Narratives revisited - professional Vs family owned businesses

The conventional wisdom on management elevates managerial capitalism as being superior to family-owned businesses. How does this narrative stack up against reality? 

This report points to a Credit Suisse study which uses its data of over 1000 publicly listed family owned companies (where family controls at least 20% of the company) finds that such businesses have performed better than non-family owned ones since 2006 by an annual average of 370 basis points.

Family-owned companies, the Credit Suisse findings suggest, tend to be more profitable. Since 2006, revenue growth generated by such companies has been over 200 bps higher than that of non-family-owned companies for both smaller and larger companies. That apart, they, on average, tend to have slightly better ESG scores than non-family-owned companies... Despite the impact on revenue growth this year, family-owned companies surveyed viewed Covid-19 as slightly less of a concern to their firm’s future prospects with 21 per cent of such companies saying the pandemic had either not had a significant impact on their business or had even been a net positive. “Family-owned companies have also resorted less to furloughing their staff than non-family-owned companies (46 per cent versus 55 per cent),” the Credit Suisse report said. Among regions, performance has been strongest for family-owned companies in Europe (470bps) and Asia (over 500bps) per annum since 2006. North America, on the other hand, family-owned companies showed a more moderate outperformance of around 260 bps per annum. The report covered 12 markets in APAC, including Japan, which continue to dominate and represent a 51 per cent share of the universe, with a total of 540 companies and a market capitalisation of over $5.56 trillion.

This post is not about making the case for family owned businesses. Instead it seeks to question some of the assumptions that have stigmatised family ownership and elevated public ownership (and the associated managerial model).

Managerial capitalism has become an article of faith administered with ideological fervour at business schools. Accordingly, the desired form of a business should be an arms length relationship between shareholders, and that public and diverse shareholders, and professional managers. Professional managers are experts, who know better than owners.

Any other form of business organisation is scorned upon, deemed undesirable, and discredited. It is therefore a commonly accepted narrative that professionally managed firms are more efficient and effective than family owned and managed businesses.

The default position is to look with suspicion at Japanese, Chinese, Korean, and Indian business management, and urge them to abandon the model of family control and had over control to professional managers.  Even the European variants of conservative and prudent management is not favourably looked upon as the American managerial variant. And when the recurrent sins of managerial businesses in the US crops up with alarming regularity, the response is to urge reform at the margins.

What is the logic behind this narrative?

The idea behind managerial capitalism is this. Owners want to maximise returns on their investments. External managers bring professional expertise and can concentrate on the long-term. Accordingly, they can mobilise and deploy resources efficiently and manage it effectively to maximise life-cycle returns to owners.

In the public markets, the owners are shareholders, and shares are traded in the market. The share prices are a proxy for the firm's performance. So what's more incentive compatible than linking executive compensation to share prices?

Problem is with the underlying assumptions, which distorts the principal-agent relationship. The dispersed and liquid nature of shareholders means managers have complete autonomy and shareholders are interested only in the short-term. To paraphrase Machiavelli, dispersed share ownership comes with "uncertain commitment of the powerless majority". In liquid public markets, the shareholders are not even interested in the company, but just the share price. And these, and the ongoing market boom is but just one example, are two different things. So managers help themselves with exorbitant salaries and bonuses, while keeping shareholders happy with engineered share price bubbles through the likes of share buybacks.

As to the long-term, in its real-world interpretation, it's only as far as you remain in a position (plus a bit more for the lock-in periods). But bubbles can be kept inflated for much longer, especially when it's in the interests of the entire establishment. Look no further than quantitative easing and the primacy of stock markets in monetary policy.

It is amply clear that this form of capitalism is broken everywhere. Its signatures abound. This is a very good critique of shareholder capitalism by Sam Long.

Consider other forms of business organisation - worker co-operatives, patriarch owned and managed businesses, smaller family owned and operated businesses, and so on. All these businesses employ professional managers, but control is with the owners. Managers execute what is decided by the owners.

There are different variants of capitalism. There are the German mittlestand's and typical continental European businesses which are both owned and managed by families. There are the East Asian conglomerates with a presiding patriarch and several subsidiaries owned and managed by children and grand children. Then there is the American shareholder and private equity variants of business ownership and management.

Look at this impressive list of East Asian family owned and controlled businesses - Hong Kong's Li Ka Shing's Cheung Kong Holdings, Macau's Stanley Ho founded STDM Group, Thailand's Charoen Popkhand (CP), Malaysia's Robert Kuok empire which owns the likes of Shangri-La hotels, Indonesia's Lippo Group founded by Mochtar Riady family and Salim Group founded by Liem Sioe Leong, Philippines' SM Group owned by the Sy clan, South Korea's Chung Ju-Yung founded Hyundai Group and Lee Byung-chul founded Samsung Group. A similar list could be made about India's own family owned businesses or continental European family businesses.

These are real businesses which played a significant role in building their respective national economies. Most of them are world-class, some global leaders in their industry, and have survived the test of time and look likely to remain so for the foreseeable future. They are the most aspirational career options for the best and the brightest in all these very globalised economies.

How many companies can claim this?

In 2019 Macau’s $30bn in annual casino revenue was five times Vegas’s. Despite a slump in turnover this year as covid-19 emptied parlours, Macau’s rise looks poised to resume. It owes much to Stanley Ho, the charming scion of an illustrious Hong Kong clan. Thanks to the monopoly gambling licence he secured from Macau’s former Portuguese administrators in 1961 and held until 2002, STDM, his family’s main holding company, grew into Asia’s largest gambling empire.

It is one thing to get a license. It takes something altogether different to then do what Stanley Ho did. Granted, he was at the right place at the right time in a small country. But, over the decades, so were many others in many other countries in other sectors, without anything remotely like this effect.

See also this story of Samsung. Countless similar stories could be listed about the continental European companies. 

This is not to say that they don't suffer from serious corporate governance problems. But then so do the public companies. Further, many of these benefited from close ties with governments and associated crony capitalism. But how is that any more repugnant than the business practices and intense lobbying that tech giants in the US do to stifle competition and maximise profits? 

In fact, the general global evidence on family owned businesses and scaling point to a strong negative correlation. The literature points to “lower risk approach to debt leverage and company growth” and “low innovation and slow adaptation” compared to non-family businesses. Further, firms with larger family ownership (say, founders with more children), a feature of Indian businesses, are associated with even smaller growth. Other studies have found that firms with greater family ownership are prone to below-potential rates of economic growth, given their internal financing resources” or that “small family businesses have a propensity to deliberately limit their growth”. Further, such businesses have lower market value as investors fear opportunism and opacity.

The point here is not that family-owned businesses are superior. Instead there is a more nuanced picture. One, managerial capitalism is broken and need to be fixed. Two, family owned businesses have achieved remarkable successes in many developing countries. Three, as a general idea of business organisation, family owned businesses are no more or no less efficient than managerial forms, and their appropriateness depends on several factors. There is nothing inherently and absolutely superior about managerial capitalism as a form of business organisation. At least the form it has assumed in our times. Four, the context, stage, and sector matters in the nature of ownership and control and its impact on business growth. And this, in turn, leads to several related questions. 

Are family owned businesses better suited to economies at certain stages of national economic development? Are family owned businesses more likely to be effective in certain sectors? Are family owned businesses better positioned to grow into large companies in developing countries, and in these contexts are large companies better served by family ownership?

The larger point is that a more nuanced interpretation of business organisation is required. At least from what is taught in US business schools and is part of mainstream management thinking. Like with all else in the world, there is no one superior form of business organisation. Each have their pros and cons.