Good Governance is Rocket Fuel for Family Firms
10th November 2015
Family firms are often praised for their long term outlook, their community mindedness and strong values. But new research shows good corporate governance could not only boost a businesses "family premium" but also the financial performance.
It is well known that family firms that trade on stock exchanges have a “family premium”. But investors are often worried about certain characteristics of family businesses, for instance that the business might not be run purely for profit, but to give jobs to members of the owning family. So good corporate governance is important for family firms to reassure investors. New research by Banca March, a family-owned bank from Spain, and academics Cristina Cruz and Lucia Garces Galdeano from Madrid’s IE business school shows that it is also extremely good for performance.
The study used corporate governance scores created by two specialist firms, CSR Hub and Asset4, which look at whether firms follow best practice in terms of their board of governors, transparency, remuneration policies, shareholder rights and so on. The researchers crunched data about over 1,000 American and European companies, a quarter family-owned and three-quarters non-family owned, that covered the period 2008-2013.
The results were that overall family firms have a lower standard of corporate governance than non-family firms. When an average is taken from all five years, on the Asset4 scale family firms scored almost 10 points lower on a scale of 10-100 (66.62 compared to 57.50), while on the CRS Hub scale they were over 5 points lower (52.06 compared with 58.52 for non-family firms).
When divided by country, the results were even more striking. Of the nations studied, German firms of both kinds performed worst, and its family firms’ scores were just half that of American non-family businesses. UK firms were the best outside America.
This highlights a theme of the report: that on several metrics European family firms were particularly poor when compared to non-family owned American ones. For the formation and composition of the board, American non-family firms scored over 80 on the Asset4 scale, while European family firms scored less than 40.
Only 16% of European family firms had a corporate governance committee, compared to 99% of non-family American firms. Just 13% of European family firms reported on the implementation of director remuneration packages, compared to 98% of non-family firms and 100% of other firms in the US. True, the very low European scores are partly down to businesses not having to do certain things that American ones are required to, but they show how far short of global best practice some family businesses fall.
Why does this matter? You might look at the table above showing that German family firms have poor governance and conclude that it doesn’t – aren’t that country’s family businesses the envy of the world? Perhaps, but overall the researchers found that those firms with good corporate governance had better returns on assets that those with less good governance – almost double in 2009.
And also that the stock market performance of the best-governed firms was three percentage points better over the five-year period of the study.
If repeated over the long-term, that 3% would compound and become very significant. This suggests that a combination of family ownership, which implies stability and long-termism, combined with good governance is a recipe for good performance. There is no reason to doubt that it would also be good for unlisted firms.
And the poor performance of family businesses on many of the governance scores suggests that there is ample room for improvement. It needn’t take long. The percentage of European family firms with a remuneration committee jumped from 62% to 82% over the five years of the study, and the percentage of women on both family and non-family firms in Europe doubled in the same period.
What both of these areas have in common is that they have been subject to government and EU regulation. Businesses hate new regulations, but it doesn’t take a fortune-teller to suspect that more rules might be on the way. Family firms, on the evidence on this report, should not complain too loudly about that. But they might be advised to make changes now, and steal a march on their rivals before the rising tide of red tape lifts all ships.