Family Run Companies. Joseph A. McCahery SME and Family Business. 14 August 2009

Transcription

1 Finance and Governance of Family Run Companies Joseph A. McCahery SME and Family Business Conference 14 August 2009

2 The Presentation: 3 Steps Family characteristics ti can have a direct impact on firm performance: what factors are crucial? Families typically rely on control enhancing mechanisms to retain control over the firm: should some CEMs be eliminated due to their effect on shareholders? The absence of a suitable family successor may lead to an exit by the family: Do MBOs provide family owners with better performance opportunities?

3 Step 1 Family control provides benefits: families may provide intensive monitoring of management that attempt to appropriate corporate resources (Type I agency conflict) Family priorities may conflict with the objectives of outside investors (Type II agency problem) Economic evidence show that family firms in Asia suffer from significant Type II agency conflicts But, the evidence for US family firms shows they exhibit higher earnings quality relative to non- family firms, incur lower costs of debt, and command a valuation premium What accounts for the differences ultimately?

4 Corporate Governance Debate: Non-Listed Closely Held Family Company Financiali Participation i rights / rights managerial control rights Delegate Shareholders Directors/Managers Control

5 Corporate Governance Debate: Non-Listed Closely Held Family Company the role of CG: aligning Interests Shareholders Delegate Directors/Managers Control

6 Corporate Governance Debate Listed Family firm with Dispersed Ownership Shareholders Delegate Directors/Managers Align Interests / Monitoring Internal Corporate Governance Mechanisms: -Non-executive managers -Fiduciary i duties: Duty of care / Duty of loyaltylt -Executive pay -Disclosure and Transparency -Internal and external audit process

7 Does Family-Ownership Matter? Family Managers Family Business Listed: Founder can reduce agency problems Low Informatio on As symmetries Family Shareholders Ownership Information Asymmetries Other Shareholders In Listed Companies and Non- Listed Companies: in next generations agency problems could reduce firm value Empirical studies suggest that private equity should buy-out badly run family firms

8 Variation in Family Firm Problem: Performance How do we distinguish between those family firms that have higher agency problems? Firms with CEOs that resist replacement after poor firm performance may help to identify these firms By separating family firms run by a founding member and those run by professional CEO, it may be easier to determine the severity of the agency problems in the firm

9 What Explains Higher Firm Value in the US? The critical characteristic is not the particular legal standard but the CEO retention decision Good rule of thumb: the agency problems family firms face depend on the firm type Examples: Professional CEO family firm (valuation premium) Family CEO firms (no valuation premium) Non-family firms.

10 What about European Family Firms? Research attempts t to isolate causal effect of family CEOs on firm performance (Bennedsen et al 2007) Studies look at the variation in CEO succession decisions that result from the gender of a departing CEO s first born child as an instrumental variable The results are striking: Family characteristics have economically large effects on decision to promote a family or unrelated CEO Male first-child firms are 32.7% more likely to appoint a family CEO than female first-child firms Family CEOs have strongly negative impact on performance

11 Summary Family control can have both positive and negative properties Segments of the literature show that founder-ceos have positive effect on firm performance (Villalonga and Amit 2004) As we saw in Step 1, the critical event for firm is the retirement of the founder, coupled with passing the reigns to an heir, which leads to a decline in performance of the firm The evidence shows furthermore that family control has positive associations in the US, but exhibits weaknesses when descendants are involved in top management

12 Step 2 Founders and their families when their equity position declines typically rely on control enhancing measures (CEMs) to exercise substantial control over the firm Wedge between families control rights and cashflow rights is prevalent among large family firms in US, East Asia and Western European countries What is the impact of CEMs on firm value? Current focus in on the type of mechanism used

13 Family-run firms predominate in OECD economies Proportion of OECD Firms That are Family-Run Percent Italy 99 US Sweden EU Spain UK Source: Nancy Upton and William Petty, Venture Capital Investment in Family Business, Venture Capital, 2000, Vol. 2, No. 1, pp

14 Votes Controlled by Families Percentage of votes controlled provides measure similar to those used in studies of ultimate ownership (LaPorta 1999; Claessens et al 2000; Facio and Lang 2002) On average, families own 15.3% of their firms equity and 18.8% of the votes. Non-family blockholders on average own a slightly higher percentage of family firms equity than families themselves (16.2%), yet the voting rights associated are substantially lower (13.2%) Share ownership by large blockholders is larger in non-family firms (22.1%) as one would expect

15 How are family firms controlled in US? Dual class shares, voting agreements and pyramids are most common forms in US What is the impact of control enhancing mechanisms on firm value in US? Result differs across CEMs: 1) dual class has negative impact on value (but not for second and later generation firms) 2) pyramids and voting agreements have a positive effect on value (legitimate business explanations) Villalonga and Amit (2006) 3) family control is frequently enhanced through board representation in excess of voting control and through presence of family CEO

16 What About Family firms in Europe? Wide range of CEMS employed in Europe Dual class shares, voting agreements and pyramids are the primary source of the wedge in Europe Italian research shows that control enhancing devices have positive and significant effect on performance Rationale: more profitable firms may be willing to Rationale: more profitable firms may be willing to block possibility of a change in control (Favero et al 2006)

17 Summary: Should we Constrain the Use of CEMs? In US, excess control that t families obtain above equity stake through dual class and disproportional representation comes at a cost of reduced firm value Thus, since it hard to measure the corresponding benefits that families gain from controlling firm as well as not being invested in companies equity, its difficult to measure the net effect of families employing these measures On the other hand, there appears to be additional benefits from firms using these mechanisms, particularly in the US and Europe

18 Step 3 Succession represents the biggest challenge to family run firms We are all familiar with the studies that show that only one in six family firms survives to the third generation One in eight survive to the fourth generation Clearly succession can also mean selling the firm Despite resistance by some family members to sell, the owner s aim should be to maximize family welfare Poor governance may block succession by encouraging an insiders culture reducing firm value

19 Fig. 1: Reasons for the Sale of the Business No suitable successor No successor available Approach by interm ediary/advisor Approach by non-family management Need additional capital for growth Poor growth prospects Death of illness of the CEO Cash Flow problems Lack of profitability Liquidation Score Source: CMBOR/EVCA

20 Fig. 2: Succession Options Considered Sale to private equity com pany Sale to existing management w ith private equity Engage advisor to sell business Sale to/merger w ith another company Sale to external management with private equity Employ new management but retain ownership/control Sale to external management without private equity Sale to existing management w ithout t private equity Pass business on to next generation Source: CMBOR/EVCA Score

21 Equity to the Succession of Family Businesses In Europe Source: EVCA 2005)

22 Succession Option Transferring the business to another family member When a suitable family successor is not available. There are three other possibilities: Sale to internal or external management Sale to internal or external management (management buy-out/in) Trade sale (sale to another firm) Listing on a stock exchange

23 Dynamics Associated with Buyout Decision of Family Members Ownership transfer process is opportunity to align family and business interests Evidence from US suggests 2/3 of family firms fail to carry out intergenerational succession planning Dynamics associated with buyout: loss of independent identity, absence of qualified 2 nd tier to run business, approach by intermediary

24 Buyouts of Family Firms Business performance is associated with the outcome Non-executive director associated with positive outcomes Family owners can rearrange wealth portfolio and maintain involvement Average 8.9% post-mbo Professionalization increases post MBO/I Re-emergence of family culture post-professionalization Recognition of positive aspects of family Negative family culture removed

25 How Family Firms Keep Locusts at Bay Type II Concentrated Family Ownership Type I Non-listed or listed family firms with a controlling family stake, but no family management Non-listed family firms with family- management / Listed family firms with a controlling family stake and family-management No Family Management Family Management Non-listed or listed family firms with control-enhancing mechanisms, but no familymanagement Type IV Non-listed or listed family firms with control-enhancing mechanisms and familymanagement Type III Diluted Family Ownership

26 Pi Private Equity and dpublic Good Average Annual Employment Growth Source: EVCA/CEFS 2005 ( ) Source: Global Insight/NVCA 2004 ( ) Source: BVCA/IE Consulting 2005 ( ) Source: Finance/DBAG 2004 ( )

27 The Private Equity-Family Firm Partnership Exit Strategies Building Trust Establish/Maintain Relationship Boundaries Know Your Partner

28 Partner Selection Family Repayment of loans and profit distributions (80%) Investors (Limited Partners) Capital/loans Management Fee Manager Limited Partnership General Partner Carried Interest (20% profits) An effective family governance structure Strong interface with the private equity partner Company Experience with family firms Smaller fund size Fund s investors

29 Investment t Design Family Shareholders Repayment of loans and profit distributions (80%) Investors (Limited Partners) Capital/loans Limited Partnership Management Fee General Partner Manager Carried Interest (20% profits) Company Ownership and Control Board Seats

30 A Case Study: Dirickx Groupe - 3i Minority Stake: Buy-out family members Acquisition program The deal has enabled my family to successfully secure a portion of its assets while allowing Dirickx to remain independent and accelerate its international development. 3i brings a global network of contacts and its strategic vision to our company

31 The Formula Financial Capital Symbolic Capital Emotional Capital Family Managers Family Business Trust, Commitment, Long term view Low Informa ation Asymmetr ries Ownership Financial Capital Value-added Services Family Shareholders Low Information Asymmetries Identifiable Shareholders

32 Empirical Work: Scholes et al 2007 Alternatives to succession within the family If a family successor is not available or willing, sale to a private equity firm and/or incumbent management is most popular alternative. Ownership When solely family are in control of the firm prior to the buy- out/in, there is significant scope for growth and expansion. Governance NEDs appear to have a beneficial effect on company strategy as strategic t change is less when they have been present. Should a venture capitalist be involved in the succession process, the most likely outcome is a drive towards efficiency improvements. Debt Debt levels have little effect on strategic direction post buyout/in.

33 Summary Family CEOs underperform firms with professional managers as CEOs While most family firms rely on control enhancing mechanisms to retain control over the firm, it is hard to measure the net effects of firms using these mechanisms Buyouts offer family members a means to align market and family interests and, if structured optimally, a mechanism to retain involvement while potentially enhancing firm profitabiltiy