlo A., Stefano W. Giglio, Maddalena Honorati, Fausto Panunzi, 2006, The Performance of Italian Family Firms, CEPR Working Paper.
  6. Isakov
  7. Maury, B., 2006, Family ownership and firm performance: Empirical evidence from Western European corporations, Journal of Corporate Finance, 12, 321-341.
  8. McConaughy, D. L., M. C. Walker, G. V. Henderson, C. S. Mishra, 1998, Founding Family Controlled Firms: Efficiency and Value, Review of Financial Economics, 7, 1-19.
  9. Pérez-González, F., 2006, Inherited Control and Firm Performance, American Economic Review, 96, 1559-1588.
  10. Sraer, David, David Thesmar, 2007, Performance and Behavior of Family Firms: Evidence from the French Stock Market, Journal of the European Economic Association, 5, 709-751.
  11. Villalonga, B., R. Amit, 2006, How do family ownership, control and management affect firm value?, Journal of Financial Economics, 80, 385-417

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